Is U.S. Trade Imbalance a cause of concern?

Dr. Umesh Chandra Yadav
Associate Professor
Department of Economics,
V.S.S.D College, C.S.J.M. University Kanpur, India

Alok Kumar Yadav
Assistant Professor
Department of Economics,
Bareilly College, M.J.P.R. University Bareilly, India

For over four decades, United States of America (U.S.A. /U.S.) economies have been in a continuous trade deficit, but with China trade deficit arises since late 1980s. This paper firstly analyzes U.S. trade structure. Though, China is the largest trading partner of U.S., but the merchandise trade surplus has tilted in favour of China and other strong economies. The U.S. stands at a trade deficit of $14 billion in 1991. In the late 2000s, it increased to nearly $83.5 billion; and in 2008, to nearly $285 billion. By 2017, the trade deficit with China had jumped nearly 39% over the previous decade, to a record $396 billion. For the last 23 years, Chinese economy system has run an enormous trade surplus with practically every nation on earth. Thereafter, a Random-effects GLS regression is performed using panel data set for time period 1991 to 2017 with maximum possible coverage of U.S. trade imbalance with world and particularly with China. The result of model revealed that the goods imported by U.S., FDI net inflows; and total reserves of partner nation’s variables provide most of the explanatory power and are intuitively reasonable except partner nation’s GDP, whose value is statistically insignificant on U.S. trade imbalance. But with China, it is statistically significant at one percent level. A U.S. import goods has a negative and significant impact on its trade deficit with a coefficient below unity. The FDI net inflow of bilateral trading partner has a positive impact on U.S. trade deficit, which reveals its importance. The U.S. dollar index of major currencies has no statistically significant impact on U.S. trade deficit with world, but with China it is statistically significant at 5 percent level. The total reserve with expected negative signs supports the fact that the accumulation of total reserve by foreign nation affects partner U.S. trade imbalance. Moreover, the effect of total reserve (plus gold) is greater than the effects of total reserve (minus gold). The results tell us that the U.S. trade deficit is predicted to increase 0.034 when the total reserve (minus gold) of other nations goes up by one, while the U.S. trade deficit is predicted to increase 0.0347 when the total reserve (plus gold) of other nations goes up by one. From this study we concluded that, the current tension in U.S.-China economic relation is mostly smoke and mirrors. The U.S. trade deficit with world and/or China’s trade is not due to the trade policy of China, rather Americans nature of over spending than home production which is covered by imports. Trump’s Trade war with Chinese imports would mean increased duties on Chinese products which will raise the manufacturing costs of the Chinese firms. China will retaliate by imposing duties on American products. But being a large nation, both U.S. and China welfare actually rises or falls will depends on the net effect of two opposing forces viz. reduce in the volume of trade and improvement in the terms of trade.
Keywords: Trade, Imports, Trade Imbalance, Foreign Direct Investment
JEL Classifications: F11, F14, F21

INTRODUCTION
Generally Speaking, for the last 14 years (2003), Chinese economic system has run enormous trade surpluses with practically every nation on earth (Shank, 1994). Currently U.S. is China’s largest trading partner, biggest source of imports and third largest export market of U.S. economies. U.S.-China economic ties have expanded since 1979 (China’s economic reform); however, merchandise trade has tilted in favour of China (Chen, 2014). Since 2006 China grabbed the number one overseas market position for the U.S. (table 1). Low-cost Chinese goods and inputs of production are of great help for U.S. consumers and producers respectively both. China keeps U.S. interest rates low by accumulating largest U.S. treasury and debt securities (Morrison, 2018).
From the U.S. perspective, despite growing U.S.-China commercial ties, China’s incomplete transition to a free market economy, maintaining state-directed policies, extensive use of trade barriers, slow movement towards implementing WTO framework, interventionist policies towards RMB value has deteriorated the U.S.-China economic relationship and has contributed to U.S. job losses in some sectors (Moosa & Ma, 2013) (Morrison, 2018). In response to Chinese these disruptive policies, the Trumph Administration has pledged to promote ‘free and fair trade’ by imposing certain trade barriers in regard to China.
With the realization of U.S.-China trade imbalance and to derive important implications, the current study has attempted to determine factors behind the U.S. trade imbalance with world and separately with China. For this purpose, firstly we will analyse U.S. trade structure and thereafter, a Random-effects GLS regression is performed using panel data set for time period 1991 to 2017 (i.e. for 26 years). Our analysis is based on maximum possible coverage of U.S. trade imbalance with world and China separately. Result of the study showed that though, the coefficient of world GDP is negative but its impact on U.S. trade imbalance not statistically significant. However with China, it is statistically significant at one percent level. Our result also shows that the U.S. imports from world and with China have significant effect on U.S. trade deficit.
LITERATURE REVIEW
Employment in the U.S. is the major point of contention. A research by EPI1 finds that the growing U.S.-China trade deficit has cost 3.2 million jobs particularly in advanced technology products in all 50 states of U.S.A between 2001 and 2013. This happened after China joined WTO (Scott & Kimball, 2014). A 2014 study by the NBER2 concluded that increase in U.S.-China trade imbalance particularly after 2000, has significantly suppressed overall U.S. job growth (Acemoglu, Autor, Dorn, Hanson, & Price, 2014). Investment plays a vital role in the bilateral commercial ties. China’s accumulation of foreign exchange reserves (FERs) and a foreign direct investment (FDI) net inflow has been a major driver of her overseas investment3. China holds rank 1 and 3 in global FDI inflows and outflows respectively in 2015. Nearly two thirds of the total inflows were concentrated in only three countries – the United States, China and Brazil. A FDI inflow in BRICS is highly concentrated towards China alone received more than 50 per cent in 2015 (UNCTAD, 2016). China’s FERs result from: (1) large annual trade surpluses and FDI inflows; (2) RMB devaluation and (3) holding of foreign currencies (Huges, 2005). Though, foreign currencies holding generate low returns but they provide relatively safe investment. Moreover, China has diversified its abroad investments to gain access over raw materials, food, and technology. As a result, Chinese FDI outflows have increased by 7.7 times between 2006-2016 from $21 billion to $183 billion (Scott & Kimball, 2014). China holds totalled $1.54 trillion of U.S. securities as of June 20174 (Scott & Kimball, 2014). A high U.S.-China trade deficit could also make U.S.A. heavily reliant on China for its debt finance (Kim, 2014). China might threaten to sell U.S. debt securities over a policy dispute, it could sharply depreciate U.S. dollar against global currencies, thereby damaging the U.S. economy (Scott & Kimball, 2014) (Gu, Zhou, & Beg, 2014). China is not following fair trade and may be manipulating its renminbi (RMB) (Kim, 2014). Half of the U.S. trade deficit is with China, Mexico, Japan and other East Asian nations and it could depreciate the value of the U.S. dollar against these major nation currencies (Salvatore, 2007). The RMB was pegged between 1997 and 2005 to the U.S. dollar; afterwards it was allowed to appreciate about 9% till 2007. Thus, RMB is not allowed to appreciate to fair value (Corden, 2009). Even if RMB is allowed to appreciate, People’s Bank of China maintains stable exchange rate with major currencies (Lum & Nanto, 2007). Moreover, Americans prefer consumption than to save. (Yue & Zhang, 2014).

DATA AND METHODOLOGY
Firstly, we will examine the structure of U.S. trade. Thereafter we will, examine the relationship between U.S. trade imbalance and goods imported in U.S., in accordance with other variables.
“Any economy is linked to the rest of the world through trade and finance. Spending on imports escapes from the circular flow of income i.e. that part of the income is spent on foreign produced goods. In addition, the prices of nation goods relative its competitors have direct impacts on demand, output, and employment due to which demand shifts away from domestic goods towards goods produced abroad. Moreover, as international investors shift their assets around the world, and thereby affect income, exchange rates, and the ability of monetary policy to influence interest rates.” (Dornbusch & Fischer, 2010) This is precisely what happened with United States.
These considerations lead to the model:
Trade Imbalanceij = ?0 + ?1 GDP current US dollarj + ?2 goods importij + ?3 FDI net inflowsj + ?4 US Dollar Indexij + ?5 total reserve minus goldj + ?6 total reserve plus goldj + µij (1)
where,
The explanatory variables in the model are defined as follows:
l Trade imbalance shows the U.S. merchandise exports minus U.S. merchandise imports with world.
l GDP at purchaser’s prices is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products.
l Goods import show the c.i.f. value of goods received from the rest of the world.
l Foreign direct investment refers to net direct investment equity flows in the reporting economy.
l Trade Weighted U.S. Dollar Index Broad is a weighted average of the exchange value of the U.S. dollar against the currencies of a broad group of major U.S. trading partners.
l Total reserve minus gold comprise special drawing rights, reserves of IMF members held by the IMF, and holdings of foreign exchange under the control of monetary authorities. Gold holdings are excluded.
l Total reserves comprise holdings of monetary gold, special drawing rights, reserves of IMF members held by the IMF, and holdings of foreign exchange under the control of monetary authorities.
l ? is the vectors of coefficients; and
l µij represents the other omitted influences on trade imbalance, assumed to be well behaved.
Is the U.S. trade imbalance made by world or particularly by China? The hypothesis is that U.S. trade imbalance with world and particularly with China is contributing U.S. massive trade deficit. If this happens, then the coefficient of the goods imported by U.S. variable ?2, would be positive and statistically significant. The regression will test other variables to check the correlation between U.S. trade imbalance and the variables i.e. if “x causes y” and the null hypothesis is rejected, the variable will be significant in relation to the U.S. trade imbalance. Hence, a variable is considered significant if it has a ?-value < 0.1. The description of the data set is presented in table 2 in appendix.
Data are in current U.S. dollars and are borrowed from UNCOMTRADE5, World Bank6, Federal Reserve Bank of St. Louis7.
STRUCTURE OF TRADE
“The main driving force behind China’s impressive economic growth has been an expansion of exports” (Shank, 1994). In 2017, U.S.-China was largest trading partner, but this merchandise trade has tilted in favour of China and other strong economies (table 1). Half of all U.S. exports to China are machinery, mechanical and electrical appliances, vehicles other than railway, aircraft, and spacecraft, optical, photographic and parts thereof (figure 1); Half of the U.S. imports from China are mainly machinery and mechanical appliances; electrical equipment; sound recorders and reproducers, television image; and parts thereof (figure 2).
Figure 3 portrays the share of each HS Section commodities in total imports of U.S. in 1991 and in 2017. The figure shows that machinery, mechanical and electrical appliances constituted the main import section in both years and its share in total imports rises between 1991 and 2017. Vehicles other than railway, aircraft, spacecraft and mineral product saw their share decline during the same period. Figure 4 depicts the share of top 20 countries in total import by U.S. in 1991 and in 2000. The figure shows that the China constituted the number one position in 2017 by replacing Japan.
U.S. policy makers were concerned of the size of the U.S.-China trade deficit. The U.S. stands at a trade deficit of $14 billion in 1991. In the late 2000s, it increased to nearly $83.5 billion; and in 2008, to nearly $285 billion. By 2017, the trade deficit with China had jumped nearly 39% over the previous decade, to a record $396 billion (figure 5). For the last 23 years, Chinese economy system has run enormous trade surpluses with practically every nation (figure 6). Few analysts contend that this persistent trade deficit of U.S.-China indicate that trade is not fair and balanced, making U.S. economy weaker.
EMPIRICAL RESULT
The result of the regression (see table 3 in appendix) determines the U.S. trade imbalance with world and separately with China for the equation (1). The model fits the data well across our sample of studies. The conventional variables behavior and the estimated coefficients along with their signs are statistically significant and economically reasonable except GDP (in current US$). The result of the model revealed that the exporter’s GDP has negative but not statistically significant impact on U.S. trade imbalance. However with China, it has a positive value of .00374 and is statistically significant at one percent level which shows that China’s high GDP decreases U.S.-China trade deficit to some extent.
Our parameters of key interest are the U.S. imports from world. Like our expectations, the U.S. imports from world have significant effect on U.S. trade deficit. Since, ?2 is negative and statistically significant at 1 percent conventional level in the sense that each one unit increase in U.S. goods import from the world increases the U.S. trade deficit by 0.39. On the other hand with China, the U.S, trade deficit increases by 0.90. This result is in constant with our expectations. Thus, it accepts the hypothesis that the U.S. goods import is causing the trade deficit. The FDI net inflows have positive effects and also have a statistically significant impact on U.S. trade deficit i.e. each one unit increase in FDI net inflows of foreign nation decreases U.S. trade deficit by .0215, but with China the case is not so. The U.S. dollar index of major currencies has no statistically significant impact on U.S. trade deficit.
Finally, as a sensitivity analysis we estimate our model by including an additional explanatory variable the total reserve (minus gold) and the total reserve (plus gold) of other nations. The both have a negative effect on the U.S. trade deficit. The results tell us that the U.S. trade deficit is predicted to increase 0.034 when the total reserve (minus gold) of other nations goes up by one, while the U.S. trade deficit is predicted to increase 0.0347 when the total reserve (plus gold) of other nations goes up by one. Furthermore, only 8.3% of the variation of the trade imbalance remains unexplained by this model.
CONCLUSION
Current tension in U.S.-China economic relation is mostly smoke and mirrors. The U.S. trade deficit with world and/or China’s trade is not due to the trade policy of China, rather Americans nature of over spending than home production which is covered by imports. Classical viewed that trade deficit problem to be get resolved by price and wage flexibility. But with U.S. persistent deficit is a cause of concern i.e. there is something wrong fundamentally, hence made necessary to adopt protectionist policy. Trump’s Trade war with Chinese imports would mean increased duties on Chinese products which will raise the manufacturing costs of the Chinese firms. China will retaliate by imposing duties on American products. But being a large nation, both U.S. and China welfare actually rises or falls will depends on the net effect of two opposing forces viz. reduce in the volume of trade and improvement in the terms of trade. Though, the appreciation of the dollar against RMB has the potential to decrease the trade deficit and possibly China’s surplus, but this move would only hurt China and not save the world because U.S. imported less from China, than it is importing more from other countries. The economic downturn may lead to the stability challenge of the international trading system. China imports only sparingly in sectors in which it exports, which has led to fears that Chinese firms are dominating the developed nations industries. However, low labour costs have a much greater impact on China’s trade surplus. China as the fastest growing economy with large foreign exchange reserves and its huge population could generate new demand, make it a potentially enormous market for foreign goods and thus could prove to be a much more significant market for the U.S. & other economies exports in the future. Many Chinese products contain U.S.-made inputs and some U.S. products contain Chinese-made inputs. Thus it is not fair to conclude that U.S.-China trade imbalances are due to China wrong practices rather it is largely because of the role of trade in intermediate goods. The rapidly changing nature of global supply chains may show where products are being imported from but they often fail to reflect who benefits from that trade. Under trade war and U.S. economic hegemony situation, relatively open trade and/or voluntary restraints is a more practical solution for reducing U.S.-China trade imbalance.
NOTES
1. Economic Policy Institute, https://www.epi.org/
2. National Bureau of Economic Research https://www.nber.org/
3. http://www.frbsf.org/economic-research/publications/economic-letter/2011/august/us-made-in-china/
4. https://home.treasury.gov/news/press-releases/sm0301
5. https://comtrade.un.org/data/
6. http://databank.worldbank.org/data/reports.aspx?source=world-development-indicators
7. Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/TWEXBANL,

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