What Impact Will TPP Have on the US Trade Deficit?

Trade agreements like the North American Free Trade Agreement (NAFTA), the Korea-US Free Trade Agreement (KORUS), or the upcoming Trans-Pacific Partnership (TPP) are often evaluated in terms of what impact they will have on the US trade deficit.

“U.S. trade and investment agreements have almost always resulted in growing trade deficits and job losses,” argues Robert Scott of the Economic Policy Institute.¹ “This is important to keep in mind as secret negotiations for the Trans-Pacific Partnership (TPP) continue, most recently in Washington and New York. The United States has a large and growing trade deficit with Japan and the 10 other countries in the proposed TPP. This deficit has increased from $110.3 billion in 1997 to an estimated $261.7 billion in 2014.”

But should the outcome of a trade negotiation like TPP be measured in terms of whether it generates a trade surplus for the United States? To answer this question, it is important to get the analytics of what causes trade deficits right.

Overall Trade Deficits versus Bilateral Trade Deficits

The first question to address is what causes a country to run an overall trade deficit vis-à-vis all of the countries it trades with. A quick review of economic theory provides some surprising answers.

A nation runs a balance of payments deficit when it spends more than it earns (and finances the difference on foreign credit), buys more than it sells (and finances the difference on foreign credit), or invests more than it saves (relying on capital coming from abroad). These are all equivalent ways of saying the same thing.

The only way to cure a trade deficit is to change these macroeconomic relationships, so as to spend less and earn more (on the part of households, corporations, and governments).

This perspective leads to some widely unappreciated conclusions. There is no way to use trade policy alone to cure a trade deficit—yes, a country can expand exports, but if the firms, workers, stockholders, communities, and tax authorities do not change their expenditure and savings patterns at the same time, expanding exports will not change the overall trade deficit. Similarly, there is no way to use exchange rate policy (either on the part of the deficit country or the surplus country) alone to cure a trade deficit—a change in relative currency values can expand exports or reduce imports but once again unless the firms, workers, stockholders, communities, and tax authorities affected change their expenditure and savings patters at the same time, there will be no change in the overall trade deficit.

Preliminary figures show that US households, corporations, federal and state governments spent roughly half a trillion dollars more than they earned in 2014, resulting in a trade deficit of $505 billion to make up this difference between spending and earning. For this trade deficit to go down in 2015, the ratio between spending and earning will have to decline, with US households, corporations, federal and state governments saving more of what they earn or collect in taxes.

Note that the above analysis has focused on a nation’s overall trade deficit. The expansion of exports or the change in relative currency values might change a bilateral trade relationship (like the US-Japan trade balance within the TPP, or the US-China trade balance outside of the TPP) but unless the underlying expenditure/saving ratio is altered the overall trade deficit in the deficit country will remain the same with changes in bilateral figures popping up here and there and elsewhere. So as long as US households, corporations, and federal and state governments spend $505 billion more than they earn, the overall US trade deficit will not change. This is why economists say that the determination of overall trade balances is a macroeconomic phenomenon: The tiny secret about overall trade deficits and surpluses is that they are not about trade at all, but about the relationship between expenditure and saving in the deficit or surplus country.

TPP Bilateral Trade Balances among Participants in the Negotiation

Turning to bilateral trade relationships, the first observation to make is that a regional trade negotiation like TPP cannot logically lead to a net trade surplus for all of the parties. Overall trade volumes among the members of TPP may expand as a result of the negotiations, but the sum of new exports and new imports among the participating countries must always equal zero.

Some TPP participants will find themselves with a resulting net trade deficit, others with a net trade surplus vis-à-vis the other partners in the negotiation. Does this mean that those governments with a net trade deficit outcome did not negotiate hard enough, or should have not participated in the trade pact? No, because the objective of a trade pact is to allow all parties to use their resources more efficiently.

Of course the United States should be forceful in trade negotiations to remove obstacles to the penetration of US goods and services into Japan or Malaysia or the other TPP member states, but this is because the US government wants the US economy to operate with high productivity, not because this will affect the US trade deficit. The central implication here is that judging the success or failure of a trade negotiation like TPP in terms of whether it will create a net trade surplus or a net trade deficit for the United States is simply wrong-headed.

Reality Check

Here is a reality check for readers of this PIIE blog post: should the US government push ahead with the TPP negotiations even if industry-by-industry projections strongly suggest that the US will end up with a net trade deficit vis-à-vis the other TPP economies when the negotiations are over?

Hint: The answer is Yes!, the US should push ahead, forcefully pushing for as much market access as possible, but not walking away if the TPP outcome is a net trade deficit for the US. Why? Because the objective of the TPP negotiations is to allow US firms and workers to do more of what they are most competitive at, raising productivity, wages, and profits at home, not misguidedly focusing on bilateral trade balances.

Theodore H. Moran, a nonresident senior fellow at the Peterson Institute for International Economics, holds the Marcus Wallenberg Chair in International Business and Finance at the School of Foreign Service, Georgetown University.

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