Deficit Spending Doesn’t Work; Balancing Trade Does

In 2008 and 2009, both American political parties favored increased deficit spending, which they called a “stimulus” in 2008 and a “recovery plan” in 2009. The main difference was that the Democrats sought increased government spending, while the Republicans sought tax cuts. Whenever they compromised, they increased government spending and cut taxes at the same time.

But a new force arose in American politics in 2009 and 2010. Calling themselves the “Tea Party,” these people favored balanced budgets and pushed the Republican Party in that direction. It turns out that the Tea Party adherents had the right idea. For trade deficit countries like the United States, continued deficits provide little short-term benefit and large long-term risk.

But no party — not the Democrats, not the Republicans, not even the Tea Party — has yet figured out how to solve the unemployment problem. Meanwhile, we just conducted a study of world statistics for all economies of at least $100 billion GDP from 2007 through 2011. Our main finding is that balancing trade would provide a reduction of two percentage points in the U.S. unemployment rate.

We began our study by focusing on a basic prediction made by John Maynard Keynes which has been ignored by most economists. In most of his 1936 book, The General Theory of Employment, Interest and Money, Keynes advocated government deficit spending to fight recessions, but in a chapter toward the end he discussed the danger of tolerating mercantilism, the trade strategy designed to produce trade surpluses in its practitioners and trade deficits in its victims. Keynes wrote:

[A] favorable [trade] balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression. (p. 338)

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