AMERICA'S RECORD TRADE DEFICIT: A Reflection of Economic Strength.

• Author: GRISWORLD, DANIEL

AMERICA'S chronic trade deficit continues to set records, month after month, year after year, not only for its size, but for its share of an expanding gross domestic product (GDP). The large and growing gap between how much the U.S. imports and how much it exports continues to fuel anxiety among policymakers, economic commentators, and critics of American trade policy. However, those worries rest on a fundamental misunderstanding of the trade deficit's causes and consequences.

Although the U.S. has run a trade deficit every year since 1975, those deficits have reached an unprecedented level as the expansion of the 1990s stretches into a new decade. The U.S. ran a deficit on goods and services of more than $360,000,000,000 in 2000. That is up a third from the then-record deficit of $264,000,000,000 in 1999, and more than double the deficit of 1998.

Trade skeptics, a majority of Americans, and a surprising number of trade journalists believe that a trade deficit of such magnitude can be only bad news. They assume that the deficit imposes a drug on growth and a net loss of jobs, because of either lost export opportunities or rising imports that displace domestic production. During the debate in 2000 over granting permanent normal trade relations to China, for example, opponents predicted that the deal would expand America's bilateral trade deficit with China and cost as many as 1,000,000 jobs in the U.S. economy during the next decade.

Immediate worries about the trade deficit have been compounded by more long-term concerns that the deficit is unsustainable. Critics warn that chronic and growing deficits will burden future generations with a crashing foreign debt, leave America vulnerable to foreign pressure, and undermine foreign investor confidence in the U.S., triggering capital flight, a downward spiral of the dollar, and a "hard landing" for the economy.

In 1998, those and other concerns prompted Congress to appropriate $2,000,000 to establish and fund the Trade Deficit Review Commission with a mandate "to study the nature, causes, and consequences of the United States merchandise trade and current account deficits." The 12-member panel of private citizens, half appointed by the Democratic leadership and half by the Republican leadership in Congress, heard testimony in Washington and around the country from economic experts, business and labor leaders, and other witnesses on the alleged causes and consequences of the deficit. The commission issued its final report on Nov. 14, 2000.

The report was really two starkly contrasting documents beneath a single cover--one authored by the Republican-appointed members, the other by those appointed by the Democrats. The Democratic side concluded that the trade deficit poses a threat to the U.S. economy, both immediately and in the long run. The Republican side, while agreeing that large and growing deficits cannot continue indefinitely, concluded that the deficit reflects more positive developments in the U.S. economy, such as relatively strong growth and rising levels of investment.

How policymakers view the deficit will have important implications for U.S. trade policy. If they accept the view that it poses a real danger to the economy, they will be more inclined to impose new trade barriers in an effort to curb imports, and less inclined to support new trade agreements that would open markets at home and abroad. If they accept the view that the deficit is not a real danger, they will be more inclined to pursue further reductions in trade barriers to stimulate global trade.

Congress and the Bush Administration will face political pressure to do something to "fix" the trade deficit. Although it was not a major issue during the 2000 election campaign, both the Republican and Democratic parties cited it as a problem in their platforms. With power in Congress almost evenly divided between the two parties, the deficit could be a major part of the trade policy debate.

Widespread misunderstanding about America's trade deficit tilts the political playing field against further trade liberalization and toward harmful fixes that could include erecting barriers to imports. If new regional or multilateral trade agreements are negotiated during the 107th Congress, opponents of expanding trade will likely raise the same charges they have in the past about the impact of bilateral deficits and the overall trade deficit on jobs, industry, and the economy.

Evaluating claims about the consequences of the deficit requires an understanding of its causes. Not surprisingly, the two factions of the Trade Deficit Review Commission came to widely differing conclusions about the causes of the persistent U.S. trade deficit. The Democratic-appointed members contended that it is caused primarily by high trade barriers abroad, predatory import pricing, declining competitiveness of core U.S. industries and low wages and poor working conditions in less-developed countries. The Republican-appointed members explained the deficit as the result of macroeconomic factors in the U.S. economy--specifically levels of national savings, investment, and economic growth--and exchange rate movements.

Economic theory and experience weigh heavily in favor of the explanation that trade deficits are driven primarily by macroeconomic factors, in particular investment flows, and not by allegedly unfair trade barriers or declining...