One of the worst effects of modern Keynesian economics is that its aggregate demand (total spending) approach to output and employment provides a pseudo-scientific justification for the central fallacy of mercantilism, which dates back to the 16th century. According to this ancient myth a deficit in a nation’s balance of payments results in its loss of demand, income, and jobs. This fallacious doctrine has been demolished time and again by economists during the past two-and-a-half centuries. Yet like the Phoenix it continually arises from its own ashes.
A few weeks ago the Commerce Department reported that the U.S. trade deficit increased to $47.2 billion in April from $44.2 billion the previous month. This $3 billion increase brought forth the usual dire warnings of economic doom from our Keynesian neo-mercantilists. Dean Baker co-director of the the Center for Economic Policy Research, for example, wrote:
To remind folks who never suffered through a [Keynesian] intro course or forgot their suffering, a trade deficit means that demand generated in the United States is going overseas. Money spent by businesses or consumers is going for goods and services produced in Europe, Mexico, and China rather than in the United States. . . . A larger trade deficit has the same implications for the economy as a sudden cutback in consumer spending or business investment. It means less demand and fewer jobs.
But Baker is not content to seize on this small blip in monthly trade balance figures as an opportunity to regurgitate this discredited mercantilist dogma for the billionth time. Using some statistical legerdemain, he goes on to project dire effects fro this development on the U.S. labor market:
Data from a single month are erratic, but the average trade deficit over the three months fro February to April was running at an $85 higher annual rate than the trade deficit of the prior three months. This means, other things equal, $85 billion more of the demand generated in the United States would be creating growth and jobs in other countries rather than in the United States. This loss of demand would translate into roughly 700,000 jobs. This is the result of having consumers and businesses switch their spending from domestically produced items to goods and services that we get from other countries.
First, by annualizing and averaging the monthly data, Baker is obscuring the fact that the deficit for February-April actually averaged only $21.25 billion higher than the previous three months and that he is extrapolating these data 9 months into the future. Furthermore, by comparing the size of the deficit during the past three months to the previous three months Baker is cherry picking the periods he is comparing to make a projection that is at odds with the recent historical movement in the trade deficit. In fact if we take the two-year period from the end of 2011 to the end of 2013, we get a very different picture: the trade deficit has fallen continually with one slight interruption, from a quarterly rate of over $140 billion to under $120 billion, meaning that over the past two calendar years the average annual trade deficit has declined by over $40 billion.
Second, and more to the point, even if the trend projected by Baker is realized, other things equal, it would not cause any net loss in jobs whatever. What our neo-mercantilists fail to realize is that every dollar in excess of U.S. exports that is spent by U.S. residents on imports of goods and services is spent by foreigners on the purchase of U.S. assets, i.e., invested in U.S. stocks, bonds, bank deposits, real estate, physical capital. (Actually a small portion of these net dollars earned by foreign exporters are used to pay interest and dividends owed to U.S. residents who own foreign assets.)
In other words, not a dollar of “spending” leaves the U.S. as a result of the trade deficit. Checking deposits in U.S. banks are merely transferred from U.S. importers to foreign exporters. These dollar deposits are then transferred back to U.S. residents by their foreign owners in exchange for U.S. assets (or to pay interest and dividends owed to U.S. owners of foreign assets). The dollars that are invested in U.S. assets by foreigners are ultimately spent on goods and services because they are either invested in U.S. businesses via financial markets and institutions or are invested directly in the U.S. subsidiaries of foreign firms .
In either case, the firms use these funds to pay wages, purchase physical capital goods and software, invest in R&D, etc. The only effect on the labor market of a trade deficit is therefore a redirection of workers from U.S. export industries to industries producing capital and consumption goods for domestic use.
