Balance as a norm

My previous two pieces — and probably more to come! — have argued in favor of reimposing a strong international norm of balanced trade.

My friend Steve Roth pointed me this morning to a piece by the always excellent Martin Sandbu, which argues the contrary, that the case for trade balance is overstated. I responded with a logorrheic BlueSky thread, which I reproduce for posterity below.

Where I think Sandbu and I agree is that there is nothing magic about the number zero. Many of the benefits attributed to balance can be achieved while running a modest surplus or a modest deficit. Enforcing balance as a never-to-be-violated constraint would be impossible and overly draconian. In any given year, nearly all economies will run at least a small surplus or deficit. Zero is an infinitessimal target.

But what I insist is that a norm of international balance is desirable. Most countries should be very near balance, especially over a several year cycle. The international trading system should encourage the use of tools on the capital side of their balance of payments by which countries can bring their own trade towards balance.

Countries should not resort to tariffs for this purpose. Tariffs may — or may not! — have some role to play with respect to industrial policy, but they are poorly suited to promoting balance. Tariffs discourage balanced and unbalanced trade indiscriminitely, where capital-side interventions can target imbalance directly. Tariffs are costly and complex to enforce, are perceived by trading partners as hostile, and are unusually susceptible to corruption. They are a poor tool, as we observe in real time.

But countries running large, persistent surpluses or deficits should be subject to a rebuttable presumption they are doing something wrong. We've collectively erred by tolerating and frankly encouraging persistent and growing imbalances in the trading system. I hope we survive the error.

The international trading system should be managed under a presumption that ownership of each country's productive capital is domestic, so that domestic governments are free to regulate, rather than forced to cede control to investor-protection mechanisms enshrined in treaties and managed by technocrats whose interests may be at variance with domestic publics'. In a world of balanced trade, a presumption of domestic ownership can mostly be true. In a world of unbalanced trade, it cannot be.

Anyway, what follows is my long BlueSky thread, "rolled-up" and lightly edited, and then a few paragraphs of extra commentary:

I agree with @martinsandbu.ft.com on the jobs case! Manufacturing (like production in general) is not a jobs program. The wealthier we get, the more paid work will migrate to services we value for very human-specific reasons, relationships, care, trust, insight, just the pleasure of interaction.

But I think Sandbu was a bit slippery in migrating from the general case to the weaker jobs case. What we want from manufacturing is not jobs, but capabilities: “We” need to be capable of making and doing things, and the only way to build and sustain and improve that kind of capacity is doing.

Why do “we” need to be capable of doing these things? The obvious shut-down-conversation case is “national security”, but the broader cases are national resilience and technological capability. The last but not least case is conflict avoidance.

The traditional liberal case that interdependence breeds peace has failed spectacularly and famously over and over. Today we live in an era of @himself.bsky.social’s and @abenewman.bsky.social's "weaponized interdependence".

Peace is better served by reducing the vital-national-interest-ness of cross-border entanglements than by magnifying those and hoping the cost of breaking anything overwhelms inevitable strife.

And all of this is before we consider the financial side of unbalanced trade. The US has been a bit of a special case, pre-now, because of the centrality of the dollar and the apparently inexhaustible willingness of trading partners to hold USD assets, even through weakening-dollar periods.

But trade imbalance often presages financial crises, both domestic and international. Or sometimes orderly devaluations. But the more market participants anticipate devaluations, shockingly, the less there is actual trade imbalance. The anticipation disciplines the trade.

The last bit worth considering is who “we” are in this story. Must it be a nation-state? Is the EU one “we” or many countries? Why can Florida run a persistent trade deficit with other states? (I imagine it does, not sure.) Why was that a bigger problem for Greece?

I think the answers here have to be textured. For resilience and national security, “friendshoring” might be sufficient. Indeed, from a resilience perspective, you want to diversify across domestic and foreign supply, as well as among different foreign suppliers.

As @martinsandbu.ft.com suggests in the piece and in a reply, there’s nothing special about balance, the arbitrary zero point, for national security or resilience. Unbalanced friendshoring may be fine, with sufficiently reliable friends.

But to say there’s nothing special about zero doesn’t mean it’s fine to stray arbitrarily negative for indefinite periods of time. If you are going for resilience by diversification, you do want a meaningful domestic component to your portfolio. Too negative too long and you’ll lose that.

The main, most important thing (for a large, diversified economy with geopolitical pretensions) is to maintain generalized capacity, or “metacapacity”, and that requires substantial, continuous doing and improving of things in the world you value and rely upon.

(Hypothetically a trade deficit country whose paper is coveted abroad could use its fiscal flexibility to run a kind of noncommercial industrial university system, maintaining, building, innovating capabilities that could be scaled up should terms of trade shift. Whether this could “work” without the feedback of market discipline is, I think, an open question, but it’d obviously be hard to get right, and hard politically to sustain.)

The place where that zero point of balance is not in fact arbitrary is the financial side.

“Friendshoring” might assist with resilience and national security with sufficiently good friends, but durably unbalanced trade means someone is accumulating promises from a “friend” whose economy may be shifting from the tradables that might repay them.

Again, quantities matter. A country can run a small deficit relative to its growth indefinitely, and the potential burden of accumulated promises will remain modest. Even on the finance side, the zero point isn’t magic, we shouldn’t make a fetish of it.

But if the scale of accumulated promises is growing relative to the deficit economy, that’s going to yield problems if it continues indefinitely, perhaps even do damage to that “friend” assumption in friendshoring.

That’s why I think the “we” ultimately has to be defined by fiscal union. Florida can run its deficits, because we gradually and as a matter of course redistribute to fill in the holes in net worth it would otherwise yield.

("We" in that last meaning other states, the rest of the fiscal union including surplus states.)

The EU can become more relaxed about its internal trade balances if it builds up similar redistributive and mutual insurance mechanisms between states.

If we end up with some persistent deficit countries, but with deficits small enough to be overwhelmed by growth, that’s fine.

But letting zero be the normative attractor serves that cause of “small enough to be overwhelmed by growth”.

Without that norm, we find ourselves untethered, making excuses, eventually in crises — internally due to lost capability, and externally due to accumulating promises that will become one party’s terrible burden or another party’s unfair loss.

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Addendum: I want to be very clear that I think Trump’s tariffs are hideously stupid, even though overall balance is a thing the US legitimately should work toward.

I’d propose a foreign payouts tax to help us grope towards balance.

That's it for my thread! A few more comments...

Sandbu suggests

the current level of the US current account — just over 3 per cent of GDP — should not be unsustainable for an economy that can count on nominal growth of 4 per cent over the long term and enjoys global reserve currency status (if it can keep it).

I think this is a lot too sanguine. GDP may not be the right denominator. We want to compare the current account deficit against a measure of the economy's capacity to produce tradables. The US current account deficit is now more than a third of its total exports. Maybe that would be okay if we were sure this fraction would be stable. But since 2014, exports have been growing more slowly than GDP. It seems worthwhile to remedy that going forward.

Sandbu is correct that, by any measure, the US current account deficit was larger during the mid-aughts. In those days, optimists could console themselves with "dark matter", a name given to the discrepancy between the US' very large current account deficit and its stable NIIP ("net international investment position").

Unfortunately, that stability has disappeared in the intervening years. The US NIIP has deteriorated sharply whether measured in absolute terms, as a fraction of GDP, or as a fraction of exports.

This "deterioration" is due in part to the US' persistent current account deficit, but also due to what seemed like good news for America. Since the financial crisis, US assets (and so US assets in foreigners' hands) outperformed foreign assets (and so foreign assets in US hands), causing the net value of assets foreigners hold to grow even faster than the growth suggested by the assets they receive from unbalanced trade. Call this "dark antimatter"!

Whether due to good news or bad, the value foreign holders expect their US asset holdings to deliver has been growing, much much faster than the US tradables economy or the US economy writ large. The probability of disappointing those who've placed a high value on US promises, one way or another, is likely also growing.

We are faced with the fundamental financial-side cost of international imbalance. If a country's persistent current account deficits are not corrected by other means, they will eventually be corrected by some kind of disappointment of foreign assetholders. Those episodes of disappointment can be quite dangerous, to the deficit country, to the human race.

We are in a rather terrifying moment. The right thing to do would be to bring leaders of goodwill together in something like a new Bretton Woods conference, to agree upon a fair path back toward balance that minimizes disruption and supports the growth of all parties.

I wish I had more faith in our current leadership.