Globalization is frequently identified as a primary force affecting the structure and development of the US economy as we enter a new millennium. How are trade deficits connected to globalization? Are those deficits really a problem?

Bilateral and overall trade deficits do not provide a reliable signal about the openness of markets or the health of an economy. It is commonplace to read alarming newspaper reports about our bilateral deficits with certain trading partners-Japan, China, and Mexico-and our overall trade deficit. The reporting would lead one to think that deficits are 'bad' and that countries with which we run deficits are not allowing us fair access to their markets.

Bilateral deficits do not provide a good signal about the openness of markets. The fact that Japan exported 56% more to the U.S. than it imported from the U.S. in 1997 (see Table 1) is often used to argue that Japan is closed to U.S. goods. However, the data also show that for that same year, the U.S. exported 145% more to Australia than we imported from Australia. Our percentage surplus with the Netherlands was even higher, at 158%. No reasonable person would argue that the U.S. is closed to Australian and Dutch goods. Therefore, we cannot use the imbalance with Japan to conclude they discriminate against us. It is still possible that they do, but the devil is in the details, not in the aggregate bilateral trade flows.

Table 1
1997 Bilateral Export/Import Ratios for Japan and the U.S.

	Japan	US
Australia	0.55	2.45
Germany	1.45	0.55
Netherlands	5.00	2.58
China (Mainland)	0.52	0.19
U.S.	1.56
World	1.24	0.77

Note: Table entries shows the column country's exports to the row country divided by the column country's imports from the row country. Source: International Monetary Fund's Direction of Trade Statistics

What causes variation in bilateral balances? The principle at work-comparative advantage-also explains your own ongoing deficit with your hairstylist. She offers a service that you demand, but she probably buys nothing from you in return. However, your deficit with her is probably more than offset by your surplus receipts elsewhere. Bilateral deficits are the rule in modern economies with extensive specialization.

The same principle works, to a lesser degree, with countries. Australia exports a huge bounty of natural resources to Japan (where such resources are scarce), but Australia demands much less from Japan. Meanwhile, the U.S. has no need for Australia's natural resources, we have our own. But Australia demands a good amount of U.S. output. Hence, the U.S. runs a surplus with Australia while Japan runs a deficit. In a world with many countries, it would be shocking to find bilateral balance. Free markets will generate bilateral imbalance.

What about the overall trade deficit? Is that a problem?
An overall trade deficit means that as a nation we are importing more than we are exporting. When we do this, we must make up the difference by selling assets to foreign residents or taking out loans from them. They don't give us goods for free!

This is the same principle that applies to a household: When we spend more than we earn in income, we must make up the difference by going into debt or selling off some worldly possessions. Most households run large deficits at certain points of the lifecycle-when buying a home, putting children through college, or other periods of extraordinary expense. It is clear why a household might go into debt, and seeing another household in debt should not alarm us. For one thing, it's their debt, not ours! And even if they are too far in debt, the main consequence is that they must tighten their belts in the future and perhaps that those who lent to them will need to do the same.

How about a country? When we add up the balance sheets of all households, firms, and governments in a country we might find that the country in the aggregate is borrowing from abroad-i.e., it is running a trade deficit. Our instinctive reaction should be 'So what?' If the individuals, firms, and governments who have gone into debt had their eyes open, then there is no reason for the rest of us to panic.

The same motives for household indebtedness apply to countries. Countries may go into debt when they are undergoing major industry restructuring. For example, many emerging market countries run overall deficits as foreign investment pours in (in the form of loans or equity stakes) to finance their industries of the future. Another reason a country could run a current account deficit is if many of its households find themselves at that point of the lifecycle where they are more prone to be net borrowers than net lenders.

Either of these explanations might fit the U.S. today. The U.S. certainly looks like it is developing many of the industries of the future-e.g., biotechnology, software, telecommunications, and e-commerce. When much of this activity is occurring at once, it might be natural for a country to borrow from other countries that lack sufficiently attractive investment opportunities. Furthermore, trading partners, such as Europe and Japan, have demographic trends that demand more saving than is needed in the U.S. (i.e., their retirement crises make our Social Security problem look minor by comparison).

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