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An Exploration of the U.S. Trade Balance and Its Import from China: The U.S. Current Account and National Saving
1. Introduction
The economic ties between the United States and China have expanded substantially over the past two decades. According to Morrison (2014), total U.S.-China trade surged from $2 billion to $562 billion during the period 1979-2013. The trade gap between these two countries has
widened increasingly. In 2006, the U.S. trade deficit peaked at $635 billion (balance of payments basis) and has slightly declined since then. In the same year its current account deficit peaked at $811 billion (Feldstein, 2008). A sustaining high trade deficit may have long-term implications on the U.S. dollar exchange rate and its domestic interest rate. The value of its currency may depreciate and the domestic interest rate may rise. Some worry that such pressure on the
currency appreciation and interest rates increase will contribute to business failure and job loss in the United States.
A large and persistent trade deficit raises the concern that it increases U.S. reliance on international borrowing, meaning the sale abroad of U.S. bonds and other securities (Bown, Crowley, McCulloch, & Nakajima, 2005). In particular, a huge deficit with China forces the U.S. to depend heavily on China in order to finance its debt, which is indicated by China’s massive U.S. debt securities accumulation. Data from the U.S. Department of Treasury shows that China holds approximately $2 trillion worth of the U.S. securities in the foreign reserve portfolio, making it the largest holder globally.
As the U.S. continues to suffer from massive trade deficit with China for years, interest and curiosity have attracted numerous attentions on this issue. Many have accused and blamed the Chinese exports to the U.S. for worsening the U.S. trade imbalance. As this accusation remains heated, a review of the fundamental relationship between the U.S. trade deficit, its imports from China, and other economic factors deem to be essential.
This paper hypothesizes that the U.S. imports from China does not contribute to the U.S. severe trade deficit. An empirical approach is adapted to investigate how the U.S. trade deficit is
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related to possible economic causes. The outcome provides statistical evidence that the U.S. imports from China does not influence the trade deficit significantly and that current account and national saving play a vital role in the trade balance.
This paper proceeds as the following. Section 2 discusses some contributing elements of the U.S. trade deficit and contradictory views from scholars. Japan will be compared with China with respect to trade imbalances and current account surplus with the U.S. Following that,
Section 3 studies major relevant economic factors that shape the trade imbalance and constructs a model to test the hypothesis. Nest, Section 4 provides the regression outcome of the model and offers alternative explanations for the U.S. trade deficit. Finally, Section 5 serves as a conclusion for this paper.
2. Literature Review
2.1 Benefits and Challenges of Trading with China
The U.S. suffers from massive trade deficit with China, which is likely to result in fewer jobs, replaced production, and increasing reliance on international borrowing (Bown et al., 2005). Lum and Nanto (2007) analyze the situation by presenting some political and economic benefits of trade for the U.S. to trade with China, as well as accompanying challenges. They list the benefits as the following: (1) the allocation of available resources is more efficient for both sides; (2) China as a rapidly emerging economy offers U.S. business the opportunity to expand in high pace; (3) China’s compliance with the agreement of WTO will stimulate the development of Chinese market forces; (4) China’s dependency on export and import will foster social and economic pressures for democracy, which benefits the U.S. (5) China’s population and power are large enough to impose influences on the world market. The five challenges that the U.S. must face when trading with China are the following: (1) increasing quantities of imports from China impose substantial threat or injury to U.S. competing industries; (2) imports from China may receive unfair aid or subsidies from national government entities; (3) the U.S. deficit stems largely in China’s policy to maintains an undervalued currency (henceforth renminbi); (4) China may enjoy unfair competitive advantages arising from the failure to adopt and enforce
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internationally recognized standards for environmental regulation and working conditions; (5) U.S. economic engagement with China may contribute to the strengthening of Chinese military. 2.2 Relevant Variables of Regression
2.2.1 GDP
The U.S. trade deficit accumulates to $450 billion, which is 4.6% of the country’s GDP in 2000, and the numbers surge to $780 billion and 6.3% respectively in 2005. However, most economists deem that trade deficits exceeding 2 or 3 percent of GDP are unsustainable. This contradiction indicates the necessity to consider GDP in analysis.
2.2.2 Exchange Rate and Interest Rate
Exchange rate and interest rate are closely related to each other and the exchange rate between the U.S. dollar and renminbi has long been under dispute. Although renminbi has appreciated by approximately 9%, China has still been under the accusation of pegging renminbi to the U.S. dollar and of not allowing renminbi to appreciate to a fair value (Corden, 2009). Salvatore (2007) warns that if the value of U.S. dollar depreciate because of large trade deficit, the interest rate is likely to be driven up, which may lower worldwide economic growth. Makin (2009) states that renminbi should have appreciated because China’s output growth surges relative to its
expenditure. But in order to favor exports and gain advantages over its trading partners, Makin (2009) observes that China tries to keep renminbi undervalued by buying a huge amount of foreign treasury bonds, of which the U.S. bonds take a large proportion. His concern is that such action will lower the interest rate in the U.S., which will in turn increase expenditures and demands on Chinese imports, making the U.S. more dependent on China.
Viewing globally, the entire U.S. trade deficit with other countries results from the current international monetary system where U.S. dollar takes the dominance (Yue & Zhang, 2014). The U.S. has a strong incentive to run a trade deficit under the current international monetary system. Therefore it is unsurprising that the Chinese exchange rate does not lead to the rising trade deficit of the U.S. (Yue & Zhang, 2014). In spite of 25 percent appreciation in the renminbi, the prices of Chinese exports do not increase much, so a fall in the U.S. imports from China should not be expected (Yue & Zhang, 2014). The influence of exchange rate on the
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reduction of trade deficit is very limited and it is unconvincing that the Chinese exchange rate hampers the U.S. exports to China (Yue & Zhang, 2014). As a matter of fact, China is the third-largest export market of the U.S. (Morrison, 2014). All these controversies makes it essential to take exchange rate (trade-weighted) and interest rate into account.
2.2.3 Saving
Yue and Zhang (2014) identify two determinants of the U.S.-China trade deficit: (1) Americans prefer consuming to saving; and (2) the U.S. imposes restrictions on the high-tech exports to China. In 2000, the U.S. government relaxed monetary policies to resist recession. Since then there has been a long-run expansion of consumption in the U.S., leading to a ballooning of imports. Also aided by a housing boom, Americans borrowed against their increasing property values and consumed much more than the saved (USCBC, 2011). Both Corden (2009) and Woo (2008) attribute the U.S. trade deficit Therefore, it is worth testing if the U.S. trade deficit can be reduced by an increase in its domestic savings.
2.2.4 Current Account
In 2012, the U.S. recorded a trade deficit of $44.8 billion based on balance of payments and a current account deficit of $440.42 billion. Current account links a nation’s overall income and expenditure to its international position (Pilbeam, 2013). Current account not only records transactions including tangible goods but also trade in services, net foreign income, and
unilateral transfers (Bown et al., 2005). Considering the positive sales produced from exports and the proportion of trade balance in current account, a current account surplus usually symbolizes positive net exports (Pilbeam, 2013). Therefore, a huge current account deficit is likely to lead to trade tensions and trade wars. In particular, the U.S. trade deficit with China was $315.11 billion in 2012. Trade tensions are increasing between the world’s two largest economies, the U.S. and China, because of such a large trade imbalance. The U.S. has been running large current account deficit while China has accumulated big surpluses.
2.2.5 Export and Import Elasticities
Elasticities cannot be left out when considering the influence of exchange rate fluctuations in the short and long term (Chiu, Lee, & Sun, 2010). In the short run, the devaluation of a nation’s
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currency imposes little influence on the exports and imports volumes since elasticities of export supply and import demand are small, but devaluation does lead to a drop in the prices of exports and an increase in the prices of imports, which will worsen the country’s trade balance (Chiu, Lee, & Sun, 2010). In the long term, the elasticities of export supply and import demand go up, meaning that their sum is larger than 1, and then the trade balance of a country improves (Chiu, Lee, & Sun, 2010).
2.2.6 Import from China
Different views arises regarding the extent to which import from China contributes the U.S. trade deficit. Some assert that China undervalues renminbi intentionally, while others claim that the U.S. should be responsible for the deficit. The trade gap will not be narrowed with renminbi appreciation, rather, it will be narrowed when the U.S. budget deficit is cut (Chinn and Steil, 2006). Studies have found that every 100 dollars in budget deficit reduction yields a decrease in trade deficit from 20 to 50 dollars (Chinn & Steil, 2006).
Yue and Zhang (2014) mention that the restrictions on the export of high-tech products to China also contribute to the trade imbalance. Their analysis rejects the popular misconception that the Chinese government has been manipulating its currency to gain price edge for its exports. Limiting import from China will not be a solution either, Bown et al. (2005) explain that restrictions will only shift the U.S. import demand from China toward other low-cost foreign suppliers rather than domestic import-competing industries.
2.3 Similar Case: Japan
The purpose of taking Japan as comparison is to suggest that it is necessary to look at current account of the deficit nation rather than that of its trading partner, and to offer possible solutions to the U.S. trade deficit from both sides. China, Japan and other emerging markets in East Asia are blamed for contributing to half of the U.S. trade deficit and undervaluing their currencies against U.S. dollars (Salvatore, 2007).
In the 1980s, the U.S. and Japan had a similar trade gap where the U.S. ran a current account deficit whereas Japan had a current account surplus (Ito, 2009). To tackle this problem, the U.S. increased protectionism and tightened monetary policy (Ito, 2009). Ito (2009) explains
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that as with the debate with China, the U.S. accused Japan of manipulating its currency to favor its exports. Batra and Beladi (2013) also blame China and Japan for maintaining a high value of the US dollar to make inroads in the U.S. market. Ito (2009) illustrates that the response of U.S. was to impose a 20% tariff on Japanese imports, which was followed by a 50% appreciation of the yen. As a result, Japanese current account surplus went down by 1.5% of GDP, but this decrease did not impact the U.S. trade deficit.
Furthermore, Ito (2009) ascertains that China and Japan are economically different. He states that China is much less developed than Japan in 1980s viewing from a per capita basis. Besides, compared to Japan, China has higher national saving and investment. He argues that the fundamental difference lies in financial systems. He explains that China’s banking system is dominated largely by state-owned institutions and thereby inefficient owing to the long-term direct control on industries by government, whereas financial systems in Japan were relatively healthy and strong in 1980s.
3. Data and Methodology
According to Mankiw (2013), with C denoting consumption, I denoting investment, G denoting government spending, X denoting exports, M denoting imports, and Y denoting gross domestic product (GDP), the basic accounting identity is expressed as below:
Y = C + I + G + X - M, where (X - M) is trade balance
This equation shows that trade balance is a component of gross domestic product and that trade surplus will increase it while trade deficit will decrease it. By subtracting taxes (T) from
government spending and subtracting consumption (C) from both sides of the equation above, the result is:
Y – T – C = I - (T - G) + (X - M)
The left side of the equation represents private savings (SP). On the right side, (T - G) signifies
government savings (SG). By rearranging, a relationship is established between investment,
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S – I = X – M where S = SP + SG, SP = Y – T – C, and SG = T – G
Mankiw (2013) also notes that savings is positively related to interest rate while investment is negatively related to interest rate. This relationship and the equation above illustrate that trade balance is closely related to the interest rate. In the model, effective Federal funds rate will act as interest rate for simplicity as commercial banks have different interest rates. Trade balance is directly influenced by exchange rate, which is defined as the price of a unit of domestic currency in terms of foreign currency (Mankiw, 2013). As the U.S. has a number of large trading partners, trade-weighted dollar index will be used instead of the exchange rate to a single currency.
In accordance with Feldstein (2008), an increase in the U.S. saving rate is fundamental for a lower U.S. trade deficit. By pointing out the fact that the current U.S. saving is so low that the country must import from other nations to invest in domestic equipment and constructions, the author claims that low national saving forces the U.S. to import more than it exports, thus contributing to the huge trade deficit. Therefore, the U.S. saving rates, both private saving and government saving, will be included in the model. The reason to separate government saving is based on a research by Ito (2009), which confirms the significantly positive relationship between government budget balance and current account. He finds that 1 percentage increase in budget balance leads to 0.23 percentage increase in national saving rate for industrialized countries.
Apart from factors such as GDP, interest rate, exchange rate and saving, import from China is considered. China has been under the accusation of manipulating its currency to benefit its exported goods and services. Moreover, in recent years, China has taken a major share of U.S. imports, leading to a widespread view that China should be responsible for the overall U.S. trade deficit (Bown et al., 2005). Thus, import from China as a main parameter should be taken into account.
All the considerations mentioned above lead to the model: Trade Balancet= β0+ β1 ln GDPt+ β2 Fed Ratet+ β3 ln Dollar Indext
+ β4 ln Import(China)t+ β5 ln Saving(Private)t
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In this model, all the variables are at time t and β is the vector of coefficients. The data is obtained from The Federal Reserve of St. Louis Economics Research Data (FRED) website and the U.S. Bureau of Economic Analysis. Quarterly data spans from the first quarter of 1992 to the last quarter of 2012, and the description of the data set is provided in the appendix. Trade
Balancet is the entire trade balance of the U.S. (balance of payments basis), GDPt is real gross
domestic product, measured in chained 2009 dollars,Fed Ratet is effective Federal funds rate, Dollar Indext denotes trade-weighted U.S. dollar index inclusive of major currencies,
Import(China)t is U.S. imports from China, mainland on a customs basis, Saving(Private)t denotes U.S. net private saving, Saving(Government)t denotes U.S. net federal government saving, Current Account (to be added in the next section) denotes total current account balance for the U.S., and εt denotes other omitted impacts (to be examined in robustness test) on trade balance.
The trade deficit is analyzed with respect to China, accompanied by the question “is the U.S. trade deficit made in China?” This econometric model is constructed and tested to see if there is indeed such a relation. The null hypothesis is that the import from China does not contribute to the U.S’s enormous trade deficit. If the import from China does contribute to the U.S. trade deficit, the coefficient of Import(China) variable, β4, would be statistically significant.
4. Empirical Result and Analysis
In this section, the robust regression results are briefly presented in Table 1. A robust regression is conducted to confirm that the omitted factors do no influence variables of major concern, and the outcome show that significance levels of variables remain unchanged between multiple linear regression and robust regression.
TABLE 1 Regression Results from Trade Balance
1 2 3 4
Coefficients Coefficients Coefficients Coefficients GDP -97.352*** (0.000) -24.731*** (0.002) -25.617*** (0.001) -24.049*** (0.004)
9 Fed Rate 3.420*** (0.000) 0.425*** (0.000) 0.461*** (0.002) 0.936*** (0.000) Dollar Index 62.925*** (0.000) 18.993*** (0.000) 19.328*** (0.000) 25.747*** (0.000) ImportChina -3.230 (0.539) 2.104 (0.117) 2.111 (0.121) 0.812 (0.634) Savingprivate 13.536*** (0.000) -- 0.504 (0.716) -- Savinggovernment -0.027*** (0.000) -- -- -0.005 (0.042) Current Account -- 0.011*** (0.000) 0.012*** (0.000) 0.012*** (0.000) Constant 510.501 (0.017) 138.843 (0.031) 142.301 99.945 (0.173) F-statistic 194.84 3609.10 2958.00 2561.89 R2 0.9322 0.9928 0.9921 0.9928 Observation 84 84 84 84
Note: P-values are in parentheses. *, **, and *** represent statistical significance at 10%, 5%, and 1%, respectively.
Equation 1 above is assessed by taking all variables for 84 observations. Table 1 column 1 provides regression results for the baseline model. The result indicates that GDP imposes a negative effect on the U.S. trade balance. As government saving increases, the trade deficit decreases. For every one billion increase in government saving, the trade deficit would drop by 0.027 billion. This result is consistent with what could be seen from the U.S. economic history, where net federal government saving and the U.S. trade balance move in the opposite directions. The Fed Rate have statistically significant positive effects on trade deficit. Nations with high and persistent trade normally have higher interest rates than those with balanced trade or surpluses, and the reason is that higher interest rates will attract foreign funds to finance trade shortfalls (Batra & Beladi, 2013). However, rational agents will perceive that a budget deficit would indicate lower government expenditures or higher taxes in the future. Therefore, they will reduce their consumption and raise their saving today. The private saving can be used by government to finance its deficit, and thereby placing no upward pressure on interest rates. In addition, vast
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foreign hoard of U.S. bonds and securities contributes to low domestic interest rate in the U.S. (Batra & Beladi, 2013).
Moreover, Dollar Index is positively related to trade balance and it is statistically significant at 1% level, indicating that a depreciation of the U.S. dollar is likely to reduce the trade deficit. The difference of import and export elasticities regarding real exchange rate is approximately between 1.5 and 1.9, which means that if the ratio of exports to GDP is assumed to be 10 percent, then an expected depreciation of 11 to 20 percent is required to reduce the ration of trade deficit to GDP to 10 percent (Hooper, Karen, & Marquez, 2000). From a global standpoint, Feldstein (2008) believes that resolving the global imbalance will need a fundamental realignment of currencies, and that the value of the dollar will need to decline relative to the euro, renminbi, the Japanese yen and other Asian currencies. Likewise, Dong (2012) finds that both U.S. exports and imports are less responsive to exchange rate movements, due to global trade pattern and changes in firms’ pricing behavior. He shows that if the U.S. current account deficits decrease to zero, it may require a depreciation of the U.S. dollar from more than 20 to 40%.
The parameter of key interest is the U.S. imports from China. In line with the expectation, the U.S. import from China does not have a significant effect on the U.S. trade deficit as indicated by statistical insignificance either with or without Current Account variable. This outcome shows that the U.S. trade deficit declines by 3.230 billion for each one billion increases in imports from China. Moreover, approximately 93% of the variation of the trade balance is elaborated this model, meaning that only 9% remains unexplained.
On the basis of the original model, Current Account, as an additional explanatory variable is included. Similar to the baseline model, GDP, Fed Rate and Dollar Index are statistically significant at 1% level in this new regression. It is important to note that after the inclusion of Current Account, private and government saving are not statistically significant, but F-statistic value is boosted to over 1600, ten times higher than the baseline model. Besides, 99.28% of the variation is explained with the inclusion of Current Account variable. Which implies that trade balance is closely related to current account balance.
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In macroeconomic terms, the current account deficit is equal to the difference between the nation’s total (private and public) savings and its total domestic (private and public)
investment spending (Bown et al., 2005). Because current account already includes private and government savings, in the new regression, variables Savingprivate and Savinggovernment are not statistically significant. The regression result shows that the current account and the U.S. trade balance are positively related to each other, when the current account goes up by 1 billion, the U.S. trade balance is expected to increase by 0.011 billion. It can also be inferred that a current account deficit is due to the lack of private saving or government budget deficit. In the regression results without either private saving or government saving or both, current account remains statistically significant at 1% level. This confirms the contribution of current account deficit to trade imbalance.
As shown in the Table 1, as expected, GDP, interest rate and exchange rate are closely related to trade balance throughout the whole process. However, after current account is considered, the effect of these three factors on trade balance decreases as reflected by the changes in the coefficients. The variable ImportChina stays statistically insignificant in the baseline and new model, therefore the null hypothesis is not rejected, the U.S. imports from China does not contribute to its trade imbalance.
5. Conclusion
While trade and current account deficits are often portrayed as alarming developments, economic theory indicates that a trade or current account deficit (or surplus) is intrinsically neither bad nor good (Bown et al., 2005). Whether a deficit should be regarded as a problem is determined by a country’s current and future circumstances. During the past two decades, the U.S. has witnessed a rising trade deficit with China. However, the short answer to the question that whether imports from China contribute to the U.S. trade deficit is negative, according to the analysis in the previous section. In recent years, the U.S. bilateral trade imbalance has been increasing not only vis-à-vis China but also most other trading partners (Mann, 2005). However, official purchases of U.S. dollar assets by the U.S. trading partners, particularly China, have facilitated the high level of the U.S. domestic consumption, and some believe that large-scale foreign purchases of
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U.S. securities have been responsible for keeping the long-term interest rate low domestically (Setser & Roubini, 2005). The U.S. deficit is benign as long as the borrowing level is reasonable, considering the country’s economic forecast and the interest rates (Bown et al., 2005).
The U.S. trade imbalance has been enormous and enduring, indicating a fundamental disequilibrium in the accounting balance of the country and the world. Viewing from the perspective of current account, the Congress may come up with a plan to cut down the federal budget and thereby increase public saving and trade balance. This option is also supported by previous research, which indicates that every $100 reduction in budget deficit will yield a reduction in trade from $20 to $50 (Chinn & Steil, 2006). Therefore, the U.S. should increase domestic savings and cut down expenditures to achieve current account balance. Since 2000, the way how the U.S. current account deficit is being financed has changed from shares to bonds (Feldstein, 2008). Foreign governments are willing to buy the debt that could finance the U.S. current account deficit, because they want to sustain their export surpluses with the U.S. (Feldstein, 2008). Meanwhile it may be worrisome to the extent that foreign governments will not continue to finance the deficit; the U.S. should maintain its internal balance (Feldstein, 2008). Similarly, a study by Ito (2009) confirms that budget balance plays an important role in the determination of current account balance. The U.S. cannot achieve long-run sustainability of the current account deficit without reductions in other bilateral imbalances (Bown et al., 2005). If the decrease in the trade deficit with China is achieved through either China-specific import barriers or renminbi appreciation, there will be a corresponding increase in other bilateral imbalances (Bown et al., 2005).
Reductions in the U.S. current account and trade deficit will necessarily imply lower aggregate current account and trade surpluses in other countries. As the biggest source of imports of the U.S., China has been running a trade surplus with the U.S. Feldstein (2008) suggests that reducing China’s remarkably high national saving rate (more than 40 percent of GDP) is the key to shrinking China’s trade surplus. The author claims that this can be accomplished by increasing household consumption and government expenditures on public programs in health and
education. Similar view is held by Hung and Qian (2010), who argue that the high saving rate in China is the need for precautionary saving because of the inadequacy of China’s social safety net system such as a country-provided healthcare system. Batra and Beladi (2013) emphasizes that
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massive purchase of U.S. securities drives up the interest rate and thereby the saving rate of the holder country. While Feldstein (2008) agrees that the U.S. trade deficit will dwindle with a more competitive dollar, he points out the crucial requirement for a lower deficit is an increase in the U.S. national saving, particularly household saving (0.5 percent of disposable personal income in 2007). Low saving rate in the U.S. is also the point criticized by the current account surplus countries (Ito, 2009).
To mitigate the trade deficit, the U.S. should not focus on restricting import from China as such massive imbalance does not stem only from China. However, China could be of help by allowing more market-oriented financial institutions, as suggested by the comparison with Japan. The U.S. imposition of barriers targeting China is likely to result in international repercussions. Bown et al. (2005) claim that the U.S. government should enforce multilateral agreements rather than selective trade policies on the country level, which neither increases national or global welfare, nor reduces overall trade imbalance significantly. Specifically, these authors also assert that restrictions on the U.S. imports from China will not benefit domestic import-competing industries, rather, the restrictions are more likely to divert the demand toward other foreign suppliers with lower costs than China. As stated by Bollino (2007), the preferences of American consumers exhibit a relatively high elasticity of substitution between domestic and imported goods. Because trade deficit is the difference between national saving and national investment, an increase in the U.S. saving rate is necessary for reducing the U.S. trade deficit.
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16 Appendix Descriptive Statistics
Variable Observations Mean Std. Dev. Min Max
Trade Balance 84 -31.96 20.08 -66.43 -1.83 GDP 84 12733.10 1989.24 9123.00 15433.70 Fed Rate 84 3.22 2.14 0.07 6.52 Dollar Index 84 87.44 10.77 69.53 111.57 ImportChina 84 14.93 11.29 1.68 38.22 Savingprivate 84 432.2 168.43 210.60 1100.50 Savinggovernment 84 -408.20 439.33 -1351.90 176.20 Current Account 84 -98.02 58.04 -214.50 -6.23
