August 1, 1995 | Commentary on Foreign Aid and Development

ED080195a: Trade Deficit Myths

The Clinton administration's near collision with Japan over automobiles and auto parts almost started a trade war with America's second-largest trading partner.

Fortunately, the White House backed off from insisting on numerical targets in trade agreements, even though numerical purchasing quotas were the heart of its position. Thus, what was largely a defeat for Clinton's managed-trade policy is a victory for the American consumer.

But the president and his trade team may not have learned the larger lesson from their defeat. Underlying the Clinton administration's policies toward Japan is an irrational fear of trade deficits and the belief that protectionist policies are necessary to combat them.

In fact, myths and faulty assumptions about trade deficits are the intellectual foundation of the administration's managed-trade policies.

Trade deficits are more a sign of strength than of weakness. The meaning of the U.S. trade deficit is that Americans can afford to buy more goods than their foreign trading partners. This is a sign of America's wealth. The influx of foreign goods and services in return for dollars adds to America's wealth by increasing our standard of living; it does not detract from it.

The way protectionists see it, most people run a trade "deficit;" with their grocer. When you go to the supermarket and buy $150 worth of groceries, protectionist theorists could chalk this up as a trade "surplus;" of $150 for the grocer, while you have a "deficit" of $150. But this is not the case at all. The grocer ends up with $150 in currency, while you have $150 worth of groceries. It is a mutually beneficial transaction. Both you and the grocer are winners.

Another misunderstanding involves trade-deficit figures. At least one-third to one-half of the U.S. trade-deficit figure consists of U.S. imports from overseas subsidiaries of American companies. For example, when Ford Mexico sends a motor from its plant to the Ford assembly plant in Detroit, it is counted as an import: a "deficit" supposedly is created. If the car is then sold in the United States, why should this still be calculated as part of the trade deficit? Most of the money made from this sale stays in the United States.

Protectionists claim trade deficits are a major cause of unemployment. History shows, however, that unemployment typically drops as the trade deficit rises.

For example, while the trade deficit leaped from 1983 to 1984 and peaked in 1987, the U.S. unemployment rate fell from 9.6 percent in 1983 to 5.5 percent in 1988. When the trade deficit began to shrink from 1989 to 1991, unemployment rose from 5.3 percent 6.7 percent. When it began to rise from 1992 to 1994, unemployment shrank from 7.4 percent to 6.1 percent.

U.S. policy-makers often use Japan as an example of how a country can eliminate trade deficits by managing trade and industry. A closer look reveals that too much government "management" may be responsible for Japan's current economic malaise. If living standards are the measure of success, Japan has lost the "economic war" with the United States. For example, the real purchasing power of Japanese consumers is 30 percent to 40 percent lower than that of American consumers. Thus, the Japanese are at least one-third poorer than Americans.

Japan's lower standard of living can be attributed partly to managed trade and industrial policies that drive up the costs of consumer goods. For example, policies that restrict agricultural imports force the average Japanese family to spend about 25 percent of its disposable income on food, compared to less than 12 percent for Americans.

Advocates of managed trade argue that closed overseas markets are the chief reason for America's trade deficit. But if American companies are so beset by closed markets overseas, why is America the world's largest exporter? The United States exported more than $697 billion in goods and services in 1994. By contrast, Germany exported $607 billion and Japan only $395 billion. Clearly, most U.S. exporters find overseas markets for their goods.

Many trade-deficit "hawks" argue that the United States has an open market, while Japan restricts U.S. imports. Thus, Japanese protectionism is the cause of the U.S. trade deficit with Japan. In truth, Japan and the United States have relatively equal levels of protectionism.

Most Americans don't realize that Japan is the largest overseas market for U.S. goods and services. Last year alone, Japan imported $51 billion in goods from the United States. That was more than America exported to the United Kingdom and Germany combined ($25.9 billion and $18.7 billion, respectively).

Moreover, on a per-capita basis, Japan buys more from the United States than the United States buys from Japan. For example, on average, each Japanese citizen bought $444 worth of U.S. goods and services in 1994, while each American citizen purchased $441 worth of Japanese goods and services. But because Japan's population is about half of America's, a deficit exists.

Trade deficits are not harmful to the economy. If they were, America would not be the economic powerhouse it is today.

Note: Bryan T. Johnson is a former policy analyst for international economic affairs at The Heritage Foundation.

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