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Posted by: Michael Mandel on February 21
The debate over the trade deficit and dark matter goes on. Brad DeLong takes a shot at it here, concluding that:
I believe what Rudi Dornbusch said: that when highly intelligent and respected economists begin evolving plausible theories that—this time—the trade deficit is sustainable, that is the time to start running for the hills, because the crash is near.
Martin Wolf’s Financial Times Economic Forum hosts a dark matter debate between Willem Buiter and Ricardo Hausmann, and others here. And Brad Setser has a very long and very thoughtful response to me here.
I believe that most of the discussion of the trade deficit and dark matter misses the big picture. Let’s take a step back to get some perspective. In my view there have been two very dramatic changes in the U.S. economy compared to ten years ago. First is the remarkable and unanticipated acceleration of productivity growth. Second is the equally remarkable and unanticipated widening of the measured trade deficit, a hallmark of globalization.
These changes are enormous. Productivity growth in the nonfarm business sector has averaged 2.9% annually since 1995, compared to roughly 1.6% over the previous ten years. That means nonfarm business output in 2005 was roughly $1.2 trillion higher than if productivity growth had continued at the previous anemic pace. (Comparing the CBO’s ten year GDP forecast in 1996 with actual growth gives the same answer—GDP in 2005 was roughly $1.2 trillion higher than expected 10 years ago).
At the same time, the trade deficit today is far higher than anyone would have forecast ten years ago. In 1995, the trade deficit in goods and services was $91 billion, or 1.2% of GDP, and at least one forecaster, DRI/McGraw-Hill, projected that it would virtually disappear by 2005. Instead, the goods and services deficit was more than $700 billion in 2005, or 5.8% of GDP.
So here’s the two “big facts” which define the U.S. economy today. We produce, on an annual basis, $1.2 trillion more than expected. And our net imports are $700 billion greater than expected, inducing an equal amount of borrowing.
Seemingly, these two facts point in opposite directions. After all, if you become more productive, you would expect to borrow less rather than more. The puzzle gets bigger rather than smaller.
Remarkably, the DeLong, Setser, and Wolf pieces never mention productivity. Not once. They focus on the second fact—the larger- than-expected trade deficit—without once mentioning the first fact, the higher than expected productivity growth.
I think omitting the acceleration of productivity from the discussion of the trade deficitis a big mistake. To my mind, it is essential to come up with a framework which handles both “big facts” simultaneously. That’s what I will discuss in my next post.
Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.