Are Trade Deficits Bad for Long-Term Growth?

Like most economists, I’ve been trained to believe that running a trade deficit is not an indication of economic sin, and running a trade surplus is not an indication of economic virtue. Indeed, I’ve written at various times about the virtue of running a trade deficit, if the foreign borrowing was used to fund investment.

Well, I’ve been changing my views about trade deficits, and the latest European financial crisis just brings me further along those lines. It’s not Greece that troubles me, it’s Spain and Germany.  A few years ago, Spain was the darling of investors and economists. Spain was running a trade deficit, yes, but it was vibrant and growing. From 1995 to 2005, real per capita GDP in Spain grew at an excellent 2.8% annual rate.

By contrast, real per capita GDP growth in Germany poked around at an annual 1.2% rate from 1995 to 2005. Wrote one 2006 paper from the Centre for European Policy Studies:

Germany and Italy have been the laggards in terms of growth since the start of EMU in 1999.

However,  Germany did have one advantage —it ran trade surpluses where Spain ran trade deficits. In fact, the gap between Germany’s surpluses and Spain’s deficits widened over time, even though Spain had stronger growth.

If it turns out that Spain runs into a financial crisis because of all its external debt–accumulated during the good years–then we will have to go back and ask whether that growth was sustainable and real.

And the same thing goes for the U.S. The U.S. had strong per capita GDP growth and a big trade deficit, and then was hit by a massive financial crisis. Score one for the trade deficit as a more accurate signal.

More to come on this topic.


  1. But is the problem a trade deficit or a government budget deficit? Suppose a country is a net importer of capital because its economic growth potential is awesome and the government balances its budget at whatever level of spending its citizens think desirable. Will that lead to ruin? I don’t think so. I think you need government deficits as well for a country to get itself into serious trouble. Otherwise, if a crisis hits, foreigners just take a lower return on their investment for awhile, but that’s not a big deal.

  2. It is this kind of simplistic analysis that gives many economists a bad name. The experiences of Spain and Germany were entangled with so many different variables that trying to reduce causation to just trade deficits is ludicrous. Another mistake you make is that you simply assume a trade deficit means piling up debt, when it’s equally likely that “deficit” was paid out in investments or equity. Oil billionaires re-invested heavily into American markets: one of the theories I’ve read explaining the extremely low volatility in the market pre-recession was that all that Middle East money flowing in kept real estate and equity prices stable and rising. Finally, debt is a magnifier, creditors simply let you bet more on your decisions, allowing you to bet much bigger on good ideas while magnifying the consequences of bad bets. All the current hand-wringing about the evils of debt is simplistic moralizing that doesn’t understand this basic truth. It is as though a drunk driver plowed into a kid and then people started moralizing about how we should ban cars?! What nonsense.

    • CompEng says:

      Maybe, but people aren’t only irrational, they’re predictably irrational. If you give people extra room to hang themselves, many will. But if you make people pay up front, it’s amazing the fiscal discipline they develop.

    • So the next step in your argument is that we should ban cars, right? Why should we let people drive when so many people are getting killed in auto accidents every year? Saying people are predictably irrational is a meaningless statement if you can’t describe how exactly that “predictability” manifests itself. If they are so predictable, it would be easy to make money off that predictability yet I don’t see that happening. I agree that people are more frugal with their own money, but most debts have to be paid off too: not everybody declares bankruptcy and most suffer the consequences of their bad decisions and debts. Hamstringing those who know how to use debt because of the irresponsible actions of a foolish minority that lives beyond their means is a silly response.

      • CompEng says:

        What did I argue for? Nothing. I only stated the results of easy money were predictable: people buying stupid stuff and going into debt. Is that precise enough? And credit card companies *are* making money off of that. To avoid the problem of not getting paid back, credit card companies have been lobbying to change bankruptcy laws to make sure bankruptcy is hard to claim and their debt is high on the list (reasonably enough).

        Most of America’s consumer culture is built on trying to tease people into pushing the bounds of what they can afford. Should that be illegal? No. But it’s unethical.

    • You didn’t argue for a specific policy but you make the same behaviorist arguments that those who want more regulation make, even though they usually have no idea what the details of those regulations should be. I think easy money goes both ways, if somebody tells you your house is worth double what you paid for it just 3 years ago and offers to make you a loan with an exploding interest rate, it’s up to you to smell something fishy and refuse such a loan. Worse, many home owners lied about their salaries on their mortgage applications, yet many whiners only want to talk about the cases where the lenders misled the homeowners. As for whether the stuff they bought was stupid, I agree that it mostly was, but that’s up to them to decide. My car analogy was chosen for a specific reason: a car is a powerful tool, just like debt. Some people are going to misuse it, but their stupidity doesn’t damn the tool. Nobody holds a gun to anyone’s head and forces them to use a credit card. I believe the bankruptcy reform you’re referring to already passed 5 years ago (although maybe you’re referring to further pending reform?), I see no indication that it was a bad law. From what I read, it was far too easy to declare bankruptcy in the past and shed your debts, I like that they tightened that up. I agree that most consumer marketing is conceived to whip up material lust, but I don’t see anything unethical about that. Brazen and short-sighted perhaps, but as always it’s up to the consumer to have some self-control and you cannot regulate your way to that goal.

    • Finally, we’re completely in agreement, CompEng. 😀

    • Oh, just remembered that there was a good EconTalk where they talked about the benefits of that 2005 bankruptcy reform, among other credit-related issues.

      • CompEng says:

        I found that a bit hard to read because of the format, but otherwise good. If the synopsis is correct, then I don’t have a problem with the legislation. The main problem I have with credit card debt rules as I currently understand them is they would allow you to borrow a bunch of money at say 8% interest, and then the interest rate on the money you already borrowed could be raised dramatically in a fairly quick and arbitrary fashion.
        That’s never been a problem for me because I tend to pay the cards off very quickly, but I could see that being a problem in some instances.

      • Without knowing the details of exactly how those contracts are structured, I believe that’s because credit card debt is an extremely short-term loan, so as they roll the debt over, they sometimes change the rates to reflect the current credit market. A credit card is not a long-term loan, even though many people treat it as such, so I don’t see any problem with changing rates. Other credit card companies can always pay off your debt and transfer it to a new card with them, so as long as that competition is available, rates should reflect market conditions.

  3. gregorylent says:

    what all grandmothers say, you can’t spend more than you earn .. there is a reason for this “folk wisdom”

  4. Maybe it is time to stop talking about growth without talking about population growth and age distribution and workforce growth.

    Even our corporations, as holders of nearly $1 trillion in cash, seem to be acting like old folks who are more inclined to live conservatively on their accumulated wealth than taking risks on innovative ideas.

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