The U.S. Trade Deficit: A Dangerous Obsession

Joseph P. Quinlan And Marc Chandler

From Foreign Affairs, May/June 2001

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Summary:  The United States is obsessed with its ever-growing trade deficit. Yet trade is no longer a valid measure of global competitiveness. Today U.S. firms compete in the world marketplace through foreign-affiliate sales instead of exports -- and they do so with unparalleled success. Overblown fears about the burgeoning trade deficit, along with a slowing U.S. economy, could spark protectionist policies in Washington, which could then trigger retaliations around the globe. This outcome -- not the size of the trade deficit -- is the greatest danger.

Joseph P. Quinlan is Senior Global Economist at Morgan Stanley Dean Witter and author of Global Engagement: How American Companies Really Compete in the Global Economy. Marc Chandler is Chief Currency Strategist at Mellon Financial Corporation.

THE WRONG SCORECARD

Every U.S. president over the past quarter-century has confronted an annual trade deficit. But the cavernous trade gap inherited by President George W. Bush dwarfs those faced by his predecessors. America's current-account deficit (which measures the cross-border exchange of goods, services, and investment income) averaged more than $1 billion a day last year, reaching a record 4.4 percent of GDP. Many economists worry that the huge trade deficit, which must be financed by foreign investors, could lead to a full-blown financial crisis if and when those investors become unwilling to fund the imbalance. Something as benign as stronger economic growth in another country, for instance, could attract a larger share of the world's savings, leading to higher U.S. interest rates, a weaker dollar, and a grimmer economic outlook for the United States and the world.

Economists offer various explanations for the persistent U.S. trade deficit. Some argue that America buys more from the world than it sells because its companies are growing less competitive. Others blame the "unfair" trade restrictions and labor policies of other countries. Still others point to the underlying strength of the dollar, which makes American goods and services more expensive for foreign buyers.

Whatever the proper explanation, a simple and important fact is absent from the debate: the trade balance is no longer a valid scorecard for America's global sales and competitiveness. Given a choice, U.S. firms prefer to sell goods and services abroad through their foreign affiliates instead of exporting them from the United States. In 1998, U.S. foreign-affiliate sales topped a staggering $2.4 trillion, while U.S. exports -- the common but spurious yardstick of U.S. global sales -- totaled just $933 billion, or less than 40 percent of affiliate sales. How U.S. firms compete in world markets, in other words, goes well beyond trade.

Still, trade erroneously remains the standard benchmark of global competitiveness. More worrisome, it is the most important factor shaping U.S. international economic policy. Overblown concern about the swollen trade deficit, combined with a slowing economy and the expectation of rising unemployment, could ignite a new round of trade protectionism in Washington, which could spark similar responses around the globe. The greatest danger on America's trade front, therefore, is not the size of the deficit but the nation's obsession with it.

INSIDER TRADING

The rule "make where you sell" increasingly governs the way American companies do business. It explains, for example, why Ford Motor Company and General Motors have long owned affiliates in Europe and have recently entered promising emerging markets such as Brazil and China. The principle also underlies Dell Computer's direct-investment positions in Europe and Latin America, as well as those of Cisco Systems and Microsoft in China. And because of the increased globalization of services, U.S. service giants such as American International Group, Citigroup, FedEx, and Yahoo have also set up foreign affiliates, leading the boom in U.S. foreign direct investment (FDI) over the last decade.

American companies simply cannot afford the luxury of ...

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