3 Reasons Why The Trade Deficit Is Bad For The Economy

3 Ways Trade Deficits Hurt the US Economy

Many of America’s most successful business leaders and investors, from Carl Icahn to Warren Buffet, and of course President Trump, think that the trade deficit is hurting America’s economy.  These are people who’ve made a lot of money because they know how the economy works, and they’re punished when they’re wrong—they have skin in the game.

On the other hand, people who live in ivory towers (economists and journalists) say that the trade deficit doesn’t matter.  These people are charlatans—they are not held accountable when they make mistakes, and most of them are slaves to their donors.  The Cato Institute, for instance, is a libertarian think-tank that argues trade deficits are not just benign, but good.

Anyways, let’s cut through the rhetoric and look at the facts.  Here are three reasons why the US trade deficit is bad for the economy.

How the Trade Deficit Harms the Economy

The trade deficit harms America’s economy in many ways.  For example, it creates systemic fragility (through the accumulation of debt) and acts as a vector for market contagion.  But in this article I’ll focus on less-technical arguments.offshore outsourcing infographic

The trade deficit hurts America primarily through the process of offshore outsourcing (hereafter offshoring).  Offshoring is when a domestic company hires a foreign company to do something (like make stuff) for them in the foreign country.

For example: an American company (Acme Inc) hires a Chinese company (China Corp) to build laptops for them—China Corp builds the laptops in China, and then Acme Inc imports them to, and sells them in America.

Offshoring often leads to trade deficits, since we end up buying much more from foreign countries than we sell to them.

1. The Trade Deficit Costs America Jobs, Causing Unemployment

This point is pretty simple.

In 2015, America’s goods trade deficit was $736 billion, or 4% of our GDP.  Since GDP is simply the total output made by America’s working population, and since 4% of America’s GDP is imported, then it follows that 4% of America’s workers are displaced by these imports.

This means roughly 6 million workers are displaced imports.

Of course, this neglects the jobs gained the service industry surplus, but on the other hand, it doesn’t account for the fact that labor-intensive jobs are more likely to be offshored (companies offshore because American workers are more expensive than Mexican workers).

Looking specifically at manufacturing: manufacturing contributes $2.2 trillion dollars to the economy.  Since 78% of the US trade deficit is in manufactured goods, this means that we’ve offshored $573 billion worth of production.  That’s one-third of our manufacturing industry.  Finally, since manufacturing employs 12.3 million Americans, then we know that roughly 4 million more are displaced by imports.

Manufacturing brings wealth into a region, and therefore supports local services and supply chains.  For example, a car factory supports hairdressers and accountants, but not the other way around.  This “job multiplier” has been studied extensively.

As it turns out, each manufacturing job usually supports 1.58 other service jobs.  This means that since 4 million manufacturing jobs are displaced by imports, then about 6 million service jobs were also lost.

According to this method, the goods trade deficit costs America at 10 million jobs.

And no, you can’t blame this on automation. Stop jousting windmills.

2. The Trade Deficit Increases Income Inequality

gini coefficient chart
Income inequality can be encapsulated in a measurement called the Gini Coefficient: one represents perfect inequality, zero represents perfect equality. As you can see, American incomes have been growing more unequal since 1973.

Offshoring replaces demand for domestic output with demand for imports—rather than make it, we buy it.  In turn, this replaces demand for domestic labor with demand for foreign labor (we hire foreigners, not Americans).

This increases income inequality because it lowers American wages.

How?

When a business is offshored, people lose their jobs.  Some of these people cannot find new work, and drop out of the labor force; the rest find other work, but usually earn less (since manufacturing jobs pay so well).

In fact, the average wage cut for a worker who lost his job in an exporting industry (America’s largest exports are manufactured goods) was 17.5% (you used to make $50,000 a year, now you make $40,000).

Additionally, people who are laid-off compete with everyone else for (fewer) jobs.

real vs nominal US wages

This shifts bargaining power from workers to employers, who can pay less to attract the same number and quality of employees.

How much are wages impacted?  A lot.

From 1950 to 1973 worker’s productivity gains were reflected in wage gains on a nearly 1:1 basis (the more work you did, the more you were paid).

However, since then productivity increased by 72%, but average wages stagnated.

US worker productivity chart

If wages had continued to rise with productivity, the current median wage would be $33.60 an hour, as opposed to $21.00.

Most of this divergence is caused by the growing trade deficit, although immigration (particularly illegal immigration), higher taxes, and superfluous regulation also helped kill the American dream.

3.  Offshoring Reduces America’s Living Standards

The US trade deficit also lowers most American’s standard of living by boosting foreign demand for American assets (this is on top of wage stagnation, of course).

Foreigners are furiously buying US stocks and property, which inflates their prices.

Most Americans are being squeezed—particularly by increasing housing costs, which are 73% higher today (in real terms) than 40 year ago.

In fact, the primary reason why the median household has less disposable income today than in 1985 is because the cost of housing has increased so dramatically (by a multiple of 3.5), while wages have not.

Not to mention the fact that offshoring hasn’t brought down the cost of goods, when you account for product quality.  For example, household appliances are twice as expensive today as they were 40 years ago.

This is made abundantly clear in the graph below, which shows the change in US disposable income over time.

You can clearly see the regression in the median, not the mean, which means that most of the gains are going to a small portion of the population.

declining middle class chart

The Trade Deficit is Bad for the Economy. Period.

Trade deficits are bad for America’ economy, and people.  This is well attested to both historically, and according to the economic data.

But of course, there’s more to it than that.  Trade deficits also endanger America’s national security, and infringe on our sovereignty, but creating a system of import dependency.  There are strong political reasons to shrink the trade deficit.  It boils down to the maxim: money is power.  Why are we investing, and enriching places like China, rather than focusing on building-up America?

It’s senseless.

America needs to shrink the deficit, that’s the bottom line.

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About Spencer P Morrison 82 Articles
JD candidate, writer, and independent intellectual with a focus on applied philosophy, empirical history, and practical economics.Author of "America Betrayed" and Editor-In-Chief of the National Economics Editorial.

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