The Mysterious US Trade Deficit
Pat Choate and Charles McMillon
Consider this. The World Economic Forum's 1996 Global
Competitiveness Report concludes -- again -- that the United States
economy is the world's most competitive. President Clinton
proclaimed in his February 4, 1997, State of the Union Address, "I'm
proud to say that today America is once again the most competitive
nation and the number-one exporter in the world." In the spring
of 1997, the Federal Reserve raised interest rates to slow an
economy with booming corporate profits, soaring stock prices, and
Yet, a peek behind the glitter of record stock prices and high
corporate profits reveals a deepening economic dry rot -- a nation
that is eating its seed corn and squandering its economic leadership
position, here and abroad, in the pursuit of short-term gains for a
few global firms. Though largely ignored, the facts are these: US
consumer debt ratios are at an historic high, sales are weak, wage
growth is flat, savings are low and US economic growth is anemic.
The world's economy is also slowing, with the weakest recovery on
record, but it is still growing far more rapidly than the U.S.
economy. This is a poor foundation on which to build a secure future
for the U.S. or the world.
Specifically, the US economic recovery of the past six years is
the weakest on record -- continuing at a rate barely half that of
the 1982-90 recovery and far less than half the rate of the 1960s.
The US productivity growth of the past four years -- that is, the
annual growth in all nonfarm output per hour of labor -- is only
0.22 percent or roughly 1/7th that of the 1980s; about 1/15th that
of the 1960s.
Perhaps most illuminating for the long-term future of the nation
and its businesses, the US seems unable to control its trade
deficits. Between 1991 and 1996, for example, the merchandise trade
deficit more than doubled. It went from a $74 billion deficit in
1991 to a $187 billion loss in 1996. For the period 1982-1996, the
total accumulated US trade deficit was $1.8 trillion.
Do these trade deficits matter? Of course, they do. While many
global firms owe much of their current good fortune and cost
advantages to cheap foreign sourcing and production, trade deficits
stunt the growth of the overall economy.
Trade is one of the four defining components of Gross Domestic
Product; the other components are personal consumption, gross
private investment and government spending. In 1996, for instance,
the net trade deficit ($114 billion) equaled a full 1.65 percent of
the Gross Domestic Product. Had the US trade accounts simply been in
balance, the 1996 growth rate would have been a robust 4.1 percent
rather than a weak 2.5 percent. The vital point is that a trade
deficit -- more outlays than receipts -- reduces, not expands, the
domestic market and domestic production.
Put into statistical context: But for our persistent and rising
trade deficits, the US economy would have high growth rates akin to
those of the booming 1960s. Indeed, today trade is largely providing
the reverse of its traditional "creative destructive"
function by now shifting resources out of highly productive, high
wage traded manufacturing sectors and into far less productive,
lower wage service sectors that do not face global competition.
Modern policies, together with today's fabulous new technologies,
could provide unprecedented growth and prosperity for the U.S. and
The obvious questions about all this are these:
If the US economy is so competitive and strong then;
- why have we run massive trade deficits for 36 out of the past
38 years even with growth generally far slower in the U.S. than in
the world economy?
- why do we now have the largest trade deficit in US history even
with the global exchange value of the dollar the weakest ever in
1995 -- and only slightly recovered today?
- why in 1996 did we have a US merchandise trade deficit with the
European Union of $15 billion, a $16 billion deficit with Mexico,
$23 billion with Canada, $39 billion with China, and $47 billion
- why do we have big deficits with Mexico and China, while Europe
and Japan have big surpluses with these same two nations?
- why do two of our principal competitors, Japan and Germany,
have massive trade surpluses year after year, business cycle after
business cycle -- more than $135 billion for Japan in 1996 and
more than $70 billion for Germany -- while we have massive trade
Again, the basic question is: Why are other nations -- though they
are supposedly far less technologically advanced, less productive or
less competitive than we are -- able to amass a $3.5 billion per
week trade surplus with us?
There is no single answer to these questions. Why? Because with
the end of the Cold War, the entry of more than one billion new
workers into the global labor market, and the unbounded global
pursuit of profits, capitalism has entered a new phase. It is a new
capitalism -- raw, dynamic and largely unregulated in a world
desperate for capital and jobs. It is competition where the speed of
today's information and transportation technology has abolished old
assumptions about the geographic location of state-of-the-art
production. It is a way of doing business where change is swift and
no job, no worker, no company, and no nation is safe. Most
important, it is a form of capitalism where the interests of the
global company and those of the nation-state are often in conflict.
Key Questions and Answers
The reality of a global capitalism where drugs, arms, investment,
piracy, political bribery, capital flows, protectionism, and
traditional commerce often mix, often by the same people, is brought
into sharp relief by three questions.
The first is: Why does the United States have a $3.5 billion per
week merchandise trade deficit?
Second: how do other nations maintain their trade surpluses,
sometimes certainly at their own expense, but often at US expense?
Third: can the US build a prosperous and peaceful future by moving
its productive capacity to other nations and undermining its most
highly productive working consumers?
Here are some answers.
1. Cold War Thinking
Economic gain is the principal goal of other nations'
international economic policy making. Geopolitics dominates US
Thus, the United States ignores China's violations of nuclear
treaties, counterfeiting, human rights abuses, religious persecution
of Christians and Buddhists, and all other outrages. Why? The excuse
is "constructive engagement"-- the professed hope that
more trade with China will create more democracy and responsible
behavior there. The reality is "constructive engagement"
is little more than political appeasement that helps a handful of
former US government officials and transnational corporations profit
from political tyranny.
Similarly, the President and Congressional Leaders are willing for
US taxpayers to bear the cost of Japan's defense, even as that
nation keeps its markets closed to US exports and mounts massive
annual trade surpluses with us. Likewise, the United States
purchased the Turkish Government's support of our 1991 military
campaign against Iraq by increasing the quota of textiles that
Turkey's producers could export to the US market.
Now as in the past, US leaders and opinion-makers stand ready to
sacrifice the well-being of specific US industries to ill-defined
and often unrealized foreign policy objectives, such as our current
China and Japan policies. The consequence is comparatively more
foreign imports to US exports.
2. Low Foreign Production Costs
The International Labor Organization has identified 1.2 billion
unemployed or grossly underemployed workers worldwide -- 1/3 of the
world's labor force -- in what the ILO describes as the worst global
unemployment crisis since the 1930s. The end of the Cold War and
breakup of the Soviet Union has brought almost one billion new
workers into the world labor market. Vast numbers of these workers
are intelligent, educated and desperate enough to work for wages
which are at or below subsistence even for the local area. For many
products, other nations have sufficient production capacity to meet
the entire world demand. China, for instance, can supply many types
of apparel for the entire world and at a price no other country can
match. The labor pool of China, India, Pakistan and the balance of
Asia is so great that they could be the source of all the world's
manufacturing and do so at labor rates 1/20 that of the industrial
Today, the sure path to lower costs and higher profit for
manufacturers is to shift production to these low cost locales. This
is precisely what is happening. It is why half of the US merchandise
trade deficit is now with developing nations.
As a few corporations in an industry shift production to low-wage
developing nations, the entire industry then faces increasing
pressure to do the same. This is the pattern now well underway in
the United States. The result is to shift jobs in this nation from
highly productive manufacturing jobs to lower wage, less productive
service work. In the process, US productivity growth is undermined,
even as the flow of imported manufactured goods increases.
3. Global Firms Dominate US Economic Policy Making
The Chairman of Boeing says that in 20 years he wants Boeing to be
thought of as a "world corporation," not as an American
company. The CEO of United Technologies says that his company is now
doing so much manufacturing in Asia that part of the company
headquarters is being shipped to the East. The head of NCR reports
that his corporation is a transnational enterprise with interests no
longer bound by national borders.
Most of today's CEOs share this global view. Likewise, this
sentiment dominates the thinking of CEOs whose companies depend on
foreign goods, academics, think tanks and media funded by global
firms, and free-trade ideologues. These are the people who set US
One index of their influence is that they overwhelmingly dominate
the membership of every influential Presidential Advisory Committee
for Trade including that for Policy and Negotiations (ACTPN). These
people support the shift of US production to other nations and have
large financial interests in that outcome.
Consequently, imports now dominate US manufacturing in the
American market. Specifically, in 1970 imports were equal to less
than 11 percent of the US manufacturing Gross Domestic Product.
Today, they equal 51 percent.
Most significant, much of what constitutes US trade is intra-firm
transactions between the foreign and domestic operations of global
firms. For example, in 1995, more than 66 percent of the US-produced
automotive exports to Mexico were to firms that were "related"
by equity holdings with the seller. More than 85 percent of US
imports of cars and parts from Mexico were from related sellers. How
could this be? Largely, these numbers reflect that the Big Three
auto makers and their suppliers are shifting much of their
manufacturing to their low cost Mexican factories. This is why trade
patterns no longer have anything to do with traditional patterns of
national "comparative advantage." It is why Mexico now
exports more cars to the U.S. than the U.S. exports to the world.
4. The Corruption of US Policy Making
US trade policy making is corrupt. In part, it is corrupt because
inexperienced people are in charge. While other nations staff their
trade functions fully and well, the United States places the
formulation and administration of its trade policy making in the
hands of a few amateurs with strong political connections. For most,
their primary function is to rationalize the failure of US trade
policy to a gullible public and corrupt Congress.
Global interests -- domestic and foreign -- spend vast amounts of
moneys to corrupt the process. Their principal mission is to keep US
markets open and their foreign investments safe. Much of this money
goes to the financing of US politicians. Some goes to propaganda.
Some goes to lobbying.
Often, the lobbying position of large US corporations and foreign
governments is indistinguishable, because their interests are
similar -- open US markets.
The corruption of the process is highlighted by the vast number of
former officials who now serve as lobbyists, publicists or advisors
for global private interests. These people either do not understand
conflicts between US interests and that of other nations or private
firms, or simply do not care. Despite what they believe or do, the
enrichment of these ex-officials stands as a lesson and lure for
those still in office. The lesson, simply put, is that it pays
enormously to put the private globalization interests of powerful
individual firms ahead of US interests -- or anything else -- in the
5. Ideological Inflexibility
This generation of US opinion leaders is as indoctrinated in the
academic principles of free trade as the prior generation of Soviet
leaders was indoctrinated in the principles of Marxism. This creates
an inflexibility of mind that resists action even in the face of
obvious failure. How else can one explain the resistance of honest
people to changing policies that have resulted in massive trade
deficits in 36 out of the past 38 years? Indeed, the solution to the
current trade deficits being proposed by our leaders is an expansion
of the very policies that have resulted in the massive US trade
deficits. The dogmatic pursuit of failed policies and the
ideological inability to alter course even in the face of disaster
is a principal reason for continuing US trade deficits.
6. Residuals from Prior Trade Agreements
The United States has several hundred trade agreements in effect.
Many were made in an earlier time under vastly different
geopolitical circumstances. Often these deals were made at a time
when the US was explicitly using trade as aid. While that era is
over, these agreements continue in effect, often placing the US
economy at a disadvantage.
Auto deals among Mexico, Canada, Japan and the United States are
one such example. Autos and parts account for more trade than any
other single product. In 1996, US imports of vehicles and parts were
two-and-one-half times greater than imports of crude oil: $130
billion versus $51 billion.
Residual elements of prior trade agreements have contributed
significantly to this deficit. One US goal in the NAFTA
negotiations, for instance, was to eliminate Mexican and Canadian
restrictions on the production and sale of vehicles. Yet, the
agreement allows Canada to force US auto makers who sell in Canada
to manufacture most of their vehicles there. The agreement also
allows Mexico to keep most of its auto investment and production
restrictions in place until at least 2004, even as the US market
remains totally open to imports from those two countries.
As a result, the auto and parts trade deficit with Mexico in 1996
was more than $15 billion and with Canada it was $13 billion.
Similar examples exist with most US trade agreements.
7. Discrimination Against US Producers and Investors
As a matter of common practice, most other governments
discriminate against foreign producers and investors in ways both
flagrant and subtle. Germany, for instance, allows local content
requirements to be part of the bidding process on heavy electrical
equipment. Similarly, France has barred GE from bidding on the
privatization of Thomson, the giant electronics company, thereby
clearing the way for bids from two French companies -- Alcatel and
Lagardere. Brazil imposes tariffs of 70 percent on imported cars,
but reduces that to 35 percent on those whose manufacturers also
produce cars in Brazil. Korean tax authorities have regularly
audited Koreans who buy foreign-made products. The goal of this
discrimination is to reduce imports and encourage domestic
8. Tax Systems
The GATT and its successor, the World Trade Organization, have
sanctioned the Value Added Tax System (VAT), allowing a full rebate
of all VAT taxes on goods exported from countries that use the VAT.
Thus, nations with a VAT tax, such as Germany and France, can get a
VAT rebate on their export goods. By contrast, the income tax used
in the United States is not trade-approved and not rebated.
Consequently, US exports carry a full load of taxes while goods
produced in countries that use the VATS do not. The price
differential often puts US goods at a disadvantage, particularly in
Equally significant, the US Internal Revenue Service only collects
a small part of the taxes owed by foreign-owned corporations
operating in the United States. The IRS reports that European
manufacturing operations in the United States report taxable profits
on sales at half the rate of domestic corporations. Asian companies
report taxable profits on sales at one-tenth of US companies.
Consequently, foreign companies operating in the United States evade
at least $30 billion of US taxes annually, an underpayment that
greatly increases their competitiveness against US companies.
9. Selective Enforcement of US Laws
While trade constitutes a substantial portion of the US economy,
the US Government devotes limited resources to the enforcement of US
trade laws. In this environment, the choice of which abuses to
attack is most often a political decision. For example, the first
case brought by the United States at the World Trade Organization
was for Chiquita Banana -- a company whose principal work force is
in Central America -whose exports are locked out of the European
market. The principal reason for US interest here is the owner of
Chiquita Banana contributed hundreds of thousands of dollars to the
1996 Presidential campaigns of both Bill Clinton and Bob Dole,
making them advocates of this case. This example is neither unique
nor extreme. US trade officials ignore most foreign violations of US
trade laws. The result is a vast flood of goods into the US market.
10. Foreign Labor and Plant Closing Standards
Continental Europe and Japan have rigorous plant closing
regulations that severely restrict the freedom of companies to
reduce their work forces or constrain their production. Many
multinational companies operate with duplicate factories, but in
different nations. As overall demand falls, these companies reduce
production and employment in those nations with lax public
requirements and continue operation in those with tough regulations.
The US has the weakest such standards among any industrial nation.
Therefore, US factories are the first to face layoffs and reduced
production. The net effect is to close US factories, increase US
imports from the foreign plants, and create a larger US trade
11. Theft of Intellectual Property
America has the most creative and prolific inventors in the world.
Equally important, much of US basic science in done in open
universities and federal laboratories where foreign nationals are
welcome, even subsidized.
The primary focus of international espionage today is to secure
the results of that research and the details of US technology.
America is the principal target. Countries on the USTR's "priority
watch list" include Argentina, China, the EU, Greece, India,
Indonesia, Japan, Korea and Turkey. These and other nations have
thousands of full and part-time economic spies at work in this
country. Politically, these nations' agents of influence are working
vigorously to weaken US protections for holders of intellectual
property. Commercially, these spies are scooping up information and
sending it to their masters. Lost sales and greater trade deficits
flow from this piracy and theft.
Software is a clearly visible example of the cost of technology
piracy. Three days after Microsoft introduced Windows 95 in the
United States for $89.95, copies were available throughout Asia for
$4 or less.
The unique problem faced by software makers is that there is no
degeneration of quality from copy to copy. The result is blatant
piracy, particularly in the developing world. Of every four software
programs in Mexico, only one is legal. In China the piracy rate is
98 percent. Some countries, notably the Philippines, Indonesia, and
Thailand, are jokingly called "one disk countries" because
their piracy rate is almost 100 percent. By contrast, the piracy
rate in the US is 25 percent.
At the same time, other governments provide inadequate protection
and impose extraordinarily high fees associated with the filing,
issuance and maintenance of a patent over its life. The European
Union's patent fees, for instance, are higher than those of the
United States. Other nations, such as India, refuse to adopt even
the weak standards they agreed to under the WTO. Japan continues it
practice of "patent flooding"-- a quasi-legal way to
extort licenses from foreign patent holders. The net result is a
diminished technological capacity for the United States, weakened
exports, and more imports derived from pirated technology.
12. Non-Tariff Barriers
As a succession of trade negotiations have lowered tariffs, other
nations have excluded US imports through a host of non-tariff
barriers. Japanese public works authorities apply dozens of criteria
to engineers, architects and construction that effectively preclude
all non-Japanese. Mexico requires partial ownership by Mexican
nationals of trucking and other vital commercial services. Europe
has adopted a set of product standards that are unique to the
European market, thereby giving local manufacturers a competitive
advantage. China requires corporations to produce in China if they
are to sell in China. China also requires foreign corporations to
share or license their technology to Chinese enterprises.
The imagination of local protectionists is the only limit on
non-tariff barriers. The net result is substantially fewer US
exports and a higher trade deficit.
13. Tariff Differentials
The United States provides Most Favored Nation status to most
other nations -- that is, the US gives all nations the same low
tariffs that it provides any other nation. If we give France an
extraordinarily low tariff on cutlery, for instance, we give all
other nations the same deal. Yet, other nations, particularly
developing nations such as China, often do not reciprocate. While
the average US tariff on imports is less than 3 percent, for
instance, China's average tariff on imports from the United States
is 23 percent, plus an additional 17 percent Value Added Tax or a
total of 40 percent. This vast differential encourages imports into
the United States and discourages exports to other nations such as
China. The result is a higher US trade deficit.
14. Bribery and Corruption
The USTR reports that "the most consistent complaints that
the Administration receives from US industry and labor
representatives are that bribery and corruption compromise US market
access in many foreign markets." Bribery and corruption
determine procurement decisions in many countries. Yet, if US firms
pay there, they are subject to criminal prosecution here. The US
Government has repeatedly attempted to get other nations to adopt
procedures that will eliminate, or at least reduce, the effects of
bribery and corruption on procurement decisions. Regrettably, these
efforts have been largely unsuccessful. Consequently, US producers,
while secure in their integrity, often lose to others with no
scruples or constraints.
15. Manipulated Exchange Rates
Changes in exchange rates alter the price competitiveness of goods
and services virtually overnight. When the dollar is strong, the
competitiveness of US exports is reduced and that of foreign imports
is increased. The reverse is also true. Many other governments
explicitly use their exchange rate as a balance wheel to set the
level of their trade balance. The Chilean government, for example,
is currently manipulating their Peso, which does not float freely.
They have recently re-weighted the basket of currencies to which the
Peso is pegged. Much like the recent experience in Mexico, the
Chilean Government's goal is to maintain a US trade surplus with
Chile during the time Congress considers Chile's accession into
US policy makers have never developed an exchange rate policy and
rarely consider the exchange rate consequences of economic policy.
The Plaza Accord of 1985 in which the U.S. joined with other
industrial countries to weakened the dollar and to improve the US
trade position was a rare exception. The value of the dollar to the
Yen fell from 256 Yen per dollar in 1985 to 82 per dollar in the
mid-1990s. This currency manipulation provided temporary trade
relief. Nevertheless, other nations increased their competitiveness
to offset the US move and again the US trade deficit soared.
Japanese auto makers, for instance, are competitive at an exchange
rate of 90 Yen per dollar.
Virtually every other time that the U.S. Treasury has engaged
significantly in exchange rate measures has been to assist other
countries or global financial interests. In 1995 -- as the U.S.
faced record trade deficits -- the US Treasury increased the value
of the dollar against the Yen to assist Japan's Government and
banking sector deal with a recession and financial pressures. The
result of US actions was to reduce the cost-competitiveness of US
products in the Japanese market and increase that of Japanese
manufacturers here. It worked. Japanese auto makers are now flooding
the US market with their exports. The U.S. trade deficit soared to a
new record in 1996 and seems assured of setting another record in
In short, the price competitiveness of goods in many nations is as
much a function of the Government exchange rate policy -- theirs and
ours -- as of producers' competitiveness. The net effect of all this
is fewer US export receipts and more foreign import bills.
16. The Trade Deficit Phobia of Other Nations
Many US opinion leaders argue that trade deficits do not matter.
Leaders in most other nations are phobic about trade deficits, as
are the citizens of their nation. Consequently, nations such as
Japan, Korea and others will undertake virtually any action required
to maintain a trade surplus, even if only a small one. To do
otherwise would result in the replacement of the head of government.
In such an environment, public policy dominates market forces. As a
result of this phobia, other nations are willing to limit what US
producers can export to their markets regardless of foreign
The United States is the only nation in the world that tolerates
an unbounded trade deficit, which means that we are the dumping
ground for the excess production of others. Again, the outcome is
massive US trade deficits.
17. International Cartels
The first legislative action of the Japanese Diet upon the end of
the US Occupation was to authorize the creation of economic cartels
for Japanese industry. Likewise, Germany has always encouraged the
formation of cartels. Cartels are illegal in the United States,
except in a handful of areas approved by the US Justice Department.
As European and Japanese industry have strengthened, they are
cartelizing a large and growing number of industries. Consumer
electronics is one of the most obvious cartels. According to Akio
Morita, co-founder of Sony, the Japanese and European consumer
electronics industries formed their cartel-like arrangement in the
mid-1980s. Their goal is to coordinate and focus the actions of the
members' companies in a way that increases profit and reduces risk.
The leaders of this industry meet at least twice a year to discuss
products, production and markets. The participants use patent pools,
price fixing, production scheduling, market allocations and other
techniques to control competition.
The net result of foreign-dominated, global cartels is that the
ease of entry into various markets for US producers is impeded and
competitive US companies face predatory competition, here and
elsewhere. The consequence is fewer US exports, foreign domination
of key industries, and a growing vulnerability to imports.
The global mechanisms that have long guided international trade
are trapped in a time warp of the Cold War, a moment when the United
States had an uncontested superiority in most industries and the
Soviet Union posed a real and imminent danger. But that era is past.
The old mechanisms of trade are now severely dysfunctional and
require fundamental overhaul.
In the interim, the remaining competitive advantages of the US
economy and its workers are being dissipated by a trade policy that
favors foreign over domestic production.
Our economic rivals have trade surpluses not simply because of
their competitiveness, but also because the basic goal of their
national trade policies is to advance the interests of their nation
and people, not adhere to some abstract theory of global trade. This
is the economic lesson our ancestors taught the rest of the world,
but one that we seem to have forgotten. Until we learn it again, our
trade deficits and our future prospects will only worsen.