U.S. Trade Deficit

   

Vietnam's exports to the U.S. are growing fast.   It also runs an overall current account surplus. If it has resumed purchasing dollars in the foreign exchange market to keep its currency from appreciating, it may soon be a test case for Trump's policy toward countries that intervene to maintain an undervalued currency.

If Trump wants to set targets for China’s imports, he should focus on its imports of manufactures—not on getting tweetable deliverables out of the soybeans and oil that China will import (from someone) no matter what…

China is a big country, and, at least until recently, it was growing relatively fast. So it stands to reason that it should have been among the most rapidly growing markets for U.S. exports.  The rapid growth of U.S. exports to China is the kind of thing that is often asserted in foreign policy speeches seeking to illustrate the importance of a healthy Sino-American relationship.    And it is often sort of implied in more recent articles that highlight the impact of China's slowdown on U.S. firms. But, well, China wasn't actually a rapidly growing market for U.S. exports of manufactures even before its recent slowdown.  The emphasis here is on "exports." I intentionally am not equating the sales of U.S. firms in China with U.S. production. Obviously, China’s retaliation against U.S. tariffs has played a large role in the data for the last few months. But the trend here dates back to the start of Obama’s second term. It isn't new. Over the last five years (since the end of 2013), China’s GDP (in dollar terms) is up 40 percent. U.S. GDP is up something like 20 percent. Exports of manufactures to China and Hong Kong are up less than 10 percent.* In other words, exports of manufactures to China were falling both as a share of Chinese GDP and as a share of U.S. GDP over the last five years (the fall during the crisis reflects China's broader reorientation toward domestic investment, and was matched by a fall in China's exports, though the downtrend actually started before the crisis). There have been times when the Chinese market for particular U.S. exports did grow rapidly in dollar terms. Chinese imports of aircraft rose from around $5 billion before the crisis to close to $15 billion by 2013. China’s imports of U.S. made autos (BMWs and Mercedes SUVs more than anything else) soared between 2007 and 2013, as the German luxury auto brands met booming Chinese demand after the global crisis from the facilities they constructed in the United States in the early aughts.** But there just haven’t been many big success stories in the past few years. In dollar terms, total U.S. exports of manufactures doubled in the five years that followed the global crisis. And then they basically stalled in the last five years. Total exports of manufactures (excluding refined petrol) to China are up a cumulative $10 billion (an average of $2 billion a year) over the last five years. That just doesn’t register in an economy as big as that of the United States.    To be sure, U.S. semiconductor firms get a large share of their sales from China, though many of those semiconductors aren't manufactured in the United States anymore and many of their sales to "China" don't reflect final Chinese demand.*** And U.S. companies that produce in China for the Chinese market—Apple and GM in particular—are exposed to swings in Chinese demand.   Their offshore profits certainly matter for the stock market, and thus indirectly impact U.S. consumer demand. And China buys a lot of commodities these days. I just don't think China's imports of commodities tell you as much the openness of China's economy, as China has to import commodities from someone.   There is another angle worth considering too—U.S. exports of manufactures haven’t done well in general over the last five years. The relative weakness of growth in U.S. exports to China might say more about the U.S. than China. But it turns out that the U.S. experience in China isn’t unique—exports from Europe and the rest of Asia have also lagged China’s own growth. Europe has done the best (exchange rates do matter), but its export performance also has lagged China's dollar GDP. Call it indirect evidence that Xi’s industrial policies, which often have an import-substituting component, have been modestly successful. Or evidence that China’s market still isn’t particularly open. A percentage point of growth in China hasn’t, in the post crisis period, typically translated into a percentage point growth in China’s non-commodity imports.**** The policy challenge is fairly obvious, at least to me.    China wants to preserve access to the U.S. market for its own manufactures—it wants to avoid premature decoupling (see Greg Ip). But its offer, to date, doesn't seem to include anything that would materially change the currently stalled trajectory of U.S. manufactured exports.*****  China's reported concessions would make it easier for U.S. firms to set up shop in China (and be treated as Chinese once they establish in China and thus compete in theory on a level playing field) and expand the set of U.S. commodities that China would purchase (corn and rice for example, plus more oil and LNG). Apart from the modest reduction in tariffs in autos, I at least don’t see any concrete offer to change the policies central to China’s recent pattern of import-substituting growth. That would require China abandon some of its domestic subsidies, and—somehow—credibly commit not to favor domestic Chinese production over imports.****** Remember, narrow-body aircraft (Boeing 737s) are among the biggest U.S. exports of manufactures to China. And in the future, narrow body planes will compete with a subsidized, indigenous, Chinese product for sales to China’s state-owned airlines. The basic set up here matches the market structure that China used to favor its own "indigenous" telecommunications equipment producers over the last fifteen years (see Roselyn Hsueh). Unless something more changes, U.S. aviation component producers will still face informal pressure to set up shop in China to get sales to COMAC. The Wall Street Journal reported that this pressure was basically a given a few months back: "When China set out to build its first large commercial passenger jet in 2008, state-owned Commercial Aircraft Corp. of China made clear it would buy components only from joint ventures whose foreign partners would share technology." That kind of deal minus the forced technology transfer would still create opportunities for U.S. firms, but not necessarily opportunities for U.S. workers.    Even if China reverses its U.S. specific auto tariffs and U.S. exports face the new standard 15 percent tariff rate, I would now bet that U.S. workers will make fewer, not more, cars for the Chinese market over the next few years. BMW and Tesla are now both investing more in China, thanks to a shift in Chinese policy that has allowed foreign owned auto manufactures to invest without necessarily forming a joint venture. The old joint venture requirement effectively acted as a tax on manufacturing luxury cars in China; getting rid of it encourages firms to produce more not less in China. BMW is now talking about using its Chinese factory as an export base. There aren't many ways to make up for the $25 billion of autos and aircraft that the U.S. now exports to China, especially when China has policies that aim to subsidize and support indigenous production of semiconductors and medical equipment. So long as China's policies here can only be adjusted at the margins, the downward trend in U.S. exports of manufactures relative to China's GDP seems likely to continue.   China’s vision of its future seems to be one where it increasingly exports capital goods while it imports consumer goods and commodities. That’s ultimately a vision where there is less trade with the world’s other advanced big economies than was the case in the period that immediately followed China’s entry into the WTO.  So, setting commodity purchases aside, maybe a deal that creates more scope for U.S. firms to succeed in China if they invest in China is the best that the U.S. can realistically expect to do? That though is a world where the benefits of China's growing economy will largely flow to those who own valuable technology that can be licensed to a firm that produces in China, not to a broader group of Americans.******* * Exports to China and Hong Kong are up by just over 5 percent since 2013; exports to China itself are up more like 10 percent. However, I strongly believe that trade through Hong Kong should be added to the Chinese data. U.S. exports to Hong Kong used to account for something like a fifth of total U.S. manufactured exports to greater China, and I think it is clear that a lot of U.S. exports to Hong Kong don’t stay in Hong Kong. Adding in exports to Hong Kong also helps raise U.S. exports to "China" to levels that match what China thinks it imports from the United States. ** These exports sometimes get discounted because they come from German companies. They shouldn’t be. The German transplants support a ecosystem of local suppliers, and ultimately support far more U.S. jobs than say GM’s production in China. It of course would be great to have exports of goods that are both designed and manufactured largely in the United States, but outside of aircraft, there just aren’t all that many examples. *** Weijian Shan is an extremely impressive man. But I wasn't persuaded by his argument. It equates U.S. firms with the United States a bit too much for my taste. And China's apparent importance to U.S. semiconductor firms clearly warrants a bit more critical scrutiny. I would bet that the bulk of Micron's and Intel's sales to China don't reflect end-demand in China. And, well, we know from the trade data that U.S. semiconductors exports to China and Hong Kong account for something like $10 billion of the $200 billion plus (total imports of integrated circuits were $300 billion) of semiconductors that China imports. That's a quite low share. It no doubt reflects both transfer pricing and the extensive use of Asian fabs by U.S. firms. **** In technical terms, the income elasticity of China’s imports looks well below 1, especially if commodities are excluded. See, among others, the ECB's research department. This may have changed a bit in the last two years, but I increasingly suspect the rise in China's manufactured imports over the last two years is tied to the rise in semiconductor prices more than any structural shift. ***** For those who are interested, here is the bilateral balance in manufactures. There is no particular reason why it should balance.    The gap with China reflects the broader imbalance with East Asia, as there is substantial Korean and Taiwanese content embedded in the typical Chinese electronic export. But it also illustrates that the slowdown in U.S. exports in the last five years hasn't been matched by a slowdown in U.S. imports. ****** The Trump Administration does seem to be asking China to live up to its WTO commitment to report its domestic subsidies. But China is under no obligation to give up its domestic subsidies, only to report them. And in an economy with Chinese characteristics, determining the exact subsidy is difficult: all state firms tend to get preferred access to credit. ******* Apart from tourism, and the transport of goods, "services" still tend to be hard to trade across borders (U.S. exports of services to China are mostly education and tourism, which require the physical movement of people). Most proposals for liberalizing services trade would in practice tend to make it easier to invest in China to deliver services in China, not use U.S. workers to provide services across the border. I am setting IPR license fees aside here, they are a bit different.

  

Both China and the U.S. provided their respective snapshots on the state of global trade earlier this month… The U.S. October trade data showed that the U.S. imports continue to grow at a robust clip. The Chinese November trade release by contrast showed a significant weakening in Chinese import demand. Up until now China’s imports had been surprisingly strong even as other signs suggested that China’s overall economy was slowing.  Both are important data points going into 2019. Combined growth in both Chinese import demand and U.S. import demand (Trump’s stimulus has overwhelmed his protectionism) in 2017 and 2018 drove the recovery in global trade, and helped propel Europe’s growth. With Chinese demand now faltering and Europe showing signs of weakness, the United States is now at risk of becoming the sole remaining engine of global demand. And that feels risky, as, well, Trump has consistently been against a rising import bill. At least in theory. His fiscal policies of course have predictably pushed U.S. imports up, something that is likely to be increasingly apparent as the q4 data continues to roll in. The October U.S. trade data release. The overall U.S. trade balance these days is the tale of two very different stories—a falling trade deficit in oil (higher production, and now, again lower prices) and a rapidly rising deficit in non-petrol goods trade.* There just isn’t much of a story in services trade in the past few years; the U.S. services surplus has been broadly constant—the action has been on the goods side. Because the overall trade deficit hasn’t changed that much, I don’t think the rise in the deficit in non-petrol goods trade (and in manufacturing trade) has gotten as much attention as the scale of the underlying shift warrants. Since 2014, the non-oil goods deficit has basically doubled in dollar terms—initially because of a fall in exports after the dollar’s rise, increasingly because the stimulus has raised U.S. import demand. That’s a big swing, one big enough to overwhelm the dramatic improvement in the oil balance. That story this year was complicated because the trade deficit unexpectedly fell in the second quarter of 2018. But it is now clear that this was a false positive signal, as it was a function of a set of one-offs—the soybean pre-tariff surge, a pause in the growth in imports are a large rise in q4 of 2017—rather than a break in the basic narrative. In q3 the non-petrol deficit rose steadily, and October’s deficit was higher than that of q3. The trade deficit in manufactures is now consistently topping exports—e.g. for every dollar of manufactures the United States exports, it now imports two. Manufactures here is adjusted to exclude refined petroleum. Obviously, the manufacturing deficit isn’t new. But the scale of it is. In a world of regional supply chains, North America's deficit supplies the net demand for manufactures needed to sustain large surpluses in Asia and Europe. The deficit in manufactures—as Eduardo Porter highlighted in a recent article—has important geographic consequences. Manufacturing was once an important source of employment in a number of small towns. The “real” goods data is if anything a bit worse, as the price of imports has been falling a bit, so the rise in real imports top the rise in nominal imports. Real non-petrol imports are now up more than two times as much as real non-petrol exports in the post-crisis period. Nominal GDP has been growing—so the swings are smaller as a share of GDP (and until recently the widening deficit largely reflected a fall in exports as a share of GDP). But as the data from the last half of 2018 rolls in, the non-petrol goods (and non-petrol goods and services) deficit is starting to widen as a share of GDP too. The broader balance of payments still benefits from the post-crisis fall in nominal interest rates (which has held down the interest bill on a net external debt that approaches 50 percent of GDP if you leave out the “gold” at Fort Knox) and the United States' substantial offshore profits (largely in the world’s low tax jurisdictions). But the q3 current account deficit rose significantly, after a surprise fall in q2. Why care—well, Trump was elected on a promise that he would make American manufacturing great. But his policies really have been a boon to the United States' trade partners. The surpluses that both China (reflecting the broader East Asian manufacturing ecosystem) and the euro area run with the United States are up substantially. Trump’s stimulus was in many ways a global stimulus. U.S. imports of manufactures are now rising by around 10 percent y/y (a bit faster than the overall economy), well up from the 2 percent growth rate (an admittedly slow pace of growth) in the last four years of the Obama administration. And, well, it isn’t clear that U.S. imports will continue to grow at this current pace— Most obviously, because demand growth is likely to slow a bit from its rapid 2018 pace, and import growth reflects strong demand growth (as well as the strength of the dollar). And, if Trump does go ahead with either the threatened tariffs on China or the threatened tariffs on autos it will in the short-run add a substantial fiscal drag to the United States—as there is no realistic way to replace all imports from China or all imports of autos with U.S. production in the short-run. So higher tariffs will result in higher prices for consumers (less spending) and a rise in government revenue (as many firms will have no choice but to pay the tariff). Frame this however you want: Trump undermining his own stimulus with his trade policies, or as an end to a free ride the U.S. fiscal stimulus provided to the world over the last year. Either way, it would put new pressure on the rest of the world—and Europe in particular—to find domestic sources of growth. And then there is China— China isn’t quite as big a source of global demand—at least for manufactures—as its rapid growth would imply. Since 2012 China’s economy has expanded by about 41 percent (in real terms) but its imports (in dollars) of manufactures are only up about 15 percent if you take out semiconductors—where there has been a big price hike that is now reversing. U.S. imports are up far more (off a bigger base). But China still matters. The recovery in its non-semiconductor import demand, along with Trump’s stimulus, helped drive the broader revival of global trade in 2017 and 2018. Chinese demand wasn't all commodities either, imports from both Europe and the rest of Asia jumped (after broadly stalling after 2012). And it now seems that China’s demand growth is faltering. Admittedly, the story is complex. Oil import volumes are up, coal and iron imports may be down for administrative reasons, and China (still) imports in order to export. Real export growth of only 1 percent y/y (per Tao Wang of UBS) implies less need for imported parts. But it is now hard to believe that Chinese demand itself has not slowed. The downturn in imports in November was fairly broad based. And perhaps slowed by more than has been officially reported. See Keith Bradsher and Ailin Tang. Now China is poised to do some sort of stimulus, one that may help support import demand over the course of 2019. But for now, one of the main engines of the global trade recovery of the past two years has faltered. And the other, well, its President never liked being an engine supporting the rest of the world’s growth— One final point before signing off. China stands to benefit from a sizeable positive shock to its terms of trade. What are China’s two biggest imports? Integrated circuits/semiconductors ($300 billion in 2017) and crude oil and petroleum products (over $200b). Together, these two products account for about a quarter of China’s total imports (to be sure, some imported semiconductors are re-exported as finished electronics, but China’s new economy uses some domestically as well). And the price of both are now falling. Memory chip prices are down by about 10 percent, and could fall by more. Oil is now well under $60 (WTI is even lower). That’s going to help China’s trade balance. It isn’t clear to me that—absent a Trump tariff shock—China’s trade deficit will continue to shrink and that the current account will swing into deficit. I suspect that we are at least at a temporary inflection point on China’s import growth, with a clear shift down for a few months. China’s surplus could rise even as its export growth slows sharply. And I am waiting for signs that the recent surge in the non-oil trade deficit in the United States is fading—with strong overall demand growth it has had a bigger impact on the composition of output and employment than on the level of output and employment. But, unlike some, I do think the absence of any sustained (non-oil) export growth since the dollar appreciated in 2014 is an underlying point of weakness for the United States. When the tides turn and the United States needs to draw on global demand to support its growth, it may lack the export base needed to benefit from the opportunity… a 10 percent fall in the dollar that boosted real manufacturing exports by 10 percent would now only deliver a half point boost to U.S. growth… and the numbers don’t get that much better if you add in agriculture.   * Service trade is in my view a bit over hyped for the United States—the transport of people and goods is still the biggest category of services trade, and, well that is really a function of tourism and goods trade. A bit too much trade in intellectual property and in financial services currently involves a low tax jurisdiction for my intellectual comfort. The monthly data also doesn’t provide much information, as services trade is poorly measured in general and largely estimated in the monthly data.

   

It is hard to think of a President more committed—at least rhetorically—to closing the trade balance than President Trump. The usual criticism of his trade policy is that it is overly focused on a single goal—reducing the bilateral, and ultimately the overall, trade deficit, to the exclusion of more traditional goals like liberalization (e.g. expanding trade) or expanding the scope of the traditional rules governing trade. President Trump has made it equally clear he cares about the manufacturing balance.    Yet the results of the first seven quarters of his presidency show, ironically, the limits on what can be achieved through trade policy alone. To be sure, the impact of Trump's new tariffs (on China) and the new trade deal (with Canada and Mexico) aren't in the data yet. President Trump's trade policy for the first six quarters of his presidency consisted of halting further liberalization (by opting not to participate in the TPP) and a set of fairly narrow, sector specific trade cases (steel, solar, washing machines); the really big shift in policy is only now starting.   But, well, the trade actions to date haven’t come close to achieving the turnaround in manufacturing trade President Trump promised. Imports of manufactures are up significantly. (I forecast out the third quarter based on the first two months of data, if China's September numbers are indicative, I may have been too conservative). I used a somewhat unconventional measure to look at changes in the real trade balance. I used the contributions data in the national income and product accounts rather than the trade data directly. And I calculated the contribution each quarter from the national income and product accounts data and then summed the contributions over time. This avoids the difficulties of scaling real trade measures to real GDP (I think) – and takes out the effect of price movement. This allows me to paint a picture about what is happening to different sectors of the economy—manufacturing for example, petrol, and even services (though there isn’t a story in the services data over the past few years)—as well as the overall numbers.* What jumps out in the data on manufacturing trade? Well, two macroeconomic factors. One: The dollar’s 2014/15 appreciation led export growth to stall, and created a significant drag on the economy at a time when overall demand growth was weak. Falling exports added to the pressure on the manufacturing sector created by the fall in oil and agricultural investment (see Neil Irwin of the New York Times). Two: Trump’s stimulus has, as predicted, supported strong import growth—even in the face of Trump’s “America first” trade policy. Yep, so far Trump’s overall policy mix—his combination of stimulative macroeconomic policies and more aggressive trade policy—has delivered a net stimulus of about 1 percent of U.S. GDP to the United States' main manufacturing trade partners. Trump’s stimulus—and the still relatively strong dollar—are making German and Chinese exports great (again). In technical terms, the cumulative contribution of trade in core manufactures (capital goods, autos, and consumer goods in the trade data) has been negative 0.9 pp of GDP over the first six quarters of Trump’s presidency, and based on the data for the first two months of the third quarter of 2017, the cumulative (negative) contribution will soon be over a percentage point of U.S. GDP. Germany, Japan, Korea, China and many others certainly don’t like Trump’s challenge to the existing trade rules. But they all also have—to date—benefited from strong U.S. demand for exports. The recent import surge, when the q3 data is factored in, will have delivered a benefit to them that is roughly comparable in size to the swing associated with the dollar’s 2014/15 rise. We will see what happens when Trump’s tariffs on China take place. Import growth could cool—the full tariffs would cover roughly a quarter of U.S. “core” goods imports (imports of consumer goods, capital goods, and autos). However, the net effect of putting tariffs on imports of around 2.5 percent of U.S. GDP depends on how much trade is diverted to other trade partners. And export growth also looks to be slowing on the back of the dollar’s strength in the last two quarters, weakness in emerging economies and other countries’ retaliation for Trump’s trade action. Reducing your imports doesn’t improve your trade balance if exports also fall. At least for now, though, “macro” factors trump “micro” factors. Trump’s stimulus has had a far bigger effect on the global economy than Trump’s protectionism. Analysts who look at the nominal trade data haven’t observed the deterioration in the trade balance that I have highlighted, at least not yet. The current account balance has also stayed relatively constant. That isn’t primarily because of services. Or even because of the income balance, though the surplus generated by the offshore profits of U.S. firms remains large. The main offset to the quite significant widening of the manufacturing deficit over the last four years has been the U.S. oil boom. Those who argue that the U.S. can never grow through exports (or substituting domestic production for imports) should take close look at the oil sector. Over the last decade, the fall in the real petrol balance (e.g. rising domestic U.S. production relative to U.S. demand) has added close to two percentage points to U.S. growth.    The improvement in the real petrol balance over the last six quarters has been about 0.5 pp of GDP (based on cumulative contributions), roughly half the deterioration in the non-oil goods balance. A payoff from Trump’s policy of “energy dominance”? Perhaps. But it is more likely a function of changes in the oil price, and the evolving cost structure of U.S. production. Fracking the Permian basin (in West Texas and New Mexico) has generated an amazing amount of oil, at a fairly low cost. The shale boom started under Obama—not under Trump—and it was initially propelled by a combination of a high global oil price, a weak dollar, and good old-fashioned American ingenuity. The dominance of macroeconomic factors extends to one other component of the trade balance—tourism (tourism generally accounts for the bulk of the U.S. services surplus with East Asia; many other services, alas, seem to be exported primarily to tax havens***). U.S. tourism imports (Americans taking vacations abroad) rise when the dollar is strong— and U.S. tourism exports (foreign tourists visiting the U.S.) tend to grow when the dollar is weak (e.g. 2005 to 2014). Trump’s more restrictive immigration policies have added some friction at the border no doubt. But the “stop” in tourism exports actually came in early 2015, six quarters before Trump (and a couple of quarters after the dollar moved).   One final point: I framed this as an argument that Trump’s trade policy hasn’t had the expected effect on the trade balance, as the evolution of the trade balance has been driven by macroeconomic factors—the dollar’s strength, U.S. demand growth, and foreign demand growth. It equally could be presented as an argument that the overall macroeconomic effect of Trump’s coming tariffs will be fairly modest so long as the Fed is free to react to any drag on U.S. activity from the tariffs. The aggregate effect on the economy of even relatively aggressive trade action—as Goldman Sach’s economic research team has argued—ends up being fairly small in a standard macroeconomic model, absent a mistake by the Fed or a shock to “confidence.” The sectoral effect, of course, remains significant (ask soybean farmers in the Dakotas). And, well, it is also worth remembering that the impact of the tariffs on China would also be expected to induce changes in China's policy mix. If China responds by using fiscal policy to stimulate domestic consumption demand, that's good for the world. But it stabilizes output by loosening monetary policy, that would typically be expected to result in a weaker currency —which would offset some of the impact of the tariff on China while shifting some of the pressure over to China's trade partners. * Over the grand course of time, the contribution of exports and imports should generally balance out (no country can run a large trade deficit forever, though it is possible to run a modest trade deficit over time so long as the interest rate on a country's external borrowing is modest). A symmetric expansion of trade, if it reflects the healthy development of comparative advantage, raises the overall level of output as both partners specialize in what they do best. Such dynamic gains are by definition not captured in an analysis of the contribution of trade in the national income and product accounts. The national income and product accounts instead draw attention to the impact of trade on demand, and what matters there is the growth of exports relative to imports. Broadly speaking, what the trade data shows is that the U.S. has increasingly specialized in the production of goods and services for the domestic economy, rather than specializing in the production of goods and services for the global market. A drag on demand from trade has a much more negative overall economic impact if it comes at a time when overall demand is weak. ** The q2 data was heavily influenced by both changes in the petrol balance and changes in the food and feeds balance. In fact, the petrol and the “soybean” surge (measured in the food and feed balance) account for the entire increase in U.S. exports in q2. The available data suggests that the surge in soybean exports will reverse itself, but not likely until q4. For my forecast, I assumed 2018 q4 exports fell back to their q4 2017 level. They may be optimistic. *** I am only partially joking. Ireland is the number one destination for a lot of IPR related service exports, the Caribbean is the number one destination for exports of financial services. See tables 2.2 and 2.3 in the BEA's services trade data.

The best way of painting a more accurate picture of the economic relationship between China and the U.S.? Add in data on U.S. exports to Hong Kong.