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
- Maintain a stable currency and discourage the building of foreign dollar reserves;
- Improve incentives / remove disincentives for investing abroad;
- Remove / scale back policies that encourage borrowing and consuming at the expense of saving and investing; and
- 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.