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15 February 2008

Comparing Oranges and Trade Deficits

In this world of extensive multilateral trade and investment, of what conceivable relevance is a measure of the volume of good and services trade between any two countries? America's "trade deficit" with China is as relevant as is your "trade deficit" with, say, your columnist Maureen Dowd. I'm sure that every year you buy more from her than she buys from you. I'm also sure that you're not bothered by this "deficit" - and for good reason: in a world of multilateral trade, no two entities are likely to have so-called "balanced" trade with each other.

Don Boudreaux in a letter to the New York Times

This is the kind of logic economists love to use. Although they recognise and spent a lot of time analysing scale effects in other areas, when it comes to making analogies it's popular to compare nations with households. Here Boudreaux baldly states that the US trade deficit is equally relevant to the deficit between one employer and employee. I think that is very unlikely. The US trade deficit has a far bigger impact on the world economy. Very small deficits between small players all tend to wash out. But in the the case of the US we're talking about an enormous temporal imbalance. Nations can spend decades without generating any net value, but individuals don't have that luxury or danger. For sure, it will wash out over time, but that's going to be a painful process. The government may be right in trying to bring forward some of that pain.

I think people do get too worked up about the trade deficit, because it does reflect the immediate preferences of the nation (whatever that means) and because it will eventually balance out on its own. But I don't think it's meaningful to glibly equate a national deficit with an "individual" deficit. Even though I dare say it is quite gratifying to believe the rest of the world is so much stupider than you.

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