Imports, Trade Deficits, and the Economy

I came across this article today in the Financial Times.  The Times talks about the current US trade deficit (which means that imports exceeds exports).  The Times makes a crucial (albeit common) mistake.  To wit:

A surge in imports caused the US to record its biggest monthly trade deficit since the 2008 global financial crisis in March, prompting economists to say the economy probably contracted in the first three months of the year.

This is actually an incorrect interpretation of the data (even the economist they quote in the article doesn’t support this conclusion).  Trade deficits and imports do not drag on the economy.  They drag on GDP.

A quick definition lesson:

GDP stands for Gross Domestic Product.  In other words, it is a measurement of the production of goods and services that takes place within national borders.  Since imports, by definition, take place outside of national borders, they must be removed from GDP, thus the formula for GDP is:

C+I+G+(EX-IM) = GDP, where:

C = consumption

I = investment

G = government spending

EX = exports

IM = imports

Due to this mathematical identity, rising imports would naturally lower GDP.  But that does not mean imports are a drag on the economy.

GDP is often used as a proxy for economic activity.  It’s a pretty good tool, to be sure, but it shouldn’t be the only tool used to gauge economic activity.  Other indicators can, and should, play a part as well: industrial production, retail sales, standard of living, prices (in terms of labor-hour costs), that sort of thing.  By relying on a single measurement, such as GDP, it gives rise to false notions, such as imports harming an economy.

The truth of the matter is imports help economic growth, not hinder it.  Remember that all trade occurs because both parties benefit.  Imports occur because the buyer (who just happens to be of a different nationality from the seller) obtains a better value for a good/service than he could get domestically.

Let me try to put this in “real-world” terms to make my point that imports are beneficial for an economy crystal clear:

If, indeed, imports harm an economy and exports strengthen an economy, why do nations bother with embargoes?  Just prior to US involvement in World War 2, the Japanese were invading everyone in Asia.  The Japanese main source of oil for their war machine was the US.  President Roosevelt, in order to put the squeeze on Japan economically, ordered an embargo and stopped shipping oil to Japan.  The reason?  Japan was benefiting from these oil imports!  If imports actually harm a nation, then FDR’s actions should have been the exact opposite: he should have flooded Japan with oil.  Their imports would have skyrocketed (making them worse off), our exports would have skyrocketed (making us better off during the Great Depression) and maybe World War 2 could have ended right then and there.  But nobody believes that because intuitively people know (to some extent) imports are a good thing, economically.

The real fear with imports is that a nation might become so dependent upon another that said nation would acquire some kind of monopoly power over them.  This fear, regardless of how realistic it may be, at least acknowledges that imports are a benefit and the lack thereof is a cost.

EDIT: All this is not to say that there are not costs associated with imports.  Imports may cost jobs, for example.  What I am saying is there are no special costs associated with international trade that are not seen in domestic trade.  If a firm decides to buy wine from New Hampshire as opposed to California, Californian jobs can be lost.