Guest Opinion -- Debunking the Deficit 'Threat'

Dec. 21, 2004
Economist skewers "Living Beyond Our Means" myth

The specter of imminent doom is always a popular theme in the media, which tends to fixate on startling numbers, even when it fails to understand the concepts behind them. America's trade deficit is increasingly falling into this category. The 1999 trade-deficit data show a whopping $107 billion increase (65%) over 1998, the deficit reaching $271.3 billion, thus dwarfing the previous 1998 record. While the numbers themselves are hard to fathom, they reek with negative connotations. And monthly data -- a record $31 billion -- plus for May -- clearly indicate that this year's trade deficit will establish another new high. In the face of such numbers, newspapers, politicians, and even some academics have again been ringing the "living beyond our means" alarm bell, a popular 1980s theme that disappeared with the change of administrations, although the flow of red ink did not. For example, Investors Business Daily wrote in 1998 that "a trade gap does signal an economy living beyond its means." Last September a respected academic told a Washington audience that the current trade deficit means that America "is using up $103 of resources for every $100 of GDP [gross domestic product] we produce." That same month The New York Times featured an article entitled "United States Sets a Record for Living Beyond Its Means," claiming that America "is outspending its income by more than ever before." And last Jan. 21, another Times piece spoke of America's "insatiable American appetite for German cars, French perfume and Japanese televisions . . . ." Such dire warnings send a chilling message -- that the trade deficit reflects a consumption binge that will lead to disaster. Such allegations, however, are an inaccurate portrayal of the U.S. economy over the last 10 to 12 years. They reflect both ignorance and confusion concerning the nature and meaning of our import/export data. Policy makers would do well to ignore this prattle because it is misguided on virtually every basis. First, we must understand exactly what kind of condition "living beyond our means" suggests. "Means" is economic capability; in more common parlance, it is income, as estimated by GDP or some similar measure. Living beyond one's means implies that consumption spending exceeds total income. And, of course, a person can only spend more than he or she currently earns either by running down personal assets or by running up debt. It is erroneously argued that America's excess of imports over exports signifies that the U.S. is not only eating all of its own "pie" (GDP), but consuming other nations' pies as well -- in the form of imports. Under this logic, the U.S. must be consuming more than it produces, with America's switch from net international creditor to the world's largest debtor supposedly proving this point. Alas for the "sky is falling" crowd, the argument is erroneous. It fails to make a critical delineation between different kinds of spending. If consumption spending were to exceed income, the nation would indeed be living beyond its means. But consumption today absorbs only about 65% of GDP; real investment exceeds 20%. Clearly, spending (or borrowing) to go on a vacation is very different from spending to finance a college education. America's economic reality is very far from consuming more than we produce. Further, the composition of imports -- the proportions of industrial supplies, investment goods, and consumer items -- is another critical delineation that is ignored. Back in 1988, for example, imports included about $150 billion of capital goods and durable industrial supplies, products that fuel and nurture U.S. economic growth. And in 1991, while the media focused on the $73 billion excess of imports over exports, it ignored the fact that the value of total imported capital goods and industrial supplies was roughly three times greater than the deficit figure (the excess value of all imports over all exports) itself. Alas, many economists were guilty of the same sin. To the degree that imports both embody and propel investment efforts -- activities so critical to raising productivity and future income -- the "living beyond our means" descriptor is totally inappropriate. And by 1997 and 1998 the investment share alone of imports had risen to 44%. Much of the U.S. trade deficit and required balance of payments financing, then, supports investment, not consumption. And the continuing volumes of such imports have certainly been a contributing factor to the unprecedented rates of GDP growth and investment that have characterized this record-setting economic expansion. The pundits also have failed to realize that balance of payments numbers are essentially cash-flow data and not balance-sheet bottom lines. "Living beyond our means" would suggest shrinking national wealth, but again the data show otherwise. Tangible national wealth grew at robust rates during the 1990s. The latest figures available (1998) display record numbers-$24.88 trillion. Understanding the composition of imports makes it hardly a surprise that 1998's 5.5% growth in tangible wealth-highest since 1994 -- coincided with a record trade deficit. And intangible assets -- knowledge and technology -- have grown even more. While there may be some problems associated with trade deficits, "living beyond our means" is hardly one of them. Quite to the contrary, a very substantial proportion of U.S. imports comprises investment-type items critical to the economic growth of the country. So let's discard this fiction, take our fingers off the panic button, and resist policies to cure a nonproblem. Donald Losman is professor of economics at the National Defense University, Washington. Losman has authored four books, including The Promise of American Industry (1990, Quorum Books), written with Shu-Jan Liang, as well as opinion columns for newspapers such as the Wall Street Journal and The New York Times. The views expressed are his own and do not represent those of the U.S. Dept. of Defense or the National Defense University. IndustryWeek reviews and periodically accepts submissions for guest columns. Send columns to George Taninecz, managing editor.

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