Are trade deficits always bad?
This article of mine was first published in the third-quarter 2015 edition of Personal Finance magazine.
When you add up all the transactions each month of South African importing and exporting businesses, you will currently find that more is bought from businesses overseas than is sold to businesses overseas. This is commonly known as a trade deficit.
Trade deficits are generally regarded as a bad thing. There is a concern that “we are sending money out of the country instead of keeping it here, making us poorer.” While deficits can be problematic for countries, this is not always true. Not all trade deficits are created equal, but most regard them as an evil to be tolerated with gritted teeth at the very least, and at worst the catalysts for national catastrophe.
In truth, not all trade deficits are bad, and in fact some are tremendously positive. To understand this, we need to think about what trade deficits are in the first place.
When a country as a whole runs a trade deficit, it means that on aggregate its businesses are buying more goods from foreigners than they’re selling to foreigners. How are they able to do this? Well, think about one of those businesses…in fact, even better, think about one individual person who spends more than their pay check. How can she do it? She could sell an asset she already owns, like her iPod or bicycle; she could have someone generously give her the money; she could use up some of her savings; or she could borrow money from someone, which has to be paid back.
Not all deficits are created equal because not all deficit funding and spending is created equal.
Assessing her ‘trade deficit’, we might ask various questions like, did she spend wisely, did she borrow on prudent terms, and is she financially stable?
In a very similar way, one needs to ask the same sorts of questions when trying to understand the nature of a country’s trade deficit. What type of funding and by whom? What type of importing and for how long? How financially stable is the importing nation?
Problematic deficits arise where the importing nation is already financially rickety, where the funding is borrowed indefinitely from complacent lenders or whittling down meagre savings or assets, and where the imports don’t add to the productive capacity of the country.
A healthy deficit would be one where, for a relatively short period of time, a financially stable nation imports capital goods, funded either by manageable debt or a portion of a large savings or asset base.
South Africa is a financially fragile nation, which has run a large trade deficit pretty much non-stop since 2003, funded by selling assets to, and borrowing money from, foreigners. These are finite sources of funding. We also know from the macroeconomic data that a significant and growing portion of imports are consumer goods as opposed to productive capital goods, since there has been a relative decline in mining and manufacturing sector activity relative to retail activity. Put simply, many South Africans have been borrowing to consume. We can see this at the state level, where government has borrowed hundreds of billions of rand over the past six years to fund its heavily consumption-oriented expenditure. We have also seen it at the household level with the rampant growth in unsecured lending fuelling the importation of appliances, TVs and lifestyle products.
Of course, South Africa does also import capital equipment aimed at improving the country’s productive infrastructure, and imports of ‘consumer’ goods like smartphones allow us to access technology that make us all more productive (contrary to popular opinion about smartphones!). But is this enough to allow South Africa to rest easy about the trade deficit? Time will tell, but South Africa’s sub-par economic growth suggests the deficit has not been put to good use.
What can policymakers do about the deficit? Higher import tariffs or weakening the rand are exactly the wrong kinds of solutions, but elaborating on those is a story for another day. The real nub of the problem lies in debt-addicted economies where consumption and production are out of balance. Fixing that requires a whole raft of reforms, from slashing red tape, lowering barriers to investment, and lowering taxes, to targeting lower rates of inflation through higher interest rates, and balancing the budget.
When the funding dries up, a country running a bad trade deficit is not only forced to live within its ‘pay check’ but also has to repay the debts it ran up buying nice goodies. This can come as a rude shock, and while it is a necessary pill to swallow, it can cause major hardships and recession, and can elicit poor policy choices to stem the pain, like printing money.
By contrast, countries that run sensibly funded trade deficits to buy the capital and technology that will make them more productive and globally competitive are the countries that will win in the 21st Century.