In praise of America’s trade deficit

I have had two takes on US President Donald Trump’s trade war in the past month. First, I pointed out that too many people accept the dubious claim that reducing the trade deficit will boost manufacturing, and explained why we should be sceptical. Second, I wrote about how a tax on imports hurts exports just as much (maybe more, as suggested by some modelling of Trump’s tariffs), so we shouldn’t expect it to reduce the trade deficit.

I hope you will indulge me for a third go. Lost in all the commentary are the strong reasons why the US should actually want to maintain its trade deficit and why everyone else might treat it with benign neglect. So this week, Free Lunch rectifies that omission. Share your reactions at freelunch@ft.com.

It is taken as axiomatic, way beyond Trumpian circles, that global financial “imbalances” are a bad thing. (Why the scare quotes? I don’t like the word “imbalance” because it seems to presuppose unsustainability: something out of balance can’t remain in that position for long. I prefer “asymmetries” as a more neutrally descriptive term.)

But external surpluses and deficits reflect domestic saving and investment decisions. Economies that save more than they invest run external net surpluses (those extra goods they export over those they import pay for building up claims on capital abroad). Those that invest more than they save run external net deficits (those extra goods they import over those they export makes it possible to invest without cutting consumption as much, while building up liabilities to where the extra goods come from).

This is the modern view of international economics: external “imbalances” are a function of macroeconomics, not of trade. Seen in a different light, net trade patterns are caused by financial flows and not the other way round. That’s another reason why, as I wrote last week, we shouldn’t expect trade policy to have much effect on net deficits or surplus. (Trade policy can and does affect gross bilateral trade flows, of course, as well as changing how trade affects specific sectors such as semiconductors.)

Our default judgment about how appropriate those savings and investment decisions are should, I think, be neutral or positive. Countries make different decisions (through individual market action and public policy) about whether to be net savers or net borrowers. If a global financial and trade market makes all those desires compatible, that, in principle, gets every country what it wants, subject to making it compatible with what others want. The burden of proof is surely on those who want to criticise those domestic decisions.

There are some obvious arguments that I’ll mention to put aside. One is that a government may make what we think of as bad choices. So a relatively poor country such as China could let its citizens consume more without investing less. Or it may not reflect our political or democratic sensibilities. So US elites did not for a long time have the interests of declining manufacturing areas at heart. These are valid critiques — of politically constrained domestic decisions. They are not valid critiques of the global financial and trading system.

Such a critique would have to claim that there is something inherent to the system that makes it too difficult for a country to make the best choices for it.

In the short run, there is a sensible Keynesian version of such an argument: a country that cuts domestic demand and hence imports, or acts to strongly expand exports and generate demand from other countries’ consumers, can cause slowdowns, recessions or unemployment in other countries which may not have the fiscal or other means to counteract it. Hence the label “beggar-thy-neighbour” policy. But to repeat: this can only be a short-term phenomenon. It is not an argument against long-term structural asymmetries, those that persist through the business cycle, including in times of full employment.

And yet, there is a highly popular belief that China and other structural surplus economies force the US to run a structural deficit. When you pause to think about it, this is an odd view. Beijing’s policies no doubt aim to shape China’s net surplus. But why think of this as forcing Americans to do anything, rather than offering them a cheaper-than-otherwise opportunity to consume and invest more, if they want to?

If Americans wanted to balance their external account, they could do so in many ways; most easily through a revenue-neutral tax reform that would provide an incentive to domestic business investment and reduce consumption. The fact that they choose not to do so suggests that they rather like the benefits that come with a structural trade deficit. And they are right, as we should be tempted to agree when we look at what those benefits are.

An external deficit means you can invest more than you save; ie you don’t have to cut consumption as much. For the US, this “more” amounts to about $1tn a year of foreign-funded US investment, or just over 3 per cent of GDP. For comparison, total business investment is close to 14 per cent. As the chart below shows, EU businesses invest a solid 1 per cent of GDP less — and the bloc has a structural net surplus.

What is more, 1 per cent of GDP is also how much more US businesses spend on research and development compared with their EU peers. And total US R&D spending has grown from about 2.8 per cent of GDP a decade ago to 3.6 per cent today, just while the external deficit expanded too. It is hard to avoid the conclusion that the US’s structural net inflow of capital is precisely what affords America its current innovative edge.

For example, it allows the US to burn enormous amounts of cash to build data centres to train the large language models that have hit the world like a Sputnik flyover — without reducing consumption to fund those capital expenditures. Those amounts are set to exceed $300bn just this year. So that’s about a third of the current account deficit right there. 

For another example — this one to do with the semiconductor and green industry incentives of Bidenomics — construction spending on manufacturing facilities tripled (in nominal terms) to $240bn during the period of a widening trade deficit. Again, foreigners funded several hundred billion in hopefully productivity-enhancing investments, so that Americans did not need to sacrifice current consumption for future return.

The point is that these — and many more investments — are things America is delighted to have. But without the external deficit, it would only be able to have them if it curtailed consumption. That is not an attractive alternative, judging from the recent slump in Trump’s popularity.

What about the rest of the world? By running surpluses with the US, they are building up claims on the US economy. But more importantly, they are letting American businesses take the risk on the big investments that are not, as a result, being made in surplus economies. Whether that’s smart depends on your view of the risk. Massive capital spending to train LLMs will bring fortunes if the spenders can reap the return — but if they are just providing the early investments that everyone else can then just cheaply replicate, such as China’s DeepSeek, they will simply have subsidised the rest of the world. Something similar can be said for pharmaceutical research.

So whether the rest of the world should be happy about the US sucking in investment funding depends on their assessment of the risks — but this is no systemic critique of “imbalances”, and there is a strong case for being grateful to America. Meanwhile, there are fewer ambiguities about how the deficit benefits the US. It’s like Trump’s old fever dream of building a big, beautiful wall and forcing Mexico to pay for it, except much more valuable and it’s Europe and China lending the money without having to be asked.

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