Dr. Maurice Obstfeld, in his insightful article for the Peterson Institute for International Economics (PIIE), tackles the popular but misguided notion that trade deficits require “management,” a sentiment echoed by figures like Michael Pettis. Obstfeld succinctly dismantles these claims, shedding light on both theoretical and empirical shortcomings. I would like to add my own observations to his robust analysis.
Before diving in, let’s clarify a key distinction: the trade balance (the gap between exports and imports) differs from the current account (which includes exports, imports, and other financial transactions, such as income from investments). However, for our purposes, this distinction is less critical; the essence of my argument remains the same. Now, let’s proceed.
In the realm of national income accounting, the current account reflects the difference between national savings and national investment. For those who enjoy a bit of algebra, here’s the formula:
Current Account = Savings – Investment.
This equation, while seemingly straightforward, masks a complex reality. If one believes that a current account deficit—where investment exceeds savings—is inherently problematic (a premise I will contest shortly), the solution appears simple: boost savings or cut back on investment. Just like that, the issue is resolved, right?
But let’s get real for a moment. What can governments realistically do? I emphasize “realistically” because proposals often float around that are utterly disconnected from practical implementation. The truth is, governments have limited control over the major determinants of savings and investment. Unlike an individual balancing a checkbook, national savings and investment are influenced by a multitude of external factors: the aspirations of domestic and foreign citizens, corporate strategies, and countless other elements. In essence, savings and investment are emergent phenomena, not mere dials that can be adjusted at will. It’s not merely challenging to manage these variables; it is fundamentally impossible. Beneath that seemingly simple accounting identity lies a labyrinth of complexities.
Certainly, governments can exert some influence over national savings, which comprises both private and public savings. By opting for a balanced budget (avoiding deficit spending), a government could theoretically help mitigate the current account deficit. However, as Obstfeld points out, this strategy has its limitations. Moreover, governments have attempted to sway private savings and investments through incentives and capital controls, but these incentives often lack the persuasive power of mind control—they don’t always yield the desired results and can lead to unintended consequences.
Now, let’s address the underlying assumption that a current account deficit is inherently negative. This notion couldn’t be further from the truth. Trade deficits often signal positive developments, as noted by Robert Carbaugh, an economics professor at Central Washington University:
Countries experiencing rapid economic growth frequently sustain long-term current account deficits, while those with sluggish growth tend to show long-term current account surpluses. This relationship likely stems from the connection between robust economic growth and substantial investment. Innovative breakthroughs, resource discoveries, or economic reforms often fuel rapid growth, leading to lucrative investment opportunities. When a country’s national savings fall short of financing these ventures, it turns to foreign savings, resulting in a net financial inflow and a corresponding current account deficit. As long as these investments yield profits, they will generate the necessary returns to honor the commitments made for their funding. Consequently, when current account deficits are driven by sound, profitable investment strategies, they contribute positively to output and employment growth rather than hindering it. (International Economics, 18th ed, pg 302, emphasis in original).
Current account deficits are not inherently detrimental when they are a reflection of fruitful investment opportunities, as seen in the United States. This is why the U.S. has successfully maintained current account deficits for over four decades, often setting new records in industrial production and maintaining its status as a global productivity leader. However, this could shift under the strain of policies like Trump’s trade war. If businesses relocate to the U.S. primarily to sidestep tariffs, this suggests they find operating domestically less profitable than abroad. Thus, trade deficits arising from such trade tensions are cause for concern.
