The Expected Widening in the U.S. Federal Budget Deficit Has Trade Protectionist Implications
With the recent U.S. congressional passing and presidential signing of the Tax Cuts and Jobs Act of 2017 and the Bipartisan Budget Act of 2018, the federal budget deficit is projected to increase in the next few years. According to projections by the nonpartisan Committee for a Responsible Federal Budget, the U.S. federal budget will rise from $665 billion in fiscal year (FY) 2017 to $753 billion in FY 2018 and $1.1 trillion in FY 2019. Unless these increased federal budget deficits are financed out of increased U.S domestic saving, they imply increased financing from the rest of the world. Increased lending to the U.S. from the rest of the world implies a widening U.S. trade deficit. President Trump appears to have viewed the persistent U.S. trade deficit a result of “unfair” trade practices on the part of some U.S. trading partners. (I presented a counter argument to this view in my November 17, 2017 commentary entitled “At Least We Can Be Thankful to the ‘11’ Fair Traders”.) The Trump administration has imposed import tariffs on solar panels and washing machines recently and has announced its intention to impose import tariffs on steel and aluminum because of perceived unfair trade practices on the part of trading partners. If past is prologue, a widening in U.S. trade deficits resulting from widening U.S. federal budget deficits in the next couple of years could trigger more protectionist actions by the Trump administration.
Let’s look at some data to build a case that U.S. federal budget deficits are related to U.S. trade deficits. Plotted in Chart 1 are annual observations of U.S. net exports of goods and services from 1970 through 2017. Net exports are exports minus imports. So, if net exports are negative, it means that the value of goods and services imported by a country are is greater than the value of its exports. If net exports are negative, it means that a country is running a trade deficit. The data in Chart 1 show that the U.S. has consistently been running trade deficits from 1976 through 2017.
When a country runs a trade deficit, it means that the residents of that country are spending more on goods and services than they are producing. To see this, let’s look at the identity for GDP:
(1) GDP = Goods & Services Spending + (Exports – Imports)
GDP is the value of goods and services produced in an economy. Goods and Services Spending is the aggregate spending by households, businesses and government entities. Imports enter the GDP identity with a negative sign in order to avoid double counting. That is, imports account for some of the Goods & Services Spending. Because GDP represents the value of goods and services produced in an economy, imports need to be subtracted from Goods & Services Spending. Because exports are not part of domestic Goods & Services Spending but are produced in the economy, exports are added to Goods & Services Spending.
By rearranging the terms in identity (1), we get:
(2) GDP – Goods & Services Spending = (Exports – Imports)