Don’t Be Misled By Politicians’ Trade Balance Rhetoric

The economic concept of «the balance of trade,» namely the difference between imports and exports of goods and services for a given country, can be of use to economists when they want to know, specifically, in which direction capital is flowing.

Yet for most politicians, including U.S. President Donald Trump, the concept of trade balance is invoked in order to justify everything and its opposite. Members of the media are also often confused about this issue. This is no less true when it comes to discussions of the renegotiation of the North American Free Trade Agreement (NAFTA) that recently got underway.

To be clear, the balance of trade tells us absolutely nothing about how a society enriches itself. In most cases, though, the concept is used in reiterating the old mercantilist theory that prevailed in the 17th and 18th centuries.

Yet mercantilism is as false as it is simple. Basically, according to this way of understanding the economy, if we export more than we import, all is good, and the bigger the gap, the better. And if it’s the other way around, if an economy imports more than it exports, then the sky is falling. It follows from this line of thinking that a country should do everything in its power to have, according to the Donald Trumps of this world, «more balanced» trade — or even better, a «trade surplus» with other countries — to come out the «winner.»

This notion, however, is completely misguided, and has been disavowed by just about every serious economist over the past hundred years and more. There are several reasons for this. First of all, each of us has a «trade deficit» with someone. You probably have one with your grocer. That is to say, it is very likely that you buy (or «import») more from your grocer than you sell (or «export») to him or her. Indeed, you probably also have a trade deficit with your dentist, your hairdresser, or your children’s music teacher. But is this something you worry about, or should worry about? Of course not.

Now extend this reasoning to trade between, say, Montreal and Laval, or Prince Edward Island and Saskatchewan. Have you ever worried about the trade «surpluses» or «deficits» between these different places?

History can also shed some light on this issue. During the 1930s, the United States had a trade surplus for 102 months out of 120. The problem: This period of «large trade surpluses» corresponded to the Great Depression, a period of terrible poverty during which the United States did all it could to restrict imports!

The trade balance informs us of only one side of trade between countries — for instance, that we import more than we export — but this means that we are sending dollars abroad. In other words, foreigners are «buying» Canadian dollars with goods that they produce and sell us. But then, what do they do with those dollars? It’s not as if they just bury them in their backyards. These dollars represent assets with which they can, for example, buy shares in Canadian companies or bonds issued by Canadian governments (municipal, provincial, or federal). In doing so, they invest in Canada, and we thus «recover» this supposed «loss» caused by a trade deficit. Moreover, these investments make us richer because they serve to improve the productivity of Canadians, and increased productivity is the key to higher incomes.

When we export more than we import, on the other hand, we acquire foreign assets, which means that we invest in foreign countries. A part of the returns from the investments we make in the productivity of other countries comes back to us, which also makes us wealthier. Indeed, this phenomenon explains a portion of the returns earned by our pension plans. Once again, this cycle of trade in merchandise and capital allows us, ultimately, to achieve a better standard of living.

Again, economists (the good ones) use the concept of the balance of trade simply because they want to know the direction of the flow of capital. However, no matter which way goods and services go, everyone is wealthier because of trade. And that’s why 99 per cent of economists agree that the mercantilist theory is an old, discredited idea, whose implementation would be harmful all around (memo to Donald Trump and his advisors!).

In sum, when you hear a politician or commentator talking about the «trade balance» to explain how we’re getting poorer or richer depending on whether it’s going up or down, know that this person is advancing a vision of the world that will make us all worse off.

Michel Kelly-Gagnon est président et directeur général de l’Institut économique de Montréal. Il signe ce texte à titre personnel.