America’s Trade Deficits: Blame U.S. Policies – Starting with Tax Laws
Kenneth E. Austin
University of Maryland
Please cite the paper as:
Kenneth E. Austin, (2020), America’s Trade Deficits: Blame U.S. Policies – Starting with Tax Laws, World Economics Association (WEA) Conferences, No. 1 2020, Trade Wars after Coronavirus, Economic, political and theoretical implications
Abstract
This conference paper is a follow up to American Trade Deficits and the Unidirectionality Error, (Austin, 2019) which explained that main-stream economists have badly misunderstood or misrepresented the cause of U.S. trade deficits.
For over 15 years, the United States has been locked in an escalating and seemingly endless trade war with political allies and adversaries. Whatever the cause, the consequences of U.S. trade deficits3 have been stark. The deficits helped hollow out American industrial capacity and substantially reduced job creation. This paper makes no political prognosis about changes in U.S. trade policies, but Covid-related supply-chain disruptions have exacerbated these tensions.
The paper shows why reducing American trade deficits requires American policy changes, rather than actions by its trading partners, as is commonly assumed. The only feasible policies to “re- shoring” manufacturing and reduce trade deficits must reverse the policies and incentives that initially drove off-shoring and the deficits. That means reducing the financial inflows that are the root cause of trade deficits. Any other policies are futile and must logically fail. But directly reducing such inflows has been previously unacceptable to American elites and policymakers.
Trade imbalances must equal their financing. That is an immutable identity. But the direction of causality has changed in recent decades. Today, U.S. trade deficits are caused by large and persistent inflows of foreign financing (savings). Because the economics profession’s balance- of-payments theories are based on outdated premises, they mislead policymakers and the public.
Some countries deliberately seek trade surpluses to stabilize and grow their own economies. While U.S. officials complain, those countries walked through doors that the American Government opened and adamantly refused to allow to shut. The best examples are perverse tax incentives for financial inflows, such as 26 CFR §1.895-1 and 26 U.S.C §871(h)(1) that increase the trade deficit. The United States even attracts these inflows by helping foreigners conceal their American income from their home tax authorities.
Effective American policies to reduce U.S. trade deficits will reduce trade surpluses elsewhere. That will implicitly force structural adjustments to reduce the Global Savings Glut at its sources.
title=”Author’s Correction”
Mea Culpa. My institutional affiliation was inadvertently edited and I failed to notice. I am adjunct professor at the University of Maryland Global Campus (UMGC), which is a separate institution within the University of Maryland System. The name “University of Maryland” refers to the University of Maryland at College Park. I apologize for any misunderstanding.
Hi Kenneth,
The work you propose is very interesting, as it shows very clearly the causes of the problem and the measures proposed. I recently read Pettis and Klein’s book (2020) and the argument reminded me a lot of them, as you explain at the beginning.
In a sense, the text argues that the United States has a passive role, since deficits are due to inflows (savings from other countries), something that is not the decision of the American country. However, personally, I find it difficult to link this to the role of the United States as the issuer of the central currency of the international financial system. As you point out in reason 2 of section 5, precisely both mechanisms are related. However, can one continue to be the issuer of the hegemonic currency and take the measures you point out to break the deficit? Is this compatible without reforming the global financial system?
Furthermore, in relation to this you comment that: “Is “exorbitant privilege” really a privilege or just a status symbol of a vain man? Is everyone else happy to let America have the honor of sitting at the head of the table so that it can pick up the check? Is it really a privilege to borrow and spend the money instead of earning it yourself by doing the things you buy? ”
At this point, personally, I find it difficult to see how it would be negative for a country to be the holder of the hegemonic currency. In this story, the United States is the victim, structurally, the current hegemonic power occupies the position that the colonies occupied in Hobson’s scheme.
In my view, it is important to start from the crisis of the 1970s, when the United States took a turn and laid the foundations for the subsequent financial and trade globalization, in which the dollar will be key as the center of the world financial system. To a certain extent, Mian, Straub & Sufi (2020) recognize that the foundations of the current inequalities come precisely from the turn of this era. The question would be, why did the United States make that turnaround? Why open the way to the financialization of the economy and increase the role of the dollar as its center if this harms the productive sector? Here my opinion is what I point out in my text: a problem of profitability of the productive sector.
Although it is true that this does not favor the United States as a whole, since there are sectors, such as the industrial sector, that suffer especially. However, the financial sector is favored. In the same way, this is where social classes and inequality come in. Es decir, creo que se puede hablar de “burden” para ciertos sectores de la sociedad estadounidense, pero no en conjunto.
Thank you very much.
Juan Vázquez Rojo
Universidad Camilo José Cela and Corporación Universitaria de Asturias
Hi Juan,
You comments are interesting. But you are putting too much weight on exactly the assumed premises that I have challenged. You seem to assume that the benefits of having a “hegemonic currency” (your term) are axiomatic. But by definition of axiom, it’s only an axiom if there is no basis for questioning its truth.
Premise #1: You make it clear that you believe that an Hegemonic currency is of great value.
You stated “At this point, personally, I find it difficult to see how it would be negative for a country to be the holder of the hegemonic currency.”
While the dollar’s role as an international transactions currency does have a positive value, it is not essential to American economic prosperity. I would consider it a convenience. It does confer the ability to impose economic sanctions is a useful alternative to military force, but that is a new and perhaps temporary development. The system was not designed for that purpose.
The use of the dollar as a unit of account conveys few substantial benefits for the US.
Finally, I have explained – in detail – why the dollar’s role as a savings vehicle is extremely destructive of US economic interests and the direct cause of undesired US current account deficits. The US is a special case in this respect, but not entirely unique. If a country does not need to borrow abroad, it is essential that they not do it. Spain is a case-in-point. Pettis has written extensively about the economic relationship between Germany and Spain. https://www.businessinsider.com/michael-pettis-spain-surplus-germany-deficit-2011-7 These are purely the mechanical consequence of unsustainable economic policies and processes. They are not the result of some plot by economic masterminds as political scientists are prone to believe. In fact, that analysis is in direction violation of Austin’s First Law of Historical Causality: “No actual historical event can be explained by a conspiracy theory. If they had planned it that way, something else entirely different would’ve happened.”
While I do not doubt that the present US status quo is defended by those who benefit from it at the expense of others (e.g. the large international banks), the other 330 million Americans would be better off if those net inflows were gradually eliminated. The widespread rage among ordinary Americans at the economic and political elites that propelled the candidacies of Bernie Sanders and Donald Trump will not go away (and has serious analogues in Europe). The rage was directly and indirectly fueled by the trade deficit, financial excesses, and job losses caused by the inflow of unwanted savings. It will not go away until it is addressed.
That is why I believe that the rolling back the incentives given to foreign savers and thus reducing American trade deficits is desirable. Furthermore, other deficit countries should be encouraged to take similar defensive measures. Free trade is economically valuable. But free trade and free finance are different things. Completely free financial flows are dangerous and countries should have the right to control them. (That would allow them to solve Mundell’s Trilemma without needing to accumulate large stocks of forex reserves.)
Please note that I am making these arguments based exclusively on technical criteria.
Premise # 2: The current international monetary and finance system was designed by US. It serves its intended purpose.
As a matter of fact, the current international monetary and finance system is not a designed system and some economists consider it a “non-system.” The EMU and Breton Woods were designed systems with long and highly complex sets of written rules. But when Breton Woods broke down, it was not replaced by another designed system and many countries were free (if they could make it work) to designed their own policies. So the current system has some rules, but often they are not enforced. The dollar is no longer the “official” reserve currency, but the US did not restrict its use as a reserve currency. So the “system” if there is one, is an evolved system with a loose set of rules. And the behavior of the system has changed as global economic conditions have changed. The current problem of global imbalances is the result of the Global Savings Glut.
What is striking is that the US remains at the center of a system that is economically dependent upon it, but no longer in US interests. Either the economics will destroy the capacity of the US to maintain that system (a variation of the Triffin Dilemma) or American politics will destroy it.
As you point out on page 2 of your article, hegemonies work because they are mutually beneficial and the hegemon works through incentives, persuasion, and incentives. Thus, even after the collapse of Breton Woods, the US allowed and even encouraged the use of dollar reserves as a public good. However, in the 21st century, it became a burden as trade-surplus countries learned to export their internal imbalances to the US.
If the current system is not ended soon by design, eventually, the operation of Stein’s Law” (“If something cannot go on forever, it will stop.”) will do the job. Then, the problem of surplus saving moves back to its countries of origin. That is where the problem should be solved through higher domestic consumption.
Kenneth, I have read your paper and looked at some numbers. It has taken some time to have all the data together. FRED is the source I use. Evidence shows a growing fiscal deficit in some periods over the past 40 years due to tax revenue reductions while keeping stable fiscal expenditures. There is a downward long-run trend from 1981 onward on tax revenues while expenditures remain fairly constant. This is partially financed with the savings from emerging economies as reserves in central banks and rich people avoiding taxes and exchange risks. Get rid of those two very interesting tax clauses you pointed out, and the incentive will be gone to save in US dollars. But, will that make for balanced budgets?
International finance changed concept when the definition went from surplus rich countries to deficit poor countries. Now flows run from surplus poor countries to deficit rich countries. This is true not only of the States.
On the external side, the problem is more complicated. Yes, people save in the top currency to use Strange’s concept. They do this because it is riskless by definition. Having all those external dollars inside the US would generate inflation if they did not go out again. To go back to Triffin, how did they get out of the US in the first place, and why did the world accept them? Because it was the leading country and economy after WWII.
.
US outsourcing in the late 1980s and early 1990s was a reflection of high labour costs in the US. So they followed the leader, Motorola, I believe, and all was well until someone realised jobs were being killed. The stock market was up, but employment as a proportion of the labour force was down. That is a productivity problem, not a monetary one. In any event, if all foreign depositors were to deposit their foreign reserves
denominated in some other currencies, someplace else, US banks still have the capacity to generate credits in dollars to cover the external deficit given that until further notice, the US dollar remains the top currency.
I agree entirely with the idea of getting rid of those two tax clauses.
For the record, US trade deficit is concentrated mainly on China and that has to do with global value chains that begin there. So more has to be changed than only the tax clauses. Trade wars do not get rid of global value chains. The shape will change but the GVC will remain starting from China for technological reasons, not monetary ones. That is the Huawei nonsense war.
On the simultaneity of external savings and deficits, you would need to prove it econometrically if you want to make a hard sell. It is a very interesting idea.
Hi Oscar,
Thank you for your comments.
Please let me respond to your last one first. It is the logical cornerstone upon which all my technical arguments are built.
The issue of “the simultaneity of external savings and deficits” is not subject to econometric verification. It is based on a mathematical, logical, and accounting identity. It is as close to absolute truth as one can ever have in economics. Any statistical deviation between the current account and the financial account (neglecting the de minimis, newly-defined “capital account”) are errors. These errors and defined by the World Bank (https://datacatalog.worldbank.org/net-errors-and-omissions-bop-current-us-0#:~:text=current%20US%24)-,Net%20errors%20and%20omissions%20(BoP%2C%20current%20US%24),the%20current%20and%20capital%20accounts):
“Net errors and omissions constitute a residual category needed to ensure that accounts in the balance of payments statement sum to zero. Net errors and omissions are derived as the balance on the financial account minus the balances on the current and capital accounts.”
I understand that many economists who do not specialize in open-economy macroeconomics may not realize that this relationship is so exact. But what never fails to amaze me is that many mainstream American economists who do specialize in this, or claim to understand it: either do not understand it or ignore it when it suits their purposes. Please see the details my real-world economics review article from last December, http://www.paecon.net/PAEReview/issue90/AustinK90.pdf, pages13-19.
The Balance-of-Payments Identity and the national and global Savings-Investment Identities and the Keynesian Savings-Investment Equilibrium Conditions, are the structure of my analysis. Respecting these identities does not make an argument ipso facto correct. But violating any of them is a fatal error and makes an argument logically wrong (or, at least, requires a new formulation).
Back to your first question regarding the relationship between US budget and external deficits. One of my key points in these last two papers is that casual observations regarding the direction of causality in the US case are wrong. The world’s external balances must logically sum to zero (an identity). That is not the case with fiscal deficits. Every country can run a government deficit by borrowing from the private sector. There are no necessary links between fiscal and budget deficits and the direction of causality cannot be assumed. This requires rigorous individual analysis.
An unnecessary and unwanted financial inflow will reduce aggregate demand, necessitating fiscal stimulus. In the late 1990s the US was running a budget surplus. Then, the backflow from the Asian financial crisis, financed not only a larger US current account deficit, but the dot.com bubble and recession in 2000. The fiscal response was a large tax cut and a spending increase in response to the Al-Qaeda attacks on 9/11. But the recovery was slow because of continuing financial inflows that financed a deterioration of the trade deficit and a bubble in the housing market. When the crash came, there was another round of fiscal stimulus.
So my answer is to your question, “But, will that (eliminating the external deficit) make for balanced budgets?” is ceteris paribus – yes. Or, at least, it will reduce the budget deficits. If the Global Savings Glut drives foreigners to continue to buy US assets, it may require imposing higher taxation on them to balance the current account deficit. It may raise interest rates, but economic growth and tax revenues will increase and the need for fiscal stimulus will decline or reverse.
This might be relatively unique to the US (and maybe other Anglophones, UK, Canada, NZ, Australia) for a variety of reasons. However, it is clear and demonstrable in the American case. Current arrangements force the US to continue to play the role of consumer and borrower of last resort. They have allowed surplus countries to avoid domestic reforms to fix their internal imbalances. This inflicts unnecessary debt and unemployment on the US and is neither politically nor economically sustainable.
Re: your paragraph #3, I’m a not sure that I understand your point. Explaining the origins of the problem and the dollar’s role as a reserve currency in a world of flexible exchange rates (which do not require a reserve currency – Europe does not engage in large-scale intervention) does not alleviate the damage.
But my Hobsonian point is relatively simple: “If savings to finance investment is scarce, economies neither want to, nor need to, export their savings.” But savings are often too abundant to be profitably invested in home markets and that reduces aggregate demand. So the savings are exported to buy foreign assets. Hobson first observed this in the late 19th century industrial countries of Europe, and then the US (his theory of imperialism). But it is now clear that this often happens at earlier stages of development, as in China and much of the rest of East Asia. This explains why some countries need to excrete their surplus savings and your arguments might explain why they might wish to acquires dollar assets with their savings, but it does not mean that the US needs to, or can, absorb the savings.
Regarding your point on the China-US bilateral imbalance, please see my paper from last December (Ibid) and Section X: A Note on the non-consequence of bilateral trade balances (pages 34-35).
Once the US external imbalances are reduced to zero, many of the other trade war issues will either go away, be reduced in magnitude, or (aside from agriculture) be more amenable to rational solutions.
Thank you for your detailed comments and questions.
Ken
PS. This dialogue has started too close to the end. Maybe the discussion can be extended.
Hi Oscar,
Thank you for your comments.
Please let me respond to your last one first. It is the logical cornerstone upon which all my technical arguments are built.
The issue of “the simultaneity of external savings and deficits” is not subject to econometric verification. It is based on a mathematical, logical, and accounting identity. It is as close to absolute truth as one can ever have in economics. Any statistical deviation between the current account and the financial account (neglecting the de minimis, newly-defined “capital account”) are errors. These errors and defined by the World Bank (https://datacatalog.worldbank.org/net-errors-and-omissions-bop-current-us-0#:~:text=current%20US%24)-,Net%20errors%20and%20omissions%20(BoP%2C%20current%20US%24),the%20current%20and%20capital%20accounts):
“Net errors and omissions constitute a residual category needed to ensure that accounts in the balance of payments statement sum to zero. Net errors and omissions are derived as the balance on the financial account minus the balances on the current and capital accounts.”
I understand that many economists who do not specialize in open-economy macroeconomics may not realize that this relationship is so exact. But what never fails to amaze me is that many mainstream American economists who do specialize in this, or claim to understand it: either do not understand it or ignore it when it suits their purposes. Please see the details my real-world economics review article from last December, http://www.paecon.net/PAEReview/issue90/AustinK90.pdf, pages13-19.
The Balance-of-Payments Identity and the national and global Savings-Investment Identities and the Keynesian Savings-Investment Equilibrium Conditions, are the structure of my analysis. Respecting these identities does not make an argument ipso facto correct. But violating any of them is a fatal error and makes an argument logically wrong (or, at least, requires a new formulation).
Back to your first question regarding the relationship between US budget and external deficits. One of my key points in these last two papers is that casual observations regarding the direction of causality in the US case are wrong. The world’s external balances must logically sum to zero (an identity). That is not the case with fiscal deficits. Every country can run a government deficit by borrowing from the private sector. There are no necessary links between fiscal and budget deficits and the direction of causality cannot be assumed. This requires rigorous individual analysis.
An unnecessary and unwanted financial inflow will reduce aggregate demand, necessitating fiscal stimulus. In the late 1990s the US was running a budget surplus. Then, the backflow from the Asian financial crisis, financed not only a larger US current account deficit, but the dot.com bubble and recession in 2000. The fiscal response was a large tax cut and a spending increase in response to the Al-Qaeda attacks on 9/11. But the recovery was slow because of continuing financial inflows that financed a deterioration of the trade deficit and a bubble in the housing market. When the crash came, there was another round of fiscal stimulus.
So my answer is to your question, “But, will that (eliminating the external deficit) make for balanced budgets?” is ceteris paribus – yes. Or, at least, it will reduce the budget deficits. If the Global Savings Glut drives foreigners to continue to buy US assets, it may require imposing higher taxation on them to balance the current account deficit. It may raise interest rates, but economic growth and tax revenues will increase and the need for fiscal stimulus will decline or reverse.
This might be relatively unique to the US (and maybe other Anglophones, UK, Canada, NZ, Australia) for a variety of reasons. However, it is clear and demonstrable in the American case. Current arrangements force the US to continue to play the role of consumer and borrower of last resort. They have allowed surplus countries to avoid domestic reforms to fix their internal imbalances. This inflicts unnecessary debt and unemployment on the US and is neither politically nor economically sustainable.
Re: your paragraph #3, I’m a not sure that I understand your point. Explaining the origins of the problem and the dollar’s role as a reserve currency in a world of flexible exchange rates (which do not require a reserve currency – Europe does not engage in large-scale intervention) does not alleviate the damage.
But my Hobsonian point is relatively simple: “If savings to finance investment is scarce, economies neither want to, nor need to, export their savings.” But savings are often too abundant to be profitably invested in home markets and that reduces aggregate demand. So the savings are exported to buy foreign assets. Hobson first observed this in the late 19th century industrial countries of Europe, and then the US (his theory of imperialism). But it is now clear that this often happens at earlier stages of development, as in China and much of the rest of East Asia. This explains why some countries need to excrete their surplus savings and your arguments might explain why they might wish to acquires dollar assets with their savings, but it does not mean that the US needs to, or can, absorb the savings.
Regarding your point on the China-US bilateral imbalance, please see my paper from last December (Ibid) and Section X: A Note on the non-consequence of bilateral trade balances (pages 34-35).
Once the US external imbalances are reduced to zero, many of the other trade war issues will either go away, be reduced in magnitude, or (aside from agriculture) be more amenable to rational solutions.
Thank you for your detailed comments and questions.
Ken
PS. This dialogue has started too close to the end. Maybe the discussion can be extended.
Hi Kenneth
Thank you for sharing such an interesting article. I highlight the emphasis on promoting an alternative discussion in the field of economic theory with respect to traditional postulates. It is very wise to start from Hobson’s theoretical approach. It is a great contribution of the text.
I share your criticism of the false identity between investment and savings. Listing the different definitions of investment is very illustrative to defend the hypothesis of the paper. It seems to me central when you point out that total world savings are not channelled into profitable investments, generating a sum of capital outside the productive sphere.
In this sense, I think that the contributions made by Marx in Volume Three of The Capital can be useful. Starting from the plethora of capital, Marx emphasizes the role of interest-bearing capital and fictitious capital as alienated mechanisms of accumulation. I find this discussion echoed, even though Marxism is not part of your theoretical approach.
Having said that, I have two concerns that I would like to share. The first is to know the role you give to the breakdown of the Bretton Woods monetary agreements of 1971. The French government was very emphatic in the 1960s that the United States enjoyed an “exorbitant privilege” in financing its deficits. The financing of the Great Johnson Society, coupled with U.S. military spending resulting from the Vietnam War, forced the U.S. government to increase its deficits. To what extent was the increase in global surplus savings the result of U.S. domestic needs? That is, to what extent did the decoupling of gold from the dollar promote a policy of increasing deficits? Did promoting a deficit trade balance play against the United States at a time when the dollar consolidated its role as an international reserve currency?
The second question consists of the possible responses of the US government. You defend the restriction of international financial flows to the United States. In this sense, would the control and taxation of surplus savings to the United States impact negatively on the role of the dollar as an international reserve currency? Is there a need for a greater participation of other currencies in international trade and finance? Would restricting the dollar to international transactions have a negative impact on the hegemony of the United States?
Thank you very much.
Greetings,
Eduardo Mtz-Ávila
PhD Candidate, Institute of Economic Research, Universidad Nacional Autónoma de México
Hi Eduardo,
Thank you for your comments. You raise a couple of interesting issues.
First, as a general comment, the Bretton-Woods system was set up to meet the immediate needs of the post-WWII world. That world was exceptionally capital scarce (anything that the Nazis didn’t destroy, the American Army Air Corps destroyed). When the US was the only major industrial power, the world needed US savings to finance growth and supply the goods and services which could no longer be produced elsewhere.
The original design may not have been ideal (I would have preferred Keynes vision, especially bancor and more reliance on capital controls), but it worked well enough (allowed rapid economic growth in the rest of the OECD) until about 1970 when capital and savings became more abundant.
By the 1960s, other industrial countries were less dependent on the US. The US current account surplus was no longer large enough to finance continuing private US purchase of foreign assets, so the US financed the capital account (todays financial account) deficit by reserve sales. (And the dollar was fixed at what became on highly overvalued rate.) This made countries such as France accept payment in dollar reserves that were, by gentleman’s, agreement, not supposed to be converted to gold. The French complained that they we being forced to sell real assets for less valuable dollar reserves. Giscard named it an “Exorbitant Privilege” in February 1965 – six years before the US ran its first post-war trade deficit. The original “Exorbitant Privilege” has nothing to do with the “privilege” of running trade deficits and borrowing money (which the US generally is reluctant to do with the possible exception of the early 1980s).
However, post-Bretton Woods, when the major-country, fixed-exchange-rate system was abolished, the original dollar reserve role was no longer necessary. But the United States did nothing to prevent other countries from purchasing dollars for whatever purpose they wished. The Japanese soon perfected the art of buying dollar reserves to undervalue their currency and run trade surpluses. This allowed the Japanese to simultaneously maintain their high rate of saving and aggregate demand. The rest of Asia copied the Japanese model and even refined it. By the beginning of this century, the dollar’s undesigned reserve-currency role had become an “Extraordinary Burden” to the United States. It forced the closing of thousands of previously productive US factories and the loss of millions of jobs. And while imports soared, exports did not, so there were no corresponding job gains in export industries.
Exorbitant Privilege, defined as running perennial trade deficits, is simply a way to sell books and justify US policy inaction. It is a way for other countries to require the US to run a trade deficit so that they can undervalue their currencies and run trade surpluses. Only if the US actually wanted to run trade deficits and absorb the employment losses is the dollar’s reserve role a good thing. Otherwise, it’s as much of a privilege as cleaning the rest of the world’s toilets. Of course, the rest of the world may not be entirely truthful when they tell the US that they envy this “privilege.”
Actually, the elimination of the residency-based tax privileges granted to foreigners would not be a “capital control” or restriction. In fact, the current system is a capital control, but the gun is aimed backwards and causes unwanted US trade deficits and job losses. The resulting de-industrialization is economically wasteful for all parties (US and foreign). It serves no legitimate (or illegitimate) purpose.
As for the rest of the world, it is in their interest that if they produce more, they should consume it themselves rather than send the surplus to the United States. Such will be their fate; If they produce more, they will have to consume more.
Thank you Eduardo for your comments and questions.
Ken