The great Don Boudreaux of George Mason University drew my attention to the Minutes of the Fed’s Federal Open Market Committee of June 12-13, in which the “Staff Review of the Economic Situation” contains the following lines (on page 4):
Net exports made a negligible contribution to real GDP growth in the first quarter, with growth of both real exports and real imports slowing from the brisk pace of the fourth quarter of last year. After narrowing in March, the nominal trade deficit narrowed further in April, as exports continued to increase while imports declined slightly, which suggested that net exports might add modestly to real GDP growth in the second quarter.
This is telling us that “net exports” (exports minus imports) bring a positive “contribution” to GDP growth when they increase (as they did in the first quarter of 2018), and a negative contribution when they decrease. This implies that exports “add” to GDP and that imports subtract from it, which is not true.
To confirm what the FOMC is saying, look the Minutes of its March Meeting, which related to the fourth quarter of 2017, when “net exports” had decreased (that is, imports had increased more than exports). The Staff Review of the Economic Situation says (on p. 3):
The change in net exports was a significant drag on real GDP growth in the fourth quarter of 2017, as imports grew rapidly.
Contrary to what the FOMC says, net exports or net imports cannot affect the calculation of GDP for the very simple reason that imports do not enter into GDP at all. By definition, GDP is domestic production (that’s the “D” and the “P” in GDP, or gross domestic product), so it includes only exports. Exports are part of GDP; imports are not.
I explained this accounting point in a 2016 Regulation article as well as in my EconLog post “Misleading Bureaucratese” (October 30, 2017). My new book (What’s Wrong with Protectionism? Rowman & Littlefield, 2018) repeats the explanation.
My argument is congruent with standard GDP accounting, in the United States as in other countries. It is summarized on page 2-9 of the Bureau of Economic Analysis’s Concepts and Methods of the U.S. National Income and Product Accounts (November 2017), from which I quote in another EconLog post. The BEA is the federal bureaucracy responsible for the US national accounts.
Protectionists claim that more imports imply less GDP because they view imports as substituting for domestic production (instead of being purchased by domestic production). This protectionist theory contradicts standard economic theory, but it is not logically invalid. However, claiming that imports reduce GDP as a matter of accounting is logically false.
One of the formulas for calculating GDP says (in a simplified form) that GDP = expenditures by residents + exports – imports. These last two terms may look like “net exports” but this is just a statistical artefact. Imports are subtracted in the formula for the only reason that that are inadvertently captured in the estimate the statisticians obtain for the expenditures by residents, and have to be removed because GDP is domestic production. This does not mean that imports are deducted from GDP, but that they are not part of it.
To better understand, consider the following analogy. Suppose the empty weight of your pickup truck is 3 tons. You put a payload—say, a chunk of rock—of 1 ton on the pickup bed. If you now weigh your pickup, the balance will indicate 4 tons, its loaded weight. Empty weight = loaded weight – payload. You can calculate the pickup’s empty weight by weighing it loaded and deducting the weight of the rock. You deduct the weight of the rock because it was already included in the weight of the loaded truck. It would be nonsensical to say that if you had loaded the truck with a heavier rock, the truck’s empty weight would have decreased. It is nonsensical because the loaded weight would have increased by the same amount, which would have cancelled the increase in the payload’s weight. In other words, it is not true that the weight of the rock is deducted from, or makes a negative contribution to, the empty weight of the truck; the weight of the rock is simply not part of the empty weight of the truck.
The error that imports count as a negative contribution to GDP is commonly made by journalists who know little economics or by politicians with an interest in blaming imports for lower GDP. How the FOMC can commit such an elementary economic error is puzzling. The Fed is probably the largest employer of economists in the US, and any of the latter should have known that the statement quoted above is either false or very sloppy.
When I was working on my Regulation article, I wrote to the BEA. I pointed out that their usual formulation in their public communications was misleading because it suggested that imports reduce GDP as a matter on accounting. In an email of June 19, 2015, the BEA argued that this is not what they mean to say. I quote from their email to me (emphasis mine):
The reason imports are a subtraction in the calculation of GDP (C + I + G + +X – M) is because imported goods and services are included in the value of consumer spending (C), business investment (I), and government consumption expenditures and gross investment (G). Because we only want to measure what is produced domestically, we therefore must subtract imports in the equation to ensure that imports do not enter into our value of domestic product (GDP).
The text in the GDP news release reads “imports, which are a subtraction in the calculation of GDP…”, correctly identifies imports as a subtraction in the calculation of GDP without saying it “contributes” to GDP in any way…
Why do Federal Reserve economists say the contrary, implying that imports (as part of “net exports”) contribute negatively to GDP?
READER COMMENTS
Cyril Morong
Jul 13 2018 at 12:41pm
Alot of what we import are resources U. S. firms use in producing final goods and services. Does that affect the numbers at all? Does there cost become part of the price of final consumer goods?
Pierre Lemieux
Jul 13 2018 at 1:19pm
As your last question suggests, the cost of imported intermediate goods is included in the price of goods (or services) produced (C, I, G, or X). So again imports cancel out in Y=C+I+G+X-M.
Cyril Morong
Jul 13 2018 at 9:10pm
Thanks
John Hall
Jul 13 2018 at 1:09pm
It’s pretty normal to say net trade contributed positively or negatively to GDP growth and then that exports rose or fell by such and such an mount and imports rose or fell by such and such an amount. The problem is when you say exports contributed some amount and imports subtracted some amount. If you don’t do that, then you’re fine when talking about net trade.
Sometimes people use special aggregates like final sales of domestic product (GDP ex inventories), gross domestic purchases (GDP ex trade), and final sales to domestic purchasers (GDP ex inventories and trade). These leave me a little squeamish. People might say things like, well GDP wasn’t good, but the composition was good because final sales to domestic purchasers rose. But people don’t usually go through the effort of actually showing why final sales to domestic purchasers is indicative of future GDP growth.
Ted
Jul 13 2018 at 1:41pm
Excellent post. Straightforward and thought-provoking. I liked your truck analogy. Thank you.
Robert Rawlings
Jul 13 2018 at 1:45pm
I do not see that the FOMC is claiming that imports reduce GDP as a matter of accounting which is what I take this post to be about.
They merely say ‘net exports might add modestly to real GDP growth in the second quarter.’ which suggests only a belief that greater export demand may tend to increase total production which does not sound unreasonable.
Robert Rawlings
Jul 13 2018 at 1:45pm
I do not see that the FOMC is claiming that imports reduce GDP as a matter of accounting which is what I take this post to be about.
They merely say ‘net exports might add modestly to real GDP growth in the second quarter.’ which suggests only a belief that greater export demand may tend to increase total production which does not sound unreasonable.
Pierre Lemieux
Jul 13 2018 at 3:55pm
Robert: Note the statement: “Net exports made a negligible contribution to real GDP growth in the first quarter.” It is “negligible” (but positive) because imports increased less than exports. Imports pulled down the number of “net exports.” Please note also my second quote of the FOMC, which makes what they mean clearer.
Robert Rawlings
Jul 13 2018 at 4:41pm
Perhaps I’m just reading it differently but those statement all seem consistent with a view that a change in net exports may affect GDP not because (GDP = expenditures by residents + exports – imports) but rather because a change in net exports will reflect changes in demand for domestically produced goods which will in turn cause GDP to change.
Robert Rawlings
Jul 13 2018 at 4:42pm
Perhaps I’m just reading it differently but those statement all seem consistent with a view that a change in net exports may affect GDP not because (GDP = expenditures by residents + exports – imports) but rather because a change in net exports will reflect changes in demand for domestically produced goods which will in turn cause GDP to change.
Jon Murphy
Jul 14 2018 at 6:54am
But that’s not necessarily true. It may indicate that, but it doesn’t have to as a matter of course.
Robert Rawlings
Jul 14 2018 at 12:59pm
Agreed. Should indeed have said “will probably” or just “might”
Marcus Nunes
Jul 13 2018 at 2:04pm
Since imports go into the GDP identity with a minus sign, when it grows it is said that “if it weren´t for the increase in imports, GDP growth would have been higher”. 20 years ago The Economist said just that. When asked why import growth was so high, the answer was “because GDP growth was robust”!
Don Boudreaux
Jul 14 2018 at 1:53pm
Brilliant!
EB
Jul 15 2018 at 6:43pm
Yes, Don, brilliant. But we should not stop there. We cannot develop a theory only from identities, and any analysis that relies on them is not an explanation but at best a description –as when we say by definition X=X1+X2 and then any change in X can be described by changes in X1 and/or X2. This is why any “analysis” based on double-entry accounting is at best a description. It applies also to all other identities, such as MP=VY.
Unfortunately, the practice of macroeconomic reporting relies on accounting and other data on aggregates “to explain” how the economy is doing. We know how deficient that approach is, although those data are the reality which most theoretical frameworks of the economy pretend to explain (as Richard Wagner likes to say in those frameworks macro variables are primitive variables that can be meaningfully related directly to one another in a causal manner –see for example his paper with A. Devereaux https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3054617 ). I was lucky enough to learn about the deficiencies of macroeconomics early on my career (in the early 1970s), but I had to ignore them because my customers (decision-makers in high private and public positions) were expecting I explained them the data! Yes, for years, I knew very well how the data were collected, processed and used in various countries –including China.
Upon retirement, I have been reviewing alternative approaches to macroeconomics. New ideas have been presented and discussed, and I hope soon we will see significant developments in the direction that Richard and others have taken. In the meantime, we can mock people that continue using old approaches, but we should not blame them because they are relying on what they have learned in undergraduate macroeconomics over the past 60 years.
dede
Jul 15 2018 at 10:10pm
“the weight of the rock is simply not part of the empty weight of the truck.”
After your liter of water analogy from a few months ago, I am looking forward to the next. Each of them makes the understanding so obvious!
As to : “How the FOMC can commit such an elementary economic error is puzzling”, I may argue that you have not been paying attention to what they have been doing over the last ten years, have you?
Comments are closed.