The three quotes above give two opposite views of a country’s trade deficit. According to the first two, by Donald Trump, the U.S. trade deficit is a major problem that must be fixed. According to the third quote, by 18th-century economist Adam Smith, the idea of a balance of trade is absurd. Who’s right? I won’t keep you in suspense. President Trump is wrong and Adam Smith is right. But what matters crucially is why Trump is wrong and Smith is right.

First, the U.S. merchandise trade deficit, which is what most people are referring to when they talk about the trade deficit, is somewhat offset by the positive balance on services and further offset by the difference between income received from abroad and paid abroad.

Second, even for those who worry about the trade deficit, there’s no good reason, in a world with about 200 countries, to worry about the balance with a particular country.

Third, the deficit on goods and services, plus the difference between income received from foreigners and income paid to foreigners, is necessarily equal, except for measurement error, to the surplus in the capital account.

Fourth, an almost surefire way to reduce the merchandise trade deficit is to engineer a recession.

This is from my most-recent Defining Ideas article at Hoover, “Donald Trump Vs. Adam Smith,” September 6, 2019.

And one of my favorite parts:

Some people worry that foreigners who own plants in the United States are a threat to this country. It’s hard to see how. Are foreigners who own businesses in America worse than Americans who own businesses? That might surprise Americans who work for them. In 1988, Democratic presidential candidate Michael Dukakis gave a speech at the Moog Automotive Company, an auto parts firm near St. Louis, in which he expressed some of the same fears that Donald Trump had at the time. “Maybe the Republican ticket wants our children to work for foreign owners, pay rent to foreign owners and owe their future to foreign owners,” he said in his speech to the workers, “but that`s not the kind of future Lloyd Bentsen [his vice-presidential running mate] and I want for America.”

There was one little problem: Dukakis’s audience did work for a foreign owner. Moog Automotive was owned by a subsidiary of a company based in Turin, Italy. Embarrassing!

Read the whole thing: it clears up a lot of aspects of the trade deficit and it’s not long.