Question

Question 1: The US Economy is experiencing a huge trade deficit over last few decades. Explain the causes and consequences of this trade deficit on the US economy.

Question 2: Under what circumstances the trade deficit is really bad and under what   circumstances the trade deficit is not too bad? Explain.

Answer 1

Answer to Question 1

Causes of US Trade Deficits-

1. We know that whenever there is excess of national investments over national savings, the result is deficit. To finance the deficit government must rely on inflow of foreign capital, which must in turn be matched by an offsetting deficit in our current account.In order to attract foreign capital, trade must be balanced. Thus, to solve the problem of deficits, national savings must be high. In this view, a low level of national savings in the US have resulted in trade deficits.

2.Another cause associated with the US trade deficits is the movements in the exchange value of dollar. Trade deficit expanded when the US dollar appreciated in the 1980s, and fell when the dollar depreciated in the following decades. The reason behind this is the influence of other countries' economic policies. For example- China in 1994 devalued its currency against US dollar and continued to purchase dollar since then. China accumulated a reserve of US dollar as high as $143 billion by 1997. As a result, US trade deficit has increased by more than 25% per annum. Similarly, other countries like Japan also practised similar policies which affected trade deficit in the US.

3. Significant capital inflow to the US over the past few years also contributed to US trade deficit. Foe example- Due to the Asian financial crisis, Asia has invested in the US in search of a 'safe-heaven'. This resulted in appreciation of dollar. Such private investments contributed to the huge trade deficits in the US.

Thus, US trade deficits have been increased due to low national savings, economic policies of foreign countries, appreciation of dollar etc and have been exaggerated by the Asian financial crisis.

Consequences of US Trade Deficits-

One of the direct consequence of US trade deficit is the elimination of millions of employees from the US manufacturing jobs over the past two decades. As most trade in the US involves production and export of manufactured goods, deficit in trade resulted in loss of jobs in such industries. Another consequence of Trade deficit in the rising inequality in income among the people of US. Trade deficit also led to decrease in wage decline, stagnation in the standard of living of the people and reduced competitiveness of certain industries in world trade. The workers who lost their job in the manufacturing industries as a result of trade deficit will have to search for another job in the long run. When they find job in sectors other than manufacturing sector, which do not require the skill they possess, the wage is quite low. In case of the industries which were closed during the deficit cannot be revived easily.