Sorting Out Some Confusion on Trade and GDP

While inflation is the biggest economic problem right now, trade policy is another reason why GDP shrank last quarter. It is also a common source of misunderstanding. This post attempts to clear some things up.

University of Central Arkansas economist Jeremy Horpedahl notes two overlooked factors in today’s bad GDP news: 1) a decline in government spending and 2) a decline in net exports.

The spending decline was expected, as temporary COVID spending programs have begun to expire, though other big spending bills will partially take their place as the infrastructure bill and other recent trillion-dollar packages begin paying out over the next several years. While this can cushion short-term GDP numbers, those government spending projects will create less value on average than alternative private uses of those resources. Short-term stimulus means long-term harm.

The decline in net exports is more complicated. The Trump-Biden tariffs and the retaliations they sparked put a damper on global trade even before the pandemic. They added to existing friction points in trade, such as excessive regulations on ocean shipping, ports, and trucking.

As things go back to normal, the supply network problems exacerbated by these policies are still being untangled. If Congress and the administration are looking for ways to boost growth without raising spending, they should liberalize trade and reform regulations.

GDP measures how much stuff people create. Trade regulations block people from making stuff, often for no good reason. Moving toward freer trade would boost GDP in both the short and long run.

Trade also confuses some pundits. There will be talk on economically illiterate cable news shows about how America’s trade deficit is causing today’s economic troubles. As usual, those pundits should be ignored. Economists going back to Adam Smith know that the trade deficit has nothing to do with economic health. It is neither good nor bad. For example, Russia’s economy may shrink this year by as much as 45 percent, but it has a massive trade surplus. In America, the trade deficit went up throughout the gangbusters growth of2021. It tends to be highest during booms and lower during recessions.

Americans buy all those imports with dollars. Foreign sellers in China or Japan can’t use dollars at the grocery store—so they send them back to America. Some of those dollars buy American exports. Most of the rest goes to investments in American businesses and government bonds. Every dollar of trade deficit is a dollar of capital surplus. It’s a wash. People spend their dollars one way instead of another, but they get spent just the same. It doesn’t matter for GDP.

The only reason net exports are in the GDP equation is to avoid double counting. When an American buys a foreign import, she first has to earn the dollars to pay for it by making something here in America. That earlier production was already counted once in GDP. Similarly, exports count toward GDP, even though Americans don’t consume the final product. Exports are the price we pay for imports. Any imports beyond that are paid for by cash earned from other domestic production that doesn’t get exported, and was already counted in GDP.

As with most other issues, do not listen to hysterical, hair-pulling cable news pundits on trade deficit issues. The economy has serious problems, but the trade deficit is not one of them. Policy makers should instead focus on liberalization—perhaps starting with repeal of the Jones Act.

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