The trade balance, the current account balance, and other definitions

I saw Don Boudreaux speak about statistics yesterday. He used the trade deficit as an example of a frequently misunderstood statistic. Unfortunately, I feel his discussion may have done more to muddle the issue than clarify it. Correctly understanding the details of the trade deficit should be of interest to both those who did and did not attend the particular lecture in question.

Boudreaux made three statements that I felt were either incorrect or incomplete:

1. The trade balance measures the value of merchandise goods exported minus the value of merchandise goods imported. The current account balance includes net exports of services.
2. The inclusion of services meaningfully alters the size of the trade deficit. [Update: I was likely mistaken in interpreting this as an implication of Prof. Boudreaux’s remarks. See his comment below.]
3. Media sources frequently report the trade balance without properly recognizing its components and relative significance.

My thoughts on each of these claims follow. Please email me (link on right sidebar) if I have made an error.

What is the trade balance?

Economist Intelligence Unit:

The trade balance is the difference between exports and imports. It may measure visible (merchandise) trade only, or trade in both goods and services. Invisibles are difficult to measure, so the balance of trade in goods and services is less reliable and more likely to be revised than the visible balance.

So Boudreaux could be right that only the merchandise trade balance is reported. However, I don’t think that is US practice:

The U.S. Bureau of Economic Analysis collects and compiles U.S. services import and export statistics. The U.S. Census Bureau and the U.S. Bureau of Economic Analysis combined goods and services into one report and began publishing a joint monthly press release, titled U.S. International Trade In Goods and Services report (FT900), in January 1994.

The BEA’s International Economic Accounts page lists data on the balance of payments, trade in goods and services, international services, international investment position, and direct investment. I am unable to find a “trade balance” statistic that excludes services.

The US Census Bureau’s Foreign Trade Statistics page currently has the headline: “Trade Deficit Increases in May 2006. The Nation’s international deficit in goods and services increased to $63.8 billion in May from $63.3 billion (revised) in April, as imports increased more than exports. (12 July 2006)”

Similarly, here is John Makin’s testimony given at the Trade Deficit Review Commission:

Let me offer some basic definitions. The trade balance, as usually measured for the United States, is the difference between the dollar value of goods and services sold abroad and the dollar value of goods and services purchased abroad. The major categories of the trade balance are the balance on merchandise trade (or net goods sales to foreigners) and services trade (or net services sales to foreigners). The other major category of U.S. external accounts is net income on foreign investments which, when added to the trade balance, gives the more comprehensive current account balance.

Perhaps there are some analysts who mistakenly label the net exports of merchandise goods the “US trade balance.” I have been unable to find a data source that makes that mistake.

What is the current account balance?

Not to be confused with the trade balance, the current account balance is “the balance of trade in goods and services plus net rents, interest, profits and dividends and current transfer payments.” That is more than merely goods plus services. The distinction is important, too. Recall the Lazear-Mankiw-DeLong discussion earlier this summer.

Does the inclusion of services meaningfully alter the size of the trade deficit?

Census & BEA release for May 2006:

In May, the goods deficit increased $0.5 billion from April to $70.1 billion, and
the services surplus was virtually unchanged at $6.2 billion. Exports of goods
increased $2.4 billion to $84.2 billion, and imports of goods increased $2.9 billion
to $154.3 billion. Exports of services increased $0.4 billion to $34.4 billion,
and imports of services increased $0.3 billion to $28.2 billion.

Professor Boudreaux noted that the service sector comprises 80% of US GDP, but goods still dominate our export profile by about 2 to 1. Moreover, the services surplus of $6.2b is fairly small compared to the goods deficit of about $70b. The distinction between the merchandise trade balance and the trade balance does not significantly alter the picture: the US is running a deficit around 6% of GDP.

Does the media understand these facts?

Probably not. Paul Krugman may be careful about his statistics and know that the trade deficit includes both goods and services when opining on the subject, but most newspaper employees haven’t won the J.B. Clark Medal. I wouldn’t be suprised if the popular press frequently misreports the merchandise trade balance as the trade balance. Successful media outlets employ people like Lou Dobbs, who writes:

The president’s fast-track authority is set to expire next year, more than 30 years after its passage. It is no coincidence that the United States has now posted a trade deficit for 30 consecutive years.

You mean the fast track authority that Clinton didn’t have and Bush had to fight for in 2002? Good grief. Whether Dobbs is including services in that calculation is the least of our worries…

3 thoughts on “The trade balance, the current account balance, and other definitions

  1. Chen Yao

    have you noticed US running deficits with China in both current and financial accounts? any idea/opinion?

  2. Don Boudreaux

    Jonathan makes important points.

    First, there is indeed some confusion over the meaning of “trade deficit.” Is it a synonym for a deficit in the merchandise-trade account? Or for a deficit in the current account? My discussion on Thursday was aimed more at criticizing popular discussions — not just from the likes of Lou Dobbs, but of less-hysterical folks such as major network-news anchors and NPR reporters. I didn’t mean (although I surely was unclear) to suggest that official government reports are confused on the issue. Such reports generally define their terms carefully.

    The popular press can be forgiven for being confused, because economists themselves still (as I read the literature) haven’t yet settled upon a consensus meaning of “trade deficit.” See, for example, Figure 4.6 (and the accompanying discussion on pages 123-124) of Douglas Irwin’s book Free Trade Under Fire, 2nd ed. (Princeton Univ. Press, 2005). (Doug is probably THE — and certainly one of the — finest and most respected trade economists under the age of 50.) In this book Doug sometimes uses “trade deficit” as a synonym for “merchandise-trade deficit” — although, of course, he’s careful to explain that the current account is a much more meaningful measure of trade than is the merchandise-trade acccount.

    Jonathan’s second point that the current-account differs from the merchandise-trade account in important ways beyond merely its inclusion of trade in services is absolutely correct — and important. And his reference to the recent blogosphere debate between DeLong and Mankiw is smack on target.

    I was too cavalier in my talk in emphasizing only the “services” difference between the two accounts. However, my point in that talk wasn’t to give a lecture on international trade or on balance-of-payments accounting. It was to explain ways that statistics can be misleading. Neverthless, Jonathan is right that this fact doesn’t excuse any misrepresentation that I made about the full range of differences separating the merchandise-trade account from the current account.

    Similarly with any impression that I might have given that trade in services significantly reduces the trade (or current-account) deficit. I confess that I don’t now recall precisely what I said, but I certainly never intended to imply that Americans’ exports of goods and services comes close to equaling Americans’ imports of goods and services.

    I do recall making the point (which I believe to be valid) that as the U.S. economy continues to become increasingly specialized in producing services, the services component of trade will grow over time. (Although still only a small part of U.S. international trade, as Jonathan points out, it IS growing — a fact signalled by the recent furor over so-called “outsourcing.”)

    My position on the balance of payments is identical to that of Adam Smith’s: it’s all pretty meaningless and misleading; lots of precise numbers conveying more misunderstanding than insight.

    I agree with Jonathan, of course, that the media do not understand these things — not only because they and their audience are innumerate, but because they are also, largely, economically illiterate.

    Thanks to Jonathan.

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