How Not to Sound Like an Idiot About the Trade Deficit, Part 1

Ok, we need to talk about the trade balance…not so much whether trade deficits are bad, since I fear that we’re not even ready for that conversation yet. Let’s instead just focus on what the trade balance is and how it works logistically- I swear I have a point here.

The “trade balance” is just exports minus imports- in other words, the amount of stuff that we produce in the US and sell to foreigners minus the amount that is produced in foreign countries that US consumers buy. (If you’re not reading this from the US, just pretend for a few minutes that you are.) When exports are greater than imports there is a “trade surplus” (positive trade balance) and when imports are greater than exports there is a “trade deficit” (negative trade balance). We can talk about the trade balance in a global sense, as I did above, or we could talk about the trade balance with a particular country in an analogous fashion.

This all sounds pretty simple, except…well, as globalization becomes a bigger thing, it gets a little tricky. For example, let’s say Apple get iPhone parts from China, finishes producing it and whatnot in the US, and sells it to someone in Germany. Technically speaking, the value of the parts counts as an import and the value of the finished iPhone counts as an export, and the difference contributes to the trade balance. But it can get even weirder- one of the things I like to tell my students is that my work is contributing positively to the trade balance. How is this, given that I don’t get shipped overseas to give my lectures?

Here, I think the Brookings Institution can explain it better than I can:

If you are not an economist, the idea that America’s education of foreign students is an export may seem strange. What makes a service like education an export is that foreigners pay U.S. institutions, so money flows into the U.S. from abroad. Education of a French student in the United States is an export in exactly the same way that the visit of a Chinese tourist to Disneyland is an export, or the provision of stock brokering services on the New York Stock Exchange to a German financial company is an export. When we provide a service that leads to foreigners sending money into the U.S., that’s an export with exactly the same economic effects as when we sell soybeans or coal abroad.

Weird, but it makes perfect sense if you think about it.

Now that we understand the trade balance, here’s a quiz: consider the following scenario. What impact does this transaction have on the US trade balance?

A Canadian citizen comes to Michigan to buy a pair of shoes. He buys the shoes and then brings them back to his home in Canada. (For the sake of simplicity, assume that the shoes were made in Michigan.)

Spoiler alert: it’s a bit of a trick question. Conceptually, this obviously counts as an export from the perspective of the US. In terms of data collection, however, it’s a little less clear. Specifically, I guess it depends on whether the shoes are declared at customs and such, since the store isn’t going to directly report that they sold shoes to a visiting Canadian. In terms of the actual economic contribution, it counts whether it gets reported or not.

By now you may have guessed that the scenario that I gave you is not random, and you’re right:

There’s…well, a lot to unpack here. First, I did a little digging, and I learned that despite the government’s lamentations, NAFTA is still in effect. This means that there’s no reason to smuggle the US shoes into Canada, since there’s no tariff on shoes made in the US anyway. But let’s make things more interesting and assume instead that the shoes weren’t made in the US and instead made in a country that Canada doesn’t have a trade agreement with. In this case, Canadians can still bring a limited amount of these goods home with them from the US without any tariff consequences, provided that they spend at least 48 hours in the US. (You can see more detail here if you are curious.)

I almost didn’t want to tell you any of that though, since it’s a bit like missing the forest for the trees. EVEN IF Canadians were smuggling shoes back home with them, it has a far more negative effect on Canada than it does on the US- in fact, it probably doesn’t have a negative impact on the US at all. Let’s see how it stacks up:

Canada: doesn’t sell a pair of shoes (since the Canadian bought the US shoes instead), doesn’t get tariff revenue that it might otherwise be entitled to

US: sells a pair of shoes, might not get national income accounting credit for it as an export

This makes me wonder…did Trump forget that we’re not Canada? As a pure point of logic, it doesn’t make sense to complain both about trade deficits and about things that decrease the trade deficit. (Even if the shoes were made outside the US, there’s likely some added value provided by the retailer that counts as an export.) I mean, the only even remotely reasonable thing to complain about in this process from the US perspective is that the US may not get official credit for the export. Or, put a slightly different way:

For the nerds in the audience that remember your Y=C+I+G+NX, this implies that some items that should be in NX get counted as C instead. For most macroeconomic purposes this doesn’t mater a *whole* lot I guess, unless of course you’re specifically obsessed with the trade deficit.