GDP Accounting and Trade: How GDP accounting misleads trade policy
Wednesday, August 5th, 2015
By Russell Lamberti, Chief Strategist: ETM Analytics
International trade is one of the most misunderstood issues in economics. The common misguided narrative goes something like this: exports are good and imports are bad, therefore exports should be promoted by industrial policies, while imports should be curtailed as much as possible by industrial policies.
Like necessary evil, so the thinking goes, imports are supposed to be tolerated but kept to a bare minimum. Trade surpluses are said to be the route to boosting gross domestic product (GDP) and national wealth.
This is the basic thinking behind the poorly conceived New Growth Path (NGP) and the Industrial Policy Action Plan (IPAP) championed by the minister of trade and industry, Rob Davies, which also finds comprehensive expression in the National Development Plan.
Conventional GDP accounting tells us that exports add to GDP and imports subtract from it. The standard GDP accounting equation looks like this:
GDP = Consumer Spending + Investment Spending + Government Spending + Exports – Imports
Now, it is important to understand that modern GDP is an accounting calculation, not an economic calculation, and it turns out that applying accounting logic to economic problems can be a big problem.
The GDP equation has many faults, but here we will only focus on the exports and imports part of it. To an accountant, when you export a product, you receive money for it, and when you import a product, you pay money for it. All the accountant sees is money in or money out, and then he or she applies it to the accounting calculation of GDP. Exports = money in = higher GDP. Imports = money out = lower GDP.
But this is a problem to the economist who sees value as something more than just money. After all, if money was the be-all and end-all of value, then we would all spend our days hoarding piles of money. Instead, we use money to acquire things we value. Money also has value, of course, but only because we want to use it to get things we ultimately value, like food, clothes, fun experiences or a machine that will help our business become more efficient.
When people pay money for a good (a useful thing), they demonstrate by their actions that they value the good more than the money, or else they wouldn’t make the trade. Likewise, when we import products from overseas, we are demonstrating that we prefer the products we are trying to buy to the money in our wallets or bank accounts.
When people export a product for money, they do so because they personally value the money, as a way of obtaining some other good, more than the product. It is clear that importing and exporting both add value to the economy by making people better off based on their individual, subjective needs.
Applying accounting logic to economic problems might sound like a trivial problem in the real world – something only irrelevant ivory tower economists would debate – yet it is actually one of the most dangerous ideas in history.
When applying the “global test” to the idea that exports must exceed imports, it is obvious that all countries cannot simultaneously do this, since total global trade has to balance – unless Earth started trading with Mars. This creates an immediately antagonistic, zero-sum global trade arena, where countries devalue their currencies, impose restrictive rules on companies, or even use outright trade sanctions in order to create trade surpluses.
In other words, applying accounting logic to an economic problem has made countries more hostile to one another. Instead of promoting greater international peace and cooperation, it promotes hostility, mistrust, and economic warfare.
This is tremendous folly. Not only is there no need for all this trade protectionism, but in pursuing such policies the economy is made worse off, not better.
Firstly, when minister Davies and his department tries to get South Africa to substitute imports with locally produced goods by means of forced subsidies or import tariffs, he is making the bizarre case that forcing people in South Africa to buy more expensive or lower quality goods will benefit them.
Secondly, there is a blatant and crude disregard for the millions of people employed or running businesses in import-related sectors, including shipping, freight, retail outlets, commercial property development, maintenance, support services, and so on. Raising tariffs or lowering import quotas or weakening the currency places this vast sub-economy at risk.
Thirdly, subsidising exporters directly or indirectly with tariffs may benefit a narrow group of domestic producers, but what remains tragically unseen are the industries that were never able to thrive and the jobs that were forgone because tax money or consumer spending power was forcefully diverted away from them.
Finally, trying to boost exports and curtail imports by weakening the exchange rate is doubly silly because not only is it damaging economically but it also eventually backfires, making imports rise and exports fall! Remember, people import when they value money less than goods. Weakening the value of the money only creates a greater desire to import more. And people export when they value money more than goods. Weakening the value of the money only creates a greater desire to export less.
For three decades now South Africa has bought into the GDP accounting fallacy and tried to weaken its currency, impose tariffs, and lavish subsidies upon favoured industries in order to boost exports and GDP. The current minister of trade and industry has taken this even further, implementing a raft of trade barriers, while the ruling ANC has managed policy in a way that weakens the rand in the vain hope of reviving the export sectors. The net result has been even larger trade deficits and dismal export performance, not to mention an industrial sector in obvious decline.
Perhaps it’s time that we let accountants manage budgets and balance sheets instead of GDP calculations?