Question

Show graphically how an increase in US government spending affects the US trade deficit.

Answer 1

A trade deficit occurs when a nation imports more than it exports. For instance, in 2018 the United States exported $2.500 trillion in goods and services while it imported $3.121 trillion, leaving a trade deficit of $621 billion. Services, such as tourism, intellectual property, and finance, make up roughly one-third of exports, while major goods exported include aircraft, medical equipment, refined petroleum, and agricultural commodities. Meanwhile, imports are dominated by capital goods, such as computers and telecom equipment; consumer goods, such as apparel, electronic devices, and automobiles; and crude oil. (The deficit in goods, at $891 billion, is higher than the overall deficit, since a portion of the goods deficit is offset by the surplus in services trade.)

The balance of imports and exports, or the trade balance, is part of the broader measure of the U.S. economy’s transactions with the rest of the world, known as the balance of payments. The economy’s balance of payments consists of the trade balance, or current account, and the financial accounts, or the measures of U.S. purchase and sales of foreign assets. The financial accounts include financial assets, such as stocks and bonds, as well as foreign direct investment (FDI). These accounts generally balance, since a current account deficit—the trade deficit—results in a corresponding financial account surplus as foreign capital and investment flows into the country.

causes

• More government spending, if it leads to a larger federal budget deficit, reduces the national savings rate and raises the trade deficit. A portion of the budget deficit is effectively financed through a rise in the total amount Americans borrow from abroad.
• The exchange rate of the dollar is important, as a stronger dollar makes foreign products cheaper for American consumers while making U.S. exports more expensive for foreign buyers.
• A growing U.S. economy also often leads to a larger deficit, since consumers have more income to buy more goods from abroad.

Economists generally see these factors as more important than trade policy in determining the overall deficit. That’s because making it easier or harder to trade with specific countries tends to simply shift the trade deficit to other trading partners. Thus, economists warn against conflating bilateral deficits, which reflect the particular circumstances of trading relationships with specific countries, with the overall deficit, which reflects underlying forces in the economy.

The reason for the deficit can be boiled down to the United States as a whole spending more money than it makes

Today’s $621 billion deficit, representing about 3 percent of gross domestic product (GDP), is down from a 2006 peak of more than $760 billion, which at the time was over 5 percent of GDP. The deficit has averaged $535 billion since 2000, much higher than in previous decades, when it accounted for well below 2 percent of GDP. The United States ran either a surplus or a small deficit through the 1960s and 1970s, after which a large deficit opened in the 1980s and continued to expand through the 1990s and 2000s.

By far the largest bilateral trade imbalance is with China. The United States ran a $419 billion goods deficit with China in 2018. The next largest contributor to the goods deficit, at $151 billion, is the European Union, followed by Mexico at $81.5 billion, Japan at $67.6 billion, and Malaysia at $26.5 billion.

The deficit with China expanded dramatically beginning in the early 2000s from an average of $34 billion in the 1990s. Some economists refer to this as the “China Shock”and attribute it to the unexpectedly rapid growth of China’s export manufacturing sector in the late 1990s. This happened as Beijing undertook deep economic reforms and implemented policies to subsidize production, accelerate industrialization, and boost exports. In the process China earned the moniker “the world’s factory.” Economists also note the acceleration of Chinese export growth after the country’s entry into the World Trade Organization (WTO) in 2001.

These factors meant a rising flow of Chinese electronics, apparel, and other goods into the United States, which helps to explain China’s contribution to the deficit, as well as the deficit’s concentration in the manufacturing sector. U.S. manufacturing employment dropped from 26 percent of the workforce in 1970 to 8.5 percent in 2016, a fall that Hufbauer and others say was accelerated by Chinese competition. However, most economists attribute the bulk of the reduction to automation, productivity increases, and demand shifts from goods to services.