Foreign Trade’s Impact on GDP

The treatment of foreign trade statistics in the GDP estimates is tricky, confusing, and may contribute to an unwarranted aversion to imports. The reason is that we add categories of spending to get to GDP, but we subtract imports. For example, we add Consumption spending to Investment spending to Government spending to spending on Exports, but we subtract spending on Imports to get: GDP = C + I + G + X – M.  It’s easy to make the leap from imports being subtracted to get to GDP to imports being a negative in a more general sense. Exports add to GDP, but imports subtract from GDP. Imports must, therefore be bad.  Furthermore X > M is good while M > X is bad. Right?

No, wrong. Imports are subtracted because the other spending components , C, I, G, and even X all have import components , which  generate income among our trading partners just as our exports generate income at home. It is easier to subtract imports at the end than it would be to make C net of imports, I net of imports, and so on. Imports don’t really reduce domestic income; they just don’t add to it. By subtracting them at the end, it is not necessary to make all the other spending categories net of imports. It’s merely a convenience.

Nevertheless, we tend to treat imports as some sort of negative or bad thing even though, when you think about it, imports are what we gain from international trade while exports are what we pay in international trade. We export in order to pay for our imports even though that is hard to see since importers and exporters tend to be different people with different motivations. Henry George’s famous quote clarifies it best for me. If you are in a war, why does your enemy wish to close your ports? To prevent your exports or your imports? His quote was to the effect that “Protectionists wish to do to you in peacetime [limit you imports] what your enemies wish to do to you in wartime.”

What impact did our imports and exports of goods and services have on our first quarter real GDP estimate, released last recently? Well, according to the official report, real exports of goods and services increased 2.9% in the 1st quarter, compared to a decrease of 2.8% in the 4th quarter. Therefore, exports alone accounted for a positive change in real GDP of 5.7% from the 4th to the 1st quarter. However, real imports of goods and services increased 5.4% in the 1st quarter compared to a decrease of 4.4% in the 4th. Considered alone, the increase in imports was 9.8%, making the net contribution of foreign trade in goods and services a negative 4.1%.

We continue to import more goods and services than we export, and that gap increased in the 1st quarter. Would you call that bad or good?  It is good for producers and exporters that we exported more, but it is also good for consumers that we imported more, even though, on balance, foreign trade contributed more to our trading partners income than our own. A net import balance is actually a good thing in that we are getting more from foreign trade than we are paying.

The problem with it is that it is not sustainable. In the long run, we have to pay for our imports with exports although that discipline works more directly on other countries than it does on the United States since the Dollar is a reserve currency that foreigners are willing to hold and use.

When we have a net import balance, as we have for many years running, we “pay” for it with by borrowing in the form of a net foreign capital inflow. That capital inflow is a mirror image of the deficit in trade. That “inflow” of capital may take the form of drawing down our bank balances abroad or building up foreign balances in the U.S. or a foreign accumulation of bonds, stocks, real estate here or a de-accumulation of such assets that U.S. citizens own abroad. The details can get confusing (they just did), but we summarize them by saying we pay with a capital inflow or by borrowing from our trading partners.

We became a “net debtor country” around 1985 when foreign assets in the U.S. first exceeded U.S. assets abroad. If the dollar had not been a reserve currency in high demand by foreigners, we would have had to correct that foreign imbalance long ago. The special status of the dollar makes it easier to borrow (a good thing) and easier to run up a huge foreign debt (a bad thing).

It is ironic that when our trade balance worsens, it has been a sign that the U.S. economy is stronger and foreign economies are weaker because growing domestic income stimulates our demand for imports while weaker foreign income growth lessens their appetite for U.S. goods and services.




Comments (10)

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  1. Andrew says:

    Informative post. Didn’t realize imports were more important than exports.

  2. Tim says:

    Will be interesting to see what happens once the dollar is no longer the reserve currency.

  3. Jack says:

    Trade imbalance is unsustainable. At some point the decreased appetite for U.S. goods and services, combined with increased foreign retention of funds is a recipe for disaster.

  4. Kyle says:

    Ah monetarists. Any trade imbalance will be corrected by floating currency rates.

    Has the U.S. ever corrected their traditional way of calculating the real value of imports?

  5. Joe_in_Dallas says:

    The equation GDP=C+I+G+X–M so often used seems deceptively simple because each parameter isn’t presented with its dependencies (i.e., all parameters actually depend on each other, non-linearly and variable over time.) Maybe those smart enough to work at the Fed have models that include those dependencies but I suspect they are far from reality.

  6. Gabriel Odom says:

    At least we aren’t going back to Mercantilism. I swear, half the time I hear people talking about protectionism, it’s just mercantilism in a different outfit.

  7. H. James Prince says:

    So the -exports is purely an algebraic construction? Interesting. I didn’t realise it was so interconnected, but it makes more sense now.

  8. Kyle says:

    Here’s a simple story that Friedman liked to tell.

    Say I sell tooth brushes to the brits (lord knows they need them) for $50, and then use that money to buy an amount of bubble gum which fetches $70 back home.

    So X-M= -$20, when in fact I actually made $20 by taking advantage of market forces.

    This is a terribly rudimentary formula.

  9. H. James Prince says:

    Could you please explain that?

  10. Daniel Deronda says:

    Mercantilism could be protectionism in a new outfit, but mercantilism in most historical cases outlaws trade with countries, whereas protectionist ideals still allow imports they just add tariffs to make sure that the countries good are cheaper to buy. They can’t be the same.