A Wall Street Journal story of last week, “The Verdict on Trump’s Economic Stewardship, Before Covid and After,” makes many good points. It also falls into some popular economic errors. Here is an obvious one:
Trade itself turned out to be a drag on the economy. U.S. export growth slowed starting in 2018 as Mr. Trump’s tariff battles ramped up. The U.S. trade deficit, reflecting an excess of imports over exports, grew to $577 billion in 2019 from $481 billion in 2016.
We are told that imports or a trade deficit necessarily constitute “a drag on the economy.” This elementary error stems from the misunderstanding of a national-accounting identity: GDP = C + I + G + X – M. This identity is often misunderstood as meaning that M (imports) constitutes a “drag” on GDP because it subtracts from GDP measured as the sum of personal consumption expenditures (C), gross private investment (I), government expenditures for goods and services (G), and exports (E).
I have blamed the Wall Street Journal and other journalists before for repeating this myth: see my Regulation article, “Are Imports a Drag on the Economy,” Fall 2015. Perhaps one can find a serious economic argument to the effect that imports reduce GDP—although I and most economists since David Hume, Adam Smith, James Mill, or Jean-Baptiste Say don’t think so. But if such a serious argument exists, it is not that the trade deficit (X-M) subtract from GDP in an automatic, accounting, arithmetical manner as some people imagine is shown by the accounting identity above.
The demonstration is simple. National statisticians (the Bureau of Economic Analysis in the United States), in one of their ways of measuring GDP (from the expenditure side), subtract M because it is already included in their measures for C, I, and G. Consumption expenditures, as measured in the national accounts (in the United States as elsewhere) already incorporate imported consumption goods; investment expenditures already incorporate imported capital goods; and government expenditures already incorporate imported goods and services (foreign consultants, for example). Why do statisticians subtract M? Because imports, by definition, are not part of GDP (gross domestic product) and must not be included in any measure of the latter. M cannot reduce the measure of GDP because it is not part of it.
For another statement of my argument, see my “A Glaring Misuse of GDP,” Regulation, Winter 2016-2017. In still another Regulation article (“Peter Navarro’s Conversion,” Fall 2018), I summarize and illustrate the argument:
Imports have to be removed because they are not part of GDP, which is gross domestic production. … Think about the guy on the scales who subtracts 1 lb. to factor in the weight of his shoes; his weight doesn’t change if instead he subtracts 2 pounds because on that day he is wearing heavier shoes. Likewise, American output doesn’t change because more imports are both added and subtracted.
An economist with the Federal Reserve Bank of St. Louis, Scott Wolla also pointed out this misleading error: I reported on, and linked to, Wolla’s article in another Econlog post: “The St. Louis Fed on Imports and GDP,” September 6, 2018.
Many former college students who took a macroeconomic class and glanced at the accounting identity GDP = C + I + G + X – M in a (perhaps not so good) macroeconomic textbook make the same error. The Wall Street Journal should not.
READER COMMENTS
Craig
Oct 20 2020 at 10:53am
Right now I wonder without imports where would inflation be? More money chasing even fewer goods? I have to be honest, I don’t understand why foreigners keep sending us stuff, I really don’t.
Jon Murphy
Oct 20 2020 at 11:06am
Well, either foreigners are especially generous, or we simply look at what they are buying: US goods, services, and assets. We do robust trade in all three.
Pierre Lemieux
Oct 20 2020 at 11:48am
@Craig: One way to grapple with your question is that, as long as there is some economic freedom in the world, “foreigners” do not really send “us” stuff. There is a small business in Vietnam that sends shoes to a small American business because both think the price is good and more than covers their risk. The American business will sell the shoes to American consumers that are happy with the price-quality ratio. The Vietnamese business will rapidly get rid of its dollars (it is probably forced to do so by its own government, but that’s a slightly different story), which a Vietnamese farmer (or a middleman) will grab to import soybean meal.
Pierre Lemieux
Oct 20 2020 at 12:10pm
@Craig: The real question, then, would be, Why would a member of the Vietnamese nomenklatura grab the dollars and put them under his mattress or buy a dollar-denominated bond with them.
Craig
Oct 20 2020 at 12:36pm
What strains credulity right now of course isn’t that foreigners would want to sell things to Americans, but why they are willing to CURRENTLY take dollars? What’s underpinning my post which I think I likely should have made a bit more clear is the fact that the government is selling bonds, the Fed is then buying these bonds by creating money ex nihilo. Great little Latin phrase so that they can avoid saying, “We’re printing money”
https://fred.stlouisfed.org/series/M2
2/1 — 15.428
10/8 – 16.999
And they’re promising to print trillions more too.
The economy was partially demobilized, now partially paralyzed by COVID, there’s more money chasing fewer goods. I know this to be a recipe for inflation, yet, there doesn’t seem to be altogether that much and in part that’s because imports increase the supply of products, so imports, for sure, are dampening inflation pressures. So, sure, Americans should be glad that foreigners are willing to trade electronic dollar blips in exchange for actual products.
But my question is, while we’re standing around counting our lucky stars, is someday and I would suggest sooner rather than later they’re going to realize they’re being taken for suckers.
“Why would a member of the Vietnamese nomenklatura grab the dollars and put them under his mattress or buy a dollar-denominated bond with them.”
That’s the million dollar question, right? Why would you see the dollar as a store of value right now? I don’t. As for a dollar-denominated bond, I mean, sure there are bonds other than treasuries, but treasuries right now have an effective negative yield. In fact that is part of the reason the stock market is on steroids and that’s because holding money at 1% is a guaranteed loser. The risk of not taking a risk is a guaranteed loss.
Jon Murphy
Oct 20 2020 at 1:36pm
Some key points:
First: The Fed cannot print money, either de facto or de jure. The Fed can increase or decrease the money supply, but that is not comparable to printing money. It’s a common, but incorrect, libertarian trope that the Fed prints money.
Second: You’re incorrectly assuming they are buying dollars for the sake of dollars. As you note, a US dollar is only valuable insofar as it can be exchanged for something. Most of those dollars come back to the US in the form of foreigners buying US exports and buying US-based assets. Some dollars are used to facilitate other foreign trade (since the US dollar is the reserve currency of the world).
Third: Your entire argument relies on foreigners being “suckers.” While it is possible the 6.7 billion people who do trade in some form or another with the United States are all suckers, I find it extraordinarily unlikely especially when some significant and influential subset of that population deal with currencies and economics every single day. So, what are they missing? What’s the key information you possess that no one else does?
Jon Murphy
Oct 20 2020 at 2:01pm
As a quick aside, Craig-
I found your characterization of foreigners as “suckers” interesting. For much of the past 4+ years, the US has been the “suckers” for letting t he foreigners sell us stuff and buy few things in return. But your characterization turns that argument on its head.
Craig
Oct 20 2020 at 2:19pm
“First: The Fed cannot print money, either de facto or de jure. The Fed can increase or decrease the money supply, but that is not comparable to printing money. It’s a common, but incorrect, libertarian trope that the Fed prints money.”
What are they buying the bonds with?
“My perspective, as with those of all other members of the FOMC, was given a thoughtful and fair hearing at the table. After deliberation, the majority of the committee concluded that under current and foreseeable conditions, the better approach was to purchase $600 billion in Treasuries between now and the end of the second quarter of next year, on top of the amount projected to replace the paydown in mortgage backed-securities. The math of this new exercise is readily transparent: The Federal Reserve will buy $110 billion a month in Treasuries, an amount that, annualized, represents the projected deficit of the federal government for next year. For the next eight months, the nation’s central bank will be monetizing the federal debt.” — https://www.dallasfed.org/news/speeches/fisher/2010/fs101108.cfm
So if it makes you feel better to say that all they do is increase the money supply. Fine, but ultimately the government issues bonds that physically doesn’t exist (I actually remember the physical bonds you could buy at banks and people would give them to children at birth or at birthdays, etc and you’d hold them in a safety deposit box, I have some for my kids born in 2011). The Fed buys them with money created, ex nihilo (money had not existed) and the government armed with this electronic currency makes all kinds of direct deposits to people who then show up at Publix with their cards and buy actual products.
Characterize it anyway you like, but they have embarked on a dangerous course and one day you’ll wake up with a line at the bank. Seems like these events always blow up very, very quickly.
Jon Murphy
Oct 20 2020 at 2:56pm
With money, as your quote and link from the Fed shows. But that money existed prior.
The Fed prints money when they buy (or sell) bonds in the same way your local bank creates money when it loans funds to a prospective homeowner.
I recommend going through this paper by Steve Horwitz on how the Fed actually works.
Craig
Oct 20 2020 at 3:18pm
“With money, as your quote and link from the Fed shows. But that money existed prior.”
No it didn’t exist prior. They are flat out saying that they are creating the money EX NIHILO. OUT OF NOTHING.
Jon Murphy
Oct 20 2020 at 3:25pm
I know that is your understanding, but it is incorrect. Think about my analogy about the local bank loaning money and read the piece I link to by Steve.
Craig
Oct 20 2020 at 3:30pm
The only solace of course is that the Fed now has assets on its balance sheet and of course the Fed can sell the bonds and pull money out.
The entire thing is sketchy.
Radford Neal
Oct 20 2020 at 6:21pm
John Murphy: “The Fed cannot print money, either de facto or de jure.”
Could you explain? Surely it must be the case that central banks in many countries at many times in the past have “printed money”, else how does one get 1000000 percent per year inflation? Are you claiming that the Fed is somehow incapable of doing what the central bank of Zimbabwe was able to do?
Jon Murphy
Oct 20 2020 at 7:35pm
Absolutely. I am discussing just the US central bank. I don’t know much about other central banks. I’m not a monetary economist; I focus primarily on law & economics.
The Fed does not have a money printing press. Only the Treasury has the authority to print new money in the United States. The Treasury then deposits that money in the Federal Reserve, much like how you deposit money at your local bank. The Fed can then decide how much money it wants to allow to circulate through various operations. But the key takeaway here is only the Treasury can print money.
In other countries, their central bank may be able to print money. But in the US, the Fed cannot.
Radford Neal
Oct 21 2020 at 10:21am
Jon Murphy: Thanks for explaining what you meant. I think there is a mis-communication with the other commenters here for two reasons.
First, by “The Fed”, probably most people really mean “The US government”, so saying that it’s the Treasury department, not the Fed, that prints the money is to them an unimportant distinction. Of course, there are some political distinctions involved, but ultimately Congress + the executive would have complete control of both.
Second, by “printing money”, people usually mean increasing the supply of base money, which nowadays includes lots of money that exists only electronically, not as pieces of paper. My impression is that the actual printed money gets produced in response to demand from people for paper currency. If the Fed created more electronic base money, and the Treasury then refused to print more paper money, one would have a situation where people have money in their bank account, but when they go to their bank and ask to withdraw it as paper money, the bank says that they can’t, since the bank doesn’t have any more paper money. This would be an interesting scenario to contemplate, but does not seem to have arisen recently. I speculate that if this happened in an inflationary context, the result would be an even further decline in the value of this money, since it would no longer be fulfilling its basic function as a medium of exchange.
Jon Murphy
Oct 21 2020 at 11:51am
If the miscommunication is “the Fed” meaning the US government and increasing the money supply is the same as printing money, then my objection to Craig’s comments is all the more vital. Both those things are massively incorrect.
Student of Liberty
Oct 23 2020 at 3:47am
Actually not, as far as I understand. US dollars banknotes circulate freely in Vietnam and because their government is even worse than yours, retailers are happy to get these dollars, which do not depreciate as fast as the dongs. In Cambodia, you can even get US dollars from the ATMs!
I do not know the amount of paper US dollars that circulate abroad but I would think it is substantial, there is demand for these and the Fed does not have to pay their token interests on them at all.
Joe Hamilton
Oct 24 2020 at 10:36am
I’m not an economist and don’t recall the term one would use but they call the U. S. dollar or the U. S. currency the global trade currency, similar to what gold was in earlier times and likely would be again if the current system collapsed. There are advantages to the economy whose currency plays this role and one is what you point out: those dollars are printed, spent, go overseas and never come back. During times of hyperinflation such as the Tulipmania in Holland, the national treasury burns wheelbarrow loads of their currency in public to restore confidence. We Americans are in a fortunate position where we don’t have to go to that trouble.
China wants to take over this role and tried to cobble together a system with Russia, Brazil and India a few years ago. Ultimately there will be another Bretton Woods-type conference and China will make its play to assume that role. I don’t think that is something the rest of the world really wants and a worsening U. S. trade deficit with China only increases its likelihood.
Jon Murphy
Oct 20 2020 at 11:08am
There are some theoretical arguments out there, but they require very strong assumptions. It’s like the old joke: give me enough assumptions and I can prove anything you want.
Pierre Lemieux
Oct 20 2020 at 11:52am
@Jon: And they often require resorting to mythical creatures like “the national interest.”
Vivian Darkbloom
Oct 20 2020 at 12:24pm
“Trade itself turned out to be a drag on the economy. U.S. export growth slowed starting in 2018 as Mr. Trump’s tariff battles ramped up. The U.S. trade deficit, reflecting an excess of imports over exports, grew to $577 billion in 2019 from $481 billion in 2016.”
The “error” is not obvious to me because I do not believe that the language of that paragraph blames “imports as a drag on the economy” as your title and comments suggest. The quoted language does not say that . Rather, the quoted paragraph simply states that *trade* turned out to be a drag on the economy. Why? The next sentence, immediately following, gives us a hint: “U.S. export growth slowed starting in 2018 as Mr. Trump’s tariff battles ramped up.” This suggests to me that the emphasis is on lower export growth and tariffs or perhaps even lower overall trade rather than higher imports as the cause of the “drag”. I’m pretty sure that you agree lower exports and higher tariffs would be a “drag on the economy” at least as measured by GDP?
While it is true that the paragraph also then mentions the higher trade deficit, unlike “lower trade growth” no direct mention is made of “higher imports” or that “higher exports” were a “drag on the economy”.
A better summary of that paragraph, to my reading, would be “Lower Exports (or Export Growth) were a Drag on the Economy” or “Higher Tariffs were a Drag on the Economy”, or even “Lower overall Trade was a Drag on the Economy”. Any of these choices would, I think, have been a more accurate take-away than “Imports are a Drag on the Economy”.
Jon Murphy
Oct 20 2020 at 1:46pm
On top of Pierre’s comment below, linguistically his interpretation makes sense. The paragraph quoted follows a common form: claim followed by evidence. They are making a claim (“Trade itself turned out to be a drag on the economy”) and then offer two supporting pieces of evidence (1: “U.S. export growth slowed starting in 2018 as Mr. Trump’s tariff battles ramped up.” 2: “The U.S. trade deficit, reflecting an excess of imports over exports, grew to $577 billion in 2019 from $481 billion in 2016.”).
If one wants to argue that the WSJ is not saying imports are a drag on the economy, that is fine. But such an argument would half to implicitly claim, then, that the third sentence in that paragraph is unrelated to the rest of the paragraph. That’s a rather significant claim to make.
Furthermore, the following paragraphs in the report emphasize the trade “gap” and the surge of imports following lockdowns as all weighing on GDP. Indeed, the whole section of the report is written from a very mercantilist viewpoint.
In short, while I see your point, I think your assumptions are too strong and do not make sense in context of the quoted passage or overall article.
Vivian Darkbloom
Oct 21 2020 at 1:52am
“But such an argument would half to implicitly claim, then, that the third sentence in that paragraph is unrelated to the rest of the paragraph”.
Not at all. The third sentence does not say that rising imports or a growth in imports was the cause of the “drag in the economy” in the period in question. You are simply improperly reading that into the text. As I trust you understand (and as succinctly described by the author) a trade defict is the result of two variables—imports *and* exports. The author does not make any claim in that third sentence that imports are a cause of the “drag”. A increased trade deficit can equally be caused by lower exports. You can’t simply conclude that by quoting a fact involving two variables, the author was focusing on the import side. Again, the only connection here made was to slowing export growth and tariffs. If you are going to claim someone made an “obvious error”, I suggest that the strong burden of proof is on you to show that and not merely to improperly reason from something that is not in the text.
Let me state this differently: Imagine that Jon Murphy writes something like “the US fiscal deficit accelerated last year as spending growth increased. The US fiscal deficit, which is the difference between government expenditures and revenues during the fiscal year, increased to $1 trillion.”
Based on that, is it fair for me to state that that you are implying, much less stating, that we have a *revenue* problem and that as a consequence you’ve made an “obvious error of economics”?
Jon Murphy
Oct 21 2020 at 9:21am
If one is arguing that a trade deficit is a drag, then one is necessarily arguing imports are a drag. That follows from the definition of a trade deficit, as Pierre discusses above.
Jon Murphy
Oct 21 2020 at 11:59am
Here is what I mean:
The trade balance is defined as Exports Minus Imports (for short, X-M). A trade surplus is defined as when X>M. A trade deficit is defined as X<M.
Now, in the GDP calculations, imports have no first order effect on GDP.* The trade balance is nothing more than a correction mechanism to prevent us from over/under counting GDP due to double-counting.
Thus, if one is making a statement about the effects of a trade deficit weighing on GDP, one is necessarily making a statement of the effects of imports on GDP. Furthermore, by definition, the effects of imports on GDP must be negative. Whether or not the deficit was caused by increasing imports, decreasing exports, or some combination of the two is irrelevant; one is still making a statement of the impact of imports. And that statement is incorrect. Imports have no effect on GDP.
So, again, while I see the point you are making, I contend your point does not make sense linguistically or logically, either standing alone or in the context of the article as a whole.
*There may be secondary or tertiary effects, but they are unimportant for the point here.
Vivian Darkbloom
Oct 21 2020 at 2:18pm
Jon,
You are simply wrong, textually and logically, for the reasons I stated in my comment that you are (not) responding to. Nobody is disagreeing with your equations including, I strongly suspect, the author of the piece you are attacking. A propos the latter, a suggestion—perhaps you and/or Pierre could contact Jon Hilsenrath, the author of that WSJ piece and ask him if he thinks imports reduce GDP, because he certainly didn’t write that or even imply it in the language cited to support that charge. His e-mail address is listed under his by-line.
At this point, it very disappointing that you continue to claim the author made an” obvious error” by stating that imports reduce GDP when he neither wrote or implied any such thing. Even Pierre, whose comment I was originally responding to, did not reply with the same far-fetched excuses you are now trying to rescue him with after the fact.
Jon Murphy
Oct 21 2020 at 3:24pm
Vivian-
I did respond directly to your point. You misunderstood me, sure, but I did respond. Again, you are misunderstanding the GDP equation and the implications of the post. If one is making a claim about trade deficits’ effects on GDP, one is necessarily making a claim about imports. If one is claiming trade deficits qua trade deficits are dragging the economy down, as the author states, then one is necessarily making a claim about imports being negative.
Vivian Darkbloom
Oct 22 2020 at 8:11am
“If one is making a claim about trade deficits’ effects on GDP, one is necessarily making a claim about imports.”
Jon, no one, including Hilsenrath, made or is making that claim, much less “obviously”. It’s as simple as that.
Pierre Lemieux
Oct 22 2020 at 11:47am
Jon:
You write:
That’s how I read it. In summary, the trade deficit was a drag on GDP. I think most people would read it that way.
Pierre Lemieux
Oct 20 2020 at 1:21pm
@Vivian: I might agree with your main point if “a drag on the economy” had not been so often associated, including by the Wall Street Journal, to the trade deficit, that is, imports larger than imports (or imports increasing while exports don’t increase by as much). The problem is seen to be X-M. Reading the other linked pieces of mine should persuade you.
The other point you make is different but might also explain the danger of using an accounting identity, instead of economic analysis, to draw conclusions and policy implications about GDP. Your write:
Ignoring the “higher tariffs,” which don’t show directly in the accounting identity, I would agree if the resources used to produce the vanished exports sat idle instead of producing something else, such as goods and services for the residents of the exporting countries. Similarly, automated telephone switching in the first half of the 20th century would have reduced GDP only if the former phone operators had not produced some other wanted goods and services instead.
Vivian Darkbloom
Oct 20 2020 at 1:35pm
“@Vivian: I might agree with your main point if “a drag on the economy” has not been so often associated, including by the Wall Street Journal, to the trade deficit, that is, imports larger than imports (or imports increasing while exports don’t increase by as much). The problem is seen to be X-M. Reading the other linked pieces of mine should persuade you.”
That’s extremely unfair to the author (and your readers). You seem to think it’s ok to directly quote someone and claim, based on that direct quote, that *this* is an obvious example of error. Then, when challenged, you revert to “well that paper often makes the mistake”?! I think the author deserves better.
Imagine that if I misconstrued something you wrote here. Then, when challenged as to that unfair characterization, I responded, “well, while your actual words don’t represent what I claim they did, but others on Econlog often write such things and therefore I’m justified in claiming you made an obvious error”. I suspect you would object, and rightly so.
Pierre Lemieux
Oct 22 2020 at 11:22am
If the author did not actually mean what he wrote in the same way as people write who claim that imports are a drag on the economy, I would apologize for misinterpreting him. But I would then suggest that he says what he wants to say in a different way than people who think the contrary. My substantive point remains that there is no accounting reason why trade is a drag on the economy.
Vivian Darkbloom
Oct 22 2020 at 12:05pm
Pierre,
This is *not* a debate about your “substantive claim.” It is a discussion, or debate if you will, about whether, based on what Jon Hilsenrath wrote, it was appropriate for you to lambast him in this public forum for an “obvious error”. I carefully read what he wrote and came to an entirely different conclusion for reasons that I have explained in detail above. I guess in that I’ve also made an “obvious error” even though you “see my point, but…”
Contrary to what you just wrote, I have no reason to believe Jon Hilsenrath did not “mean” every word he wrote. I have every reason to believe that you read for too much into what he wrote and were too quick to jump on one of your favorite themes (as you yourself have so proudly documented here). Finally, I find it rather uncharitable of you (also in the sense of Arnold Kling’s motto) to now suggest that all of this is the responsibility of Jon Hilsenrath for not speaking in the sames terms that *you* would like him to.
This is the last I have to say to you and Jon Murphy.
Jon Murphy
Oct 22 2020 at 12:19pm
Vivian-
You’re a lawyer. You know words matter. If people hear that “Trade itself turned out to be a drag on the economy” and that trade deficits weigh on economic growth (despite the fact that prima facie they don’t), then all sorts of mistakes are subsequently made. Mercantilism lives on such fallacies. The Trump administration’s bungling of the Pandemic lives on such fallacies. Dr. Fauci’s cries to restrict globalization lives on such fallacies.
Precision matters. Sloppy writing like the WSJ’s leads to sloppy thinking, as we see in the whole section of trade where he repeatedly makes the same errors. The fact the trade deficit rose is irrelevant!
Jon Murphy
Oct 22 2020 at 12:31pm
Let me put it this way:
The author spent 351 words on trade.
113 of those words were spent discussing how the trade deficit is a drag on the economy.
That’s nearly 1/3 (32.2%, to be precise) of a section dedicated to something you think is “obvious” that the other doesn’t think affects the economy.
That’s pretty odd, no? Why would the author devote nearly a third of a section to something he obviously knows is irrelevant?
I appreciate you want to defend him by giving him the benefit of the doubt, but extraordinary claims deserve extraordinary evidence. We need a story of why so much space was devoted to an irrelevant discussion, especially when space is a scarce resource.
Bill
Oct 20 2020 at 5:55pm
Your shoes/weight analogy is terrific!
Pierre Lemieux
Oct 22 2020 at 11:25am
Bill: It’s a stroke of genius but I must alas admit that I owe it to Tom Firey!
Thomas Hutcheson
Oct 21 2020 at 11:18am
An increase in imports subtracts from real GDP the same way (generally not :)) that an increase in the fiscal deficit adds to it.
IF a) there are unemployed resources AND
b1) the Fed is constrained from maintaining optimum monetary policy (for the sake of argument, maintaining NGDP growth at a full employment rate), AND
b2) the Fed constrained is such a way that it does not offset the higher fiscal or trade deficits,
THEN either can add to real GDP. [This of course this has noting to do with the sign in front of M or G in the identity GDP = C+I +G+X-M.]
Jon Murphy
Oct 21 2020 at 12:00pm
To my point above, one can concoct all sorts of stories where imports might affect GDP, but we need a lot of assumptions to get there. Imports in and of themselves do not affect GDP.
Thomas Hutcheson
Oct 22 2020 at 9:56am
I think we agree except as a matter of rhetoric. It seems to me better when refuting a simplistic “A causes B,” to show how A could cause B only if C, D, and E, held and then show that C, D, and E do not hold.
Jon Murphy
Oct 25 2020 at 11:11am
Again, to my point above: you can concoct any story with various assumptions. Pierre is making a simple mathematical point about GDP.
Thomas Boyle
Oct 21 2020 at 5:40pm
Oh, for heaven’s sake.
C = (GDP + M) – I – G – X
Consumption is what we care about. GDP is what we produce.
How do we feel about imports now?
Jon Murphy
Oct 22 2020 at 9:19am
I fear I do not understand your point
Thomas Boyle
Oct 22 2020 at 5:43pm
Jon, in that case I hope you won’t mind if I expand on it a little.
I have rearranged the original “GDP” equation. In that equation, imports appear to be “bad” because they are subtracted on the right. Apparently, imports “make GDP smaller”. On the other hand, investment and government spending and exports are all “good” because they are added on the right and “make GDP bigger”.
Except – we care about GDP because it’s a measure of how well the economy is doing. But, the final measure of how well the economy is doing is consumption, so let’s rearrange the equation to see what drives consumption. When we do that, as I’ve done it, now the two things that increase consumption (C) are GDP (G) and imports (M), while consumption is reduced by investment (I), government spending (G) and exports (X).
Now we see that exports are not a “good thing” but rather are the price we pay for something (imports, as it turns out); we see that investment is not a “good thing” but is rather the price we pay for something (future consumption, not captured by this equation, which looks only at a single period); and so forth.
My purpose was just to rewrite the standard form so that “good” and “bad” were reframed, to illustrate that the standard form is technically correct, but entirely misleading.
Jon Murphy
Oct 22 2020 at 8:17pm
Oh. I gotcha. That makes more sense
Pierre Lemieux
Oct 22 2020 at 11:03am
Thomas: In your rearrangement of the equation, there are still no imports. This is not surprising because it is the same accounting identity where, in the original form, there were no imports.
Thomas Boyle
Oct 22 2020 at 5:54pm
I believe that “M” is the variable representing imports.
GDP = C + I + G + X – M
Part of the problem with the equation is that imports are directed into either consumption, investment or government spending. So, “C” includes part of M, and so do I and G. We can split “C” into Cd and Cm, where Cd = Consumption of domestic production and Cm = Consumption of imported production. Similarly I and G can be split into Id + Im and Gd + Gm.
Then,
GDP = (Cd + Cm) + (Id + Im) + (Gd + Gm) + X – M
Rearranging,
GDP = (Cd + Id + Gd) + (Cm + Im + Gm) + X – M
But, (Cm + Im + Gm) = M (because those are where the imports must have gone), so those parts cancel each other out in the equation, and now
GDP = (Cd + Id + Gd) + X
Which reads as “GDP is equal to all the domestic production that goes into consumption, investment or government spending, plus domestic production that was exported.”
Alternatively, we can re-write that as
(Cd + Id + Gd) = GDP – X, which reads as “Domestic production used for consumption, investment or government spending is equal to GDP minus what was exported.”
art andreassen
Oct 22 2020 at 2:21pm
Paul: I’ve only skimmed the comments but what has jumped out is the non mention of the WTO. It is my impression that the function of the WTO is to encourage free trade. I don’t think I have ever seen a country charged with stifling their exports but all seem to try their damnedest to do so to imports.
Discussions of interest rates often mention how increasing rates will lead to an increase in the value of the currency and the adverse impact that will have on trade. Countries are constantly being charged with manipulating their currency to increase exports and decrease imports. Countries are also charged with manipulating their tax codes to impact trade the same way.
“Free Trade” and “Imports are good” are great in theory but in the real world it appears not to be carried out in practice.
Jon Murphy
Oct 23 2020 at 9:48am
I follow you all the way up to your last sentence:
I don’t understand your claim here. Free trade and the benefits of imports are great both in theory and practice (for a great overview of the evidence, see Free Trade Under Fire by Doug Irwin).
It is true that political rhetoric remains at least implicitly mercantilist with its focus on exports, but that is irrelevant to whether or not free trade works in practice.
Comments are closed.