We all read about free trade, but do we truly understand its real world effects? So many of our possessions, from the clothes we wear to the foods we eat, come to us as imports. Is free trade the solution to high prices, or is the real cost more than we bargained for?
Critics of free trade usually point to trade deficits as an example of the negative effects from reducing trade barriers. However, trade imbalances can signal several positive factors. First, a country pays for its imports with its exports. Therefore, when it imports more than it exports it increases the revenue it can use for other production. Second, trade deficits can also reflect the importation of foreign capital which only increases a country’s productive capacity and economic growth.
The U.S. economy consumes more goods and services than it produces thanks to foreign credit. One result is that each year’s external deficit adds that amount to net foreign holdings of U.S. dollar assets. This is not necessarily a bad thing. Foreign investment has historically played an integral part in U.S. economic growth and shows that America is attractive to investors. In addition, external investment mitigates the crowd-out effect of government borrowing by expanding the pool of available credit.
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