The trade deficit really matters

In today’s Washington Post, columnist Bob Samuelson declares the end of Keynesian economics. He points out that stimulating the economy with deficit spending to create jobs works fine when debt levels are low but not so well when they are high and the new deficits threaten already shaky credit ratings. Although Bob and I have jousted with each other on globalization and industrial policy issues over the years , I think he is exactly correct on this point.

But this brings us back to the issue of the trade deficit and industrial policy and their impact on economic growth, jobs, wages, and standard of living. For a very long time Anglo-American economists have been contending that employment and wage levels have nothing to do with trade deficits or surpluses. This has not been so much the case with Asian and German economists who are more favorably disposed toward export led growth strategies and broad industrial policies. But virtually all the top U.S. and British economists have held that trade deficits and unemployment are not linked because new jobs can always be created by use of stimulatory deficit spending. However, if, as Samuelson rightly argues, deficit spending has lost its punch or even become impossible, then trade deficits and surpluses come very much back into the picture.

Indeed, a glance at the statistics at the back of each edition of The Economist tells the story. Most of the countries with low unemployment and strong GDP growth rates also have trade surpluses while those suffering high unemployment and low growth also have trade deficits.

Moreover, recent developments make it clear that this tendency is likely only to be reinforced in the future. All of Asia and most of Latin America have long been committed to export led growth, and the hope that China might shift its emphasis to greater domestic consumption is being dimmed by recent reports that China not only is not going to allow the yuan to strengthen but may actually be encouraging it to weaken as Chinese growth rates diminish. Even more significant, however, is the fact that the EU has also effectively adopted the German export led growth strategy. This is true even of Britain which, though not a part of the eurozone, has nevertheless been putting great emphasis on exports as the only path to growth in light of its rigorously austere fiscal policies aimed at getting the national debt under control.

For the United States, this situation presents both an opportunity and a challenge. The opportunity lies in the size of the $500 billion U.S. trade deficit. Just halving it would create 2.5 million jobs without the need for tax reductions, further deficit spending, or further quantitative easing. Indeed, taxes could even be raised without fear of job loss. President Obama should see this as a Godsend. He can have his cake and eat it as well by increasing jobs and reducing the federal budget deficit.

To do so, however, he must face up to the challenge which is the need to adopt a new trade and globalization policy. It would not be a protectionist policy because it would continue to fulfill all of America’s international treaty obligations. But it would emphasize not only the need to export but also the desirability of finding or developing domestic sources of supply wherever competitively possible. It would actively enforce trade agreements and counter the market distortions arising from the currency manipulation, investment incentives, value added tax, and buy national policies of U.S. economic partners. In other words, it would be a kind of "tough love " free trade policy aimed explicitly at reducing the U.S. trade deficit and stimulating U.S. job creation.

The first step would be to change the President’s present objective of doubling U.S. exports to a new objective of halving the trade deficit. In this way, the United States would be entering the same post-Keynesian world as its trading partners.