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"Bad News" on the Trade Deficit Often Means Good News on the Economy (Daniel Griswold, January 11, 2005, Free Trade Bulletin)

In 8 of the years since 1980, the U.S. current account balance has moved in a positive direction (i.e., the deficit has shrunk or "improved") as a share of GDP from the previous year. In 16 of those years, it has moved in a negative direction (i.e., the deficit has grown or "worsened"). Of those years in which the balance moved in a negative direction, 10 have seen a moderate movement of between 0.0 and 0.5 percentage points, and 6 have seen a more rapid movement of 0.7 to 1.3 percentage points.

How has the U.S. economy fared under each of those three current account scenarios? To address that question, Table 1 lists the size of the current account as a share of GDP for each year since 1980, along with the change in the current account percentage, real GDP, manufacturing output, and the unemployment rate from the previous year. (Changes in manufacturing output and the unemployment rate are measured from December to December to more fully capture the trend of that year.) The years are grouped in three categories, according to the magnitude of change in the current account balance as a share of GDP.

As the table illustrates, by all three measures of economic performance–GDP, manufacturing output, and the unemployment rate–the U.S. economy performs better in years when the current account deficit is rising as a share of GDP than in years when it is shrinking. And it performs especially well in years when the current account deficit is rising most rapidly.

By the most basic measure of economic performance, the change in real GDP, evidence points to a stronger economy in years in which the current account deficit is rising. In those years since 1980 when the current account deficit declined as a share of GDP, the economy grew each year by an average of 1.9 percent. In those in which the current account deficit grew moderately, real GDP grew at an annual average of 3.0 percent. In those years in which the deficit most rapidly "deteriorated," to borrow another popular characterization, real GDP grew by a robust annual average of 4.4 percent–a rate more than double the growth in years when the deficit was "improving." Four of the five best years for GDP growth since 1980 have occurred in the same years when the current account deficit was growing most rapidly.

The same pattern emerges in the manufacturing sector. It has become the conventional wisdom that a trade deficit hurts manufacturing because imports presumably displace domestic production, but the plain evidence of the past quarter century contradicts that presumption. Manufacturing output actually declined slightly on average in those years in which the current account deficit shrank. In contrast, it grew by 4.1 percent in years when the current account deficit grew moderately and by a brisk 5.3 percent when the deficit grew rapidly. In fact, five of the six years that saw a decline in manufacturing output occurred in years in which the current account deficit was declining.

The pattern also applies in the politically sensitive area of employment. Again, the conventional wisdom holds that a trade deficit destroys jobs by supposedly shipping them overseas. But again the evidence suggests something quite different. In those years of an "improving" current account deficit, the unemployment rate on average jumped by 0.8 percentage points. In years when the deficit moderately "worsened," the unemployment rate fell by an average of 0.2 points, and in years when the deficit grew the most rapidly, the unemployment rate fell by an even larger average of 0.7 points. Indeed, in 7 of the 8 years in which the current account deficit "improved," the unemployment rate went up; in 13 of the 16 years in which the current account deficit "worsened," the unemployment rate went down.

The year 2004 appears to fit the pattern comfortably. Through the first three quarters of the year, January through September, the current account deficit averaged 5.5 percent of GDP, a 0.6 percentage point shift in the negative direction from 2003. That would place 2004 somewhere between a moderate and rapid growth of the current account deficit. Befitting the pattern, economic performance through the first three quarters of the year was also moderate to robust. Real GDP grew an average annual rate of 3.9 percent during the first three quarters. Manufacturing output grew during those same three quarters at an annual rate of 5.4 percent from the previous year, while the unemployment rate was on a pace to drop by 0.4 percentage points during the full year.

In 2004, as in previous years, a rising current account deficit may have been bad news to headline writers, but it appears to have accompanied good news for the U.S. economy, its factories, and its workers.

Evidence from the past 25 years directly contradicts the assumption that trade deficits impose a drag on the U.S. economy. Contrary to prevailing assumptions, "worsening" trade deficits are associated with faster GDP and manufacturing growth and more rapidly declining unemployment, while "improving" trade deficits are associated with slower GDP and manufacturing growth and rising unemployment.

The Democrats say they'd get rid of the deficit.

Posted by Orrin Judd at February 20, 2005 12:00 AM