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Worry Over the Trade Deficit?

Author: Bruce Stokes

Council on Foreign Relations

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The trade deficit is running at record levels and no one seems to care. Maybe they should.

In the month of May, the United States imported $21.3 billion more in goods and services than it exported, a record monthly deficit. At this pace, the trade imbalance could reach an unprecedented $225 billion this year. Moreover, this figure— which incorporates the surplus the United States earns in trade in services such as banking, insurance and consulting— cloaks an even worse performance in merchandise trade, where the deficit may exceed $300 billion by the end of the year.

Economists argue that the deficit doesn't really matter. If foreigners want to exchange cars and VCRs for green backs, that's a good deal. With record low unemployment in the United States, the 422,000 workers who have lost manufacturing jobs in the last year, many of them displaced by imports, can easily find other jobs. And, unlike the 1980s when the deficit signaled incipient competitive weakness, the recent run up in the imbalance merely reflects a fall off in foreign demand for American products, thanks to the Asian economic crisis, coupled with strong U.S. desire for imports.

As long as the economy stays strong, public concern about the deficit is likely to remain muted and such macro-economic reasoning will stifle policy initiatives to deal with it. But such big picture thinking masks disturbing trade trends at the micro level that Congress and the Clinton Administration will ignore at some peril.

"You can say that the trade deficit doesn't matter, in part because its cyclical and reflective of the world economy," said Lawrence Chimerine, chief economist of the Washington-based Economic Strategy Institute. "But if you do the arithmetic, half of the current deficit reflects structural trade imbalances that will persist even if the macro-economic conditions improve."

The trade deficit has actually been getting worse for some time. But the deteriorating merchandise account has been camouflaged by the rising services surplus. No longer. The services surplus is now declining, exposing a burgeoning merchandise deficit. From May, 1996-May 1997, the services surplus offset 52 per cent of the goods deficit. Over the last 12 months, it only offset 28 per cent.

And the nature of the deficit is changing. "Its not so much that we have a trade problem," said Charles McMillion, chief economist of MBG Information Services, a Washington-based business forecasting firm, "its that we have huge imbalance in vehicles, computers, televisions and clothing. Its concentrated."

This concentration is most evident in the auto sector. Over the last year, of the $24 billion increase in merchandise imports, autos and auto parts accounted for more than two-fifths of the total.

A geographic breakdown of the trade imbalance is also revealing.

The dire warnings made by critics of the North American Free Trade Agreement are now being realized. Over the last year our trade deficit with Canada and Mexico has more than doubled, to $21 billion. While the weak Canadian dollar is partially to blame, the real culprit is growing intra-company trade by auto makers, who are sourcing more and more from north and south of the border.

Europe has also emerged as a major source of the deficit, as its trade imbalance with the United States has soared 87 per cent in the last year. For the last quarter century, our trade balance with Europe has fluctuated between surplus and deficit. But, the deficit with the European Union has now worsened, more or less steadily, for the last 6 years, an unprecedented run of bad trade numbers and this year it's likely to be its worst ever.

The most disturbing trend of all involves trade with China, where our deficit last year was $57 billion. We import five times as much from China as we export to the People's Republic. So simply to keep the deficit with China from growing, exports have to grow five times faster than imports. But the reverse is happening. Exports to China this year are actually down by 5 per cent. Even the much-anticipated deal with Beijing to gain Chinese entry in the World Trade Organization is not going to turn around that trend any time soon.

Finally, surprising sources of the current trade deficit emerge when country imbalances are adjusted to account for the size of a trading partner's economy or population. The trade surpluses Taiwan and Thailand run with the United States are equal to 5 per cent of their economies. By comparison, Japan's surplus amounts to only 1.3 per cent of its economy. Taiwan also stands out with a per capita surplus in trade with the United States of $680. Every Chinese can only claim a $45 trade surplus with us. Some trading partners dodge deserving criticism, while others get bashed.

As bad as the trade deficit numbers are, they will eventually turn around, once the world economy picks up and our economy slows down. The more troubling question is how far will they correct themselves and will these sectoral and country trends improve.

"My deepest worry is that current patterns will become the new base line," said Chimerine. Its a disturbing prospect.

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