At Least Three False Ideas in One Story
The Wall Street Journal story on the GDP drop in the first quarter of 2022 echoes at least three false or misleading ideas that have passed into conventional wisdom. Some are offspring of John Maynard Keynes who, although an elitist dilettante, was not unintelligent and was certainly a genius (a rather evil genius, it turned out) in creating the new conventional wisdom under which we labor (See “U.S. GDP Falls 1.4% as Economy Shrinks for First Time Since Early in Pandemic,” April 28.)
First, the story says (reducing the claim to its logical essentials):
The labor market is a key source of economic strength right now … as employers cling to employees amid a shortage of available workers.
The reader is invited to believe that economic strength comes from a shortage (of labor). The solution of the enigma is that there is no shortage of labor but simply an increasing price of labor, that is, increasing wages or benefits. A shortage, as microeconomic theory understands it, would be a situation where nobody can hire more labor even by bidding up its price along with other employers. There is a shortage of labor as much as there is a shortage of diamonds: you can always get some if you are willing to pay the market-clearing price.
The second false, or at least misleading, idea is that
consumer spending [is] the economy’s main driver.
This is misleading because consumers are not the main driver of the economy, they are the only driver. It is only because people want to consume that they are motivated to work and produce. At least, such is the case in a free economy where consumers are sovereign. If businesses can also be called a “driver,” it is only because they try to satisfy consumer demand or other businesses who try to satisfy consumer demand. The idea underlying the quoted claim seems to be that if people want to consume produced goods and services, these things, that is, GDP, will fall like manna from heaven.
The third idea is demonstrably false, has the most complex ramifications, and may be the most difficult to debunk in a few words. The statement is:
The drop in GDP stemmed from a widening trade deficit. Imports to the U.S. surged and exports fell.
The Economist was a bit more prudent by describing the GDP drop as “a reflection of strong imports”— the fuzzy “reflection of” being, in this context, the usual hint at “caused by” without saying it. Similarly, the Financial Times said at first that the contraction was “reflecting growing trade imbalances,” but then lost it and squarely stated that “GDP was pulled lower by a growing trade deficit … as import volumes and prices surged.”
Anybody who has looked at national accounting even just in a good introductory macroeconomic textbook will know that this is demonstrably false from a strictly accounting viewpoint. GDP—gross domestic product—does not include imports by definition. Hence a drop in GDP cannot “stem from” more imports. Redefining GDP so that imports reduced it would require an altogether different national-accounting framework and new underlying theories of how the economic world works.
I have tried to explain before why the idea that imports automatically reduce GDP is false. The reader might want to have a look at my few related posts and articles, perhaps starting with “Imports as a ‘Drag on the Economy,’” October 20, 2020. Scott Wolla, an economist at the St. Louis Fed, has written a good short piece explaining the same thing: “How Do Imports Affect GDP?” Page One Economics, September 2018.
Instead of repeating what I and others have said before, let me try to use an analogy. In business financial accounts, the fundamental accounting identity that asset plus liabilities equals shareholders’ equity implies that, on the flow side, a company’s profits is equal to its (own) revenues minus its (own) expenses. We could redefine profits as its revenues minus its expenses and minus, say, the Vatican’s expenses on candles (even if latter don’t subtract more from a company’s expenses than imports from GDP, but accounting is largely a matter of conventions). This definitional change would upset the whole structure of financial accounts, but it would allow the statement that company X’s profit reduction “stems from” an increase in the Vatican’s candle expenses.
To justify this new accounting, we would need a substantive theory explaining why it is useful to conceive of Vatican candle expenditures as reducing any business concern’s profits. (Perhaps executives’ wrath at a more powerful popery disturbs them mentally into wasting money?) Such a theory may not be more difficult to defend than the idea that producing GDP (and thus income) in order to have something to exchange for cheaper imports (remember that ultimately, behind the veil of money, products exchange against products) reduces GDP.
The relations between accounting and substantive, non-truistic theories is a interesting topic, to which I have not done justice.