Keynes's Nightmare: How the Huge U.S. Trade Deficit Stifles the Recovery

Last Updated Sep 30, 2011 2:53 PM EDT

Since 2001, the U.S. trade deficit with China has cost this country 2.8 million jobs.

That statistic, courtesy of the Economic Policy Institute, is alarming on a couple of fronts. First, and most obviously, the U.S. economy can't recover unless people have work. Employees are consumers, so job-losses curb domestic spending, which hurts businesses and discourages hiring. Competition with overseas laborers also drives down wages for U.S. workers, further reducing their purchasing power. Says former U.S. Assistant Treasury Secretary C. Fred Bergsten in an op-ed this week:

It is clear that our economy can no longer rely on consumer borrowing, housing bubbles, government deficits and super-low interest rates. The United States must start selling much more to other countries, especially China and other emerging markets that are growing at 6 percent or more per year.
This is old news. The U.S., which long ago started importing more than it exports, has been running trade deficits since the 1960s. But a more current cause for concern is that the trade deficit, which runs to $600 billion per year, or 4 percent of GDP, may be directly inhibiting the economic recovery. How? By muting the job-creating effects of public and private spending.

How stimulus spending leaks abroad
As labor lawyer Thomas Geoghegan persuasively argues, the kind of Keynesian spending we have reliably used for decades to muscle our way out of recessions doesn't work as well when the balance of trade is badly out of whack. Here's why: When people hit their local big-box store these days for a little shopping, what they buy is mostly made abroad, since large U.S. manufacturers and retailers have for years been moving jobs overseas.

As a result, spending money at your local Wal-Mart (WMT) creates a lot more jobs in China than it does here. Apart from pushing up unemployment, that also weakens the impact of government stimulus by reducing the "multiplier" effect you get when formerly unemployed workers suddenly have a job and money in their pockets. (The idea there is that if I spend a buck at the mall, the merchant can use the money to add workers, who then have more dough to go shopping, continuing the virtuous circle.)

But that multiplier declines -- what economist John Maynard Keynes called "leakage" -- when spending mostly goes toward creating jobs abroad, since that money is now circulating in Guangzhou or Shanghai rather than in Albuquerque or Pittsburgh. That wouldn't be so bad if U.S. trade with China were more balanced. But it's not. As Geoghegan says, the People's Republic buys more from Japan and Germany than it does from us. Federal spending that should go toward breathing life into our wounded economy is effectively leaking to these other countries.

Where income inequality enters the equation
And here's where the U.S. trade deficit connects like a plate in the earth's crust with another shifting layer in the U.S. economy -- distribution of income, which for decades now has been flowing up to the wealthiest Americans. Geoghegan writes:

[T]he rich are so much richer now than they were in our Keynesian golden age (let's say 1940 to 1975). If Obama gets GDP growth up by 1 percent, most of that goes to the super-rich. It's beyond their capacity to consume it -- i.e., to unleash a multiplier effect. The Financial Times has a regular supplement called "How to Spend It," but it's beyond their human strength. There's too much to spend.
A stimulus can wake up an egalitarian country's economy, since everyone is spending. But a stimulus cannot wake up the economy of a super-plutocracy: The people at the very top just roll over in bed.
.... and invest in mortgage-backed securities and other speculative doo-dads (another tectonic layer). Or in mergers and acquisitions. Or in nothing at all, as large U.S. companies bury more than $1 trillion in cash in the corporate parking lot. Geoghegan:
Everything in the United States is set up to encourage the rich to put money into financial instruments rather than long-term investments. What would Keynes do? Get the rich to think outside the Wall Street banking box. Get them to put money into the part of Main Street that used to trade abroad. How do we do that? For starters, put in usury laws -- limits on interest rates. In a general way, cut down the appeal of being a creditor and not an investor.
There is, of course, an old school of thought in economics that trade deficits don't matter, at least not much. The late Herbert Stein, an economic adviser to both presidents Nixon and Ford, argued that such imbalances were nothing to worry about, famously quipping that "if something cannot go on forever, it will stop."

True, but perhaps not without causing a lot of agita before it does. As Geoghegan points out, Keynes abhorred debt, even as he recognized the necessity of short-term deficit spending when times are tough.

In our day, the trade deficit acts as both cause and effect in worsening the economy, driving jobs to our trading partners and short-circuiting policies aimed at boosting employment. It also interlocks with what I think of as our equality deficit. In combination, this suppresses the therapeutic effects of our most potent tonic for the stagnant economy -- stimulus -- while aggravating some of the very problems that make stimulus necessary. Nice trick.

Image from IMF via Wikimedia Commons

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    Alain Sherter covers business and economic affairs for