BALANCES AND BURDENS

WHAT'S SO FAVORABLE ABOUT A FAVORABLE BALANCE OF TRADE? (Melvyn Krauss, Summer 1997, Hoover Digest)

A corollary of the principle that a trade surplus is not inherently good is that a trade deficit is not inherently bad. To demonstrate this point, consider the case of a country that imports capital and runs a trade deficit. The nation gains from importing capital if the rate of return from the use of the imported capital exceeds its cost. Then, while present consumption remains the same, future consumption--net of interest payments to foreigners--will be greater than what would have been the case had capital not been imported. This was precisely the case of the United States for much of the nineteenth century, when we experienced persistent trade deficits with the rest of the world because we had to import much of our investment capital from overseas. These trade deficits laid the basis for the highly productive American industrial economy of the twentieth century. They clearly were worthwhile.

The trade deficits of the 1980s, during the Reagan years, provide an interesting special case of the principle that trade deficits can work for the general good. U.S. defense spending was high during this period because of President Reagan's desire to face down--and close down--the Soviet empire. The results have been more than gratifying--yet in part, at least, the U.S. defense buildup was financed by imports of foreign savings. Clearly, the trade deficits that financed the U.S. military buildups constituted a worthwhile use of borrowed funds even if the U.S. defense buildup was not the sole cause of the demise of the Soviet state.

Imported savings, of course, can be used to finance present consumption, in which case the trade deficits can be viewed as less benign. When savings are imported solely to increase present consumption, society passes on interest payments to future generations without a sufficient income stream from investments to support or finance them. Present consumption increases at the expense of future consumption. This probably is the case of present U.S. trade deficits and explains why many U.S. citizens are opposed to them. Note, however, that what troubles here are considerations of intergenerational equity--shifting the burden of increased present consumption onto future generations--not vague and misleading notions of flagging U.S. power and influence, as modern mercantilists misguidedly allege. The U.S. trade deficit may be unfair to future generations, but it is not a sign of American decline.

Given that we're both the only military power capable of dealing with the Islamicists and the only economy capable of driving the world economy, these deficits too seem worthwhile. Meanwhile, if we truly cared about shifting the burden of maintaining our own lifestyles to future generations we'd reform entitlements, wouldn't we? Posted by Orrin Judd at August 10, 2003 9:49 AM