The decline of orthodoxy and rise of anti-free-traders

Trade theory holds but we should redesign the system to reflect a new geopolitical reality

- AJIT RANADE

Imagine two countries that trade with each other. Let's assume that country A has a permanent trade deficit with country B. Over a long period of time, say three or four decades, which country is better off?

The textbook economic answer is the importing country, despite its consistent trade deficit. This is because the consumption level of the importing country exceeds its productive capacity. Hence living standards are higher. Country A is not living beyond its means because it pays for the deficit with funds from abroad. That country A has been America for more than four decades, it being the world's largest importer. Country B was Japan in the 1980s and then China took over that role.

What is illustrated in this simple two-country model can be reasonably extended to the more complex real world with multiple countries and a multitude of bilateral trade relations. In the real world, all trade deficits are wiped out by surpluses in the aggregate. If country A has had a permanent trade deficit, who is funding that shortfall? That deficit is funded by finance pouring in from other countries. Or capital inflows. In a world with open economic borders, a trade deficit is identical to capital inflows at the individual country level. In the case of America, its trade deficit is a structural problem and not due to low tariffs (till recently).