Peter Morici is an economist and professor at the Robert H. Smith School of Business at the University of Maryland. He is a recognized expert on international economics, industrial policy and macroeconomics. Prior to joining the university, he served as director of the Office of Economics at the US International Trade Commission.

On Monday, the US Commerce Department reported the 2007 current account deficit was $738.6 billion, down from $811.5 billion in 2006. The deficit exceeded 5.3 percent of GDP. The fourth quarter deficit was $172.9 billion.

The current account is the broadest measure of the U.S. trade balance. In addition to trade in goods and services, it includes income received from U.S. investments abroad less payments to foreigners on their investments in the United States.

In the 2007, the United States had a $106.9 surplus on trade in services and a $106.9 billion surplus on income payments. This was hardly enough to offset the massive $815.9 billion deficit on trade in goods, and net unilateral transfers to foreigners equal to $104.4 billion.

The huge deficit on trade in goods is mostly caused by a combination of an overvalued dollar against the Chinese yuan, a dysfunctional national energy policy that increases U.S. dependence on foreign oil, and the competitive woes of the three domestic automakers. Together, the trade deficit with China and on petroleum and automotive products total at least 100 percent of the deficit on trade in goods and services.

To finance the current account deficit, Americans are borrowing and selling assets at a pace of $600 billion a year. U.S. foreign debt is about $6.5 trillion. At 5 percent interest, the debt service would come to about $2000 a year for every working American.

The current account deficit imposes a significant tax on GDP growth by moving workers from export and import-competing industries to other sectors of the economy. This reduces labor productivity, research and development spending, and important investments in human capital. In 2007 the trade deficit is slicing about $250 billion off GDP, and longer term, it reduces potential annual GDP growth to about 3 percent from about 4 percent.

Financing the Deficit

The current account deficit must be financed by a capital account surplus, either by foreigners investing in the U.S. economy or loaning Americans money. Some analysts argue that the deficit reflects U.S. economic strength, because foreigners find many promising investments here. The details of U.S. financing belie this argument.

U.S. investments abroad were $ 1,206.3 billion, while foreigners invested $1,863.7 billion in the United States. Of that latter total, only $204 billion or 11 percent was direct investment in U.S. productive assets. The remaining net capital inflows were foreign purchases of Treasury securities, corporate bonds, bank accounts, currency, and other paper assets. Essentially, Americans borrowed or sold off real estate and other assets of about $600 billion to consume about 5.3 percent more than they produced.

Foreign governments loaned Americans $412.7 billion or 3 percent of GDP. The Chinese and other governments are essentially bankrolling U.S. consumers, who in turn are mortgaging their children’s income.

The cumulative effects of this borrowing are frightening. The total external debt now is about $6.5 trillion. The debt service at 5 percent interest, amounts to $2000 for each working American.

The Chinese government alone holds enough U.S. and other foreign reserves to purchase about 10 percent of the shares of all publicly traded U.S. companies. The U.S. trade deficit is the primary driver behind this phenomenon.

Bureau of Economic Analysis

Consequences for Economic Growth

High and rising trade deficits tax economic growth. Specifically, each dollar spent on imports that is not matched by a dollar of exports reduces domestic demand and employment, and shifts workers into activities where productivity is lower.

Productivity is at least 50 percent higher in industries that export and compete with imports, and reducing the trade deficit and moving workers into these industries would increase GDP.

Were the trade deficit cut in half, GDP would increase by about $250 billion or more than $1700 for every working American. Workers’ wages would not be lagging inflation, and ordinary working Americans would more easily find jobs paying higher wages and offering decent benefits.

Manufacturers are particularly hard hit by this subsidized competition. Through recession and recovery, the manufacturing sector has lost 3.6 million jobs since 2000. Following the pattern of past economic recoveries, the manufacturing sector should have regained at least 2 million of those jobs, especially given the very strong productivity growth accomplished in durable goods and throughout manufacturing.

Longer-term, persistent U.S. trade deficits are a substantial drag on growth. U.S. import-competing and export industries spend three-times the national average on industrial R&D, and encourage more investments in skills and education than other sectors of the economy. By shifting employment away from trade-competing industries, the trade deficit reduces U.S. investments in new methods and products, and skilled labor.

Cutting the trade deficit in half would boost U.S. GDP growth by one percentage point a year, and the trade deficits of the last two decades have reduced U.S. growth by one percentage point a year.

Lost growth is cumulative. Thanks to the record trade deficits accumulated over the last 10 years, the U.S. economy is about $1.5 trillion smaller. This comes to about $10,000 per worker.

Had the Administration and the Congress acted responsibly to reduce the deficit, American workers would be much better off, tax revenues would be much larger, and the federal deficit could be eliminated without cutting spending.

The damage grows larger each month, as the Bush administration dallies and ignores the corrosive consequences of the trade deficit.

Peter Morici,

Professor, Robert H. Smith School of Business, University of Maryland,

College Park, MD 20742-1815,

703 549 4338 Phone

703 618 4338 Cell Phone

pmorici@rhsmith.umd.edu

http://www.smith.umd.edu/lbpp/faculty/morici.html

http://www.smith.umd.edu/faculty/pmorici/cv_pmorici.htm