The modest drop reported in the trade deficit in June is good news, the current deficit is unsustainable. A declining trade deficit will also help to boost economic growth, as noted in a Times article this morning. However, the article missed an important part of the story. Growth due to a declining trade deficit does not directly translate into improving living standards in the United States. For example, if the economy grows 3 percent next year, but 2 percentage points of this growth is due to a falling trade deficit, then domestic demand (consumption, investment, and government spending) can only increase by 1 percent. If employment grows by 1 percent (a modest 1.4 million rate of job creation), this means that wages, on average, do not rise. In short, a declining trade deficit has the same effect on living standards as a tax increase; we will be able to see less of what we produce. This �tax increase� will come in the form of rising import prices, which will add to inflation, or an increase in the price of some items that are exported to other countries but also consumed here (e.g. food). Again, this is not an argument against reducing the trade deficit, we must do it. But it is important to realize that there is a painful side to reducing the deficit. This is why some of us argued so strenuously against the high dollar policy that led to the trade deficit. It was a policy that led to short-term gains for some, at the cost of long-term pain. We should hope that the deficit continues to fall, but we should also recognize that this can be a painful process.
--Dean Baker
