CSI: Trade Deficit - New York Times
The New York Times

April 24, 2006
Op-Ed Columnist

CSI: Trade Deficit
By
PAUL KRUGMAN

Forensics are in. If you turn on the TV during prime time, you're likely to
find yourself watching people sorting through clues from a crime scene,
trying
to figure out what really happened.

That's more or less what's going on right now among international finance
experts. The crime in question is the U.S. trade deficit, which according to
the
broadest measure reached an amazing $805 billion last year. The mystery is
how we've been able to run huge deficits, year after year, with so few
visible
adverse consequences. And the future of the U.S. economy depends on which of
two proposed solutions to the mystery is right.

Here's the puzzle: the trade deficit means that America is living beyond its
means, spending far more than it earns. (In 2005, the United States exported
only 53 cents' worth of goods for every dollar it spent on imports.) To pay
for the excess of imports over exports, the United States has to sell
stocks,
bonds and businesses to foreigners. In fact, we've borrowed more than $3
trillion just since 1999.

By rights, then, the investment income - interest payments, stock dividends
and so on - that Americans pay to foreigners should be a lot larger than the
investment income foreigners pay to Americans. But according to official
statistics, the United States still has a slightly positive balance on
investment
income.

How is this possible? The answer, almost certainly, is that there's
something wrong with the numbers. (Laypeople tend to treat official
statistics as gospel;
professional economists know that putting these numbers together involves a
lot of educated guesswork - and sometimes the guesses are wrong.) But
depending
on exactly what's wrong, the U.S. economy either has hidden strengths, or
it's in even worse shape than it seems.

In one corner are economists who think the official statistics miss
invisible U.S. exports - exports not of goods and services, but of
intangibles like
knowledge and brand-name recognition, which allow U.S. companies to earn
high rates of return on their foreign investments. Proponents of this view
claim
that if we counted these invisible exports, which they call "dark matter,"
much of the U.S. trade deficit would disappear.

The dark matter hypothesis has been eagerly taken up by some journalists,
who like its upbeat message. It seems to say that the U.S. economy is, as a
cover
article in Business Week put it, "much stronger than you think."

But there's a problem: U.S. companies operating abroad don't, in fact, seem
to earn especially high rates of return. Why, then, doesn't the United
States
seem to be paying a price for all its borrowing? Because according to the
official data, foreign companies operating in the United States are
remarkably
unprofitable, earning an average return of only 2.2 percent a year.

There's something wrong with this picture. As Daniel Gros of the Center for
European Policy Studies puts it, it's hard to believe that foreigners would
continue investing in the United States "if they were really being
constantly taken to the cleaners."

In a new paper, Mr. Gros argues - compellingly, in my view - that what's
really happening is that foreign companies are understating the profits of
their
U.S. subsidiaries, probably to avoid taxes, and that official data are, in
particular, failing to pick up foreign profits that are reinvested in U.S.
operations.

If Mr. Gros is right, the true position of the U.S. economy isn't as bad as
you think - it's worse. The true trade deficit, including unreported profits
that accrue to foreign companies, isn't $800 billion - it's more than $900
billion. And America's foreign debt, including the value of foreign-owned
businesses,
is at least $1 trillion bigger than the official numbers say.

Of course, optimists have a comeback: if things are really that bad, why are
so many foreign investors still buying U.S. bonds? And they point out that
those predicting problems from the trade deficit have been wrong so far. But
I have two words for those who place their faith in the judgment of
investors,
and believe that a few good years are enough to prove the skeptics wrong:
Nasdaq 5,000.

Right now, forensic analysis seems to say that the U.S. trade position is
worse, not better, than it looks. And the answer to the question, "Why
haven't
we paid a price for our trade deficit?" is, just you wait.

Posted by Miriam V