Many Americans fear an increasing U.S. deficit and believe it will ultimately lead to economic crisis. The facts, however, may surprise you.

By the most basic measure of economic performance—the change in real gross domestic product (GDP)—the U.S. economy performs best when current account deficits (which largely consist of the trade deficit) are high.

To be more precise, in those years since 1980, when the current account deficit declined as a share of GDP, the economy grew by an annual average of 1.9 percent. But in those years in which the current account deficit grew moderately, real GDP grew at an annual average of 3 percent.

More astonishingly yet, in those years when the trade deficit most rapidly “deteriorated,” to borrow another popular characterization, real GDP grew by a robust annual average of 4.4 percent. In other words, growth in those years was more than twice as strong as in years when the deficit was “improving.” What’s more, in four of the five best years of U.S. economic growth since 1980, the U.S. current account deficit grew most rapidly.

Manufacturing Not Hurt by Deficits

The same pattern emerges in the U.S. manufacturing sector. Nevertheless, conventional wisdom says trade deficits hurt manufacturing because imports presumably displace domestic production.

But the plain evidence from the past quarter century contradicts this presumption. Thus, U.S. manufacturing output actually declined slightly, on average, in those years in which the U.S. current account deficit shrank. In contrast, GDP grew by 4.1 percent during the years when the current account deficit grew moderately—and by a brisk 5.3 percent when the deficit grew rapidly.

In fact, in five of the six years where U.S. manufacturing output declined, the current account deficit declined.

Employment Not Hurt by Deficits

The pattern also applies in the politically sensitive area of employment. Again, the conventional wisdom holds that a trade deficit destroys jobs by supposedly shipping them overseas. But once again, the evidence suggests something quite different. In years with an “improving” U.S. current account deficit, the U.S. unemployment rate, on average, jumped by 0.8 percentage points.

In years when the deficit moderately “worsened,” the unemployment rate fell by an average of 0.2 percentage points. And in years when the deficit grew most rapidly, the unemployment rate fell by an even larger average of 0.7 percentage points.

Indeed, in seven of the eight years in which the U.S. current account deficit “improved,” the U.S. unemployment rate went up. And in 13 of the 16 years in which the current account deficit “worsened,” the unemployment rate went down.

2004 Not Hurt by the Deficit

The year 2004 also appears to fit the pattern. For example, through the first three quarters of the year, January through September, the current account deficit averaged 5.5 percent of GDP, a 0.6 percentage point shift in the negative direction from 2003.

That would place 2004 somewhere between a moderate and rapid growth of the current account deficit. Befitting the pattern, economic performance in 2004 also was moderate to robust. Real GDP grew an average annual rate of 4.4 percent last year, while manufacturing output grew 4.9 percent during the year and the unemployment rate dropped by 0.3 percentage points during the full year.

In 2004, as in previous years, a rising U.S. current account deficit may have been bad news to headline writers, but it appears to have accompanied good news for the U.S. economy, its factories—and its workers.

Drawing Various Conclusions

Still, we need to be careful about which conclusions to draw from these findings. For example, the evidence does not suggest that expanding U.S. trade deficits cause superior economic performance.

More plausibly, causation runs the other direction. An expanding U.S. economy fuels demand by American consumers and producers to buy more imports as well as domestically produced goods and services. Rising U.S. domestic output, in turn, attracts the foreign investment that finances an expanding U.S. current account deficit.

In contrast, mslowing U.S. domestic demand not only depresses U.S. output and employment growth, but also lessens demand for imports and the inflow of foreign investment. In addition to the uncertain causality, the evidence also does not address the question of how persistent and rising current account deficits may affect the U.S. economy in the long run.

Misperceptions Can Result in Poor Policy Recommendations

The “sustainability” of the U.S. current account deficit has been much debated among the experts. But whatever negative impact the deficit may have in the long run, there is no evidence that it poses a drag on the economy in the short run.

Why does all this matter? The answer is simple. Misperceptions about the U.S. trade deficit and the economy can tempt U.S. policymakers to “do something” about the deficit to show that they are concerned.

But chances are that overeager politicians would only hurt economic growth. The most obvious example of such a scenario would be if the U.S. Congress were to raise barriers to imports in the mistaken belief that protectionism would cut the trade deficit and spur the economy.

But even if higher trade barriers could somehow trim the U.S. trade deficit, there is simply no evidence that such a policy goal would deliver faster growth in GDP, manufacturing and employment.

This article appeared in Impact Analysis, March-April 2005.
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Daniel Griswold
About The Author Daniel Griswold [Full Bio]
Daniel Griswold is senior research fellow and co-director of the Program on the American Economy and Globalization at the Mercatus Center.




www.mercatus.org


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