Thus when a nation has good economic prospects and attracts foreign investment, it tends to run deficits. Conversely, when its prospects are bleak and capital is trying to escape the country, it will tend to run surpluses. Therefore, the existence of a surplus or deficit may tell us exactly the opposite of what the mercantilists believed. Deficits may be a sign of strength, while surpluses are a sign of weakness.
Unfortunately, mercantilism lives on at the U.S. Commerce Department, where deficits are viewed as nothing but pure evil, stealing American jobs and wealth. Hence, Commerce Secretary Don Evans' increasingly shrill attacks on China for contributing heavily to the U.S. trade deficit. Implicitly, he assumes that if we could make China's costs of production higher, that we would somehow benefit because production would shift back from China to here. A new report from the Federal Reserve Bank of Chicago explains why this won't happen:
"Rather than displacing domestic production ... rising imports may serve rising demand for some types of goods in the home country. So, too, imports can consist of intermediate components that become embodied in domestic production of a final good. To the extent that such components are most cheaply sourced overseas, they may help to keep domestic production competitive for the final goods in the domestic market, or even allow domestic producers to export the final good to third country markets."
In other words, by utilizing China's cheap labor, it actually increases the competitiveness of U.S. businesses. They often export unfinished goods made here to plants they own in China and export them back here or somewhere else. When sold here, much of the gain accrues to those in the retail sector and to consumers, while U.S. investors reap the return to capital. Consequently, the vast bulk of the total gains from final sales accrue to Americans, even though most of the work is done in China.
Unfortunately, China is too easy a target for unscrupulous politicians in the United States, who are pushing for tariffs on Chinese goods. Sadly, some of these politicians work in the Bush administration. Those who know better, like Council of Economic Advisers Chairman Greg Mankiw, must try harder to make their voices heard.