Never confuse an accounting identity with a causal economic relationship.
The easiest way to be wrong in economics is to reason from an accounting identity. That’s because an accounting identity tells you how things add up, not why they change. Treating it like a cause-and-effect explanation mistakes the scoreboard for the game.
Many reporters and commentators have made this mistake since the Bureau of Economic Analysis released its latest GDP report. Analysts point to the first-quarter surge in imports as the source of reduced economic activity. Beyond mere arithmetic, there’s nothing to this. It’s totally wrong as an explanation of how the economy works.
According to basic national accounting, GDP equals the sum of consumption, investment, government spending, and net exports. This last category is exports minus imports. Since imports enter negatively into the equation, it appears that purchasing goods and services from abroad makes the domestic economy less productive. Trade skeptics frequently make this argument.
Dig a little deeper, however, and the trade skeptics’ case falls apart. First, remember that GDP measures the value of all final goods and services produced within a country’s borders. It’s not a measure of national income, consumption, or wealth, but specifically of production. Imports don’t reduce domestic output — they simply reflect where the output originated.
Second, the import correction prevents inaccurate double-counting. If I purchase a pair of Italian-made loafers, that gets counted as consumption. Since what we’re trying to measure with GDP is production, my purchase needs to be subtracted later. Trade skeptics allege that America is poorer by a pair of shoes when I do this. On the contrary: America is richer by a pair of shoes, even though those shoes were produced by somebody outside our borders. Filtering out imports is a pure bookkeeping operation. There’s no causal theory of production or wealth here.
In reality, imports often make us richer. Domestic firms, by sourcing inputs from lower-cost foreign producers, can produce more than otherwise. This clearly adds to GDP. By value, about 50 percent of imports are used to manufacture items here in the country. Eliminating this cost-saving measure — by imposing very high tariffs, let’s say — would shrink output, not grow it.
It’s also worth remembering the ultimate source of America’s persistent trade deficit: We have the world’s best capital markets, and foreigners are eager to conduct transactions in them. When we buy goods and services from abroad, we send dollars to the rest of the world. What can our trading partners do with those dollars? They could buy U.S. goods, and some do. But since our trade balance (exports minus imports) is persistently negative, our partners must be doing something else with that money. It turns out that they use it to fund capital investments. About half goes to U.S. government debt, and the other half goes into private sources of capital accumulation. Investment is a major driver of long-run growth, so we should be grateful that our country can get cheap goods from abroad while supporting productive capital accumulation at the same time.
This isn’t to say that imports are totally costless. As we’re learning the hard way, there can be political fallout from long-lived trade deficits. Servicing foreign demand for U.S. securities (and hence financing our imports) means that the federal government has higher debt than otherwise. It also means a stronger dollar, which domestic consumers often like but domestic producers often don’t. Dollar appreciation makes it more attractive for US consumers to purchase foreign goods and services that compete with those of U.S. producers. The latter will lobby for policies that protect their markets but create overall costs for the American economy. However, these factors reflect political responses to economic forces, not economic forces themselves. There’s no compelling reason to believe, as a matter of economic law, that imports reduce our nation’s output.
The lesson is never to confuse an accounting identity with a causal economic relationship. The left’s flirtation with “modern monetary theory” is an example of this error. It helped enable runaway inflation — the likes of which we’d not seen for 40 years. But trade skeptics on the right are making the same mistake. Misled by a corrective technique in an accounting equation, they would erect massive barriers to specialization and trade across borders. It would be tragic if we let their economic misinterpretations shrink American production and destroy American jobs.