By Michael Stumo, CEO of CPA, and Jeff Ferry, Research Director
Some influential economists misleadingly assert that US trade deficits are caused by American households failing to save enough and also by federal budget deficits. Taking action against strategic foreign economic policies, their story continues, would be futile. This paper comprehensively disproves the savings rate argument, demonstrates how trade surplus country policies impact the US and recommends effective unilateral solutions.
Summary
Does America’s low savings rate cause trade deficits? Or do trade deficits cause a low savings rate? This working paper explains how to distinguish (a) causation from (b) mathematical interrelationships in the national income identity or equation that underlies this debate. For reasons explained below, real world changes (exogenous factors) outside the identity are the true causes. These real world changes directly impact one or more variables within the identity, transmitting through the equation by mathematical necessity. In short, national savings is related to the trade deficit in an accounting sense but does not cause it.
We further describe how policy or economic changes in trade surplus countries are transmitted to deficit countries. Becoming fluent in identifying true causation and the mechanisms of transmission is important for government officials to select US policy responses that will end global imbalances and domestic stagnation.
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There have been numerous avenues of legitimate critique advanced historically and the economics profession has rebuffed from them all. Keynes’ critique was attacked relentlessly and driven out at the first opportunity. Piketty’s recent book has brought about no earnest self-reflection. The discipline has not reworked the efficient market hypothesis in the wake of the collapse of the economy in 2007. Even something as benign as Hansen’s MAC has earned him a one way ticket to the fringe of his profession.
So, while I applaud the CPA for developing yet another valid line of critique, I also wish to remind you that the only reason anyone pays any attention whatsoever to your views is because Trump actually got elected.
Consequently, while in the short term the CPA’s brand of polite intellectual critique is a necessity; in the long term the organization needs to develop its own political strategy for developing a group of legislators committed to its historical project.
I have suggested repeatedly that the formulation of specific industrial policies is the most viable means of cultivating a distinct political presence. In response the CPA has ignored my views without having the intellectual honesty necessary to actually debate the subject. That seems to me to be a lot like the rest of the economics profession, which no longer even bothers to teach the history of its ideas.
First, the flow of money in its entirety is just one factor affecting the flow of history in general and trade in particular.
Second, money is not a physical object it is a social fact, or as the German philosopher Simmel put it in his book “The Philosophy of Money” it is the “ideal form of the tool.” If economists would preface everything they say by saying “ideally” this or that is the case and then go on to discuss why that was not what actually happened, they would be a lot more useful.
Third, if you wish to bring the U.S. trade deficit back into balance, tinkering with financial market mechanisms is no substitute for specific industrial policies.
In sum, if you wish to reason effectively with politicians it is most helpful to get rid of the disagreeable ones in the next election. One can form political coalitions around industrial policy (farm lobby anyone?). The public, to the contrary, has long since and justifiably so lost any faith in the psycho babble of economists.
Excellent work…especially this section: 7. SOLUTIONS TO REBALANCE TRADE
AND CAPITAL FLOWS
The US should first reject the false argument that
our low savings rate or fiscal deficits cause our own trade
deficits.
We also need to reject the view that free trade agreements
will fix our trade performance. They will not because
the causes of other country surpluses are so deeply
embedded in their domestic policies (exchange rate misalignment
and manipulation, wage suppression, a need
to continually increase employment, financial repression,
taxation differences) that trade agreements are ill equipped
to counter them.
The US strategy should focus upon utilizing our
own domestic laws and policies to stop absorbing surplus
countries’ oversupply. Germany, Japan and South Korea,
for example, do not import China’s surpluses and neither
should the US. What policy changes would accomplish
this?