The Economy

Trade Deficit: Don’t Worry. Budget Deficit: Worry

Donald Trump's threat to impose heavy tariffs on Mexico and China addresses a nonexistent problem. He should focus instead on the federal budget de...
Marc WagmanDecember 12, 2016
Trade Deficit: Don’t Worry. Budget Deficit: Worry

“Make America Great Again.” Hmm — certainly a catchy campaign slogan designed to rouse our inner patriot.

trade credit credit losses

Marc Wagman

Unfortunately, at least part of the message implicit in that sound bite is the misguided idea that because of our trade deficit — because the United States purchases more goods and services from our trading partners than we sell to them — American jobs are being lost and our working middle class is stagnating.

Hopefully all of that protectionist poppycock was just a lot of election-year smack. In the event it wasn’t, here’s a message for policymakers and anyone who cares enough to write to their representatives in Congress:

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“If you really want to help American working men and women in the 21st century, focus on the federal budget deficit, because that’s the one that matters. Trade imbalances have existed on and off throughout American history, yet the U.S. economy has been the world’s irreplaceable engine of innovation and wealth creation. The inexorable rise in the globe’s standard of living and productivity since the end of World War II began in the United States — and it will end here if we regress on foreign trade.”

Speaking of making America “great” again, recall how the protectionist Smoot-Hawley Act of 1930 served only to make the Great Depression “greater.” Raising tariffs on tens of thousands of goods imported into the United States, the law triggered an almost immediate reciprocal response by all of our major trading partners across the world.

OpinionThe beggar-thy-neighbor policies of the 1930s essentially shut down global free trade and, in so doing, exacerbated global economic weakness across virtually every industrial and agricultural sector, hurting no one in the United States worse than the working man.

Fast forward to 2016, and the biggest (and saddest) irony is that if the president-elect delivers on his threat to slap 35% tariffs on imports from our two largest trade partners, Mexico and China, the folks that elected Trump will consequently suffer the most.

A major reason for that: for many of the working-class people that voted for Trump, it is virtually a sure thing that prices at their favorite retailers, like Walmart, Target, and Costco, will rise in lockstep with such tariff increases.

Viewed empirically, the data doesn’t bear out what Trump is saying. The graph below illustrates this vividly.

The red line represents year-over-year percentage changes in non-farm, private-sector payroll and references the y-axis on the left. There happens to be no better single variable than non-farm, private-sector payroll growth to use as a proxy for economic growth, especially considering that a central domestic policy mantra of both political parties during the presidential campaign was jobs, jobs, and jobs.Trade DeficitsThis employment data also happens to correlate very accurately with changes in gross domestic product. Though the data goes back to 1947, when the Bureau of Labor Statistics began tracking it, one only needs to look at the recessions from the last 45 years — 1973, 1975, 1981, 1982, 1991, 2001, and the biggie, 2008-2009.

The employment data correlate very accurately with both the recessions and the timing of GDP growth. Contrast that with the year-over-year changes in net exports calculated as a percentage of GDP (i.e., the difference, negative or positive, expressed as exports minus imports divided by gross domestic product, again going back to 1947).

If you’re having difficulty discerning a pattern between the two lines, that’s exactly the point. There is little correlation between these two variables, and in fact, one can see that in periods of strong job growth, during the economic expansions of the 1960s, 1980s, 1990s, and 2000s (pre-financial crisis), in some years the trade deficit as a percentage of GDP sometimes widened.

This isn’t to be insensitive to the hundreds of thousands of American men and women who lost their jobs in, for example, the steel and automotive industries since the 1980s. However, the challenge for any democratic society built on principles of free-market capitalism is that by definition, there will be industry winners and losers.

Policymakers should stop trying to pick those winners and losers and allow labor and capital to flow where it can be used most efficiently. As a nation built on the strength of our middle class, we need to implement lower taxes and deregulation, which will encourage private-sector job growth specifically so that we can re-enfranchise those disenfranchised workers.

Now, back to getting the federal budget deficit under control. That’s the key undertaking that smart public policymakers should tackle head-on to address the needs of those same workers. No population segment will be hurt more by a widening federal budget deficit than Baby Boomer and Generation X workers.

Left unaddressed and uncorrected, federal entitlement programs like Social Security, Medicare, and Medicaid threaten the viability of our entire financial system. Hundreds of millions of Americans have paid into those systems, but the working-class people who will really rely on them in the next 10 to 20 years may be left in the lurch, uncared for and unprotected. Entitlement reform has been politically inexpedient in Washington for decades. That has to change, and fast.

Under the Obama Administration, U.S. government debt as a percentage of GDP has grown from 28% in 2008 to 72% in 2016. It’s estimated that within 10 years, interest expense as a percentage of the federal budget is going to be a staggering 17%.

Combined with all other public-sector borrowing the in United States (i.e., by municipalities and states), total public-sector debt now approaches 100% of GDP. With the exception of the period during World War II, this is historically unprecedented in the United States.

Compound that with rising short- and long-term interest rates and a U.S. bond market whose 35-year rally is now finished, higher interest expense will only exacerbate the problem for everyone.

Unchecked in a rising-interest-rate environment, public-sector borrowing could crowd out the private sector at both the corporate and consumer levels. While that is a worse-case scenario, it is conceivable, with implications unimaginable. The budget deficit is the deficit that matters, and we need to address it with tough choices while we still have the time.

Marc Wagman is executive vice president, trade credit and political risk, for Arthur J. Gallagher Risk Management Services.

The opinions expressed in this article are those of the author only and do not necessarily represent those of Arthur J. Gallagher Risk Management Services.