America’s trade policy is a disaster. There’s just no other way to describe it. In 2016, our trade deficit rose to almost $505 billion, beating the old record set in 2015. We can’t continue on this path. An economy that has that much money drained from it can only avoid a permanent state of recession through deficit spending, which is exactly what we’ve done for decades, and it’s bankrupting us. Our infrastructure is crumbling. The Social Security trust fund is on a path to bankruptcy. Medicare is already there. Household incomes and net worth are declining. And the government can’t come up with a scheme that makes health care affordable.
But what to do? How did “free trade,” the darling of economists, back-fire so badly for the U.S.? A quick glance at the balance of trade data, which is broken into “services” and “goods,” reveals a nice surplus in services. It was in this category that the U.S. economy was really expected to shine, and it has. But the “goods” part of the equation has run completely off the rails, with the deficit in goods dwarfing the small surplus in services.
What’s the problem with “goods?” Is it oil? There was a time, decades ago, when the deficit in goods was due almost entirely to oil imports. But no more. It has shrunk dramatically and now accounts for less than 25% of the goods deficit. The vast majority of our deficit in goods is due to manufactured products. So let’s focus there.
Let’s begin with a look at which nations account for our biggest trade deficits in manufactured goods. Here’s a list of the top twenty in 2016: Top 20 Deficits, 2016. China is at the top of the list, yielding a trade deficit that’s more than four times as large as the next nation on the list, Japan. In fact, so large is the trade deficit with China that it is larger than all of the nations of the rest of the world combined. It would seem that China must be doing something underhanded. Some say that the problem is low wages in China. Others claim that China manipulates its currency, keeping it artificially low, thus making its exports cheaper for American consumers and making American imports too expensive for Chinese consumers. Or maybe it’s just the sheer size of China, a big country with one fifth of the world’s population.
What is it about this list of nations that they have in common? The list includes nations from Asia, Europe, the Middle East and Central America. It includes some of the wealthiest nations on earth – like Germany, Switzerland and Ireland – casting doubt on the “low wage” theory.
I mentioned China’s size. But geographic size can’t be much of a factor. Without any people, we wouldn’t even have trade with any particular country or region. Take Antarctica. It’s bigger than China, but we have no trade with that continent at all. People are what’s important. It’s their consumption of products that drives trade. So maybe that’s where we should start looking. Perhaps the number of people in a country – or their population density – is a factor. So let’s take a look. Let’s express the trade deficit with each one of those countries in per capita terms. Now look at the list: Top 20 Per Capita Deficits, 2016.
The median population density of the 165 nations* included in this study is 184 people per square mile. The population density of the U.S. is apprximately 90 people per square mile. Seventeen of the twenty nations on this list have population densities above the median. The odds against that happening are 128:1. Conversely, the chances of that happening are only 0.7%. Clearly, population density is a factor. The average population density of these nations is 522 people per square mile – almost three times the world median and more than five times the density of the U.S.
In per capita terms, China barely even makes the list, ranking 19th out of these twenty nations. Eleven of the twenty nations are European Union nations.
And what about the claim that low wages are to blame for trade deficits? That’s clearly nonsense. The average “purchasing power parity” (roughly analogous to wages) is just over $46,000 – on a par with the U.S.
On average, the per capita trade deficit with these nations has risen by 88% in the past ten years.
The fact that America’s deficit with Ireland, with a population density close to the world median, is almost three times that of Switzerland, the number two nation on the list, is an indication that something else is going on that tilts trade in favor of Ireland, and indeed there is. Ireland is a tax haven and America is a fool to tolerate it.
Why is population density such a dominant factor in determining the balance of trade? It’s because of the inverse relationship between population density and per capita consumption. It’s because people living in crowded conditions consume less but are just as productive. The result is that they come to the trade table with a bloated labor force and an emaciated market. To understand more about why this happens, read Five Short Blasts. It’s also the theme of this blog.
Any trade policy that fails to account for the role of population density in driving trade imbalances and fails to employ tariffs to maintain a balance of trade with overpopulated nations is doomed to failure. America’s free trade policy is blind to this factor. The resulting trade deficit is inevitable.
Next we’ll take a look at the list of America’s twenty best trade partners. If population density is a factor, we should see the opposite results on that list. It should be dominated by nations with low population densities. Stay tuned.
* There are 229 nations in the world. Tiny island nations and city-states have been excluded from the study. Trade with these nations is minuscule, accounting for less than 1% of U.S. trade. The U.S. tends to have a surplus with such nations, regardless of their population density, since their economies are primarily based on tourism and not manufacturing.