Comment on 2005 Trade Figures

The verdict is in. The U.S. trade deficit had another banner year in 2005, according to data released today by the U.S. Census Bureau. The final tally showed a deficit of $726 billion for 2005, amounting to 5.8 percent of gross domestic product (GDP). This is the largest trade deficit relative to GDP and the first time that the trade deficit surpassed $700 billion since the government collected these data in 1929, and it is well in excess of what many economists consider safe territory. Yet today’s figures are worrisome not only because of the sheer size of the trade deficit, but also because a number of trends raise doubts about the U.S. ability to rein in deficits in the future.

Large trade deficits are troublesome since they can jeopardize an economy’s long-term health. Trade deficits in excess of 4 to 5 percent of GDP raise worries about economic instabilities that can lead to rapid inflation, a sharp drop in the dollar, higher interest rates and falling standards of living. The current trade deficits arise to some degree because of a comparatively high value of the dollar. A high value of the dollar makes U.S. exports globally expensive, while it simultaneously subsidizes imports into the U.S. The high value of the dollar comes about because the U.S. is borrowing money overseas, thereby stimulating demand for dollars and raising its price, the exchange rate. The U.S. government is a particularly large borrower on world markets. It has turned from a creditor to a debtor over just a few years. From March 2001 to September 2005, foreign lenders financed 81 percent of new treasury issues. The fear is that eventually investors will bring their money elsewhere, thus forcing higher interest rates and potentially causing a sharp decline in the dollar, higher inflation, and declining economic growth.

The U.S. faces massive obstacles in reducing its trade deficits. For one, the increase in the trade deficit cannot only be attributed to a temporary spike in oil prices in the second half of 2005, i.e., there are structural problems at work. Specifically, if the petroleum deficit had not increased over the course of 2005, the total trade deficit relative to GDP would still have amounted to 5.3 percent of GDP, or a record $660 billion.

One indication of structural problems is the fact that trade deficits have grown with all major trading partners. The deficit with China grew to $202 billion, with Japan to $83 billion, with Canada to $77 billion, with the European Union to $122 billion, and with Mexico to $50 billion (table 1). In all cases, except Japan’s, these are the highest trade deficits, relative to the size of the economy. The largest growth from 2004 to 2005 came for the deficit with China, which grew by 24.5 percent from 2004 to 2005 and by 140.5 percent from 2000 to 2005. The problem is that U.S. trade deficits widened with countries where the dollar stayed flat, such as China, Japan, and Mexico, and where it declined, such as Canada and the European Union. In other words, the U.S. faces obstacles beyond the dollar’s value in reducing its trade deficit.

Another problem area appears to be trade in services. While the U.S. generated a larger surplus in service trade, such as banking, in 2005 than in 2004, this surplus was still below the levels of the prior years in absolute terms and relative to the size of the economy (table 1).

A continuous trouble spot in U.S. trade is the growing gap of imports and exports of advanced technologies, such as aerospace and life science technology, and shrinking surplus in other products, such as information technology and electronics. These are areas where the U.S. presumably has a competitive advantage. Yet, for the fourth year in a row, the U.S. has imported more advanced technology products than it exported. This trade deficit grew even faster than the trade deficit overall, 20.4 percent as compared to 17.5 percent, from 2004 to 2005. This rise occurred despite the fact that two of the four largest areas of advanced technology products – aerospace and life science technology – saw a rising surplus or a shrinking deficit (table 1). Yet, these improvements were not enough to counter the deficit increases or surplus declines in other areas.

As the U.S. completes another year with a new record trade deficit, it also has become apparent that the U.S. economy faces structural problems in reducing its trade deficit. Addressing this massive deficit is necessary in the interest of the country’s long-term economic health. As first steps, this will require a return to fiscal responsibility to lower foreign borrowing and investments in America’s competitiveness.

Table 1

Trade Balance Trends in Absolute Terms and Relative to GDP, Select Years

Notes: All dollar figures are in current dollars. Changes in nominal dollar amounts are percent growth rates. Changes of shares of GDP are percentage point differences. Author’s calculations based on data from U.S. Census Bureau, Foreign Trade Statistics, Washington, D.c=: Census (www.census.gov) and Bureau of Economic Analysis, National Income and Product Accounts, Washington, D.C.: Bureau of Economic Analysis.