Wanna save the economy? Cut the trade deficit

The U.S. Commerce Department reported that the 2005 current-account trade deficit was $804.9 billion, up from $668.1 billion in 2004. The current account is the broadest measure of the U.S. trade balance. In addition to trade in goods and services, it includes income received from U.S. investments abroad, less payments to foreigners on their investments in the United States.

In the fourth quarter, the current-account deficit was $224.9 billion, up from $185.4 billion in the third quarter. In the fourth quarter, the current-account deficit exceeded 7 percent of gross domestic product.

The current-account deficit could easily top $1 trillion a year by the second half of 2006.

Separately, the Commerce Department reported that retail sales fell 1.3 percent in February, indicating that the consumer pullback is beginning.

The combination of slower-growing consumer spending and a widening trade gap will dampen economic growth by mid-year. Real GDP growth will probably grow at about a 3.8-percent annual rate in the first half, and 3.3 percent in the second.

Slower second-half growth will hit Ford and General Motors particularly hard. Consumers will become more value conscious in vehicle selection, and this will play into the strengths of Asian, especially Korean, brands. Ford and GM are not well positioned with attractive smaller and reliable vehicles in the value segments of the market. Among the offshore brands, Mazda is best positioned.

In 2005, the United States had a $1.6 billion surplus on income flows, and a $58 billion surplus on trade in services. Together, these were hardly enough to offset the massive $781.6 billion deficit on trade in goods.

In 2005, the deficit on petroleum products was $229.2 billion, up from $163.4 billion in 2004. Prices for imported petroleum rose about 36 percent from 2004, while the volume of imports fell 2 percent.

The American appetite for inexpensive imported cars and other consumer goods was a huge factor in driving up the trade deficit. In 2005, the deficit on non-petroleum goods was $537.2 billion, up from $487.6 billion in 2004. Imports of motor-vehicle parts increased 10 percent, to $83 billion, as Ford and GM continued to push their procurement offshore and cede market share to Korean and Japanese companies offering better-made and less-expensive-to-own vehicles. Even when Asian automakers assemble automobiles in the United States, they import more parts than do Ford and GM.

The Wal-Mart effect was broadly apparent. In 2005, the trade deficit with China was $201.7 billion _ a new record _ up from $162 billion in 2004. This situation is likely to become worse in the months ahead.

Crude-oil prices are rising again, and an overvalued dollar continues to keep imported cars and other consumer goods cheap. Announced production cutbacks at GM and Ford will result in more imports of motor vehicles and parts.

Meanwhile, the dollar remains at least 40 percent overvalued against the Chinese yuan and other Asian currencies. China continues to peg its currency against the dollar. Although in July China revalued the yuan from 8.28 to 8.11 to the dollar, and announced that it would adjust the currency to a basket of currencies, the yuan continues to track the dollar very closely. Currently, it is trading at 8.05.

Other Asian governments conform their currency policies to China’s, lest they lose competitiveness in U.S. and European markets. To sustain undervalued currencies against the dollar, foreign governments purchased $220.7 billion in U.S. securities. This created an 11-percent subsidy on their exports to the United States.

High and rising trade deficits tax economic growth. Specifically, each dollar spent on imports that is not matched by a dollar of exports reduces domestic demand and employment, and shifts workers into activities in which productivity is lower. Productivity is at least 50 percent higher in industries that export and compete with imports; reducing the trade deficit and moving workers into these industries would increase the GDP.

Were the trade deficit cut in half, the GDP would increase by nearly $300 billion, or about $2,000 for every working American.

Workers’ wages would not be lagging inflation, and ordinary Americans would more easily find jobs with good wages and decent benefits. Manufacturers are particularly hard hit by this subsidized competition.

Through recession and recovery, the manufacturing sector has lost 3 million jobs. Following the pattern of past economic recoveries, the manufacturing sector should have regained about 2 million of these jobs, especially given the strong productivity growth in durable goods and throughout manufacturing.

In the longer term, persistent U.S. trade deficits are a substantial drag on growth. U.S. import-competing and export industries spend three times the national average on industrial research and development, and encourage more investments in skills and education than do 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. Halving the trade deficit would boost U.S. GDP growth by 25 percent a year.

These effects of lost growth are cumulative. Thanks to the record trade deficits under President Bush, the U.S. economy is about $1 trillion smaller. This comes to nearly $7,000 per worker. Had the administration and Congress acted to reduce the deficit, American workers would be much better off, tax revenues would be much larger, and the federal deficit would be about half its current size.

Were the trade deficit cut in half, $2,000 would be recouped, but $5,000 per worker in lost growth is essentially lost forever. The damage grows larger each month, as the Bush administration and Congress ignore the corrosiveness of the trade deficit.

(Peter Morici, an occasional contributor, is a professor at the University of Maryland’s Robert H. Smith School of Business. E-mail pmorici(at)rhsmith.umd.edu.)