Sunday, February 7, 2016

Trade Deficit: The Economic BoogieMan

The Trade Deficit, according to the politicians, needs to be handled. It is the inhibitor of the growth of the United States economy. Many claim that, for example, that China has a trade imbalance with the United States, and this imbalance is impacting our economic growth. While this makes for grand kabuki theater, this sort of statement does not pass the economic sniff test. In reality, free trade benefits both parties engaged in the trade.

Marginal Utility 

The purpose of individuals participating in trade is to improve the situation of the two parties in the respective trade process. In economics, this is called "utility seeking" behavior. During the process of a trade, both parties are giving up something that has a lower value, or lower utility, to obtain something that has a higher value(utility). Of course, this means the trade is unequal, due to the fact that value rankings are subjective to each individual. For example, if someone is purchasing a meal, that customer prefers the meal over the dollars for that meal. Also, they prefer what other things they could purchase with those same dollars, at that time. On the other side of the transaction, the business owner selling the meal prefers the dollars from the customer over the meal being sold. The business owner seeks to use the dollars from the sale to do other things. 

Accounting Analysis

In this transaction with the meal and the customer, the notion of a trade deficit can be analyzed using accounting or bookkeeping methods. On the customer side, the transaction is as follows: 

Cash $7 Credit
Food Expense $7 Debt

As a blind person can see, this transaction balances. It meets GAAP standards, and it makes sense. Now, let us look at the transaction for the side of the merchant:

Food Revenue $7 Credit
Cash $7 Debt

This transaction is balanced too. There is no "deficit" or "imbalance" of trade. Of course, if one measures how much food is sold, comparing the store's sales of food to the customer's sales of food, there will  be a deficit. This is the same type of reasoning that the politicians use when using scare tactics regarding the trade deficit.

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