Have Large Budget Deficits Caused Rising Trade Deficits?

Abstract

For the United States, the 1980s have been years of both large and unprecedented trade deficits as well as massive federal budget deficits. The trade deficit rose from $25 billion in 1980 to $124 billion in 1985. During this same period, federal budget deficits soared from $74 billion in 1980 to more than $212 billion in 1985. It is widely believed that the U.S. trade deficit rose mainly because of the skyrocketing federal budget deficit. Presenting such a view are, for example, Hutchison and Pigott [25], Hutchison and Pyle [26], Clark [11], Modigliani [30], and Aschauer [2]. Besides economists, many labor unions (i.e., AFL-CIO) and official government documents (see, The Economic Report of the President, particularly of 1984) have all shared similar views.' The issues involved have important policy implications. Suppose that the basic reason for rising trade deficits is indeed the escalating federal budget deficit. In this case, policy makers may focus on curtailing the budget deficit in order to resolve the trade deficit problem that has adversely affected several sectors such as manufacturing industries and agriculture. However, if such a view concerning the causal role of the budget deficit is incorrect, then reductions in the federal budget deficit may not resolve the trade deficit dilemma and, moreover, attention will be diverted from more relevant and urgently needed policy options [6]. The purpose of this paper is to empirically investigate the conventional argument that high federal budget deficit has been the prime cause of the escalating U.S. trade deficit, finding only partial empirical evidence to support it. In section II, I argue that most of previous studies in this area appear flawed by a methodological error rendering their tests unreliable for discriminating between a number of equally plausible hypotheses. Section III describes the data and methodology used in the paper. Section IV presents the empirical results. Section V summarizes and concludes the paper.