Most Americans think incorrectly about the benefits of free trade. The general view is that it is good to export more than you import, and that the advantage is to the seller.
This is how many in the “buy local” movement view the world, along with those folks still clinging to the “economic base theory” of local economic development. It is also precisely how George III viewed the world, but he also had the excuse of insanity.
Trade is the selling of goods made in one place to people in another place. It should be obvious that a favorable balance of trade can hardly have anything to do with growth. After all, the world’s standard of living has grown some 20 fold since 1700, and there is scant evidence we run a balance of trade with Venus.
Trade can enable growth, but only through improving access to technology. To economists, technology isn’t necessarily computers and robotics, rather it is how we organize the production of goods and services and how we organize their movement to market. A huge element of this is moving production to the most efficient places. That means moving Happy Meal toys to technically unsophisticated China and orthopedic devices to modern Indiana.
A savvy reader will ask what happens when China modernizes and can produce knee joints? The answer is still that this is good. We want Chinese workers to get better and more affluent. There is an obvious moral argument here, but the pure economics of this result in an increase in the world’s productive capacity.
Unquestionably, workers who cannot learn new skills may find the disruption difficult. With or without foreign trade, we must all be prepared to adapt to new technologies.
That leads us directly to the fundamentals of trade, and why it is the importer, not exporter who benefits. It is people, not governments who buy and sell goods.
If Americans buy more goods from China than China buys from Americans, as is currently the case, that means we run a trade deficit. This sounds horrible, unless of course you realize that we are effectively trading little green pieces of paper for actual things. We get more things from them than they get from us, and that begs the question, how can this be?
The reason we can continue this deal is that the trade deficit is identically equal to something called the current account balance. This current account balance is the difference between how much American households save, and how much they invest. And by investment, economists mean the purchase of real items such as roads and bridges and new plants and equipment.
Last month’s trade deficit with China was about $29 billion. To finance this, Chinese households had to invest about $29 billion in the United States. Much of this was investment in government spending, but much was also in our stock market, and in new plants and equipment.
Without foreign trade, we would experience a significant decline in household consumption and business and government investment. That would make all of us much worse off.
Michael J. Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to firstname.lastname@example.org.