Confusion About National Accounts

September 6, 2013

Jared Bernstein of the Center for Budget and Policy Priorities has a confusing take on the composition of GDP. He takes the traditional equation of GDP = C + I + G + NX, and notes that NX is a growing negative. He concludes that our trade deficit is a drag on growth.

This is the wrong way to think about things. GDP = C + I + G + NX is an accounting identity, not a function. You can’t necessarily fiddle with one component of GDP without affecting the others. Particularly, if you get rid of some imports, then you are by definition getting rid of some consumption, investment, or government spending, and not changing GDP at all.

When you do algebra on accounting identities, it’s easy to lose sight of common-sense things like causality. Imports don’t cause GDP to be too low. Rather, imports happen because desired domestic purchases outstrip domestic production. The trade deficit is more accurately described as a symptom of insufficient domestic production, not a cause of it.

When Bernstein writes that higher trade deficits are a drag on growth, it implies that our purchases could remain constant without getting them from abroad. Get rid of some imports and domestic production must rise to take the place of those imports. It’s possible, but it’s certainly not guaranteed. Arguing from the algebra alone obscures that assumption.

In any event, I agree that our trade deficit seems extraordinarily high. Trade deficits can be reduced by higher saving, so a pro-savings tax reform would help close the trade deficit.

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