Trade Deficit Drags on Recovery

NEW YORK (TheStreet) -- On Friday, the Commerce Department is expected to report the deficit on international trade in goods and services was $46 billion in December, slightly lower than in November, owing to moderating oil prices and slower inventory build among U.S. wholesalers and retailers.

Overall, the deficit is a significant tax on aggregate demand and jobs creation, just as a government deficit increases demand for U.S.-made products and boosts employment. In the coming months, higher oil prices and stronger inventory build should push up the trade deficit again and drag on economic recovery.

Persistently high trade deficits and continuing low real estate values are the most significant reasons why the current economic recovery is slowest since the Great Depression, and why the Congress and President face so much difficulty stabilizing federal finances without risking a second, deeper recession.

Consumer spending has expanded, though haltingly, and the annual federal deficit increased from $161 billion before the financial crisis to more than $1 trillion over the last five years, injecting enormous additional demand into the system. However, too many consumer dollars go abroad for Middle East oil and Chinese goods that do not return to buy U.S. exports.

Businesses, consequently, are pessimistic about future demand for U.S.-made goods and services. And bearing higher taxes, more burdensome regulations, and increased benefits costs mandated by Obamacare, they are reluctant to hire in the United States and seek opportunities abroad.

Those barriers frustrated the virtuous cycle of temporary tax cuts and additional government spending, new hiring, and additional household spending that the first-term Obama stimulus sought to beget.

Now, the Fiscal Cliff deal will raise combined federal and state tax rates for many small businesses on expansion and reinvestment to maintain existing facilities to more than 50% -- even more in California and New York.

Prior to the Fiscal Cliff tax increases, economists predicted growth of about 2% for 2013. However, these new taxes on small business investment and innovation strike at the heart of this once vibrant American jobs-creating machine. Look for growth in the range of 1.5% and a tougher jobs market at least through mid-year.

Growth below 2% is difficult to sustain. Any disruption could set off a cycle of layoffs, falling consumer spending and ultimately a recession that pushes unemployment into double digits.

Should tax increases be necessary to reach a political compromise to further reduce the budget deficit, Congress should heed President Obama's recommendation to close loopholes like the carried interest provision -- which permits Wall Street traders and executives throughout the economy to pay lower tax rates than ordinary wage earners. That would do the least damage to aggregate demand, and actually improve economic incentives for productive investments in the United States and stimulate growth.

Imported oil and subsidized imports from China account for the entire trade gap.

Development of new onshore reserves in the Lower 48 has not delivered enough new oil, and a full push on U.S. potential in the Gulf, off the Atlantic and Pacific coasts, and in Alaska could cut U.S. imports in half. Shifting federal subsidies from cost-ineffective electric cars, wind and solar to more fuel-efficient internal combustion engines and plug-in hybrids could further cut U.S. petroleum imports.

The surge in natural gas production, and accompanying lower prices, substantially improves the international competitiveness of industries like petrochemicals, fertilizer, plastics, and primary metals. However, the Department of Energy is reviewing licenses to boost exports of liquefied gas -- a costly and environmentally risky process -- beyond what is required by statute. That would reduce the trade deficit, create many fewer jobs and spur growth less than keeping the gas at home to boost energy-intensive industries and alternatives to gasoline in transportation.

To keep Chinese products artificially inexpensive on U.S. store shelves, Beijing undervalues the yuan through official intervention in currency markets and actions of state-owned banks, which often evade calibration in their scope. China extorts U.S. firms to transfer manufacturing technology, subsidizes exports and imposes high tariffs on imports. Other Asian governments, most recently Japan, have adopted similar exchange policies to stay competitive with the Middle Kingdom.

Economists across the ideological and political spectrum have offered strategies to offset the deleterious consequences of currency strategies on the U.S. economy and force China and others to abandon mercantilist policies. However, China offers token gestures, and sadly the Treasury accepts these instead of even acknowledging Beijing's cynical strategy.

Cutting the trade deficit by $300 billion, through domestic energy development and conservation, and forcing China's hand on protectionism would increase GDP by about $500 billion a year and create at least 5 million jobs.

Longer term, large trade deficits shift resources from manufacturing and service activities that compete in global markets to domestically focused industries. The former undertake much more R&D and investments in human capital.

Cutting the trade deficit in half would raise long-term U.S. economic growth by one to two percentage points a year. But for the trade deficits of the Bush and Obama years, U.S. GDP would be 10% to 20% greater than today, and unemployment and budget deficits not much of a problem.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Professor Peter Morici, of the Robert H. Smith School of Business at the University of Maryland, is a recognized expert on economic policy and international economics. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission. He is the author of 18 books and monographs and has published widely in leading public policy and business journals, including the Harvard Business Review and Foreign Policy. Morici has lectured and offered executive programs at more than 100 institutions, including Columbia University, the Harvard Business School and Oxford University. His views are frequently featured on CNN, CBS, BBC, FOX, ABC, CNBC, NPR, NPB and national broadcast networks around the world.

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