Analysis of Trade with America’s Top Partners Exposes Flaws in Trade Theory

An analysis of trade with America’s top fifteen trade partners in 2012 once again reveals a powerful relationship between the population density of its trade partners and its balance of trade, and very little relationship between the balance of trade and the usual suspects blamed for imbalances – low wages and currency exchange rates.

Here are America’s top 15 trade partners in 2012, based upon total imports and exports:  Top 15 Trading Partners in 2012.  These fifteen nations (out of 228 nations in the world) account for 72% of all U.S. trade.  The top three nations – Canada, China and Mexico – account for 43% of all U.S. trade.  Saudi Arabia moved from 12th in 2011 to 9th.  Singapore dropped off the list, replaced by Italy.

It should come as no surprise that a few of our major sources of imported oil appear on the list – Canada, Mexico, Saudi Arabia and Venezuela.  It’s trade in manufactured goods that’s of greater interest, since it’s there that jobs are won or lost.  So let’s see how these nations stack up in terms of trade in manufactured goods.  Here’s the list:  Trade in Manfd Goods with Top 15 Partners.  Aside from China now edging out Canada for the top spot, the list doesn’t look terribly different.

Now, let’s test the results of U.S. trade with these nations against economists theories about trade – that trade deficits tend to be the result of low wages or perhaps currencies that are artificially low, and that trade deficits tend to shrink as wages rise in the surplus nation and as their currency grows stronger, making their exports more expensive and our exports more affordable.  And let’s test these results against my own hypothesis – that it’s actually disparities in population density that drive global trade imbalances while the above-mentioned factors so favored by economists actually have little or no impact.

Population Density

Let’s begin with the latter – the effect of population density – and look at a plot of per capita balance of trade in manufactured goods vs. population density.  (It’s important to express the balance of trade in per capita terms in order to remove the sheer size of a nation as a factor.  Here’s the chart:  Per Capita Balance of Trade vs. Pop Density.  (Some of the data points have been labeled with the nation’s name, some not, for the sake of legibility.)

This is a “scatter chart,” the purpose of which is to determine whether or not a correlation exists.  I had the computer generate and insert a “trend line” for the data, including the equation that defines the line and its “coefficient of determination.”  If such a chart yields a shotgun scattering of the data, then no correlation exists, and the coefficient of determination is close to zero.  On the other hand, if the data points tend to fall along a line – the trend line – then a correlation does exist and if all the data points fall perfectly along the line then we’d have a coefficient of determination of “1” – representing a perfect correlation.

As you can see, the data points do indeed tend to fall along a line – a lined defined by a logarithmic equation with a coefficient of determination of 0.51.  That’s a strong correlation.  Taking a closer look, we find the following:

  • There are four data points (nations) with a population density less than the United States, which is about 86 people per square mile.  They are Canada (10), Saudia Arabia (32), Brazil (61) and Venezuela (83).  The United State enjoys a surplus of trade in manufactured goods with all four of them.
  • There are eleven data points (nations) with a population denisty greater than the United States, and we have a trade deficit with all but one – by far the smallest – the Netherlands.  This isn’t surprising since the Netherlands is barely larger than the tiny city states which fall outside the boundaries of my theory (based on a rather arbitrary cut-off of 1,000 square miles).  They are excluded because cities represent incomplete economies.  They thrive primarily on services and are dependent on the surrounding countryside to complete their economies with resource production and manufacturing.  People who live in cities manufacture relatively little, since they lack the space required for manuacturing facilities.  The U.S. almost uniformly has a surplus of trade with city-states, regardless of their population density.
  • Our biggest surplus of trade in manufactured goods is with the least densely populated nation – Canada.
  • Our worse deficit (in per capita terms) is with Taiwan, which is also the most densely populated nation on the list.
  • Notice that, when expressed in per capita terms, our deficit with China no longer looks so abnormally large.  In fact, it falls right in line where you’d expect to find it.

It’s impossible to overstate the importance of this relationship between trade imbalance and population density.  Accurately predicting a surplus or deficit in 14 out of 15 cases is a very powerful correlation.  It puts into persepctive our very large trade deficit with China.  Of course it’s large; China is a very large country – one fifth of the world’s population.  It’s no wonder that we have a big deficit with China when we applied to them the same trade policy that produced the results we see with Germany, Japan, S. Korea, Taiwan, Mexico and other densely populated countries.  It’s exactly what we should have expected.

Low Wages

It’s impossible to gauge the effect of low wages directly, since the data on wages doesn’t exist and, if it did, it would vary industry-by-industry and even employer-by-employer, making the calculation of an average wage nation-by-nation a nightmare.  But the data is readily available for another factor – “purchasing power parity” (or “PPP”) – essentially a nation’s gross domestic product divided by its population – and it’s a good relative measure of how wages in one nation compare to another.  So let’s plot PPP vs. our per capita balance of trade in manufactured goods:  Per Capita Balance of Trade vs. PPP.

It’s immediately apparent that the data points are not randomly scattered, but tend to form a “V” shape, converging at a zero balance of trade as PPP falls toward zero.  The balance of trade tends to rise upward and outward – in either a positive (trade surplus) or negative (trade deficit) direction as wealth increases.  We already know that those nations on the surplus side (with the exception of the Netherlands) are all nations with population density lower than that of the U.S.  Those on the deficit side are more densely populated nations.

Because the data points fall on both the positive and negative side of the Y-axis, the computer is unable to generate an equation that describes the relationship that seems to be apparent in this chart.  But if we divide the data into two charts, it will be able to tell us the equation and just how strong the correlation may be.  So, first, here’s a chart for the data on the surplus side:  Per Capita Surplus of Trade vs. PPP.   There is a very strong correlation between our trade surplus in manufactured goods and a nation’s wealth.  As we deal with wealthier nations, our trade surplus (if we have a surplus) tends to be larger.  This makes sense.  Wealthier nations, where people earn higher wages, have more disposable income to spend on products both imported and produced domestically.  But, again, it’s important to note the role that population density has played here.  Not only can these people afford to buy more products, but they’re also able to utilize those products because they live in uncrowded conditions that foster high per capita consumption.

It’s also important to note there that, though these are wealthy nations, none are as wealthy (with wages as high) as the United States, with a PPP of $49,800 in 2012.  What this means is that every nation on this chart has a trade deficit with a nation (the U.S.) that actually has higher wages, not lower.  This debunks the notion that low wages cause trade deficits.

Now let’s look at the trade deficit side.  Here’s that side of the chart, with trade deficits now expressed as positive numbers so that a trend line equation can be calculated:  Per Capita Trade Deficit vs. PPP.  What we see here is exactly the same thing – that if we have a trade deficit with any given nation, it will tend to be larger if that nation is a wealthy nation.  While the correlation isn’t as strong – the coefficient of determination is .36 vs. .73 for the surplus nations – there’s still a fairly strong correlation.  Here it’s important to note that every nation on this side of the chart is more densely populated than the U.S. – most of them much more densely populated.  The per capita consumption of these people is stunted by overcrowding, leaving them incapable of consuming enough products to result in a trade surplus for the U.S.  Thus the trade deficit.  But why does the deficit tend to be larger for wealthier, densely populated nations?  These nations have grown wealthy because of their large trade surplus in manufactured goods, not just with the U.S. but with the whole world.  Poorer, densely populated nations are poor because of their overcrowding and because they haven’t been able to elevate their standard of living by manufacturing for export.

So far, it seems we can conclude that low wages don’t necessarily cause trade deficits.  And we can conclude that our trade imbalance (whether its a surplus or deficit) with poor, low wage nations tends to be small, but grows as partner nations become wealthier.  Whether the imbalance is a surplus or deficit seems determined not by wealth and incomes, but by population density relative to the United States.

Economists may argue that those deficits are due to some other factors – currency manipulation perhaps (and we’ll examine that one soon) – but as wages rise, our trade deficit will shrink as our exports become more affordable and their exports become more expensive for us.  Sounds logical, doesn’t it?  Alright, let’s see what the data says.  Let’s begin with a look at how the wealth of these fifteen nations (as measured by PPP) has changed relative to the U.S. since 2001.  U.S. PPP has risen by 38.1% during that period.  So, if a trade partner experiences the same increase in PPP, then their wealth relative to the U.S. hasn’t changed.  If it rises by 48.1%, then the wealth (and wages) in that nation have risen 10% relative to the U.S.  Using that methodology, here’s how the wealth of these nations has changed relative to the U.S. since 2001:  %Change in PPP Relative to U.S..

As you can see, eleven of our top fifteen trade partners experienced faster growing wealth (as measured by PPP) than the U.S., led by China with a growth rate of 210% in excess of the growth rate in the U.S.  On the other hand, four nations – all European nations – experienced a decline in wealth relative to the U.S., led by Italy with a decline of 20%.  If economists are right, then we should see an improvement in our balance of trade with nations that are growing more wealthy relative to the U.S., and a worsening of our trade balance with those nations where wealth (and wages) are declining.  Let’s take a look at the facts.  Here’s a chart that plots that change of wealth since 2001 vs. the change in our per capita balance of trade in manufactured goods:  %Change in PPP vs. %Change in Balance of Trade.

Here we see a shotgun-like scatter of data.  In trying to insert a computer-generated trend line, I got lines sloped in both directions depending on the type of line – linear, exponential, logarithmic and power.  To emphasize the randomness of the data, consider the following:

  • Eleven of these fifteen top trade partners grew in wealth (as measured by PPP) relative to the U.S., led by China with a growth of 210%.  Of these eleven, the U.S. experienced a worsening of its balance of trade with seven of them – the opposite of how economists say it should have responded to rising wages in those nations.
  • Four nations experienced a decline in wealth relative to the U.S., led by Italy with a 20% decline.  (The others are also European nations – the U.K., the Netherlands and France.  Germany was the only European nation among the five nations to experience an increase in wealth relative to the U.S.)
  • Of these four nations that experienced a decline in wealth (and wages) relative to the U.S., our balance of trade worsened with three of them.  It improved with the Netherlands.  This is in line with what economists predict should happen.
  • Overall, our balance of trade responded to changes in wealth among our top fifteen trade partners as economists would predict in only seven instances – less than 50% of the time.

From this data, we can conclude two things regarding the effect of wealth and wages among our trade partners: (1) The imbalance of trade – both surpluses and deficits – will tend to be larger with wealthier nations.  Whether the imbalance is a deficit or surplus has little to do with wages, but is determined by population density.  (2) Over the 12-year span studied, changes in wealth don’t predict which way our balance of trade will change.  Rising wealth is no more likely to improve our balance of trade than it is to erode it.

Currency Exchange Rates

Finally, let’s see what effect changes in currency exchange rates may have played in changing our balance of trade with these top fifteen trade partners.  Economists say that a stronger currency relative to the U.S. dollar should make a nation’s exports more expensive for American consumers and should make American products more affordable for consumers in that nation.  Thus, our balance of trade should improve.  Deficits should get smaller and surpluses should grow.

If we plot this on a bar chart, with two bars representing the percent change in balance of trade in manufactured goods and the percent change in currency, we should see both bars on the same side of the line, if economists are correct.  A positive change in the value of a nation’s currency should correspond with a positive change in our balance of trade with that nation.  So let’s see what really happened.  Here’s the chart:  %Change in Balance of Trade vs % Change in Currency.

Not only do economists seem to be wrong on this issue, the exact opposite seems to be true.  Growth in a nation’s currency exchange rate vs. the dollar is actually far more likely to correspond with a worsening of our balance of trade – not an improvement.  As you can see, economists’ prediction held true with only four nations – India, Canada, Brazil and the Netherlands.  In the case of India, a slightly weaker currency corresponds with a huge increase in our trade deficit.  In the other three cases, a strengthening of the currency corresponds with an improvement in our balance of trade.   In a 5th case – Saudi Arabia – our balance of trade in manufactured goods improved dramatically while the currency exchange rate held steady.  (The Saudi currency is pegged to the dollar.)  With ten of these fifteen nations, the change in our balance of trade was exactly the opposite of what economists predict.  The most blatant example is Venezuela.  In spite of their currency devaluing by 495% since 2001, our balance of trade in manufactured goods with them actually improved by 184%!  In the case of Italy, the Euro rose by 31% but our balance of trade with Italy worsened by 42%.  In the case of China, their currency rose by 24% while our balance of trade with them worsened by 319%!

Once again, economists are wrong and have the cause and effect relationship backwards.  Instead of currency rates affecting the balance of trade, what appears to be happening is that the balance of trade affects currency exchange rates.  If a nation has a trade surplus with the U.S., their currency strengthens.  If a nation has a trade deficit with the U.S., its currency tends to weaken.

Conclusion:

An analysis of trade between the U.S. and its top fifteen trade partners, accounting for 72% of all American exports and imports, proves that the balance of trade in manufactured goods is determined by the population density of the nation in question.  Almost without fail, America experiences a trade deficit with nations more densely populated, and a trade surplus with nations less densely populated.

Claims that low wages cause trade deficits are false.  Our worst trade deficits are with densely populated, wealthy nations.  Densely populated nations that build their economies on manufacturing for export experience growth in their wealth and wages.

Claims that low currency values cause trade deficits are also clearly false.  The cause and effect is just the opposite.  A trade deficit with a particular nation tends to drive the value of that nation’s currency higher.  A trade surplus tends to drive that nation’s currency value down.

Those who claim that if we’re just patient enough, rising incomes and currencies will reverse our trade deficits, haven’t tested their theories against actual data.

Because the majority of the world’s population lives in densely populated conditions, the U.S. is doomed to a massive trade deficit in manufactured goods and a loss of manufacturing jobs as long as it places its faith in flawed free trade theory that fails to account for the role of population density in driving trade imbalances

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