The Formula For The Trade Balance Is Backwards

By Scott Albright

You probably remember these lines from President Donald Trump starting about 19 months ago when he announced his running for the oval office:

“I’m gonna build a waaaall, I’m gonna be tough on Chiy-na”

(in his own idiosyncratic annunciations LOL).

To think that these lines along with the famous (or infamous, depending on whether you love or hate The Donald) “Make America Great Again” campaign logo could heavily aid in catapulting an unprecedented outsider to the White House is dumbfounding, to say the least. President Trump certainly is no fan of free trade although he may say otherwise. But as many Americans that voted for him may believe we have an unsustainable problem with trade deficits, how consistently do they apply this logic to their own individual trading and consumption patterns? If you buy your groceries at Wal-Mart and don’t grow any of the produce you eat or raise and eat livestock, you run a 100% trade deficit with your consumption of food. If you buy your own clothing at a department store and don’t sew or knit any of it, the same is true in this category of your consumer goods as well.

When President Trump says that we are going to build and buy American concerning labor and parts, just imagine if he used this same logic and took it to it’s conclusion and said “You, as American (individuals and households), are going to produce everything you consume.” Do you think that he would have attained over 61 million votes had he campaigned on this? Now my point here is to show the logical fallacy of his protectionism, although he certainly isn’t demanding we attempt such an impoverishing feat as individuals and households. But it does show the direction that you are going in.

A sobering reminder of the fallacies of trade deficits and protectionism comes from Murray Rothbard’s Man, Economy and State:

“It should be clear that the principles applying to the balance of payment of the United States are the same for one region of the country, for one state, for one city, for one block, one house, or one person. Obviously no person or group can suffer only because of an “unfavorable” balance; he or the group can suffer only because of a low level of income or assets.”[1]

Using scorecards within boundaries created by artificial lines in the sand only diverts attention away from what is arguably one of the best indicators of growing prosperity: Ability to import more of what one consumes. Imports amount to a saving on labor that comes as a result of a growing division of labor in society fueled by capital investment which enhances productive capacity and output, both in the aggregate and output per worker.

Another common claim you hear today by many protectionists is “manufacturing is down” and that “we should bring it back stateside and repatriate our profits.” Well, if you believe that labor is the source of all wealth and/or that job losses are inherently bad, then you may be right but wealth is measured in output, not inputs such as labor hours. According to Jeffrey Schott of the Peterson Institute for International Economics, “In the 1960s, exports and imports represented less than 10 percent of U.S. gross domestic product; today the share is closer to 30 percent. As a result, American exporters sell more U.S. goods abroad than ever before — and imports give American consumers more choices at lower prices. Americans have higher living standards because trade enables them to afford more goods.” [2] This speaks volumes to our growth in the innovative capital structure which has exponentially enhanced our output and therefore, our ability to import. We could not import with the level of trade deficits that we have if we were not productive enough in that which we produce for export. Imports and exports are really two sides of the same coin and we shouldn’t see trade deficits as detrimental to our economy, nothing could be further from the truth.

Frederic Bastiat

If there was ever any economist who championed both free trade and was willing to contest the theory of the balance of trade in a very logically consistent and iconoclastic manner, it was certainly Frederic Bastiat. In his book Economic Sophisms, he contended that we should reverse the formula itself from EX-IM=trade balance to IM-EX=trade balance.

“The truth is that we should reverse the principle of the balance of trade and calculate the national profit from foreign trade in terms of excess of imports over exports. This excess, minus expenses, constitutes the real profit. But this theory, which is the correct one, leads directly to the principle of free trade. I present this theory to you, gentlemen, just as I do all the others that have been the subjects of the preceding chapters. Exaggerate it as much as you wish; it has nothing to fear from the test. Assume, if it amuses you, that foreigners flood our shores with all kinds of useful goods, without asking anything from us; even if our imports are infinite and our exports nothing, I defy you to prove to me that we should be the poorer for it.” [3]

 

As counterintuitive as this sounds, once you consider the logical ramifications of the traditional formula, EX-IM, implicit here is that you can produce everything that you consume (maximize EX, import nothing, for example). Such a scenario would be a state of economic isolation and would be impoverishing. At the national level, it could mean that you could cut off all trade and shrink your division of labor to that which is solely in the United States. The chart below, courtesy of the U.S. Census Bureau, would seem to prove Bastiat correct.

Figure 1: U.S. Trade Deficit Vs. GDP (1980-2007)
Year Trade Deficit GDP Year Trade Deficit GDP
1980 -19,407 5,161.7 1994 -98,493 7,835.5
1981 -16,172 5,291.7 1995 -96,384 8,031.7
1982 -24,156 5,189.3 1996 -104,065 8,328.9
1983 -57,767 5,423.8 1997 -108,273 8,703.5
1984 -109,072 5,813.6 1998 -166,140 9,066.9
1985 -121,880 6,053.7 1999 -265,090 9,470.3
1986 -138,538 6,263.6 2000 -379,835 9,817.0
1987 -151,684 6,475.1 2001 -365,126 9,890.7
1988 -114,566 6,742.7 2002 -423,725 10,048.8
1989 -93,141 6,981.4 2003 -496,915 10,301.0
1990 -80,864 7,112.5 2004 -607,730 10,675.8
1991 -31,135 7,100.5 2005 -711,567 11,003.4
1992 -39,212 7,336.6 2006 -753,283 11,319.4
1993 -70,311 7,532.7 2007 -700,258 11,566.8
Source: U.S. Census Bureau. Trade deficit figure in millions of dollars. GDP given in billions of chained (2000) dollars. [4]

As communities of people grow, the division of labor becomes more diverse and they can start producing what they have a comparative advantage in and import that which they are relatively less skilled at doing and/or that which would not yield them ideal returns on labor and capital. This is why wealthier societies can afford to import more. I would contend that once you consider the effects of labor saving innovation on freeing up our time and energies so that we can do that which increases our wealth even further (designing and building newer, more innovative capital such as labor saving robots) and allows us to specialize even more in ventures that we have comparative advantages in and also to increase our imports, I don’t see how Bastiat could be proved wrong. Being able to import more is a sure sign of increasing wealth just like increasing output per worker is.

 


[1] Rothbard, Murray N., “Man, Economy, and State” (1962), Nash Publishing, p. 720.

[2] Schott, Jeffrey J., “Are Trade Agreements Good for Americans”, The Opinion Pages Room for Debate, The New York Times, March 17, 2016.

[3] Bastiat, Frederic, Economic Sophisms, 1996 (5th edition), The Foundation for Economic Education, pp. 54-55.

[4] Schmidt, Michael, “In Praise of Trade Deficits,” Investopedia.

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