Monday, August 16, 2010

More On Total Trade vs. Net Exports

I had a post last week about how trade gets reported: a) we treat exports as a positive contribution to the U.S. economy and imports as a negative contribution, and b) we never report the total amount of trade, but instead report the net difference between exports and imports, leading to analysis such as this from Vanguard:

"The economy continued to show signs of weakness in June as the U.S. trade deficit widened at an unprecedented pace." 

Alternatively, it could be reported that imports in June exceeded $200 billion for the first time in 20 months, and import activity has improved in 8 out of the last 10 months (see top chart above).  Further, if you look at the composition of imports in the bottom chart, it seems strange to consider the increases in imports to be a "sign of weakness," because they contributed to a widening of the trade deficit in June. 

More than half of U.S. imports are inputs (industrial supplies, raw materials and capital goods) that were purchased by U.S. firms and will become part of some production process in the U.S.  In June, more than $110 billion was spent by American companies on foreign inputs, which seems to indicate a sign of strength and expansion, not weakness and contraction, no?  Likewise, if American consumers could afford to spend 29.2% more on foreign cars, food and clothing this June than last June, how is that a sign of "economic weakness."      

As I mentioned before, I think this obsession with the trade deficit and "net exports" can be traced to the fact that the calculation of Gross Domestic Product treats exports as positive and imports as negative, but maybe that's not the only way to measure economic performance.  Fisher Investments summarized it this way: "Focusing on net exports is simply wonky. We benefit in myriad ways from importing goods others make more cheaply and efficiently. Plus, increased imports is a sign of economic vibrance!"

9 Comments:

At 8/16/2010 6:04 PM, Blogger Dr William J McKibbin said...

Well, your Imports + Exports = Total Trade model has me intrigued -- globalization is another argument that is bolstered by total trade thinking -- OK, I'll go with your idea and think it through...

 
At 8/16/2010 6:09 PM, Blogger Dr William J McKibbin said...

OK, I just ran the total US trade numbers from over the years, and yes, I see your point about total trade activity perhaps being the better proxy for economic vibrance vice net exports and contribution to GDP. I'm going to stay up tonight and study this harder, thanks...

 
At 8/16/2010 10:02 PM, Blogger Irrippi said...

In the model of GDP, Y=C+I+G+NX, imports are a function of Y. NX = X-M.

So a larger M (imports) usually results from larger Y (GDP). We've seen GDP rising, so it shouldn't be surprising that we see M rise.

But M represents a net decline in national income because it is productive value leaving the country. The resources spent to procure M could have been spent domestically.

The composition of imports seems encouraging because it represents more investment than consumption, however you don't show a time series for comparison. I don't know what "normal" is for the composition of imports.

X-M represents the trade deficit. In a closed world economy, the value going abroad must eventually come back, but it can come back as X or as I.

If you are saying the increase in M is good, then all you are doing is saying "hurray" twice for the same increase in Y. That's hardly productive.

 
At 8/16/2010 10:15 PM, Blogger Buddy R Pacifico said...

This comment has been removed by the author.

 
At 8/16/2010 11:56 PM, Blogger Benjamin said...

See, it goes like this: If you import more than you export, you have to borrow money to pay for the imports. You become indebted.
Eventually, your economy looks like that of a Third World nation, and your minimum wage is actually lower than in the 1960s.
Two incomes are needed where one was before, and your cars gets dinkier all the time.
Eventually, things like public universities and militaries become unsustainable.
Oh, this does not remind me of any nation.

 
At 8/17/2010 1:24 AM, Blogger Sean said...

Imports are not "bad", any more than going to Best Buy to pick up a Blu-Ray player (rather than say buying equipment to support your landscaping job) is bad. But it's very intuitive that if you're buying more in entertainment equipment than you're producing that you're racking up unsustainable debt. If 50% of your purchases are equipment, food, etc. rather than entertainment, is that good? It depends on how much you need, doesn't it?

If imports are greater than exports for any area you draw a box around, most people's basic assumptions about depreciation and investment would imply there's a net transfer of productive capacity out of that box. If the rate of that transfer is greater than the rate of growth of productive capacity, then the linear trend line of productive capacity minus debt is down, which reasonably equates to becoming poorer. Most people don't like the thought of that. And if you're getting poorer but consumption is still rising, is that good or bad?

 
At 8/17/2010 3:57 PM, Blogger Craig said...

More than half of U.S. imports are inputs (industrial supplies, raw materials and capital goods) that were purchased by U.S. firms and will become part of some production process in the U.S.

This is just one of the problems with the GDP equation. It states consumer spending, but leaves out business spending. If that situation were rectified, we'd see clearly that consumers account for only about 30% of spending.

And during a recession, it would be obvious that business expansion is slowing before any such thing shows up in the consumption numbers.

 
At 8/17/2010 5:06 PM, Blogger Irrippi said...

Craig:

Consumption consists only of final goods and services. All inputs of production are considered Investment. It does not "leave out" business spending.

If you buy a car, it is Consumption. If Hertz buys a car, it is Investment.

Yes, there are both consumption and investment goods in Imports. As Dr. Perry suggests, we ought to take a close look at the composition of imports. But the GDP equation isn't problematic; it was designed to measure something different than what you'd like it to measure. You're looking at a wrench and complaining about what a lousy job it does banging a nail into a piece of wood.

If the US imports capital equipment or natural resources, it will show up in GDP at the end of the production process as Consumption or Investment. The equation prevents double counting of inputs used to create output.

 
At 8/19/2010 11:06 AM, Blogger James said...

We benefit in myriad ways from importing goods others make more cheaply and efficiently.

This is the same argument Adam Smith made to the founding fathers and Thomas Jefferson agreed with. Fortunately most of the founding fathers were protectionist. Even Jefferson accepted tariffs as necessary to pay off war debt. Think about what kind of country we would be if that advice had been followed. We would never have developed industry but would have remained a supplier of raw materials and agricultural products to England. Instead tariffs from 1800 to 1900 averaged just under 30 percent which allowed us to industrialize in spite of England’s absolute and comparative advantage. We reaped huge benefits from higher consumer prices and as a result our consumers ended up with lower prices than the rest of the world and higher wages to boot. Importing goods made more cheaply benefits only the consumers of those goods. The additional price that would be paid if tariffs applied to protect domestic producers would carry a Keynesian multiplier which would benefit us all. A direct result of free trade is higher corporate profits and declining real wages. Is there any free trade theory that suggests increased free trade while there are slack resources is a good thing?

Are the benefits of free trade worth a 17 percent u6?

 

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