Causes of trade deficit: Multiple views

Question

I am trying to understand the causes and macroeconomic implications of running a trade deficit in the United States, and I came across a few different views on this topic. I'd like to know if there are studies that try to understand the root-cause of this trade deficit.

First, I understand that trade deficits aren't necessarily a bad thing, and it all depends on the context. Since the trade deficit reflects the difference between savings and investment, whether it's good/bad depends on what the excess investment is being used for, and whether the investments will reap benefits in the future.

That said, my focus is on trying to understand what is causing the current trade deficit to increase; I see there are different views:

1. US is consumption driven, and our consumers/government are spending beyond their means. That is, there is a huge demand from the US economy, which is causing us to import more than we export, which is causing the deficit. If we cut that spending, it will reduce the trade deficit [1].

2. East Asian countries (especially China) are experiencing a "saving glut" and instead of investing in their own country, they are exporting their capital to the US and parking it in safe US-Treasury investments. It is this capital inflow to the US that is widening the trade deficit [2,3].

[1] https://www.washingtonpost.com/opinions/everything-you-need-to-know-about-trade-economics-in-70-words/2017/05/05/a2b76a02-2f80-11e7-9dec-764dc781686f_story.html?noredirect=on

[2] https://carnegieendowment.org/chinafinancialmarkets/77009

[3] https://www.federalreserve.gov/boarddocs/speeches/2005/200503102/default.htm

Qualitative evidence for (1):

• Our savings rate, measured as fraction of saving to GDP is lower than what it was in 1950s--1970s: https://fred.stlouisfed.org/series/W207RC1Q156SBEA

• Our federal deficit is widening, and taxes aren't enough to cover the government expenditure.

Qualitative evidence for (2):

• China is a net exporter, and continues to be competitive by taking steps to prevent RMB from strengthening against the dollar.

• Savings rate in China is a high fraction of their GDP, relative to the US: https://tradingeconomics.com/china/personal-savings.

• The interest rates in the US are historically low, which is because there is a lot of demand for US treasury from abroad. Quoting from [2]:

Interest rates suggest very strongly that capital isn’t sucked into the United States from abroad, but rather is pushed into the United States from abroad.

I see a bit of truth in both sides of the story. US is consumption driven (not necessarily a bad thing), and China has high savings, probably because of a host of factors such as culture (savings minded), more income inequality (rich save more of their income than the poor), etc.

I have two main questions:

• What is the direction of causality? Is US consumption driving the trade deficit, or is foreign capital inflow driving US consumption? I'd appreciate any academic citations that argues one way or another quantitatively.

• If it's capital inflow driving US consumption, then why doesn't US just use the cheap loans to repay its current debt? Isn't it in US's control to decide what to do with the capital we get -- why spend it?

Answer 1

Often a good answer consist the most of shedding light on some aspects of the terms of the question itself. I hope a couple of remarks could be useful.

About causality, the fact is that current deficit implies reserves exit from USA, which only can be supported by reserves entering, otherwise resulting in a diminishing stock of reserves, eventually exhausting it. A capital-account superavit --net inflow of capital-- represents an inflow of reserves, in that sense financing trade deficit (see Economic Report of the President, 2004). Letting aside causality --which can be very complex and call for other matters-- both imbalances are bond to present themselves simultaneously. In other terms, the fact that trade deficit and capital superavit pop up strongly correlated doesn't mean a causality. I suspect --sorry again for the lack of evidence-- that there's no causality there indeed. Instead, those paths suggested in the question about rates of interest or foreign exchange rates could be more promising sources of explanations, probably besides productivity and cost structures (again, see Conclusions in Economic Report of the President, 2004). It would be an example of third -unknown- causal factor.

About repaying the debt with capital inflows, we have to keep in mind that those capital inflows are new debt. For example, see Kirabaeva, Koralai & Razin, Assaf. (2010). Composition of Capital Flows: A Survey, NBER Working Paper Series. Aside with debt-instruments, capital inflows also comprise equity-instruments, i.e. Foreign Direct Investments and equity purchases. Depending on the context, even the last ones could also be considered national 'debt', as it represents foreign ownership of 'local' firms.

Interestingly, the "US's control to decide what to do with the capital we get" reflects the conflation in an unique agent "US" which in practice is a set of --millions of-- firms, consumers, authorities... There is no central control on the employment of all those flows, even though all those agents are acting, and controlling, in the USA, in that sense all them constitute "US's control".