Tuesday, August 21, 2012

Growth, trade balance, and tax policy

Kevin Drum wonders how we can reduce trade deficits to increase growth, especially in a world where everyone else is trying to do the same thing. The simple answer is that we can't and almost certainly shouldn't try.

The US has been running a trade deficit for almost forty years now, leading to our enduring status as The World's Largest Debtor nation. That status only tells half the story. That debt doesn't reflect money we have to repay, in the normal sense of the word. It reflects the fact that foreign entities own more American assets than we own overseas assets. Some of those assets are bonds that require repayment, but others are factories or real estate with overseas owners. And while it's true that foreigners own more assets in the US than we own overseas, our foreign assets are also enormous. They're so large, in fact, that while we're a debtor nation, we earn more from our foreign assets than foreign owners earn from our domestic ones, a situation that has persisted for many years.

Why is this the case? It turns out that investments in the US are safer than similar investments abroad. As a result, investors are willing to accept lower returns. As long as other countries are rich enough to invest here and our assets are viewed as safe, the dollar will be stronger than our trade balance would suggest, and our trade balance will suffer as a result.

It's a form of Resource Curse, where investment safety inflates the value of our currency and makes other economic sectors less competitive, but the conditions that make investments safe are, in fact, good things. We don't want to get rid of them.

As Dean Baker concludes in the article Kevin referenced, we need to stimulate the economy through government spending. We can't borrow indefinitely to support that, so we should raise taxes. That's not what we'll actually do, of course. We'll keep lowering taxes on the rich, hoping that they'll stop hoarding money and invest it instead. They won't do so, because they'll see how poor everyone else is and conclude that there's not much profit to be made.