Question

42. Some economists warn that the persistent trade deficits and a negative current account balance that the United States has run will be a problem in the long run. Do you agree or not? Explain your answer.

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 answer is that a trade deficit can confer both positives and negatives for a country. It all depends on the circumstances of the country involved, the policy decisions that have been made and the duration and size of the deficit. Often times the observed data and the underlying economic theory don't line up.

For the past several years, the United States has been running trade deficits. Some people have reacted to this fact with doom and gloom, while others chalk it up to certain foreign governments not playing fair in U.S. markets and international trade.

When a country persistently experiences a trade deficit there are predictable negative consequences that can affect economic growth and stability. If imports are more in demand than exports, domestic jobs may be lost to those abroad. While theoretically, this makes sense, the data suggests that unemployment levels can actually persist at very low levels even with a trade deficit and high unemployment may occur in countries with surpluses.

The demand for a country's exports impacts the value of its currency. American companies selling goods abroad must convert those foreign currencies back into dollars in order to pay their workers and suppliers, bidding up the price of their home currency. As the demand for exports falls compared to imports, the value of a currency should decline. In fact, in a floating exchange rate system, trade deficits should theoretically be corrected automatically through exchange rate adjustments in the foreign exchange markets.

The United States, however, is in a unique position of being the world's largest economy and its dollar the world reserve currency. As a result, the demand for U.S. dollars has remained quite strong despite persistent deficits.

A persistent trade deficit can often have adverse effects on the interest rates in that country. A downward pressure on a country's currency devalues it, making the prices of goods denominated in that currency more expensive - in other words it can lead to inflation.

By definition, the balance of payments must always net out to zero. As a result, a trade deficit must be offset by a surplus in the country's capital account and financial account. This means that deficit nations experience a greater degree of foreign direct investment and foreign ownership of government debt. For a small country this could be detrimental, as a large proportion of the country's assets and resources become owned by foreigners who can then control and influence how those assets and resources are used.

Initially, a trade deficit is not necessarily a bad thing. It can raise a country's standard of living because its residents gain access to a wider variety of goods and services for a more competitive price. It can also reduce the threat of inflation since it creates lower prices. A trade deficit may also indicate that the country's residents are feeling confident and wealthy enough to buy more than the country produces.