Record U.S. Trade Deficit—Is it a Sign of Cyclical Strength or Structural Weakness?

In 2018, the US merchandise trade deficit hit a record $891.3 billion. Many analysts, academics and even a former policy advisor downplayed the record trade deficit, arguing that "a higher trade deficit means a stronger economy"; and, "the reason we have a trade deficit is people are investing in America".

Yet, is it that simple? Is the US trade deficit mainly the result of the US is growing faster than its major trading partners or are there structural forces at work as well? The answer is both forces are at work, but there is a growing body of evidence to suggest that the structural forces have become more important than the cyclical factors. Let me explain.

The conventional way of measuring cyclical shifts in the trade deficit is by merely comparing the relative growth rates of the US versus its major trading partners or the global average. This is a simple fact about trade economics as the relative growth rates in demand will help explain movements in global trade flows. And, the fact that the US grew 3.1% in 2018 and the average growth rate of its major trade partners was considerably less would, everything else being equal, point to a higher U.S. trade deficit.

Yet, to measure the structural forces behind the trade deficit one has to compare the growth in imports against the growth in domestic production. This comparison blocks out the strength or weakness in foreign economies and compares the competitive and physical capacity positions of US manufacturing versus that of foreign producers.

In 2018, the real gross value of imports of goods increased $143 billion, or almost $50 billion more than the increase of domestically produced US goods. This simple comparison underscores the "structural" component of foreign trade as it highlights the fact that because so much of US manufacturing has been slashed or idled, due to firm failures, plant closings or transferred to offshore affiliates the US does not have the competitive and physical capacity to produce the goods to meet the needs of consumers and businesses.

And the more worrisome part of this "structural" imbalance is that is has spread from consumer industries into the capital goods sector as well. In 2018, for example, the growth of capital goods imports were almost 3 times the growth of domestically produced capital equipment. And even though the US vehicle-manufacturing sector has been enlarged from the influx of foreign producers setting up assembly and parts plants in the US, the growth of imported vehicles and products still outpaces domestic production.

In the past two decades, the US has lost over 85,000 manufacturing establishments and with it a large amount of its productive capacity. Thus, a rising trade deficit can no longer be quickly dismissed, as "a sign of US strength", since when you look underneath the hood the US no longer produces what is in demand. And for the US to fully benefit from any new bi-lateral trade deals it needs to first rebuild its manufacturing capacity.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.