The Truth About Trade Deficits
For centuries, the mercantilist perspective has had an unfortunately persuasive voice in policy discussions centering on international trade. Essentially economic nationalism, mercantilism ruled yesteryear’s economy with its advocacy of low imports and high exports to retain a competitive advantage in the war-like international market of zero-sums(Ewert, 1996).
Although now infrequently championed under the title of mercantilism, this philosophy lingers in the popular fear of trade deficits. Many are led to believe that a deficit in trade exists when one nation imports more than it exports, leading to a preference for more “balanced trade” over free trade. The natural consequence of this misplaced fear is the doctrine of protectionism which, like its mercantilist forbearer, advocates strict economic protection of domestic producers from ghoulish international competitors.
However, open markets lead to natural balances without the need of government intervention or harmful protectionism. Thus, rather than a threat to the vitality of the American economy, the perceived trade deficit is factually a misinterpretation of international markets and a flawed justification for truly harmful protectionist policies.
Trade Deficits – The Perceived Problem
The balance of trade argument primarily contends that trade is a battleground where the United States must remain competitive so that America never becomes a “debtor nation” (Ewert 1987, para 3). The argument suggests that if the United States continues in a pattern of importing more physical goods than it exports, then the nation becomes dependent upon other nations and ends in a net loss.
This trade deficit is particularly manifested in the statistic that foreign investments in the American economy surpass American investments in foreign markets. (Ewert 1987, para. 3). Perceived as particularly menacing because of the belief that over-investment in foreign markets lowers domestic production and job creation, the trade deficit problem is a popular villain.
As Mises explains, the trade deficit argument quickly criminalizes the “unpatriotic consumption habits” of private individuals who must be curbed by benevolent government officials who better know how dollars ought to be spent in the interest of domestic prosperity (Mises 1967, 199). If these “unpatriotic” habits are permitted to perpetuate, then jobs and manufacturing processes will cease to exist in the United States and, to survive, Americans will have to entirely rely upon foreign nations.
Unconvinced, Mises argues that these policies are truly oriented to avoid government culpability for inflation and to divert the blame for rising prices on luxury-crazed consumers (193). Mises, and other like-minded thinkers, has further qualms with the trade deficit argument because of the solution that is often offered – protectionism.
Protectionism – The True Problem
The logical solution to the perceived trade deficit problem is to use government force to lower imports and increase exports. This protectionism endeavors to shield domestic producers from competition and to ensure that desired industries remain in business within the United States. However, to achieve that end, the government coercively prevents individuals from accessing desired markets abroad. Such a direct intervention into the economic decisions of private individuals is a violation of the rule of law as well as a threat to the ordering power of unfettered markets.
Thus, these means are not only illegitimate but, as Mises explains, they are also ineffective as citizens consume domestically and consequently drive up domestic prices for goods that are in artificially high demand (1969, 193). If these goods were previously exported to foreign markets, higher domestic prices will likely remove the incentive to sell them abroad and thus lessen the valued export rate.
Similarly, Mises warns that forced and artificial reduction of imports accordingly diminishes the spending power of foreign nations on American products. Thus, already reduced exports are further curbed as foreign consumers lack the capital needed to purchase those American exports that successfully enter the international market (Mises 1969, 193). As such, protectionist policies intended to balance trade actually decrease the exports they are intended to encourage.
Additionally, protectionism harms the foreign nations that mercantilist, balance of trade, and protectionist arguments tend to ignore. As Mises reminds, foreign trade involves multiple parties that all benefit from the exchange and when said exchanges are altered or halted, the standard of living necessarily decreases in the nations whose trade has been restricted (1969, 193). Thus, Mises and others advocate free trade, not balance of trade, as the proper economic persuasion.
Free Trade – The Proper Solution
As W.M. Curtiss explains, free markets completely avoid both favorable and unfavorable balances by simply striking a balance (1996, 36). Open markets will naturally discover the optimum level of foreign trade as both visible and invisible goods are voluntarily exchanged (Curtiss 1996, 37).
This perspective also recognizes the “invisible” elements, including travel and money, which are ignored by deficit arguments that generally only consider physical goods (Curtis 1996, 37). With this in mind, free market perspectives recognize that capital flows are the oft-ignored other side of a nation’s total transactions (Polleit 2005, para. 6). These capital flows, when unfettered by government intervention, also contribute to a natural balancing of voluntary international exchanges.
These voluntary exchanges are, rather than warlike, generally amicable as all concerned parties agree to the terms and outcomes of a particular trade. As Curtiss elaborates, “If you’re out of gas, you don’t feel hostile toward the person who sells you some” (1996, 37). The assumptions behind balance of trade policies ignore the fact that sometimes individual American consumers import the proverbial gas and, at other times, they export it. Such a process is both natural and expected.
With all of this in mind, it is clear that the trade deficit argument, and the proposed protectionist solution, reflects an illegitimate and improper understanding of international trade. As such, as David Hume powerfully argues, the “strong jealousy with regard to the balance of trade” and according fear that “[wealth] may be leaving” is a “groundless apprehension” not unlike a concern that “all…springs and rivers should be exhausted.” (1742, para. 4). Truly, just as rain replenishes the water supply, unhindered “people and industry” replenish the market (1742, para 4).
About The Author:
The above was written by Leah Stiles, a student of government and history at Regent University. She has completed a Koch leadership program and an internship with the Foundation for Economic Education.
Curtiss, W.M. (1996). The Tariff Idea. Irvington-on-Hudson, NY: Foundation for Economic Education.
Ewert, Ken C. (November, 1987). “The Trade Deficit” in The Freeman 37:11.
Hume, David. (1742). On The Balance of Trade.
Mises, Ludwig von. (1967). “On the International Monetary Problem” in Economic Freedom and Intervention: An Anthology of Articles and Essays edited by Bettina Bien Greaves.
Mises, Ludwig von. (1969). Interview with Professor Percy L. Greaves in Economic Freedom and Intervention: An Anthology of Articles and Essays edited by Bettina Bien Greaves.
Polleit, Thorsten. (November, 2004). “The Trade Deficit: An Austrian Perspective” in Mises Daily.