Don’t Fear the Trade Deficit — Embrace it

In the evening of October 12,  the U.S. House of Representatives and the Senate both passed the Free Trade Agreements with Colombia, South Korea and Panama. The press, members of Congress and senators all highlighted the job-creating potential of these treaties, because of their boost to exports and the manufacturing sector.

These stories leave out an important element: The value of imports. In an open market system, where countries are able and willing to trade with one another, imports play an important role in providing choices and in the development of new and better products.  They also contribute to the specialization of the domestic labor force, which ultimately increases welfare and output.

However, critics point to the trade deficit as a problem that costs American jobs. The U.S. trade deficit has indeed grown since the 1970s, and in 2010 equaled US$500 billion (in 2008, it equaled nearly US$800 Billion).  These critics argue that as people substitute domestic goods with imports, domestic industry employment will fall, and many people will lose their jobs. However, a simple analysis of unemployment, output and trade deficit data shows almost no relationship between a rise in the trade deficit and a rise in unemployment or a decrease in economic output.

 In fact, as the charts show, there seems to be a correlation between large trade deficits and reduced unemployment, as well as a larger economic output. Why? One reason is that a large proportion of U.S. imports are actually manufacturing inputs, used to produce goods in the United States. In fact, the most recent data available from the U.S. Census Bureau (August 2011) shows that 57 percent (US$106 billion worth) of all U.S. imports are capital goods and industrial supplies materials, the basis of the domestic manufacturing sector.

Even when there is some displacement of jobs due to trade, trade and labor statistics are imperfect. Sometimes these statistics fail to account for steps in the development of a product produced abroad — steps that add value at each stage. For example, the iPhone (the most recent version releases this week) is produced in China, and therefore counts against our trade balance. But the phones themselves proudly display a “Designed by Apple in California” label.  The value of this action is not found in trade statistics, and neither are the jobs labeled as “created by trade.”

In terms of consumer goods, imports allow consumers to select their preferred goods from a wider array of options. This tends to provide a broader selection of prices and to increase the available options between similar goods (even in things people might consider trivial, like coffee).

These are all facts that should be highlighted, not buried or even omitted from free trade discussions. In making decisions on trade policy, policymakers need to better understand the value of imports and not just fall into the short-sighted trap of viewing a trade deficit as a major problem.