Trade issues have become more salient for investors as the US seeks to redress the large and chronic trade deficit. In part, the issue turns on the size of the trade deficit. Much work has been done that suggests the shortfall may be not accurately measured. One of the knock-on consequences is that US savings may be undercounted as well.
There are joint and distributional gains from trade. That a rising tide lifts all boats (joint gains) is nice in theory but how those gains are distributed is critical in the competition among nations.
Within a country, trade exposes some sectors to competition, and there are some who gain and some who lose. The powers of the state were expected to help compensate those who lost, by job-retraining for example.
The Trump Administration is determined to address the large and chronic US trade deficit. Despite the dramatic ongoing improvement in the US energy trade balance, the overall trade balance is deteriorating. Many economists expect the fiscal stimulus to boost US demand for imported goods, even if there are market-opening measures that lift exports.
Top US trade officials argue that the distributional gains have not accrued to America as they should. Other countries are blocking the adjustment process in the foreign exchange market and are giving unfair subsidies and aid to their domestic businesses. The average tariff in the US is among the lowest in the world, but the US trade deficit may not be as large as the optics suggest.
In the early 1980s, when Reagan was President, the US would report the merchandise trade balance and later release the service balance. It is called balance, but the former was always in deficit and the latter consistently in surplus.
One way Reagan diffused calls for more strident protectionism was to have the two balances reported together. This had the effect of producing a smaller overall trade deficit. It made for good politics, and it offered a more accurate picture of US trade.
This anecdote illustrates the importance of how the trade balance is measured. The traditional metric was created when trade was mostly about raw materials and finished goods. One of the characteristics of what has become known as globalization is the intra-firm movement of goods at different stages of production, which has been made possible by modern techniques, enhanced command, control, and communication functions, and the drop in the cost of transportation. In 2015, intra-firm movement of goods and services accounted for 30% of US exports and 35% of US imports.
There have been numerous attempts to provide a more accurate picture of modern trade that 19th-century metrics simply cannot capture. For example, a few years ago the OECD launched a database the looked at trade on a value-added basis. Here is what it showed about the US and Chinese trade. A focus on the value-added activity would reduce the bilateral deficit by around a third (in 2009).
The US Bureau of Economic Analysis has been providing an ownership-based framework of the US current account for many years. The most recent estimate covers 2016 and is found in the January issue of the Survey of Current Business. It incorporates the income associated with local sales, i.e.,”direct investment income” is renamed “net receipts or payments of direct investment income resulting from sales by affiliates” to distinguish it from other types of (passive) income in the current account, such as royalties, licensing fees, and dividends.
When the adjustments are made, the ownership-based framework of the current account shows the US deficit for 2016 was about $246 bln compared with a $505 bln deficit under the traditional metric.
Several economists at the Bureau of Economic Analysis published a paper last year that argues the shifting of profits offshore by multinational corporations has depressed US GDP and productivity measures. Another consequence is that US exports are undercounted, and imports are overstated. It estimates that a little more than half of what the US counts as imports may actually be made in the US.
Due to the immediate circumstances after WWII, including the US acceptance of discriminatory trade practices to foster European and Japanese reconstruction and an overvalued dollar, US corporates pursued a direct investment strategy to service foreign demand. Sales by majority-owned affiliates of US corporations exceeded US exports since the government’s records began more than 50 years ago. In contrast, European companies, rely on exports. Japanese government data suggests it was not until the late 1990s that affiliate sales of Japanese companies exceeded Japanese exports.
I discussed some of these issues in my (2009) book, Making Sense of the Dollar: Exposing Dangerous Myths of Trade and Foreign Exchange. I suggested another implication of smaller US current account deficit. Given that the identity economists cite, a smaller current account deficit implies US savings are higher than often measured.
Not to belabor the point, but to suggest a couple of quick examples: Expenditures for higher education are considered consumption, not investment, and the capital gains of 401k retirement are not included in most definitions of savings. These are particularly important because of the household expenditures on higher education in the US and the extensive shift from defined benefits (pensions) to defined contributions (401k).