The truth about US trade deficits and US manufacturing

One of my central economic tenets is that the total debt burden of the United States is too high. I blame economic policies that have encouraged excess consumption and housing investment, funded by money borrowed from abroad and by excess leverage in the financial system. Borrowing money from abroad in excess of money invested abroad creates a capital account surplus for the United States. If the US runs a capital account surplus, it must run a corresponding current account deficit to balance its accounts. The biggest component of a current account deficit is the trade deficit. I therefore believe that the best long-term fix for our problems is to adopt a set of policies that for a period of time encourages the US to run trade surpluses and a capital account deficit. In other words, we should sell more US goods abroad, while we increase savings and repay our foreign creditors.

My four point plan for running a trade surplus

  1. Maintain a stable currency and discourage the building of foreign dollar reserves;
  2. Improve incentives / remove disincentives for investing abroad;
  3. Remove / scale back policies that encourage borrowing and consuming at the expense of saving and investing; and
  4. Use policy to improve our terms of trade on energy

Right now point (1) is happening, whether on purpose or by accident. I don't expect (2) to happen anytime soon, and in fact policy seems to be running in the opposite direction. Obama talks like he believes in (3), but his policies also seem to be running in the opposite direction, with higher taxes on capital and high levels of federal borrowing. On the other hand, Obama is clearly a believer in point (4).

The composition of the US trade deficit

In the first quarter of 2009, the trade deficit was equal to 2.4% of nominal GDP (subject to revision). From 1980 to 2008, the trade deficit has averaged 3.1% of GDP.

61% of the deficit in Q1 2009 was due to our trade deficit in petroleum products. Since 1980, petroleum has accounted for 45% of our trade deficit, and the petroleum deficit has been about 1-2% of GDP. This one product is the "low hanging fruit" when it comes to targeting out trade deficit.

Not surprisingly, the US typically runs a surplus in services. In Q1 2009 the trade surplus in services was 1.1% of GDP, which is near the average level since 1990.

The level of trade deficit in goods excluding petroleum has averaged about 2% of GDP. In the goods sector, the US runs at about a balance in foods, industrial supplies and capital goods. In capital goods, the US runs a surplus in civilian aircraft (Boeing) and a deficit in everything else, including computer equipment. The bulk of the non-petroleum trade deficit is tied to autos and consumer goods.

It's not surprising that the US would run a deficit in consumer goods, many of which are labor-intensive like textiles, toys and such. The US should be able to run a trade balance or even a surplus in autos, which is actually a very productive sector in the US, but one in which we are up against rather unfair trade practices abroad. The US should also be running a bigger surplus in capital goods and non-petroleum industrial supplies.

The truth about US manufacturing

It has been so long since the US has run trade surpluses that it seems we have come to believe that it would be impossible to do so again. It is commonly believed that the US has basically stopped "making stuff". Nothing could be farther from the truth. The US is actually the largest manufacturer in the world by far and in most years is the largest exporter in the world. Also, it is important to note that the US's economy is absolutely massive relative to any other country in the world, and that trade (both imports and exports) is a relatively small part of our economy compared with even large economies like China, Germany and Japan. Also, the bulk of our trade deficits since 1980 have coincided (slightly lagged) with two periods of a very strong dollar and high real interest rates, which leads to poorer terms of trade for US manufacturers and increased investment flows from abroad. If we focus on maintaining a stable dollar rather than a "strong dollar", most of the trade deficit problem goes away.

But isn't manufacturing in the United States in decline? While manufacturing employment is certainly in long-term decline, manufacturing production continued to climb right up through 2007. The recent plunge in production has brought US manufacturing back to levels last seen in 1999. Manufacturing employment, on the other hand, is back to levels last seen around the start of World War II. The difference between these two numbers is the increase in manufacturing productivity. Before the recent downturn, we were producing roughly 7.5 times what we were producing in 1948 with roughly the same amount of manufacturing workers, working out to real productivity growth of 3.3% per year.

Manufacturing production and employment:

During the same timeframe, manufacturing capacity has been growing at 3.5% per year, so capacity utilization has fallen.

Thus, when this downturn ends, the US has plenty of scope to have its manufacturing production return to its trend line, particularly in high tech equipment and other durable goods.

The key takeaways are:

Don't confuse manufacturing employment with production. Manufacturing employment since the early 1970s has been analogous to agricultural employment in the late 1800s and early 1900s, declining even while production boomed.

US durable goods manufacturing is perfectly competitive. Capital-intensive durable goods manufacturing in the US could thrive if the US government halted the currency policies that were unduly punishing it.

3 thoughts on “The truth about US trade deficits and US manufacturing

  1. Gotta love productivity growth! The pesky downside is the change in employment that you identify. The lights-out factory may be a huge contributor to the economy, but labor can’t be a fan. It’ll be interesting to see the tightrope our current administration has to walk to reconcile pro-growth (i.e. pro-productivity) imperatives with labor-friendly policies. Or are green collar jobs the answer?


  2. Douvos,
    Just like when the farms shed jobs and those workers moved to the cities to work in factories and such, the trend is for factory workers to continue to move into service and office jobs. And, as always, small-medium sized businesses (SMBs) provide the job growth while big companies shrink their workforces. Policies that help SMBs are the answer…stuff like “green collar jobs” are a tiny sideshow.


  3. From a feet on the streets view point, the shift to overseas manufacturing has been devastating and I have been in the thick of it since 1984, after Judge Greene ordered RBOC’s not to manufacture CPE but to only “market it”. I’ve been banking on import experience ever since, and this long time hollowing out is in fact very, very damaging to our own funding of social security, state and local payroll taxes, medicare, and other wage, and income related government income. If you look at the China industrial model of targeting specific industries for takeover and development, it’s been far more effective than our own Pentagon in securing a safe and secure pot of gold for our citizens. I disagree with these 30,000 foot view points on the economy. The “feet on the street” were feeling “bad” about the economy 5 years ago, and the pundits on CNBC and President Bush were yelling at them to shut up and be happy. Perhaps these “canaries” in the economic “mine” should be followed more closely.
    Many communities in China that I entered in 1984 have transformed from stone age, to gated, communities surrounded by expensive import automobiles while we stumble down a deep slide in most every City and most every State. Tell me again about US Manufacturing? Take a ride on any train, or visit any airport in China and then drive around NYC, or LA and tell me that we are kings of the road? Get real and get on the street.


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