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Wynne Godley's Crucial Warnings About the Trade Deficit Still Ignored
Alan Tonelson
Friday, September 13, 2013
Photo of Alan Tonelson
The chattering class’s denial-ism about U.S. trade deficits crucial role in triggering the financial crisis and ensuing recession reached new heights (depths?) with this week’s ballyhooed New York Times article about the posthumous influence of gadfly economist Wynne Godley.

According to the September 10 piece by Jonathan Schlefer, the growing influence of Godley, who passed away in 2010, signals the economics profession’s new willingness to rethink models and theories that failed utterly to predict the 2007-08 financial crisis.  

As many economists now acknowledge, Godley’s theories about growth, and the critical importance played by financial balances of the economy’s main sectors, not only foresaw the latest crack-up, but the smaller bursting of the late-1990s interlocking stock market and technology bubbles.

But here’s what Schlefer’s article completely ignored:  Godley was one of the few mainstream economists who warned that huge, ballooning trade deficits like those amassed by the United States since the mid-1990s would lead to major trouble.  Further, Godley’s model notably that reducing domestic budget deficits without addressing trade deficits would bring on a thoroughly unnecessary disaster on the home front – and in the rest of a world so heavily dependent on supplying American demand.

One especially specific warning from Godley way back in 1995 is worth quoting at length:

“If the US trade deficit remains around its present level for a few more years it will generate an exploding growth in overseas indebtedness which will imperatively demand correction at some stage.  The longer the correction is postponed, the more intractable the problem will become both for the US and, indirectly, for the rest of the world.  While the internal (budget) and external deficits are obviously not “twins,” they are related to one another in a way which makes it impossible to eliminate one without eliminating the other.

“If an attempt were made to balance the budget without improving America’s performance in international trade, the consequences for output and unemployment , both at home and abroad, would be extremely unpleasant.  It is a pre-condition for reducing the budget deficit without generating a depression that US exports rise substantially relative to import penetration.”

Godley’s warnings went unheeded then.  Even worse, even though his predicted calamity came to pass, they remain unheeded.  In fact, Washington’s policy mix has gotten much worse.  Federal budget restraints have now been enacted.  And President Obama – with strong support from Congress’ Republican leadership – is redoubling his efforts to sign new trade deals modeled on those that helped explode America’s international deficits to begin with.  And if Congress gives him the trade diplomacy blank check he’s seeking, in the form of renewed presidential trade negotiating authority, the path to even worse economic disaster will be wide open.

So it’s great that academe and the Mainstream Media now acknowledge that Wynne Godley had vital lessons to teach them about how the U.S. and world economies really work.  But how long will it take before the policy establishment finally admits just what the main lessons were?


(Sources: “Embracing Wynne Godley, an Economist Who Modeled the Crisis,” by Jonathan Schlefer, The New York Times, September 10, 2013, http://www.nytimes.com/2013/09/11/business/economy/economists-embracing-ideas-of-wynne-godley-late-colleague-who-predicted-recession.html?partner=socialflow&smid=tw-nytimesbusiness&_r=2& and U.S. Foreign Trade, the Budget Deficit, and Strategic Policy Problems: A Background Brief,” by Wynne Godley, Working Paper No. 138, The Jerome Levy Economics Institute, April, 1995, p. 1, http://128.118.178.162/eps/mac/papers/9812/9812010.pdf

Alan Tonelson is a Research Fellow at the U.S. Business & Industry Educational Foundation and the author of The Race to the Bottom: Why a Worldwide Worker Surplus and Uncontrolled Free Trade are Sinking American Living Standards (Westview Press).
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