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Driving Up Debt and Dragging Down Growth
Today, the Commerce Department reported the February deficit on trade in goods and services was $62.3 billion. This was up from $59.0 billion in January and about 5.3 percent of GDP. The deficit was pushed higher by rising prices from many industrial supplies and materials and increased imports of consumer goods.
The deficit on trade in goods was $72.9 billion in February, up from $69.4 billion in January, while the surplus on services increased to $10.6 billion in February from $10.5 billion the previous month.
The weaker dollar against the euro, yen and other currencies of other market economies has boosted exports. U.S. manufacturers and exportable services compete head to head with many European Union industries, and the weaker dollar improves price competitiveness of U.S. products.
However, the dollar remains stubbornly strong against the yen and the currencies of other Asian mercantilists, because their governments intervene aggressively in currency markets to frustrate market forces, subsidize exports and maintain artificial cost advantages. For example, the blooming Chinese and Indian automobile industries would struggle with much more import competition if their currencies were fairly valued, tariffs were as low as those in North America and Europe and bureaucratic barriers to foreign auto sales were removed. Coffee exports from Nova Scotia would make sense with a trade regime like that on java beans.
The average price for imported petroleum rose to $84.76 per barrel in February from $84.09 in January. The trade deficit on petroleum decreased to $31.4 billion in February from $35.8 billion in January, because the volume of imports receded from 420 million barrels in January to 367 million in February. In March, import volumes should rebound, prices should continue to rise, and the petroleum deficit will rise again.
The stubbornly large trade deficit heightens the risk of recession. The deficit subtracts about $250 billion from GDP, and that amount could double if the economy slips into a prolonged recession. In addition, it has saddled the economy with a $6.5 trillion debt to foreign governments and investors.
China accounted for $18.4 billion of the February trade deficit, down from $20.3 billion in January. February is usually a slack month for bilateral trade with China, and this deficit should rise again in March. U.S. imports from China exceed exports by a ratio of four to one, because China undervalues the yuan, and this makes Chinese exports artificially inexpensive and U.S. products too expensive in China. In addition, China maintains much higher import tariffs and restrictive barriers on imports than the United States on most products.
China revalued the yuan from 8.28 to 8.11 in July 2005 and has permitted the yuan to rise about 6 percent every twelve months. Modernization and productivity advances raise the implicit value of the yuan more than 6 percent every 12 months, and the yuan remains undervalued against the dollar by 40 to 50 percent.
China’s huge trade surplus creates an excess demand for yuan on global currency markets; however, to limit appreciation of the yuan against the dollar and drive its value down against the euro, the Peoples Bank of China sells yuan and buys dollars, euros and other currencies on foreign exchange markets.
In 2007, the Chinese government purchased $462 billion in U.S. and other foreign currency and securities. This comes to about 14 percent of China’s GDP and about 44 percent of its exports. These purchases provide foreign consumers with 3.5 trillion yuan to purchase Chinese exports, and create a 44 percent "off budget" subsidy on foreign sales of Chinese products, and an even larger implicit tariff on Chinese imports.
In addition, China provides numerous tax incentives and rebates, and low interest loans, to encourage exports and replace imports with domestic products. These practices clearly violate China’s obligations in the WTO, and it agreed to remove those when it joined the trade body.
Driving Up Debt and Dragging Down Growth
Trade deficits must be financed by foreigners investing in the U.S. economy or Americans borrowing money abroad. Direct investments in the United States provide only about a tenth of the needed funds, and Americans borrow about $50 billion each month. The total debt is about $6.5 trillion, and at five percent interest, the debt service comes to about $2000 per U.S. worker each year.
High and rising trade deficits tax economic growth. Each dollar spent on imports, not matched by a dollar of exports, shifts workers into activities in non-trade competing industries like department stores and restaurants.
Manufacturers are particularly hard hit by this subsidized competition. Through recession and recovery, the manufacturing sector has lost 3.7 million jobs since 2000. Following the pattern of past economic recoveries, the manufacturing sector should have regained more than 2 million of those jobs, especially given the very strong productivity growth accomplished in technology-intensive durable goods industries.
Productivity is at least 50 percent higher in industries that export and compete with imports. By reducing the demand for high-skill and technology-intensive products, and U.S. made goods and services, the deficit reduces GDP by about $250 billion a year or about $1750 for each worker.
Longer-term, persistent U.S. trade deficits are a substantial drag on growth. U.S. import-competing and export industries spend at least three-times the national average on industrial R&D, and encourage more investments in skills and education than other sectors of the economy. By shifting employment away from trade-competing industries, the trade deficit reduces U.S. investments in new methods and products, and skilled labor.
Cutting the trade deficit in half would boost U.S. GDP growth by one percentage point a year, and the trade deficits of the last two decades have reduced U.S. growth by one percentage point a year.
Lost growth is cumulative. Thanks to the record trade deficits accumulated over the last 10 years, the U.S. economy is about $1.5 trillion smaller. This comes to about $10,000 per worker.
The damage grows larger each month, as the Bush administration dallies and ignores the corrosive consequences of the trade deficit.
PETER MORICI is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.