Regular reader Alan Goldhammer wrote:

I fully understand how tariffs work and know that the calculation for the reciprocal tariffs was something pulled out of a hat (or some malfunctioning AI tool). However, I don’t know if imports are fully modeled for how much they add to the US economy. Any small business that brings in Chinese products to sell, adds value by creating jobs and the money that they generate from sales goes to the Federal, State, and Local governments in the form of taxes. Why should not this added value be subtracted from the trade deficit? Isn’t this also added to the US GDP?  Maybe these are just naïve questions but, as you know I am not an economist.

I told Alan by email that it’s not a naïve question and I do have answers.

I won’t focus on the role, or not, of AI in calculating “reciprocal tariffs.” As is clear from his question, that’s not what Alan is asking about.

Here’s his key sentence:

Any small business that brings in Chinese products to sell, adds value by creating jobs and the money that they generate from sales goes to the Federal, State, and Local governments in the form of taxes.

That’s all almost true. Some of the money from the sales of those products goes to governments. Most of it goes to the sellers, and they’re not chopped liver. We measure their gain by the difference between their revenues and their costs, assuming that all costs, and not just the costs of the Chinese inputs, are taken into account.

Also, yes, those sales do create jobs, but the way we economists measure the gain to workers from those jobs is not those jobs per se. It’s not even the wages, salaries, and benefits that those workers get because counting wages, salaries, and benefits overstates their gain. They have an opportunity cost, namely, the next best job they would be in if they weren’t in their current jobs. So their gain is their wages, salaries, and benefits minus the wages, salaries, and benefits they would get in their next-best job.

So far, I’ve left out a very important group: ultimate consumers of those goods. We economists call their gain “consumer surplus.” Consumer surplus is the maximum amount consumers are willing to pay minus the amount they do pay.

Now to Alan’s two questions:

Why should not this added value be subtracted from the trade deficit?  Isn’t this also added to the US GDP?

The value is not subtracted from the trade deficit because the trade deficit was never intended to measure value: it measures money flows. The U.S. trade deficit with China is the difference between what we Americans spend on Chinese goods and services and what people in China spend on our goods and services. It says nothing about the amount of value we get from those goods and services from China, other than that the value must exceed what we spend or we wouldn’t buy those goods and services. In short, we gain from trade.

In a way, Alan’s “naïve” question points to one of the key problems with even talking about a trade deficit. How bad can a trade deficit be when the values of those imports, to consumers, to producers, and to governments, exceed the amount we spend?

I think, in other words, that Alan rightly sees these values and wonders, “What’s the big deal?” He’s right to wonder.

Now to his second question: “Isn’t this [value] also added to the U.S. GDP?” The increment in wages, benefits, and salaries due to the imports IS part of GDP. GDP would be slightly lower if people were in less-productive jobs. The taxes that American governments at all levels get are not added to GDP because they’re first taken from American producers and consumers. Finally, the consumer surplus is not added to GDP. Remember that GDP measures product at market prices and so doesn’t include consumer surplus.