Scott Wolla on an Accounting Error about Imports and GDP
By Pierre Lemieux
If one does not understand what GDP is and how it is measured, interpretation errors are not surprising–especially when reinforced by ideological wishful thinking.
In a few pieces and posts, I have tried to bring attention to the mistaken treatment of imports as a “subtraction from GDP,” an error committed by many commentators, journalists, and even economists. It was thus encouraging when Scott Wolla, an economist at the Federal Reserve Bank of St. Louis, published a correct explanation in a Bank’s educational publication (see my post “The St. Louis Fed on Imports and GDP,” September 6, 2018).
Wolla strikes again with an article just published in the Journal of Economics Teaching, “The Textbook Treatment of Net Exports: Will the Uninformed Reader Understand?” Summarizing what’s important to understand in the accounting identity used to describe the expenditure side of GDP, he writes:
In short, correctly calculated, imports don’t count negatively in GDP; rather, they have no impact on GDP.
The basic reason, of course, is that imports are not part of GDP (gross domestic product) and, thus, cannot decrease its accounting value. Wolla explains that many introductory economics textbooks provide misleading information (note that Nx represents “net exports”):
The textbook treatment of net exports in the expenditures approach varies. Many textbook authors capture net exports in a single variable (GDP = C + I + G – Nx), while others have broken it into its component parts [GDP = C + I + G + (X – M)] with exports indicated by “X” and imports indicated by “M.” This extra step brings more attention to the individual role that each variable plays in the expenditures approach and is likely to help students differentiate between the two variables. Put differently, using the (X – M) approach brings direct attention to the fact that the two variables behave differently in the expenditure formula. Exports (X) are an addition to GDP. Imports (M) are subtracted from GDP; or, more correctly, they act as a corrective accounting measure used to offset an earlier addition. Textbook authors and instructors need to make this distinction clear to students. [My underlines.]
Wolla points out how mistaken are Peter Navarro (a trade advisor to President Trump) and Commerce Secretary Wilbur Ross, who stated in a policy paper:
The growth in any nation’s gross domestic product (GDP)—and therefore its ability to create jobs and generate additional income and tax revenues—is driven by four factors: consumption growth, the growth in government spending, investment growth, and net exports. When net exports are negative, that is, when a country runs a trade deficit by importing more than it exports, this subtracts from growth.
This statement reveals a faulty understanding of national accounting. As Wolla repeats,
the –M component is included as an accounting mechanism to ensure that the value of imported goods already included as personal consumption expenditures (C), gross private investment (I), or government purchases (G) is subtracted out.
One surprise perhaps is that half of the 20 introductory economic textbooks reviewed by Wolla “did not provide enough information for students to draw a correct conclusion about the contribution of imports to GDP.” Perhaps Navarro and Ross read one of those and did not go any further?
Wolla’s whole article is worth reading.