Intro. [Recording date: April 22, 2025.]
Russ Roberts: Today’s date is April 22nd, 2025, and I’m joined by economist and author Doug Irwin from Dartmouth College, where he holds the John French Professorship in economics. Our discussion today revolves around tariffs, trade, trade deficits, and the rather tumultuous climate we find ourselves in. Of course, by the time this airs, the landscape could look entirely different, so we’ll focus on the fundamentals. My goal is to provide a primer for listeners, dispelling some of the common misconceptions that seem to be floating around. That said, I suspect we’ll eventually dive into the specifics of the current moment.
Doug last appeared on EconTalk back in October 2010, where we conversed about the Great Depression and the gold standard—an episode I highly recommend. Doug, it’s wonderful to have you back on EconTalk.
Doug Irwin: Thanks for having me. It’s great to be here.
Russ Roberts: Let’s kick things off with trade deficits. What does it mean when a country experiences a trade deficit? How do we define a trade deficit?
Doug Irwin: A trade deficit occurs when a country imports more than it exports to the rest of the globe. That raises a myriad of questions, but that’s the essential definition.
Sometimes this is referred to as a current account deficit because it encompasses more than just merchandise; it also includes services and other related factors.
Russ Roberts: In the case of the United States, I want to touch on a couple of examples that are frequently discussed these days. The U.S. runs a trade deficit not just with the world as a whole but also with many individual countries of varying magnitudes, all of which collectively contribute to the total trade deficit. What does this imply? Let’s start by exploring why a country might have a trade deficit with the entire world.
Doug Irwin: There are various perspectives on this. One way to consider it—though it may sound a bit tedious—is through the lens of the Balance of Payments. If we import more than we export, we’re sending more dollars abroad to pay for those goods. Typically, these dollars don’t just remain overseas; they tend to return to the U.S. Instead of purchasing American goods, they are often used to acquire U.S. assets.
So, it’s quite insightful to see that we are not just exporting goods but also assets, and that helps balance out what we’re importing from the rest of the world.
Russ Roberts: True, some of those dollars are used for buying American goods and services, but not all of them. These dollars are split between purchasing American products and investing in American assets. When you factor in the asset position, it tends to create a balance.
There’s a bit of complexity regarding currency here. Would you like to elaborate on that?
Doug Irwin: Not particularly, as I believe it’s a rather minor point. However, you’re spot on. In my book, Free Trade Under Fire, I update this calculation periodically. For every dollar we send abroad to import foreign products, about 75 cents comes back to purchase U.S. goods or services, while 25 cents goes toward acquiring U.S. assets. So, while a dollar goes out, a dollar also returns; it’s merely a matter of how it’s allocated between buying domestic goods and services versus U.S. assets.
Russ Roberts: And regarding the currency aspect, which we’ll set aside for now, it’s a bit of a red herring. The United States often serves as a reserve currency for many nations globally, providing a liquid form of purchasing power.
Russ Roberts: If I’m not mistaken, the United States runs a surplus in services compared to the rest of the world. Is that correct?
Doug Irwin: Yes, that’s absolutely correct. This surplus has been growing over time and is quite substantial. While it doesn’t completely offset the merchandise goods deficit, it reflects the fact that the U.S. is predominantly a service economy. We excel in various services—architectural, construction, financial—and the rest of the world purchases these services from us.
So yes, we are a net exporter of services.
Russ Roberts: Additionally, we’re a net exporter of investment opportunities. The U.S. maintains a capital account surplus, signifying that the United States is a more appealing destination for global investment compared to what American investors find attractive abroad.
In net terms, the rest of the world is investing more in the United States than the U.S. is investing overseas. This capital account surplus, while a somewhat misleading term regarding financing—since it doesn’t literally equate to how you and I finance our purchases—serves as the counterpart to the deficit in goods and services, correct?
Doug Irwin: Exactly. You articulated that very well. I also concur with you regarding the financing aspect: the U.S. situation is unique because the dollar is the world’s reserve currency. People are keen to invest here; we offer safe assets, like Treasury Notes, and have a robust stock market. In comparison to other nations, our capital market is rich, deep, and liquid, presenting a safe haven with excellent returns for foreign investors.
Russ Roberts: You mentioned the stock market is doing quite well historically, on average.
Doug Irwin: That’s correct. [inaudible 00:06:09]—
Russ Roberts: Although it’s been a rough month—we’re recording this in April. Perhaps we’ll delve into that later.
Nevertheless, the U.S. is quite an attractive investment locale. On one hand, the U.S. runs a capital account surplus, meaning foreigners invest significantly more in the U.S. than Americans invest abroad. Conversely, the U.S. imports more goods and services than it exports.
Russ Roberts: Is there anything inherently good or bad about either of these situations? Do they provide insights into the overall health of the economy?
Doug Irwin: Not particularly. Let me reference an author we both admire, Adam Smith, who famously stated that nothing is more absurd than the doctrine of the balance of trade—either as a gauge for winning or losing from trade or as a cause for concern. I also recall a memorable phrase from the Wall Street Journal Editorial Page, which suggested, ‘The best way to think about the trade deficit is not to think about it.’
To put it simply, sometimes when I explain this to my students, I say: if the government didn’t release economic statistics, would you know if we were experiencing inflation? Absolutely. You’d see it every time you visited the grocery store. If we were in a recession, would you be aware? Certainly; you’d witness job losses around you, potentially even for yourself. But if we’re running a trade surplus or deficit, would you notice? No, that’s more abstract. It doesn’t directly affect you.
While there may be instances where countries should be concerned about it, I believe that in the U.S. context, with the dollar being the reserve currency, it generally isn’t something that warrants significant worry.
Russ Roberts: I want to revisit that idea of worrying about it, but first, I want to make a historical observation. Both of us have spent considerable time in these discussions, and at one point, I stopped tweeting altogether because people were asking, ‘Don’t you have anything to say about it?’ Yes, I’ve written perhaps 100,000 words or even 500,000 on the topic. Feel free to look it up; I’d be happy to share it.
I genuinely believed this debate was settled. I recall back in 2006, when EconTalk began, I had the privilege of interviewing Milton Friedman. I emphasized how great it was that economics had taught society that price controls are detrimental. He countered, ‘Oh no, it wasn’t economics that led people to oppose price controls.’ He elaborated that the reason people stopped supporting price controls was due to their lived experiences—like enduring long lines for gasoline, a direct outcome of price controls. He noted that as those individuals pass away, new generations might start to ponder: perhaps we should consider price controls on increasingly expensive items.
So, it turns out economics didn’t resolve this. I naively thought that economists had successfully educated the world about tariffs and trade deficits, but it appears the situation is more nuanced.
Now, returning to our earlier discussion, many critics invoke Adam Smith and respond with, ‘Well, Adam Smith.’ Or ‘David Ricardo. They lived hundreds of years ago. Their theories have been debunked; they’re outdated.’ What these critics fail to realize is that Adam Smith crafted a significant portion of The Wealth of Nations to challenge those known as mercantilists, who were preoccupied with the outflow of dollars from their country—in his case, England. Ironically, the mercantilist doctrine, which I consider flawed, can be traced back as far as the 1200s. So, if we’re going to dismiss doctrines based on their age, it’s worth noting that mercantilism is even more ancient than Smith’s trade theories.
Doug Irwin: I don’t believe Smith is outdated in any meaningful way. I find every time I pull The Wealth of Nations from my shelf, I discover new insights. It’s remarkable how much wisdom he packed into that work. Here’s a man who, despite lacking the Internet and having limited exposure to the world, understood so much and provided such brilliant interpretations. His insights remain highly relevant across various dimensions today.
Russ Roberts: I want to revisit a phrase you used earlier: ‘The dollars come back.’ Americans purchase goods from abroad, and in turn, foreigners possess dollars. As you mentioned, they go on to spend these dollars on both American goods and services as well as on investment opportunities—acquiring assets. This dynamic is complex.
Many argue, ‘If we’re running a trade deficit, we’re obviously giving foreigners more money than they’re giving us.’
As we’ve clarified, that’s not entirely accurate. This viewpoint oversimplifies the concept of ‘giving dollars’ by excluding the investment dimension.
Now, let’s consider a hypothetical: what if those dollars didn’t return? Imagine foreigners selling us cars and various products, and in exchange, we sent them dollars. If they decided to frame the dollars as decorative wallpaper and never utilized them to purchase American goods or invest in U.S. assets, would that spell trouble for America? We’d be bolstering their economy without receiving any stimulation in return. How unfair!
Doug Irwin: In such a scenario, we would essentially be printing worthless pieces of paper; they’d be providing us goods in exchange for something that holds no future claim on our assets or goods. These dollars might simply circulate overseas. In fact, a significant number of dollars are already in circulation globally; for instance, in Latin American countries like Argentina, dollars circulate because the local currency is viewed with skepticism. However, relative to the annual flows, I think the situation isn’t as drastic. Ultimately, it’s not inherently problematic if they don’t redeem those dollars for claims on U.S. goods, services, or assets.
Russ Roberts: But isn’t it unjust? We’re stimulating their economy while they’re not reciprocating for ours.
Doug Irwin: Not unjust. They’re assisting us by selling goods at reasonable prices to consumers eager to purchase them. Thus, I’d argue it’s a win-win situation.
Russ Roberts: Will this lead to fewer jobs?
Doug Irwin: There’s a book that should be on your reading list, The Choice. This delves into the larger issue of manufacturing and related topics. Presently, the unemployment rate in the United States hovers around 4%, historically low and near what we consider full employment. Remarkably, we have a significant trade deficit.
If you analyze the correlation between the unemployment rate and imports as a share of GDP, you’ll find a negative correlation. As the unemployment rate decreases, imports as a percentage of GDP increase because we’re buying more; the economy is thriving. Conversely, it’s during periods of rising unemployment that imports as a share of GDP decline. Therefore, imports aren’t detracting from jobs at the macroeconomic level; the correlation suggests otherwise.
Russ Roberts: Economics teaches us that trade doesn’t fundamentally alter the total number of jobs. In the short run, it can certainly affect specific industries, especially during trade disruptions or sudden shifts in international economic relations. However, in the broader sense, trade impacts the type of jobs available rather than the quantity of jobs. That said, transitions can be challenging. Some workers may face competition from foreign entities, similar to how technological innovations can lead to reduced worker demand in certain sectors. This might be a topic we revisit.
Nevertheless, the changes brought about by trade are, on average, beneficial for the country. They contribute to overall wealth, albeit not for every individual. It’s important not to overlook that many people can experience hardships stemming from industry shifts due to trade competition or technological innovation. Thus, a nation must decide how to cushion, or not, these transitions. However, as you pointed out, over the past 50 to 75 years, the U.S. has generally enjoyed a dynamic and healthy labor market, alongside a rising standard of living. Some industries have undoubtedly suffered due to foreign competition, while others have innovated to reduce costs and enhance product quality. It’s a complex narrative.
Yet, the notion that if foreigners don’t spend money here, we’ll experience job losses because those jobs aren’t stimulating the economy is fundamentally flawed. This misconception fails to grasp what dollars accomplish. The idea that we must retain our money within the country is a grave fallacy. Our concern isn’t the number of currency notes in circulation; it’s about what those dollars can purchase. Should a nation isolate itself from trade, it will likely face inflated costs for desired goods, resulting in fewer options. While it might maintain full employment, it would also experience a diminished standard of living.
Doug Irwin: Indeed. If I could offer a minor qualification or footnote, it could serve as a slight defense of mercantilism. In our previous episode, we discussed the gold standard and the Great Depression. Mercantilists reacted to the notion that the money supply was dependent on gold reserves. An outflow of gold could lead to deflation, which might not bode well for the economy in the short term. Milton Friedman introduced the idea that with flexible exchange rates, such concerns could be alleviated, paving the way for an independent monetary policy.
Thus, I believe the case for free trade is actually more compelling in the post-World War II era due to Friedman’s advocacy for flexible exchange rates, compared to the rigidity imposed by a gold standard, which often hinders responses to various economic shocks. It’s a monetary rule that can at times feel like a straitjacket.
[More to come, 17:05]
