No concept in all of economics is misunderstood and abused as much as that of the so-called “trade deficit.” This misunderstanding and abuse owes much to the word “deficit,” which conveys a sense of decline and imbalance. No one, of course, wants to be declining or unbalanced. But, in fact, the trade deficit is not a sign of any economic decline or real imbalance.
The United States runs a trade deficit whenever, during some time period, Americans import more goods and services than they export. Yet each time Americans import more than they export, foreigners invest more in America than Americans invest abroad. The reason is simple: because foreigners who wish to invest in America need dollars to do so, they can’t spend all of their dollars buying American exports. It follows that as foreigners’ eagerness to invest in America intensifies, their eagerness to buy American exports diminishes — thus causing US trade deficits to rise.
This net inflow of investment funds to America balances out the trade deficit (or, more precisely, the current-account deficit). Because investing is every bit as much an economic activity as is buying (importing) and selling (exporting), when investing is included in the economic picture — as it should be — the existence of a trade deficit signals neither decline nor imbalance. Countries, such as the US, that consistently attract a disproportionately large share of investment funds from around the world can hardly be said to be on the decline or unbalanced.
This simple reality, however, is stubbornly ignored by protectionists. The negative connotation conveyed by the term “trade deficit” is so very useful to the protectionist cause that protectionists seem to have no interest in getting their — or their audiences’ — thinking straight about this concept.
Although an obstacle to economic understanding and to an acceptance of free trade, the term “trade deficit” in particular — and, more generally, the concept of “balance of payments” — will unfortunately remain available to protectionists as a means of deceiving the economically uninformed into a self-destructive hostility toward free trade. As noted by the great economic historian Robert Higgs, “the international balance of payments has to be the most nonsensical accounting statement ever devised, serving no purpose but to justify to gullible people the government’s pernicious application of force and fraud as if its so-called protectionism were a benefit to the general public.”
The concept of a “trade deficit” sows even more confusion when it is used to describe, not one country’s economic engagement with the rest of the world, but one country’s economic engagement with one other particular country. As confusing as is the term “US trade deficit” when used to describe America’s economic engagement with all other countries, at least this term conveys economically meaningful content to people who understand economics. If, for example, the US in 2024 runs in a trade deficit of $900 billion, this fact tells us that America in 2024 was a net recipient of $900 billion of investment funds from around the world.
In contrast, when someone speaks of, say, “the US trade deficit with China,” absolutely no economically meaningful content is conveyed. In a world of more than two countries, the trade that the peoples of any pair of countries have with each other has no economic relevance whatsoever. Bilateral trade deficits or surpluses are economically meaningless.
We know what a protectionist such as Oren Cass refers to when, for example, he complains that the “US-China trading relationship became the most imbalanced in world history.” He refers to the value of American imports from China far exceeding the value of American exports to China. According to Cass and other protectionists, we Americans are therefore supposed to be alarmed. But the only alarming thing about Cass’s complaint is the gross economic misunderstanding that it reflects and fuels.
Even if we disregard the possibility that the Chinese are investing in America some of the dollars they earn by exporting to America, there’s no reason whatsoever to suppose that any two countries in our world of nearly two-hundred countries will buy and sell to each other the same amounts. Such an outcome could happen, but, were it to do so, it would be bizarre and surprising.
Let’s say that Americans in 2024 import from China $300 billion more than Americans export to China. Cass and other protectionists will point in panic to this ‘US trade deficit with China.’ But to anyone who understands economics, this panic is laughable. To see why, suppose that the Chinese spend all $300 billion on goods imported from countries in Europe, and then Europeans in turn spend this $300 billion buying exports from the U.S. In this hypothetical example — which isn’t remotely far-fetched — America can indeed be said to have a $300 billion trade deficit with China, but every cent of this $300 billion nevertheless returns to America as demand for American exports. This $300 billion of demand for American exports just happens to come from Europeans by way of the Chinese, rather than directly from the Chinese.
Nothing of significance in the American economy changes in consequence of this $300 billion of export sales being made to Europeans rather than to the Chinese. But to listen to people such as Oren Cass and other protectionists who write about America’s trade deficit with China, you’d think that something momentous — and ominous — is afoot.
In a world of more than two economic entities — more than two individuals, more than two households, more than two firms, or more than two countries — the very logic of economic specialization results in each entity producing for, and selling to, one subset of fellow economic entities and then using its sales proceeds to buy mostly from another subset of fellow economic entities. I, for example, have large and ever-growing trade surpluses with George Mason University and AIER (two entities that purchase that which I produce and sell). And I have large and ever-growing trade deficits with my local supermarket, with Amazon, with the Toyota Motor Co., with my physician, and with every other entity from which I purchase the many goods and services that enrich my life. The same economic relationships in general are true for every person in modern society. And what is true at the level of the individual is true at the level of the country: just as there’s absolutely no reason for you to worry about the trade deficit that you have with your physician or your grocer, there’s absolutely no reason for us Americans to worry about the trade deficit that America has with China.
But if the (il)logic that drives protectionists to warn of the alleged dangers that lurk in one country’s trade deficit with another country were valid, then I, you, and every other person in modern society should begin to worry about all the many trade deficits that each of us has with those economic entities from whom we purchase goods and services. And we would enrich ourselves if each of us refused to trade with any individual or company that refused to buy from us the same amount as we buy from it.
I urge Oren Cass and other American protectionists to practice for themselves what they preach for our country. I urge each of them to try to eliminate the many bilateral trade deficits that they run in their individual economic affairs. If they do so — if they succeed at having no trade deficit with another economic entity — and honestly report to us that they have thereby been enriched, I will then listen with respect to their warnings about America’s trade deficit with China. But until then, I’ll reject these warnings for what they are: foul fruits of economic ignorance.
