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America’s chronic trade deficit contin-ues to set new records,both for its sheersize in nominal terms and for its share of an expanding gross national product.Therecord deficit is fueling worry that it couldhurt U.S.industry,destroy jobs,burdenfuture generations,and cause the currenteconomic expansion to end in a “hardlanding.”But those worries rest on a fun-damental misunderstanding of the causesand consequences of the U.S.trade deficit.In November 2000 the congressionally appointed Trade Deficit Review Commis-sion issued its final report,
The U.S.Trade Deficit:Causes,Consequences and Recom-mendations for Action
.The report reflectedthe views of a sharply divided commission, with Democratic-appointed members warning of the dangers of the deficit whileRepublican-appointed members empha-sized its more benign nature.Economic theory and experiencedemonstrate that trade deficits are drivenprimarily by macroeconomic factors,inparticular investment flows,and not by allegedly unfair trade barriers or decliningindustrial competitiveness.Because of the link between tradedeficits and rising investment,larger tradedeficits are typically accompanied by improving economic conditions.A survey of the U.S.economy since 1973 confirmsthat,by almost any measure—economicgrowth,employment,industrial production,poverty reduction—the economy has per-formed better in years in which the tradedeficit rose than in years in which it shrank.America’s annual trade deficits are sus-tainable as long as the United Statesremains a safe and profitable destinationfor the world’s savings.The accumulatingnet foreign ownership of U.S.assets,America’s so-called foreign debt,does notthreaten our sovereignty,our ability tofinance that investment,or continued eco-nomic expansion. The best policy response for the new administration and Congress would be toignore the U.S.trade deficit as a target of policy and concentrate instead on main-taining a strong and open domestic econo-my that welcomes foreign investment.
 America’s Record Trade Deficit 
 A Symbol ofEconomic Strength
by Daniel T.Griswold
February 9,2001No.12
Daniel T.Griswold is associate director ofthe Cato Institute’s Center for Trade Policy Studies.
Executive Summary 
 
Introduction
America’s chronic trade deficit continues toset new records,month after month,year after year,not only for its sheer size in nominal dollarsbut for its share of an expanding gross domesticproduct.The large and growing gap betweenhow much we import and how much we exportcontinues to fuel anxiety among policymakers,economic commentators,and critics of Ameri-can trade policy.But those worries rest on a fun-damental misunderstanding of the causes andconsequences of the U.S.trade deficit. There is no dispute that the U.S.tradedeficit has reached record territory.Althoughthe United States has run a trade deficit every  year since 1975,those deficits have reached anunprecedented level as the expansion of the1990s stretches into a new decade.If currenttrade trends continue,the United States willrun a deficit on goods and services of more than$360 billion in the year 2000.
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 That’s up a thirdfrom the record deficit of $264 billion in 1999,and more than double the deficit of 1998.As ashare of GDP,in 2000 the trade deficit willprobably set a record of 3.6 percent,topping theprevious record set in 1987 (Figure 1). Trade skeptics,a majority of Americans,and a surprising number of trade journalistsbelieve that a trade deficit of such magnitudecan be only bad news.They assume that thetrade deficit imposes a drag on growth and anet loss of jobs,because of either lost exportopportunities or rising imports that displacedomestic production.During the debate in2000 over granting permanent normal traderelations (PNTR) to China,for example,opponents claimed that the deal would expandAmerica’s bilateral trade deficit with China andcost as many as 1 million jobs in the U.S.econ-omy during the next decade.Immediate worries about the trade deficithave been compounded by more long-termconcerns that the deficit is “unsustainable.”Critics of the trade deficit warn that chronicand growing deficits will burden future gener-ations with a crushing “foreign debt,”leaveAmerica vulnerable to foreign pressure,andundermine foreign investor confidence in theUnited States,triggering capital flight,a down- ward spiral of the dollar,and a “hard landing”for the economy.In 1998 those and other concerns prompt-ed Congress to appropriate $2 mil-lion to establish and fund the TradeDeficit Review Commission with amandate “to study the nature,caus-es,and consequences of the UnitedStates merchandise trade and cur-rent account deficits.”
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 The 12-member panel of private citizens,half appointed by the Democraticleadership and half by theRepublican leadership in Congress,heard testimony in Washingtonandaround the country from eco-nomic experts,business and laborleaders,and other witnesses on thealleged causes and consequences of the deficit.The commission issuedits final report on November 14,2000. The Trade Deficit Review Commission’s report was really twostarkly contrasting documents be-
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-4.0%-3.5%-3.0%-2.5%-2.0%-1.5%-1.0%-0.5%0.0%19801982198419861988199019921994199619982000 (est.)
Figure 1America’s Trade Deficits, 1980–2000
Source: U.S. Department of Commerce,
Survey of Current Business
80, no. 7 (July 2000): 88–89.
   D  e   f   i  c   i   t  a  s  a   P  e  r  c  e  n   t  a  g  e  o   f   G   D   P
 
neath one cover—one authored by theRepublican-appointed members,the other by the Democratic-appointed members of thecommission.The Democratic side concludedthat the trade deficit poses a threat to the U.S.economy,both immediately and in the longrun.The Republican side,while agreeing thatlarge and growing deficits cannot continueindefinitely,concluded that the deficit reflectsmore benign developments in the U.S.econo-my such as relatively strong growth and risinglevels of investment.How policymakers view the deficit willhave important implications for U.S.trade pol-icy.If they accept the view that the deficit posesa real danger to the U.S.economy,they will bemore inclined to impose new trade barriers inan effort to curb imports,and less inclined tosupport new trade agreements that would openmarkets both at home and abroad.If they accept the view that the deficit is not a realdanger,they will be more inclined to pursuefurther reductions in trade barriers to stimulateglobal trade. The new Congress and administration will face political pressure to do something to“fix”the trade deficit.Although the tradedeficit was not a major issue during the fallcampaign,both the Republican and theDemocratic parties cited it as a problem intheir 2000 campaign platforms.With powerin Congress almost evenly divided betweenthe two parties,the trade deficit could be amajor part of the trade policy debate.As anarticle in
CQ Weekly
concluded,“The nextpresident may need to address this tradedeficit with the same urgency that compelledhis predecessors to tackle the budget deficit.”
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 Widespread misunderstanding aboutAmerica’s trade deficit tilts the political playingfield against further trade liberalization andtoward harmful fixes that could include erect-ing barriers to imports.If new regional or mul-tilateral trade agreements are negotiated duringthe 107th Congress,opponents of expandingtrade will likely raise the same charges they have in the past about the impact of bilateraldeficits and the overall deficit on jobs,industry,and the economy.
Back to Basics on the Trade Deficit 
Evaluating claims about the consequencesof the trade deficit requires an understandingof its causes.Not surprisingly,the two factionsof the Trade Deficit Review Commission cameto widely differing conclusions about the caus-es of the persistent U.S.trade deficit.TheDemocratic-appointed members contendedthat the deficit is caused primarily by hightrade barriers abroad,predatory import pricing,declining competitiveness of core U.S.indus-tries,and low wages and poor working condi-tions in less-developed countries.The Republican-appointed members explained the deficit as theresult of macroeconomic factors in the U.S.economy—specifically levels of national sav-ings,investment,and economic growth—andexchange rate movements.Economic theory and experience weighheavily in favor of the explanation that tradedeficits are driven primarily by macroeconom-ic factors,in particular investment flows,andnot by allegedly unfair trade barriers or declin-ing industrial competitiveness.Nations that arenet recipients of foreign investment will runcurrent account deficits,while nations that arenet investors in the rest of the world will runsurpluses.(The current account is the broadestmeasure of international trade,includinggoods,services,income from internationalinvestments,and unilateral transfers such asforeign aid and private remittances.The tradedeficit includes only trade in goods and ser- vices.For the United States,the two figures arecurrently about equal in magnitude,and forpurposes of this discussion the terms will beused interchangeably.) The underlying cause of the U.S.tradedeficit is the fact that domestic savings in theUnited States is insufficient to fund all theavailable domestic investment opportunities.Any savings gap is filled by a net inflow of for-eign investment.Those foreign funds allow Americans to buy more than we sell in theinternational market for goods and services,resulting in a trade deficit.As long as the pool
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 The new Congressand administration will face political pressure to dosomething to “fix”the trade deficit.
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