Why did the US trade deficit sharply deteriorate during the pandemic?

According to preliminary data, the overall U.S. trade deficit for August 2020 was $67.1 billion, and the merchandise goods trade deficit was a record $83.9 billion. Given its relative comparative advantage, the U.S. typically experiences a trade surplus in services, and, consequently, the overall trade deficit tends to be narrower than the trade deficit involving just goods.

Despite President Trump’s trade wars and protectionist rhetoric, U.S. trade deficits have remained high through most of his current term. The pandemic shock has unleashed a unique set of forces that have led to a further deterioration of the U.S. trade balance with the rest of the world.

The basic economic identity underlying international macroeconomics – the current account balance (primarily consisting of the trade balance) is equal to the difference between national (both private and public) saving and investment – has been poorly understood by administration officials. Simply put, America runs a persistent trade (and current account) deficit because we consume more than we produce; or, alternatively, the combined saving of the U.S. private and public sectors is consistently below its investment needs. Consequently, we regularly borrow from foreigners to cover our domestic saving shortfall. 

Policies that lead to a widening of government budget deficits reduce public (government) saving, and in the absence of a commensurate improvement in private saving or a reduction in investment, is bound to worsen the current account balance and widen the trade deficit. Following the passage of the Tax Cuts and Jobs Act (December 2017) and the Bipartisan Budget Act (February 2018), some analysts had presciently warned that the U.S. was going to encounter a twin deficits problem.

Typically, the U.S. trade deficit narrows during a recession as the appetite for both domestic and foreign goods and services declines. During the past few decades, a strong domestic economy has resulted in a surge in imports and a deterioration of U.S. trade balances, and vice versa. The pandemic, however, has upended historical patterns. For a variety of reasons, the pandemic shock has actually led to a substantial spike in the U.S. trade deficit.

In contrast to prior downturns, the pandemic-induced recession and the uneven and K-shaped recovery is quite unusual. In previous recessions, consumers cut back on purchases of big-ticket items, and this caused a sharp fall in durable goods orders. Also, service sectors were largely shielded and typically experienced only modest sales impact during past downturns. In 2020, however, the durable goods sector has significantly outperformed the service sector.

Continuing uncertainty and unease associated with the coronavirus has forced many households to adopt stay-at-home behavioral alterations. As many people remain homebound, consumption patterns have undergone a radical change. Consumers have upgraded home offices and increased spending on items that augment or enhance domestic living quarters. Many of the electronic goods and much of the furniture and office equipment purchased by Americans in vast quantities over the past few quarters is manufactured abroad (especially in China and other East Asian countries). Though some of the value-added will ultimately accrue to U.S. tech companies and designers, under the traditional approach of accounting for exports and imports, we are facing a record merchandise goods trade deficit. 

The CARES Act temporarily boosted income for low- and middle-income households and thus prevented a collapse in retail spending. However, certain design and implementation flaws with the stimulus measure are becoming apparent with the passage of time. Interestingly, providing one-time stimulus checks and a temporary boost to unemployment insurance amid a pandemic that has severely curtailed various domestic service activities has generated a lopsided household spending pattern that has led to a dramatic increase in imported goods even as spending on domestic services by both locals and foreigners has sharply declined. 

It is worth noting that, in the pre-pandemic era, around two-thirds of U.S. GDP was tied to the service sector, and over 80 percent of Americans were employed in services. In economic parlance, the import leakage associated with the CARES Act stimulus is likely to be substantial and will potentially reduce the size of the fiscal multiplier.

Reduced spending on travel and tourism-related activities, and a sharp decline in global demand for aircrafts, has had a devastating effect on two major American exports. Aircraft sales (especially by Boeing) have plunged, and international travelers have been largely shut out of the U.S. Furthermore, a sharp decline in international student enrollment is adversely affecting another major source of export earnings for the U.S. Also, with the worldwide shutdown of movie theaters, Hollywood studios have seen their foreign box receipts evaporate. Overall, U.S. exports continue to struggle even as U.S. demand for foreign manufactured goods is surging, with the inevitable result being a sharp widening of the trade deficit.

The temporary spike in the U.S. trade deficit is thus primarily the result of certain unusual developments associated with the pandemic shock. Some of these are temporary in nature, and their impact on U.S. trade balances will dissipate as the development of vaccines and therapeutics allow for a return of normal activities sooner or later.

However, the underlying structural trends and challenges (domestic saving shortfall and overreliance on debt-fueled consumption) that have led to the persistence of U.S. trade deficits since the 1970s will remain in place for the foreseeable future, barring a shock to the U.S. dollar-centric global monetary order or a drastic increase in trade in services.

Vivekanand Jayakumar is an associate professor of economics at the University of Tampa.