In a simple John Adams’ world, trade deficit is wealth transfer, since it means one country is buying more than it sells. However, we live in a complex, globalized world where the official “trade balance” — exports minus imports, defined as deficit or surplus — fails to capture the intricacies of modern trade and economy.
Let’s start with a simple example of China buying soybeans from the US. The soybeans are grown in American soil by an American corporation/farmer who uses American (Monsanto) seeds and American fertilizers/pesticides. If China spends $1 billion on soybeans, almost all of that money goes to and stays in America. In such simple situations, the official trade numbers are accurate.
Complex Cases Make Trade Deficit Meaningless
BUT … imagine two million iPhones coming from China to the US in a huge ship. The US commerce department will consider that a “trade deficit” of about $1 billion. But those are American smartphones with numerous expensive parts from Japan, Taiwan, South Korea etc. and were simply assembled in China. Thus when Apple signs a check for $1 billion, China gets to keep only 5% or $50 million!!
Look at an iPhone 12. It costs about $400 to assemble. And here are the shares of various countries, based on the parts inside the phone.
And here’s the analysis for an older iPhone.
Even when we import electronics or computers made by Chinese brands — say Lenovo laptops, perhaps half of the cost goes towards parts from other countries.
Therefore, complex global supply chain systems make the official trade deficit meaningless in many situations.
When Trade Deficit Creates Profit
Let’s say Home Depot buys about $1 billion of goods from China, is it really awful for the US economy? No, since Home Depot can resell those goods for, probably, $4 billion. Home Depot is also a part of the Dow Jones Index, and therefore the stock market goes up, and a lot of people are happy.
Thus, in such scenarios, attempts to reduce trade deficit hurt American corporations and consumers.
Trade Deficit Ignores $$$$$$ from Overseas Operations
Think about how many stores there are in the world carrying the logos of Starbucks, McDonald’s, Burger King, KFC, GAP and hundreds of other US corporations.
Also, many firms such as GM, Ford, IBM, Boeing, Citibank etc. have numerous factories and branches all over the world.
All their profits — which have literally amounted to TRILLIONS OF DOLLARS over the years — belong to American corporations, but are ignored in the trade deficit/surplus calculations.
So when Trump says, “other countries have been ripping us off for decades, well, maybe the average American was ripped off, but the oligarchs and the industrialists profited like bandits from globalization!”
FDI and Other Investments
Chinese have spent hundreds of billions of dollars over the last few years buying homes in the US. Trade deficit considers money spent by tourists, but ignores investments by foreigners.
Similarly, when foreigners invest money in US corporations, it shows up as FDI (Foreign Direct Investment), but not in the trade deficit.
Foreigners Buying Our Debt
China owns $1.2 trillion of our debt. And foreigners, in general, hold $6 trillion of our debt. These are ignored in the trade balance statistics as well. (BTW, if we had zero trade deficit with China, they wouldn’t have US dollars to buy our treasuries/bonds.)
We need to update how we calculate trade balance, or we need a new metric that summarizes what really happens in the global economy. And we also need to distinguish situations where trade deficits are harmful versus beneficial.
Author: Chris Kanthan