The notion that exports and trade surpluses are good and imports and trade deficits are bad for the economy is one of the oldest and most egregious fallacies in economics. The fallacy is perpetuated each time the Department of Commerce’s Bureau of Economic Analysis (BEA) releases a new estimate of U.S. gross domestic product (GDP).
The source of the problem is a thing called the production-expenditure identity. The production-expenditure identity is fundamental to the national income and product accounts, the set of accounts, maintained by BEA, that provides a detailed picture of the U.S. economy as a whole. The production-expenditure identity expresses GDP, the market value of final goods and services produced in the U.S. in a year, in terms of expenditures. In short, the identity is meant to indicate the amount of domestic production purchased by households, businesses, governments (federal, state and local) and foreigners.
A splash of nerdiness is necessary at this juncture. For convenience, the production-expenditure identity is written: GDP = C + I + G + X – M, where C stands for consumption, as in household spending on final goods and services; I stands for investment, as in business spending on capital goods plus goods in inventories; G stands for government purchases, as in federal, state and local government spending on final goods and services (as in tanks and fire trucks, not subsidies or social security); X stands for exports; M for imports.
That splash of nerdiness has unleashed a world of mischief and nonsense. It still does. People read all sorts of things into the production-expenditure identity. Some use the identity to bolster arguments that have been shown to be bogus many times over, such as the fallacy that exports and trade surpluses are good and imports and trade deficits are bad for the economy.
The fallacy has several variants. Exports create jobs, imports destroy them; exports increase the demand for domestic output, imports reduce it. There are others. What’s crucial is the plus sign in front of exports (X) and the minus sign in front of imports (M) in the production-expenditure identity. The common translation of those two signs is: exports increase GDP; imports reduce GDP. A small step leads to a related translation: trade surpluses (when exports exceed imports) increase GDP; trade deficits (when imports exceed exports) reduce GDP.
What perpetuates the exports good-imports bad fallacy with each new BEA estimate of GDP is a similar misinterpretation. Ever encounter a statement along the lines of: “U.S. inflation-adjusted GDP would have been higher if imports hadn’t increased. Imports, of course, subtract from GDP.”?
With each new BEA estimate of GDP, “Imports, of course, subtract from GDP” is blasted out to every electron-compatible speck of the media-verse. That’s unfortunate, because the minus sign in front of imports in the production-expenditure identity does not mean “imports subtract from GDP.”
By reading BEA’s literature on how it estimates GDP, one learns that BEA estimates expenditures on final goods and services by households (C), businesses (I), governments (G) and foreigners (X) without regard for where the purchased products were produced. Consumption, investment, government purchases and exports thus comprise spending on both domestic products and imports, which means the sum of consumption, investment, government purchases and exports equals the value of domestically produced products – GDP – plus imports.
To get GDP, BEA subtracts its estimate of imports, which it obtains through a different process, from the sum of consumption, investment, government purchases and exports. That’s the reason for the minus sign in front of imports.
The next time you hear or read “imports subtract from GDP,” remember: they don’t.
Reg Murphy Center