How to correct the US trade deficit?

One of the most notable facts of the US economy in recent years lies in the accelerated growth of the trade deficit, caused by the disproportionate increase in imports. This dizzying growth in purchases made by the United States from the rest of the world seems to have no brake; Hence, this phenomenon threatens to become a serious problem for the normal functioning of this economy.

American public opinion and protectionist discourse attribute this accelerated growth in foreign product inflows to the United States to the hypothetical subsidies granted by China and other countries to its exporters, as well as to the extremely low wages observed in these nations; in such a way that, according to them, the fundamental cause of the impressive growth of imports made by the United States lies in the "unfair competition" that other countries carry out in order to place their products in the North American market.

But why foreign companies are eager to place their products in the United States ? Quite simply, it is the market with the highest purchasing power on the planet: 300 million people with one of the highest average incomes in the world; which means that, in this market, marketing and sales determine that the perceived profits are much higher compared to other nations. This immense purchasing power allows the United States to reach very high import figures.

United States GDP per capita PPP

So, really, why does this sharp increase in US purchases of foreign products appear ? Without a doubt, this was the result of the simultaneous, almost fortuitous manifestation of some factors. As we can see, the explosive growth of the US trade deficit begins during the first half of the previous decade. ¿ Which is what happened in those years?

At that time the Clinton Administration ended with an excellent performance in economic matters attributed to the growth driven by the rise of the telecommunications sector and the digital economy, but which, when assuming the Bush Administration, shows signs of cooling; So this government is forced to look for innovative mechanisms that increase aggregate demand since traditional monetary and fiscal tools have lost effectiveness. This is how the Bush Administration achieves the necessary political agreements for the Federal Reserve to establish extremely low interest rate schemes: thus, the application of low real interest rates appears as an economic policy measure .

The rates low real interest rates boosted largely, growth in aggregate demand, but best of all was that this was non - inflationary growth, as the economy was on its level of potential output. While traditional economic policy tools allowed growth to be achieved accompanied by uncomfortable increases in the prices of goods and services, now, low real interest rates provided what seemed impossible: growth with inflation rates of around 5%, even when the economy was above its level of potential product.

Having, in the economy, low real interest rates is an economic absurdity. The facts that make it possible for industrialized countries to turn an economic absurdity into a successful economic policy were the presence of an extremely efficient and adequately supervised financial system and the existence of an overvalued dollar . Even so, the economic crisis of 2008 appears due to the application of low real interest rates in an inefficient and poorly supervised branch of the US financial system.

Indeed, an overvalued dollar allows you to import all the amount of goods needed to contain inflation that could generate an expansive economic policy. Thus, the massive imports made by the United States since approximately 2004 stopped the inflationary pressures created by such an unusual way of doing economic policy.

Thus, the excessive growth of US foreign purchases cannot be attributed to the "harmful voracity of foreign companies" but to the urgent need to drain the excess aggregate demand generated by the application of a policy of real interest rates casualties during the Bush Administration and then continued by the Obama Administration. The application of such a bold policy was not a mere whim but an urgent need given the obsolescence of traditional economic policy instruments along with the cooling of "autonomous" growth generated by the push of the telecommunications sector and the digital economy.
Go to: George W. Bush administration economic policy - Wikipedia
With the Trump Administration, the policy of low real interest rates disappears , but is replaced by another policy of expansion of aggregate demand, such as the reduction of taxes to the business sector. Therefore, the push is maintained for US economic agents to acquire foreign goods. However, since the pressure exerted by the tax reduction, unlike the scheme of low real interest rates , disappears over time, it is possible that the reduction we are currently observing in the value of imports is not the result of the application of successive batteries of tariff increases, but to a reduction in the influence exerted by aggregate demand.

Therefore, if we wanted to reduce the US trade deficit, based on the above, we would have to start by proposing measures that reduce imports or increase the value of exports.

If what is desired is to reduce the volume of imports, it is not recommended to apply measures of massive tariff increases since the effectiveness of this policy has not been proven, it has only been verified that the tariff increases applied in a particular economic sector reduce the volume of imports in that particular sector.

It is clear that the volume of external purchases can only be reduced using two ways, both aimed at decreasing the purchasing power of the population. The first is to reduce the pressure exerted by greater aggregate demand and the second refers to depreciating the value of the currency, or what is the same, reducing the overvaluation of the currency. Both are unpopular measures because they create unemployment or introduce cost inflation into the economy. As we can see, appealing to the decrease in imports as a tool aimed at improving the trade deficit implies assuming a huge political cost.

The presence of an overvalued dollar , although it favors the arrival of foreign products to the North American market, at the same time, greatly hinders the exit of North American products to foreign markets. On the other hand, the huge difference between the US purchasing power and the purchasing power of other countries in the world represents another factor that discourages the export of goods by the United States.

At first glance it seems that, while the capital account of the United States receives large resources from the rest of the world and the public external debt along with the private external debt grows steadily, we must forget to increase exports, given that these resources are abundant Monetary are the cause of the overvaluation of the dollar. In any case, a strategy of substantial increase in exports and eradication of the trade deficit must be located within a fairly long timeline, such as 10 years.

Any project to increase exports that is applied in the United States must start from a notorious fact, such as the rupture between the global value chains and the North American value chains. Obviously, American production systems have very little interaction with global production chains because the evolution of the former was absolutely autonomous and independent, so much so that its origins date back to the early 19th century.

The integration of the North American productive system with the global value chains means that each of the components of the system will import intermediate goods, add a level of added value to it and then export it as an intermediate good to another country where the process will continue productive. In this operation there will be an increase in exports and an increase in imports, where the former will always exceed the latter. For every process like this one that takes place in the United States, the trade deficit will be reduced by a very small fraction; if the volume of these operations becomes larger then the trade deficit will be significantly reduced and; If these giant operations are carried out within a prolonged period of time, then we will have eradicated the US trade deficit.

The integration of North American production systems into global value chains can be carried out through the application of tax incentives and through tariff exemptions, that is, any foreign product that has a certain level of North American added value could be duty-free.

The great difference between the costs managed by the global value chains and the costs generated by the North American productive system stands as the most important obstacle that intervenes between the coupling of these two productive platforms. However, we believe that the high productivity of the US production system, the tax incentives that apply, as well as the tariff exemptions, will grant sufficient advantage to the North American productive apparatus to allow it to overcome the obstacles that stand in the way.

Perhaps the protectionist discourse would not have gained such force if the leadership in the matter of North American imports had not been occupied by China. If the distribution of the origin of these imports had been more equitable, analysts would have quickly noticed that the root of the problem is within the United States and not outside it. But, as China led North American imports, the hypothesis immediately emerged that the United States was the victim of Asian predatory behavior. So why does China lead US foreign purchases ?

In the late 70s and early 80s the "formal" Chinese communism ends with more than 100 million people able to work completely excluded from linking with any productive process. In the next two decades, Asian reformists manage to attract investors and incorporate, little by little, all that human mass into daily productive activity. In this way, China manages to increase its product and exports its goods based on low price strategies. At the same time, it manages to increase the added value of these goods, although without being able to match its peers in Korea and Japan.

China Foreign Direct Investment

In such a way that, at the time of applying the scheme of low real interest rates in the United States , China struggled to have a presence in the international markets of products because neither China nor other countries dared to make a gigantic expansion of its demand added. China was not only able to meet the voracious US demand but could do so by offering fairly low prices. In conclusion, we have that the economic policies implemented by the Bush Administration and the Obama Administration did not produce a substantial increase in the US economy but stimulated China's economic growth. Indeed, it is in the long period of Chinese growth where, for the first time in modern history, we observe that an economy is growing continuously at annual rates that exceed 7%.

China GDP Annual Growth Rate