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The Trade-Balance Creed: Debunking the Belief that Imports and Trade Deficits Are a "Drag on Growth", Cato Trade Policy Analysis No. 45

The Trade-Balance Creed: Debunking the Belief that Imports and Trade Deficits Are a "Drag on Growth", Cato Trade Policy Analysis No. 45

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Published by Cato Institute
A nearly universal consensus prevails
that the goal of U.S. trade policy should be
to promote exports over imports, and that
rising imports and trade deficits are bad
for economic growth and employment.

The consensus creed is based on a
misunderstanding of how U.S. gross domestic
product is calculated. Imports are
not a "subtraction" from GDP. They are
merely removed from the final calculation
of GDP because they are not a part of domestic
production.

Contrary to the prevailing view, imports
are not a "leakage" of demand abroad.
In the annual U.S. balance of payments, all
transactions balance. The net outflow of
dollars to purchase imports over exports
are offset each year by a net inflow of foreign
capital to purchase U.S. assets. This
capital surplus stimulates the U.S. economy
while boosting our productive capacity.

An examination of the past 30 years
of U.S. economic performance offers no
evidence that a rising level of imports or
growing trade deficits have negatively affected
the U.S. economy. In fact, since
1980, the U.S. economy has grown more
than three times faster during periods
when the trade deficit was expanding as a
share of GDP compared to periods when
it was contracting. Stock market appreciation,
manufacturing output, and job
growth were all significantly more robust
during periods of expanding imports and
trade deficits.

The goal of U.S. trade policy should
not be to promote exports at the expense
of imports, but to maximize the freedom
of Americans to trade goods, services, and
assets in the global marketplace.
A nearly universal consensus prevails
that the goal of U.S. trade policy should be
to promote exports over imports, and that
rising imports and trade deficits are bad
for economic growth and employment.

The consensus creed is based on a
misunderstanding of how U.S. gross domestic
product is calculated. Imports are
not a "subtraction" from GDP. They are
merely removed from the final calculation
of GDP because they are not a part of domestic
production.

Contrary to the prevailing view, imports
are not a "leakage" of demand abroad.
In the annual U.S. balance of payments, all
transactions balance. The net outflow of
dollars to purchase imports over exports
are offset each year by a net inflow of foreign
capital to purchase U.S. assets. This
capital surplus stimulates the U.S. economy
while boosting our productive capacity.

An examination of the past 30 years
of U.S. economic performance offers no
evidence that a rising level of imports or
growing trade deficits have negatively affected
the U.S. economy. In fact, since
1980, the U.S. economy has grown more
than three times faster during periods
when the trade deficit was expanding as a
share of GDP compared to periods when
it was contracting. Stock market appreciation,
manufacturing output, and job
growth were all significantly more robust
during periods of expanding imports and
trade deficits.

The goal of U.S. trade policy should
not be to promote exports at the expense
of imports, but to maximize the freedom
of Americans to trade goods, services, and
assets in the global marketplace.

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Published by: Cato Institute on Apr 08, 2011
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Executive Summar
April 11, 2011 No. 45
Daniel Griswold is director of the Herbert A. Stiefel Center for Trade Policy Studies at the Cato Institute in Washington, D.C., and author of  
Mad about Trade: Why MainStreet America Should Embrace Globalization
(2009).
The Trade-Balance Creed 
 Debunking the Belief that Imports and Trade Deficits Are a “Drag on Growth” 
 by Daniel Griswold
A nearly universal consensus prevailsthat the goal of U.S. trade policy should beto promote exports over imports, and thatrising imports and trade deficits are badfor economic growth and employment. The consensus creed is based on amisunderstanding of how U.S. gross do-mestic product is calculated. Imports arenot a “subtraction” from GDP. They aremerely removed from the final calculationof GDP because they are not a part of do-mestic production.Contrary to the prevailing view, im-ports are not a “leakage” of demand abroad.In the annual U.S. balance of payments, alltransactions balance. The net outflow of dollars to purchase imports over exportsare offset each year by a net inflow of for-eign capital to purchase U.S. assets. Thiscapital surplus stimulates the U.S. econo-my while boosting our productive capacity.An examination of the past 30 yearsof U.S. economic performance offers noevidence that a rising level of imports orgrowing trade deficits have negatively af-fected the U.S. economy. In fact, since1980, the U.S. economy has grown morethan three times faster during periods when the trade deficit was expanding as ashare of GDP compared to periods whenit was contracting. Stock market appre-ciation, manufacturing output, and jobgrowth were all significantly more robustduring periods of expanding imports andtrade deficits. The goal of U.S. trade policy shouldnot be to promote exports at the expenseof imports, but to maximize the freedomof Americans to trade goods, services, andassets in the global marketplace.
 
Introduction
 The merits of free trade may be hotly de-bated, but there is a near universal consensuson the objective of U.S. trade policy: to pro-mote exports over imports. If the consensus were an organized religion, its creed wouldread something like this:Exports are good, imports are bad.Exports create jobs, while imports sub-tract from output and employment.Imports represent a leakage of demandabroad. Every item we import is one lessitem we need to make ourselves to sat-isfy domestic demand. A growing tradedeficit is, by definition, bad news for theeconomy, while a shrinking trade deficitis good news. Judging by the economic press, this creedis almost universally affirmed. There are few dissenters in the trade community. Politicians,industry economists, stock-market analysts,business reporters and pundits—whatever theirparty or economic orientation—rarely contra-dict or question the creed.Like ancient pagan rituals, its affirmationfollows something of a lunar cycle–marked by the federal government’s monthly release of the latest trade numbers. Here is a samplingof headlines and dispatches over the course of the past year confirming the consensus:
Rising trade deficit could drag downU.S. recovery 
USA Today,
July 13, 2010
1
Flow of imports drags down economicgrowth
Washington Post,
August 27, 2010
2
“Trade was the biggest drag on theeconomy during the spring, subtracting3.5 percentage points from growth.”—CBS News, October 14, 2010
3
“A widening [trade] deficit is bad for theU.S. economy. When imports outpaceexports, more jobs go to overseas work-ers than to U.S. workers. . . . The wid-ening of the trade deficit cut one-half percentage point from overall economicgrowth last year [2010].” —Associated Press, February 11, 2011
4
“Many economists expect the deficit tobe a drag on U.S. growth in the firstquarter [of 2011] and possibly through-out the year. Higher imports can reduceoverall economic growth by subtractingfrom demand for domestically producedgoods and services.”
Wall Street Journal,
March 11, 2011
5
Consensus opinion is not always wrong,but in this case it is. Contrary to the assump-tions embedded in these and countless otherreports, imports are just as beneficial to oureconomy as exports. Imports deliver lowerprices and more variety to consumers whilefueling competition, innovation, and produc-tivity gains among producers. An expandingtrade deficit is not necessarily a bad sign forthe economy, but may (and often does) sig-nal more robust domestic demand for goodsand services, as well as rising investment anda larger inflow of foreign capital to finance it.Imports do not subtract from gross domesticproduct or displace overall domestic output. There is no evidence in our recent economicexperience as a nation that imports or tradedeficits have imposed a “drag on growth.”Anxieties about imports and the tradedeficit can lead to trade policies that do moreharm than good. The constant refrain thatimports reduce employment and slow theeconomy undermines public support for tradeliberalization. It falsely paints trade as a zero-sum game, pitting nations against one anoth-er in a contest to export the most and importthe least, with trade-surplus nations declaredthe winners. It tempts policymakers to believethat they can promote growth and employ-ment by raising barriers to imports and re-stricting our freedom to trade with people inother countries.
2
 Anxieties aboutimports and thetrade deficit can lead to tradepolicies that domore harmthan good.
 
 This study will examine the thinking be-hind the belief that rising imports and tradedeficits are bad for the economy. It will show how the consensus is mistaken in theory andhow its assumptions conflict with the actualperformance of the U.S. economy during thepast three decades.
 The Keynesian Consensus onImports and Growth
Behind the consensus on trade and growthlies the simple logic that things we importtake the place of things we could be mak-ing at home. Every car, end table, or pair of sneakers we import represents one fewer car,end table, or pair of sneakers that could havebeen “Made in the U.S.A.,” resulting in thelayoff of American workers who were previ-ously employed making those items.In its more sophisticated form, the con-sensus rests on the Keynesian argument thatprosperity depends on maintaining a suffi-cient level of domestic demand for goods andservices. The greater the level of domestic de-mand, the more our factories, offices, and re-tail outlets will gear up to meet that demand,and the more workers they will need to hire tosupply the demanded goods and services. Inthis framework, imports represent an unwel-come “leakage” of demand abroad.Keynesian thinking on the economy canbe boiled down to a well-known formula, theNational Income Accounts Identity:
Y = G + C + I + (EX – IM)
In this formula,
equals total nationaloutput,
equals government consumption,
equals private consumption,
 I 
equals invest-ment expenditures,
 EX 
equals exports, and
 IM 
 equals imports, with the expression
 EX – IM 
 representing the trade balance. If the two sidesmust equal, then according to basic math any increase in
,
,
 I 
or
 EX 
will raise
, whilean increase in
 IM 
will, by necessity (becauseof the minus sign), cause a decrease in
. If exports rise, but imports rise even faster, thetrade deficit (
 EX – IM 
) will grow more nega-tive, and the trade sector will “drag down” eco-nomic growth. The U.S. Commerce Department’s Bureauof Economic Analysis feeds those assump-tions in its quarterly reports on U.S. gross do-mestic product. In breaking down the com-ponents of growth, the BEA considers any increase in government consumption, privateconsumption, investment, or exports to be apositive contribution to growth in real GDP.Any increase in imports or the trade deficit isconsidered a subtraction from GDP.Here’s how the BEA analyzed the variouscontributions to the change in 2010 real GDPin its January 28, 2011, report: The increase in real GDP in 2010 primar-ily reflected positive contributions fromprivate inventory investment, exports,personal consumption expenditures, non-residential fixed investment, and federalgovernment spending. Imports,
whichare a subtraction in the calculation of GDP,
 increased.
6
[Emphasis added.] There you have it, from about the most au-thoritative source anyone could cite—the ac-tual government agency that calculates chang-es in real U.S. GDP. Imports increased in 2010and were thus, by impeccable Keynesian logic,“a subtraction in the calculation of GDP.” By the same logic, if imports had not increasedin 2010, or if they had gone down, real GDP would have been larger, incomes higher, andmore jobs created. Or so the trade-balancecreed would lead us to believe.
 Why Imports Do Not“Subtract” from GDP
At the heart of the misunderstandingover the trade deficit, imports, and growth isthe indirect method the government uses tocompute GDP for each quarter. The BEAestimates real GDP, not by counting whatAmericans actually produce, but by estimat-ing expenditures on the various components
3
 At the heart of themisunderstanding over the tradedeficit, imports,and growth is theindirect methodthe governmentuses to computeGDP.

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