Will the oil boom shrink the U.S. trade deficit? Maybe not.

January 27

In recent years, the United States has been producing more of its own oil, thanks to new drilling in states like North Dakota and Texas. More domestic oil has meant fewer imports. Fewer imports has meant a nice little jolt for the U.S. economy — or at least it did in 2013.

(Matthew Staver/Bloomberg)
(Matthew Staver/Bloomberg)

But we shouldn't expect that dynamic to last, says Robert Lawrence, an economist at Harvard's Kennedy School. In a short new paper, he argues that the oil boom likely won't reduce the U.S. trade deficit all that much over the long run.

That's because, he says, the U.S. trade deficit is fundamentally driven by domestic savings and investment patterns. The oil boom, by itself, won't change that much. If we're buying more American oil instead of foreign oil, then we're simply likely to spend more on other imported goods.*

"Unless you can tell me how the oil boom will change that pattern of savings and investment," Lawrence says, "then it's not going to change the trade balance."

This sounds awfully counter-intuitive, so let's break it down.

-- First, the numbers: Between 2000 and 2012, the United States ran a $7.1 trade deficit. About 40 percent of that deficit, or $2.87 trillion, came from the fact that Americans were buying so much oil from overseas. On the surface, then, it seems obvious that the trade deficit would shrink if the United States produced more of its own oil and bought less from countries like Saudi Arabia. Right?

-- Except, says Lawrence, that's not the way many economists look at the trade deficit. The way they see it, Americans basically aren't saving enough to finance all the domestic investments that are happening inside the United States. And the oil boom, by itself, won't be enough to shift that dramatically. Here's the key part of his paper:

The trade balance in goods and services, or what I will also refer to loosely and interchangeably as “the current account balance,” is commonly defined as the difference between exports and imports of goods and services... But the current account is also, by definition, equal to the difference between U.S. national saving and investment, and the change in the net claims of a country on the rest of the world.

This means that in order for a given shift toward oil self-sufficiency to induce an equivalent improvement in the overall trade balance in goods and services, it would have to boost U.S. national saving relative to investment by the same amount. For example, if U.S. national investment were unchanged following a drop in net oil imports, Americans would have to increase their national saving by the full value of the oil trade improvement.

--As U.S. oil production increases, more Americans will be getting their income from oil rather than from other sources. Lawrence argues that these Americans would have to have very different patterns of saving and investment to have a substantial effect on the trade deficit. Or, alternatively, the oil boom would have to produce substantial tax revenue and shrink the U.S. budget deficit dramatically.

-- But, according to his calculations, neither of these effects is likely to be huge — since the oil industry is only a small part of the U.S. economy.

--Here's another way to think about it: If the United States produces more of its own oil and buys less from abroad, that will could a dent in the trade deficit in the short term. (Indeed, this seems to have happened in the last quarter of 2013.) But over the medium term — without any other changes in saving or investment patterns — the oil boom could drive up the value of the U.S. dollar, driving down the price of other types of imports. The end result? Americans would spend less on foreign oil and more on other foreign products.

--True, other economists and modelers have concluded that the oil boom will shrink the U.S. trade deficit. But, Lawrence notes, a lot here depends on basic assumptions used, such as Americans' propensity to buy imports, or the multiplier effect of extra investment.

--There's some historical precedent for Lawrence's argument. Back in the 1980s, the global price of oil plummeted and Americans were spending much, much less on foreign oil. But the trade deficit in other goods surged. Indeed, as Lawrence notes, there's little correlation between what we spend on foreign oil and the broader U.S. trade deficit:

current account historical

In any case, there are lots of caveats here, but Lawrence's paper is a nice short overview of different ways to think about the oil boom and the U.S. trade deficit. It's worth a browse.

Update/clarification: One thing that's worth mentioning is that Lawrence's paper assumes a world with a) full employment and b) unchanged oil prices (most analyses or modeling exercises like these usually do the same). Changing those assumptions around could alter the conclusion.

Related: How the oil and gas boom will change America: An interview with Michael Levi

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