general » Why the USA Needs a Current Account Deficit

Why the USA Needs a Current Account Deficit
Could Trump's protectionist plans be doubly harmful?

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Once he has taken office in January 2017, Donald Trump is planning to implement protectionist measures in order to reduce the American current account deficit and thus boost the US economy. As we recently demonstrated, we believe this approach will raise prices in the USA, weaken American competitiveness, provoke retaliatory measures in the rest of the world and therefore have a harmful impact on economic growth in the USA. In this blog we will show that the USA actually needs a current account deficit at the moment. This is the only way of financing the high level of consumption and investment.

 

Why does Trump want to reduce the American current account deficit?

 

A country’s current account balance is essentially the difference between its exports and imports. If a country generates a current account surplus (i.e. the level of exports is higher than the level of imports), this has a positive effect on the labor market: the country is producing more goods than it consumes. If the country were only to produce the things it itself requires, then less labor would be required. A current account surplus therefore leads to a lower level of unemployment. This, in turn, reduces the strain on public coffers thanks to lower expenses in the area of unemployment and increased tax revenues.

 

Having a current account deficit has the opposite consequences for a country: the level of employment is lower and unemployment is correspondingly higher. As a result, government revenue is lower and transfer expenditure higher. This leads to an increase in public debt.

 

The USA had a current account deficit of around USD 460 billion in 2015. This equates to approximately 2.5 percent of gross domestic product (GDP). If, as expected, US imports are now reduced by implementing protectionist measures, American consumers will resort to using domestic products and thus boost the US economy.

 

And what about the financing aspect?

 

The present line of argument has not yet taken into account aspects related to the financing of an unbalanced current account:

 

  • In the event of a current account surplus, a country brings in more money than it spends in foreign trade. The consequence of this income surplus is an accumulation of assets vis-à-vis other countries. This takes the form of a higher volume of foreign shares and government bonds, for example.  These assets result in income, such as dividends or interest income, which serve to increase consumption possibilities.
  • In the event of a current account deficit, a country spends more money on imports than it earns from exports. The country thus gets into debt in the rest of the world. The reduction of this foreign debt is also a motive for lowering one’s own current account deficit.

 

Consumption, investment and their financing

 

The significance of a current account deficit for a country’s level of consumption and investment becomes clear if we examine the following relationships:

 

  • A country’s GDP can either be used for consumption purposes or for investments.
  • The citizens of a country can either spend their income on consumption or use it to build savings.
  • If we are to summarize these two statements, then the following identity applies for a national economy without foreign economic relations: the level of overall economic investments must be exactly as high as the level of overall economic savings.

 

The economic reality shows us that this identity does not apply. In the USA, for example, the level of overall economic investments has been higher than the level of overall economic savings for years. In countries such as Germany and Japan, however, the level of savings is higher than that of investments (see Fig. 1). The reason for this disparity is the fact that in a national economy that conducts trade with other countries, the identity “investment = savings” no longer has to apply. In a national economy that has foreign economic relations, disparities that may occur are offset by the current account balance.

 

Fig-1-20160158_BlogPost_Sparquote-LBSalden-13Dez2016

 

High level of consumption and investment is financed from abroad

 

If the level of overall economic investments in a country is higher than its savings, this country is living beyond its means: it is consuming more goods than it produces itself. The additional goods that are required are imported from abroad. This results in the current account deficit.

 

At the same time, as mentioned above, a country with a current account deficit earns less from foreign trade than it spends on imports. The country gets into debt in the rest of the world, meaning it is the rest of the world that allows a country with a current account deficit to have a high level of consumption and investment.

 

In summary, the following relationships therefore apply:

 

  • If a country has a high level of consumption and investment and only saves little, this results in a current account deficit (see USA and UK in Fig. 2).
  • If a country saves more than it invests – meaning it has a relatively low level of consumption and investment – this results in a current account surplus (see Germany and Japan in Fig. 2).

 

Fig-2-20160158_BlogPost_Sparquote-LBSalden-13Dez2016

 

Conclusions for the USA

 

In view of the macroeconomic relationships between consumption, investment and current account balance that have been outlined above, it is not possible – at least in the short term – to increase US economic growth by implementing protectionist measures. Lowering the American current account deficit not only requires a reduction in the level of imports but also a decrease in the level of overall economic consumption or investments.

 

  • A reduction in consumption means a rise in savings. However, as the savings rate in the USA – defined as the overall economic savings in relation to GDP – has been sinking since 2000 (see Fig. 1, above left), a higher savings rate is not to be expected in the short term.
  • Without lowering consumer demand, a reduction in the American current account deficit requires a decrease in the level of investment. But this serves to weaken US growth: investments represent an enlargement of the overall economic production apparatus, and without this enlargement no growth can take place.

 

Overall it appears that the US economy currently requires a current account deficit because only getting into debt abroad allows the USA to have a high level of consumption and investment. An abrupt introduction of high import tariffs and other protectionist measures would stifle the flow of products from overseas and therefore have a negative impact on the supply of goods in the USA.

 

Moreover, it would no longer be possible to implement a second economic policy component that has been planned by the new government: a massive decrease in taxes with the aim of boosting US consumption, combined with a rise in government investment. Such a stimulus package is not possible without the flow of goods from overseas and a level of debt abroad – meaning a current account deficit. At least one of these two economic policy objectives cannot be achieved.