Current Account Deficit Surges in First Quarter
Wednesday, June 18, 2008
Commentary by Peter Morici, Ph.D.
The Commerce Department reported this week that the first quarter current account
deficit was $176.4 billion, up from $167.2 billion in the fourth quarter of 2007. The deficit was 5.0 percent of GDP.
The current account is the broadest measure of the U.S. trade balance. In addition to trade in goods and services, it includes income received from U.S. investments abroad less payments to foreigners on their investments in the United States.
In the first quarter, the United States had a $36.1 surplus on trade in services and a $29.8 billion surplus on income payments. This was hardly enough to offset
the massive $211.0 billion deficit on trade in goods, and net unilateral transfers to foreigners equal to $31.2 billion.
The huge deficit on trade in goods is mostly caused by a combination of an overvalued dollar against the Chinese yuan, a dysfunctional national energy policy that increases U.S. dependence on foreign oil, and the competitive woes of the three domestic automakers. Together, the trade deficit with China and on petroleum and automotive products total more than 100 percent of the deficit on trade in goods and services.
To finance the current account deficit
, Americans borrowed and sold assets at a pace of about $600 billion a year. U.S. foreign debt exceeds $6.5 trillion, and at 5 percent interest, the debt service comes to about $2000 a year for every working American.
The current account deficit imposes a significant tax on GDP growth by moving workers from export and import-competing industries to other sectors of the economy. This reduces labor productivity, research and development (R&D) spending, and important investments in human capital. In 2008 the trade deficit is slicing at least $250 billion off GDP, and longer term, it reduces potential annual GDP growth to about 3 percent from about 4 percent.
Financing the Deficit
The current account deficit must be financed by a capital account
surplus, either by foreigners investing in the U.S. economy or loaning Americans money. Some analysts argue that the deficit reflects U.S. economic strength, because foreigners find many promising investments here. The details of U.S. financing belie this argument.
In the first quarter, U.S. investments abroad were $286.6 billion, while foreigners invested $411.0 billion in the United States. Of that latter total, only $46.6 billion or 11 percent was direct investment in U.S. productive assets. The remaining capital inflows
were foreign purchases of Treasury securities, corporate bonds, bank accounts, currency, and other paper assets. Essentially, Americans borrowed $364.4 billion to consume about 5.0 percent more than they produced.
In the first quarter, foreign governments loaned Americans $173.5 billion or 4.9 percent of GDP. That well exceeded net household borrowing to finance homes, cars, gasoline, and other consumer goods. The Chinese and other governments are essentially bankrolling U.S. consumers, who in turn are mortgaging their children’s income.
The cumulative effects of this borrowing are frightening. The total external debt now exceeds $6 trillion. The debt service at 5 percent interest, amounts to $2000 for each working American.
The Chinese government alone holds enough U.S. and other foreign reserves to purchase about five percent of the shares of all publicly traded U.S. companies. The U.S. trade deficit is the primary driver behind this phenomenon.
Consequences for Economic Growth
High and rising trade deficits tax economic growth. Specifically, each dollar spent on imports that is not matched by a dollar of exports
reduces domestic demand and employment, and shifts workers into activities where productivity is lower.
Productivity is at least 50 percent higher in industries that export and compete with imports, and reducing the trade deficit and moving workers into these industries would increase GDP.
Were the trade deficit cut in half, GDP would increase more than $250 billion or more than $1750 for every working American. Workers’ wages would not be lagging inflation, and ordinary working Americans would more easily find jobs paying higher wages and offering decent benefits.
Manufacturers are particularly hard hit by this subsidized competition. Through recession and recovery, the manufacturing sector has lost 3.7 million jobs since 2000. Following the pattern of past economic recoveries, the manufacturing sector should have regained about 2 million of those jobs, especially given the very strong productivity growth accomplished in durable goods and throughout manufacturing.
Longer-term, persistent U.S. trade deficits are a substantial drag on growth. U.S. import-competing and export industries spend three times the national average on industrial R&D, and encourage more investments in skills and education than other sectors of the economy. By shifting employment away from trade-competing industries, the trade deficit reduces U.S. investments in new methods and products, and skilled labor.
Cutting the trade deficit in half would boost U.S. GDP growth by one percentage point a year, and the trade deficits of the last two decades have reduced U.S. growth by one percentage point a year.
Lost growth is cumulative. Thanks to the record trade deficits accumulated over the last 10 years, the U.S. economy is about $1.5 trillion smaller. This comes to about $10000 per worker.
Had the Administration and the Congress acted responsibly to reduce the deficit, American workers would be much better off, tax revenues would be much larger, and the federal deficit could be eliminated without cutting spending.
The damage grows larger each month, as the Bush administration dallies and ignores the corrosive consequences of the trade deficit.
Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission