Are Trade Deficits Good or Bad?

The Trump administration puts a lot of emphasis on cutting America’s trade deficit with individual countries and the rest of the world. Many question whether the focus is warranted.

Keep in mind that the overall benefits of trade are numerous. Thanks to each nation’s specializations, economies of scale and simply exploiting differences between countries, international trade clearly makes the global economy more productive than the sum of its parts. But should we be concerned if a country’s international trade is no longer balanced—if a country’s exports no longer equal its imports?

The answer is simple for trade between any two countries—there is nothing to worry about. Unbalanced bilateral trade is no more concerning than the fact that most workers run trade surpluses with their employers and trade deficits with their local supermarkets. It’s no different on a macro scale when the United States runs trade deficits with some countries, such as Vietnam or Cambodia, which produce textiles and other inexpensive goods, but are generally too poor to be significant buyers of sophisticated American-made products. Similarly, countries like Brazil or the United Kingdom are willing to buy U.S. products, such as airplanes, but don’t export many of their goods to America, resulting in a trade surplus for the United States.

The problem becomes more complicated with the aggregate balance of exports and imports against the rest of the world. The aggregate trade balance, or more broadly the current account balance, reflect how much a country consumes compared to the amount it produces. In principle, these two amounts don’t have to be equal every year—the same way individual consumer spending doesn’t have to equal the same individual’s income every single year. Similarly, a country might run a current account surplus if it experiences a productivity boom, like an oil-exporting country during a period of high oil prices, and a deficit when its productivity suffers, like after a natural disaster.

But what about a persistent current account surplus or deficit? Can it be a good thing when a country consistently spends more than what it produces? Sometimes, the answer is yes. This is the case for some emerging economies, which spend heavily on investment. Running current account deficits allows them to expand their productive capacity without sacrificing their standard of living. Similarly, a developed country with excellent investment opportunities and sophisticated financial markets might also attract investment from abroad, allowing it to spend more than its current output—as is likely the case with the United States.

However, persistent trade deficits (or surpluses) might also reflect an underlying imbalance in the economy, with certain parts of it consistently failing to balance its books. In the United States, this could result from persistently high deficits run by the federal government. If household or corporate savings fall too low, this excessive government consumption could result in persistent trade deficits. On the other hand, economies with highly taxed consumption and lacking investment opportunities (like Germany), or those with strongly incentivized household savings due to the lack of a social safety net (like China) might find their domestic spending falling short of domestic output, resulting in trade surpluses.

While trade imbalances stir a lot of emotions, it is simply not possible to say if they are good or bad in and of themselves. In the case of the United States, persistent trade deficits reflect not only the excellent investment opportunities offered by the country’s deep and efficient financial markets, but also the persistent government budget deficits.