Smith Faculty Opinion Article

By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

May 12, 2009

Trade Deficit Rise in March, Drags on Recovery

Today, the Commerce Department reported the March trade deficit was $27.6 billion, up from $26.1 billion in February.

The deficit with China increased to $15.6 billion in March from $14.2 billion in February, aided by increased export subsidies and an undervalued currency. The oil import bill rose to $14.1 billion in March from $13.7 the previous month.

In the months ahead, purchases from China and the cost of imported oil will head up. President Obama’s stimulus package and other budgetary initiatives will lift spending but do little to correct the structural forces causing the huge trade imbalance with China and on oil, the huge foreign borrowing necessary to finance it, and the drag all this creates on aggregate demand, GDP and employment.

At 2.4 percent of GDP, the trade deficit subtracts more from the demand for U.S. goods and services than President Obama’s stimulus package adds. Moreover, the lift from the Obama stimulus is temporary, whereas the drag from the trade deficit is permanent.

The huge trade deficit indicates Americans spend much more abroad than foreigners spend in the United States, consume too much more than they produce, and borrow too much from the rest of the world, especially China and the Middle East oil exporters.

Simply, money spent on Middle East oil, Chinese televisions and coffee markers, and Japanese and Korean cars can’t be spent on U.S. made goods and services, unless offset by a comparable amount of exports. This creates an enormous shortage in demand for U.S.-made goods and services and is the primary reason the economy needs huge stimulus spending and huge budget deficits to keep it going. Along with the banking crisis, the trade deficit could push unemployment above 10 percent for a long time.

As stimulus packages in the United States, China and elsewhere lift the global economy, the U.S. oil import bill will increase as oil prices and demand rise, and the undervalued Chinese yuan and beefed up subsidies on exports will push Chinese consumer goods and unemployment into the U.S. market. As the stimulus spending winds down, more Americans will be pushed out of good paying jobs with benefits into poorly paying positions without benefits, and be left to charity to obtain health care.

Another stimulus package and even larger budget deficits will be required. That will require even more borrowing from China and Middle East royals and further indenture our children.

If Congress enacts further stimulus spending to keep unemployment below 8 or 10 percent, the trade deficit will exceed 5 or 6 percent of GDP and foreign borrowing could spin out of control. Deficit driven prosperity can only continue as long as foreign investors are willing to add, each year, hundreds of billions to their huge holdings of dollar denominated securities, and there is no guarantee that financing will be forthcoming.

If President Obama continues to ignore the trade deficit and paint those who see this threat to prosperity as protectionist, his policies to pull America out of recession and avert economic decline will result in a temporary economic boom in 2010 but ultimately fail when the stimulus spending is through. This will renew the cycle of bubble and collapse—this time with the government doing the borrowing.

The economy’s most fundamental structural problems are the destructive consequences of Chinese protectionism, dependence on foreign oil and dysfunctional management at U.S. money center banks. The President either fails to see these threats or lacks the courage to address them.

Together, the trade deficit with China and on oil and automotive products account for virtually the entire deficit on trade on goods and services and are simply bankrupting the country. The trade deficit with China is largely caused by an artificially undervalued yuan and Chinese protectionism. Excessive oil imports are caused by dysfunctional energy policies. The automotive deficit is exacerbated by past management’s missteps, a labor agreement with the UAW more suited to Chaplin’s Modern Times than the global competitive landscape, and Japan’s undervalued yen.

The centerpiece of President Obama’s energy policy, a tax on CO2 emissions, would make the situation much worse by encouraging more manufacturing to move to China and increasing U.S. dependence on the Middle Kingdom for both consumer goods and to finance U.S. trade and budget deficits. President Obama’s energy policies will finish what Chinese and Japanese mercantilism began—the wholesale destruction of U.S. manufacturing and the middle-class wages it supported.

Correcting the trade deficit would lift the economy much more effectively and permanently than budget busting stimulus spending. Sadly, President Obama, after promising to address trade during his campaign, has ignored the issue since his inauguration. Instead, he offers policies that will make the situation worse.

To finance the trade deficit, Americans are borrowing and selling assets at a pace of about $300 billion a year. U.S. foreign debt exceeds $6.5 trillion, and the debt service comes to nearly $2,000 a year for every working American.

The trade deficit imposes a significant tax on GDP growth by moving workers from export and import-competing industries to other sectors of the economy. This reduces labor productivity, research and development (R&D) spending, and important investments in human capital.

In 2009 the trade deficit is slicing $400 billion to $600 billion off GDP, and longer term, it reduces potential annual GDP growth to 3 percent from 4 percent.

U.S. import-competing and export industries spend three-times the national average on industrial R&D. Productivity is at least 50 percent higher in industries that export and compete with imports, and reducing the trade deficit and moving workers into these industries would increase GDP.

Manufacturers are particularly hard hit by this subsidized competition. Through recession and recovery, the manufacturing sector has lost 5.2 million jobs since 2000. Following the pattern of past economic expansions, the manufacturing sector should have regained about 2.6 million of those jobs, especially given the very strong productivity growth accomplished in durable goods and throughout manufacturing during the expansion.

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 $10000 per worker.

Had the Administration and the Congress acted responsibly to reduce the deficit, American workers would be much better off, tax revenues would be much larger, less stimulus spending would be required, and the federal deficit could be significantly reduced.

Although, President Obama promised to take such steps to curb the trade deficit during the campaign, those steps have been opposed by Wall Street, which is heavily represented among White House and Treasury political appointees. Politics and patronage seem to be getting in the way of sound economic and prudent budget policies.

The damage grows larger each month the President ignores the corrosive consequences of the trade deficit.

President Obama’s broken campaign promises are punishing the economy and American workers.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.