Scott Sumner recently had a post discussing it potential relationships between trade deficit and government debt. To summarize, since credit must come from saving, if domestic saving is too low compared to domestic investment, then foreign saving must come in and make up the difference; The United States imports foreign currency. When a government runs into a debt crisis and decides to finance that deficit by going into debt, the savings used to pay off that debt can come from domestic or foreign sources. In the US, most of it comes from foreign sources, which is part of the trade deficit.
Some defenders have used this relationship between the trade deficit and the government debt to argue that liberals (like me) and others concerned about the government debt should support payments to reduce the trade deficit. Reducing the amount of foreign savings coming to the US will raise interest rates and thus make government borrowing more expensive. The government will reduce deficit spending. However, that argument is clear, for two reasons.
First: interest rates may rise, but it is unlikely that it will reduce government spending. People who make money and budget decisions do not face the full cost of their decisions. And voters don’t vote (indeed, the cost is spread across all taxpayers). As a result, we end up in what James Buchanan and Richard Wagner called “Democracy in Lack”: politicians prefer easy choices to hard ones, and will support higher spending and lower taxes.
Voters face similar incentives. Indeed, the completely the amount of resources used to produce the same amount of expenditure will increase if prices are used to try to deal with the government debt (assuming that the same amount of deficit money appears, it will be financed with a higher interest rate than would be the case with a large trade deficit. . So, the amount needed to pay off the debt may be higher than others). No one in the political system has any incentive to reduce deficit spending even a high interest rate because “the government” is not someone who chooses one person in the marketplace. Rather, it is a collection created by many independent who they choose, each acting in accordance with their own will and interests.
Second: Fees are a blunt instrument. Even assuming (contrary to the evidence) that tariffs can reduce the trade deficit, there is no promise that debt reduction will result from reduced government spending. It may (and probably does, given the constraints on public choice discussed above) at the expense of private investment. Owners of home-based firms can find it difficult to expand, hire, acquire and produce. Since the managers of local companies do face the full cost of their actions, managers will feel the impact of higher interest rates than those who choose the government. Using tax rates to reduce the government deficit is like burning down a house to kill a spider: sure, the spider may be dead, but the collateral damage is worse.
Finally, using tariffs to reduce the trade deficit in the hope that it reduces government deficit spending misses the mark of the cause of the disease. Trade deficit it is possible show excessive government spending, but if that is the case, then the goal should be to actually reduce government spending. Of course, that is a very difficult problem for the reasons mentioned above. But just because it’s hard doesn’t mean one should choose the easy, but possibly the most dangerous option.
Many economists, from Adam Smith to today, dismiss trade deficits as “absurd” and argue that their existence causes more confusion than clarity. The connection between trade deficits and government debt supports their conclusion.
Jon Murphy is an assistant professor of economics at Nicholls State University.
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