Such statements are examples of a common error by journalists and pundits, who seem to believe that imports by necessity hurt domestic production and thus the country’s economy. Even economists sometimes fall prey to this mercantilist error, despite economic analysis having debunked it long ago.
Balance of trade / By the 19th century, economists knew that imports are not a problem—quite the contrary. In his 1848 Principles of Political Economy, John Stuart Mill wrote:
The only direct advantage of foreign commerce consists in the imports. … The vulgar theory [of protectionism] disregards this benefit, and deems the advantage of commerce to reside in the exports: as if not what a country obtains, but what it parts with, by its foreign trade, was supposed to constitute the gain to it.
A few decades earlier, in his Treatise on Political Economy (1803 for the first French edition), Jean-Baptiste Say explained that “it is no injury to the internal or national industry and production to buy and import commodities from abroad; for nothing can be bought from strangers, except with native products.” That is, peeking behind the veil of money, what a group of people buy from another has to be paid with real production.
The issue was, and still is, often presented in terms of the “balance of trade,” which equals the value of a territory’s exports minus its imports. In his Wealth of Nations (1776), Adam Smith criticized “the mercantilist system,” which considered imports harmful, and he denied the common prejudice against a negative balance of trade. In this, Smith joined his friend and fellow Scottish Enlightenment giant David Hume, who made the same anti-mercantilist argument a quarter of a century before.
Economic error / Imports are no more problematic than purchases in general. To understand this, consider an individual consumer. His income is to him what gross domestic product (which is equal to national income) is to a country. Can we meaningfully say that the individual’s purchases are “a drag” on his income? Of course not. His purchases are the very reason why he is working to earn an income. Similarly, it would be wrong to claim that our consumer should always maintain a positive personal “balance of trade”—there will likely be times in his life when it is necessary and beneficial for him to spend more than he earns.
Now, expand this perspective from the individual to a group of individuals who live inside some political border (whether national or regional). Their exports are sales realized on (and income earned from) the other side of the border, while their imports are purchases that they make over this border. Just like the individual who sells goods he produces in order to purchase what he wants, so the group sells their goods in order to purchase foreign goods, not the other way around.
The exports are the cost and the imports are the benefits, which was Mill’s point. To speak in collectivist terms, when “we” export, we ship “our” resources to foreigners; when we import, we use “their” resources. Why should we want to do more of the former and less of the latter?
Of course, we benefit from this trade in the sense that each exporter gains at least as much as his usual profit, and each importer could not have obtained a better deal at home. Goods and services are imported from the most efficient producers. Thus, exchange does not create any economic “drag.” So why does the old mercantilist fallacy persist that exports are good and imports are a “drag on the economy” or a “drag on GDP”?
Accounting and GDP / One reason for this persistent error is plain and simple ignorance of what GDP is. For instance, the Financial Times of last June 14th stated that, in Greece, “about three quarters of GDP is domestic.” In fact, 100 percent of GDP is domestic: that’s why it’s called “gross domestic product.” GDP measures domestic production during a certain period of time. Part of GDP is used to purchase imports. But there is no reason why imports would reduce what people produce, because people need their production in order to purchase imports. Saying the contrary would be like saying that an individual’s purchases reduce his salary, which is a total confusion.
Often, the import-drag error comes not from an analytical mistake about why people produce and trade, but from a simple misinterpreting of accounting identities underlying GDP. Once GDP is defined as it is, there are many ways to look at it. GDP as production is equal to total income (what is produced is what is earned), and to total expenditures (what is produced is purchased by somebody). These equalities represent the fundamental accounting identities of the national income and product accounts. These simple points are explained in standard macroeconomic textbooks as well as in publications from the Bureau of Economic Analysis (BEA) such as its Concepts and Methods of the U.S. National Income and Product Accounts (November 2014).
When we look at GDP from the expenditure side, we have
GDP = C + I + G + X − M
an accounting identity saying that what is produced and earned in the economy (GDP) goes to (final) purchases by either consumers (C is consumption expenditures), businesses (I represents investment expenditures), government (G is government expenditures), or foreign importers (X denotes exports).
Remember in passing that GDP includes, by definition, only final goods and services; intermediate goods are excluded in order not to double count—for example, the wheat that goes in the flour and in the bread.
In the accounting identity above, imports (M) are subtracted from the right-hand side as a pure matter of accounting. As measured by statisticians, C, I, and G already include imported goods, and we need to exclude those from the total because they do not count as domestic production. The accounting identity does not in any way mean that imports reduce GDP. Imports appear with a minus sign only because data collectors initially included them in C, I, and G, and thus they need to be taken out.
In the accounting identity, the two terms X − M are often put inside parentheses, as (X − M). This does not change the equation in any way, but falsely suggests that the balance of trade is part of the equation, and that a negative balance of trade reduces GDP. This practice deepens the confusion.
To repeat: imports are “subtracted” from a certain accounting identity not because they are a “drag” on GDP, but because they have been included in other variables of the equation and thus need to be removed. Hence, imports are not deducted from GDP; they are simply not added to it. This follows from the definition of GDP and the consequent accounting identities.
If we go behind simple definitions and accounting conventions, if we move from accounting to economic analysis, imports actually increase the value of GDP—that is, what it is worth for the ultimate domestic consumers. The reason for this is that imports allow all parties to produce what they are most efficient at, in exchange for what costs less to import. Some individuals may even produce in order to import—if, for example, one decides to work more in order to buy an expensive car manufactured in Germany.
What happens if people start importing more than they export, creating a deficit in the balance of trade—that is, a negative (X − M)? Since imports have increased in C, I, or G, but have been equally deducted in M, GDP does not change. Going from accounting to economics, it is true that a negative balance of trade has to be financed so that the total (current and capital) balance of payments remains in equilibrium. This adjustment will occur through capital inflows into the country. It can also be—like in the United States—that some capital inflows are autonomous: they originate from investors eager to invest here, which allows a trade deficit to develop. But this does not change the fact that imports don’t reduce GDP.
Government and the BEA / Besides ignorance of national accounting, there is another reason for the erroneous belief that imports are a drag on the economy. The interest of exporters is to reduce their competition and to arouse protectionist sentiments. Exporters are concentrated among larger companies and are less numerous than consumers who benefit from imports, so the former will organize more easily and lobby more efficiently than the latter, as the theory of collective action suggests. Widespread consumer benefits are less immediately visible than bankruptcies and jobs lost (in fact, jobs transferred to other industries). Thus, governments will naturally side with exporters rather than with consumers, and become clubs of exporters instead of associations of consumers.
The government’s interest in siding with exporters against consumers may explain why even government bureaucrats are tempted to misuse the GDP expenditure identity—or, at least, why they don’t actively combat the repetition of the error. In its monthly Survey of Current Business, the BEA appears more prudent than the typical journalist, but it still offers ambiguity. “The slowdown in real GDP growth … primarily reflected an upturn in imports,” the BEA wrote in last February’s issue of the Survey. It is true that “reflected” does not mean “was caused by,” but it could easily be read as implying some sort of drag. Moreover, a recurring chart in the Surveys shows imports as a negative “contribution” to GDP.
The regular BEA press releases are worse. In last May 29th’s release, for example, the BEA talks about “imports, which are a subtraction in the calculation of GDP.” That’s their standard terminology. When I recently questioned a BEA spokesperson about this, she admitted that my analysis is correct. She wrote in an email:
The reason imports are a subtraction in the calculation of GDP (C + I + G + X − M) is because imported goods and services are included in the value of consumer spending (C), business investment (I), and government consumption expenditures and gross investment (G). Because we only want to measure what is produced domestically, we therefore must subtract imports in the equation to ensure that imports do not enter into our value of domestic product (GDP).
Yet, in the same email, she maintained that the formulation of the press release “correctly identifies imports as a subtraction in the calculation of GDP without saying it ‘contributes’ to GDP in any way.” BEA bureaucrats would have made good medieval casuists.
Given this misleading information, it is not overly surprising that the Wall Street Journal reporter, when I questioned him about his claim that imports are a “drag on GDP” and “negative” for economic growth, replied, “All we mean to say is what the Bureau of Economic Analysis said: ‘imports, which are a subtraction in the calculation of GDP, increased.’ ” Financial journalists and editors should review their basic economics, perhaps by reading Iowa State University economist Leigh Tesfatsion’s “U.S. National Income and Products Accounting: Basic Definitions and Concepts,” found online.
As for BEA economists, they should know better because they are the producers of GDP statistics and the official guardians of its methodology. They should be held to a higher standard. But, as Public Choice theory—“politics without romance,” in James Buchanan’s words—has taught us, we must study politicians and bureaucrats not as they should be, but as they are.
