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Explaining why trade deficits occur is not easy. Common sense seems to suggest that if America stopped importing oil, or erected new barriers to imports, or encouraged more domestic production, the trade deficit would shrink. But as economists have tried to explain for years, trade deficits result when a country spends more in total than it produces, and since the US addiction to foreign borrowing is persistent, piecemeal efforts are unlikely to reduce the US trade deficit. Trade policy cannot reduce the trade deficit. If the trade balance is viewed as a problem, the United States must either save more or invest less.
The US experience with oil confirms this view. In 2011 the United States imported almost half of its domestic consumption of petroleum products (figure 1) and ran a trade deficit in these products equal to 2.1 percent of GDP (figure 2). Since the US current account deficit (the most comprehensive measure of the US trade balance in goods, services, and income) was equal to 2.9 percent of GDP at the time, it seemed fair to blame America's growing indebtedness to the rest of the world to what President George W. Bush had called America's "addiction to oil."[1] After all, in 2011 the petroleum trade deficit amounted to 72 percent of overall US net foreign borrowing.[2]
However, because of fracking and other innovations, US domestic production of crude oil has soared. It increased from 5.67 million barrels a day (mbd) in 2011 to 11.2 mbd in 2021.[3] Similarly, over the same period, US production of natural gas plant liquids exploded from 2.22 mbd to 5.4 mbd.[4] Since US consumption of petroleum products grew on average by less than 1 percent a year, the trade balance in both petroleum and energy products moved to balance in 2021. By 2021 the United States had become self-sufficient in these products.
America's transformation from large oil importer to a country self-sufficient in oil was remarkable. Surprisingly though, as shown in figure 2, the overall US current account deficit in 2021 was actually a higher share of GDP than in 2010. Indeed, even before COVID-19 led Americans to dramatically switch from buying services to buying goods, despite the continuous reduction of the oil and energy trade deficits after 2013, until 2019, the US current account deficit as a share of GDP remained fairly constant. This outcome confirms that America's real addiction is to foreign borrowing rather than to oil! Simply put, as a nation we continuously spend more than we produce, and we borrow from the rest of world to make up the difference.
As the effects of the fracking revolution on US production were becoming apparent, many reasoned that since net oil imports accounted for so much of the current account deficit, eliminating the deficits and achieving oil self-sufficiency would make a large contribution to reducing US net foreign borrowing.[5] In a paper written for the Council on Foreign Relations, however, I argued that this view was mistaken. I pointed out that without a change in American spending patterns, any improvement in the oil trade balance would be offset by a deterioration in other parts of the US trade balance. Everything else being equal, importing less oil was likely to mean more imports of other goods and services and fewer exports. I immodestly point out the accuracy of my prediction, not to claim a gift for prophecy, but rather to underscore the value of economic theory in understanding what really determines the current account.[6]
The assumption of those who predicted that self-sufficiency would shrink the trade deficit was that US spending on other foreign goods would be unaffected if the United States produced more oil at home. However, focusing on trade in particular goods or with particular partners can miss the big picture that is required to understand the trade balance.
In my analysis, I concluded that America's overall saving and investment rates were unlikely to be affected by the move to oil self-sufficiency. Relying on the definition of the current account as the difference between national saving and national investment I argued that while its composition might change, the aggregate current account balance would not be affected. This was because Americans were unlikely to save more if the oil they purchased was produced at home rather than imported. In addition, once the investment in the production facilities required to produce more oil and natural gas had been completed, American investment was unlikely to change. Accordingly, if neither overall saving nor investment were changed, the current account would remain constant. Moreover, if the US economy were to reach full employment—as it probably did in 2021—and more resources and workers had to be devoted to oil production, fewer resources and workers will be available to produce other goods and services. Given the propensity for US spending to exceed US income, the shortfall in other goods and services created by this diversion would have to be met either by increases of imports of other goods and services or by reductions in exports. Instead of a smaller overall trade deficit, therefore, the smaller deficit in oil would be offset by a larger deficit in trade in other goods and services.
This experience contains a lesson that can be applied to other cases. President Donald Trump negotiated several new trade agreements with US trading partners such as Korea, Canada, Mexico, and China in his efforts to reduce America's overall current account deficit. The Biden administration has announced it will continue with most of these policies. But the example of oil suggests that these efforts will be ineffective in changing America's overall current account balance. Just like squeezing air in a balloon in one place makes it bulge in other places, buying less from China or selling more to it will not change the US current account, unless Americans reduce their spending relative to their incomes. And even if the trade deficit with China falls, the overall deficit will not change because the United States will import more and export less to other countries. Similarly, when the economy is at full employment, the policy of the US government to "buy American" rather than foreign products, which President Joseph R. Biden Jr. is now promoting, will require more workers to produce these government purchases. This means fewer workers will be available to produce the goods and services that other Americans want to buy. Again, rather than a smaller trade deficit, and more goods made in America, the policy will lead to more imports and fewer exports of other goods and services.
The author thanks Madona Devasahayam and Steve Weisman for editorial suggestions.
Notes
1. Elisabeth Bumiller and Adam Nagourney, "Bush: America is Addicted to Oil," New York Times, February 1, 2006.
2. Calculated as follows: 72 percent = 2.1 percent (trade deficit in energy products as a percent of GDP) divided by 2.9 percent (current account deficit as a percent of GDP).
3. US Energy Information Administration, Table 4a. U.S. Petroleum and Other Liquids Supply, Consumption, and Inventories.
4. US Energy Information Administration, Table 4a. U.S. Petroleum and Other Liquids Supply, Consumption, and Inventories.
5. See, for example, Edward L. Morse, Eric G. Lee, Daniel P. Ahn, Aakash Doshi, Seth M. Kleinman, and Anthony Yuen, Energy 2020: North America, the New Middle East?, Citi GPS: Global Perspectives & Solutions, March 20, 2012.
6. For a more complete analysis of the current account, see Robert Z. Lawrence, Five Reasons why the Trade Deficit is Misleading, PIIE Policy Brief 18-6, Peterson Institute for International Economics, March 2018.
