What does a trade deficit mean for GDP? Not much.

Net exports fell in three of the last four phases of economic expansion

by Stephen Gordon

Statistics Canada’s latest release for the international merchandise trade balance shows that the trade deficit widened in July, and this is being interpreted as a sign that GDP growth will come in lower than previously thought. This might seem to be an obvious implication of a widening trade deficit when you decompose GDP into its spending components:

GDP = Consumption spending + Investment + Government spending + Net exports

Everything else being constant, a fall in net exports reduces GDP. But one of the dangers of reasoning from national accounts identities is that everything else isn’t always held constant. Here’s another national accounts identity:

Investment = Saving + Government surplus – Net exports

(I should be using the current account instead of net exports here, but this is close enough for my purposes.) Everything else being constant, a fall in net exports increases investment—and, as you can see in the first accounting identity, investment shows up as a positive contribution to GDP. Saying that Canada’s trade deficit widened is the same thing as saying that foreigners increased their flow of savings into Canada—and investment spending is financed out of savings.

So there’s no obvious reason to think that strong growth in net exports is positively correlated with strong growth in GDP: net exports fell in the expansions of 1982-1990, 2001-2008—and again in the most recent expansion:

That said, what could be considered worrisome is the drop in the levels of both exports and imports: this is indeed a sign of a slowdown in overall economic activity. But that would have been bad news even if net exports had gone up.

People should stop worrying about the trade balance; the fact that the word “deficit” is used shouldn’t alarm you.




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What does a trade deficit mean for GDP? Not much.

  1. ” A physicist, a chemist and an economist are
    stranded on an island, with nothing to eat. A can of soup washes ashore. The
    physicist says, “Let’s smash the can open with a rock.” The chemist
    says, “Let’s build a fire and heat the can first.” The economist
    says, “Let’s assume that we have a can-opener…” ”

    • The difference is, the economist has political agenda: he is obfuscating the issue to try and swindle the physicist and chemist out of the soup…

      • LOL well it’s all these assumptions ‘Everything else being constant’, ‘all things being equal’ and so on…..in a world where the whole economic system is going for a chop.

        • It was actually 30 years of free-market reforms that caused the global economic collapse of 2008 (we have still yet to recover from.) This is a little bit of history repeating… Free-market ideology produced the first global meltdown in 1929.

          Free-market doctrine doesn’t work because it is nothing more than a con-job: policies that are entirely self-serving for businessmen. It’s not surprising they kill living standards and create an economic tide that only raises the yachts.

          Only balanced policy will work. The mixed-market Keynesian system is the most successful in history by leaps and bounds.

          (Not surprisingly, free-marketers try to blame Keynes for the failure of their anti-Keynesian reforms, like soaring debt… In the post-war Keynesian era, debt was paid down in America from 135% debt/GDP to 35%. The past 30-year “age of greed” has cranked it back up to 103%…)

          • Actually it’s globalization

            200 countries more or less, 200 different economies, cultures, standards, ways of doing things…..suddenly without the barrier of the Cold War….no global body for oversight, no real regulations….just leftover crap from WWII……no wonder everything is a mess.

            And thus far there has been a lot of talk about fixing it….but little has been done

          • Free-trade globalization is one a many free-market reforms that contributed to the current mess (the most prominent failure: banking deregulation.) I don’t oppose globalization. Just the free-market kind. The main drive behind that ideology is to allow corporations to bypass first-world regulations and wage costs (winding back the clock on progress.)

            Instead of creating emerging economies it creates conditions like we had in the 19th century: poor, oppressed workers who can’t buy the products they make.

            Instead of having free-trade blocks, we need common regulation blocks to ensure workers in developing countries are sharing in the fruit of their labor and these countries actually develop. Enthusiasm for free-market globalization (“Washington Consensus”) is well past its peak.

            Fact is modern living standards and the modern middle class were created with centrist economics in the post-war era. The West would still be comprised of developing nations today if centrist government hadn’t intervened. (So emerging economies will be emerging for centuries at the rate they are going, with lots of booms and busts along the way.)

          • Well so far, emerging economies are booming and the Chinese etc are quite happy.

            In the long run……which is shorter and shorter these days….manufacturing will be gone for all countries.

            It would be nice if govts were paying attention

          • Maybe the oligarchs are happy… But these countries have huge gaps between the rich and poor, very high levels of poverty, very low productivity and GDP per capita. With these kind of 19th-century economies there are big booms followed by big busts.

            People tend to generalize about manufacturing: “My toaster is made in China; therefore everything is made in China.” The reality is the value-added sector in developed countries is complex and broad spectrum. High-productivity first-world countries are on the industrial cutting-edge constantly creating new goods and services and improving on the old as technology progresses.

            But not in developing countries like China that have 8% productivity of the US. These countries take on the lower end of the value-added spectrum.

            These countries have such low productivity because they have abysmal levels of social and physical infrastructure. So they will have to raise living standards to first-world levels before they can “take over the world.” And that will take generations, not years. And then they will be buying other first-world goods and services contributing to the global economy.

            I certainly don’t support free-trade globalization. But the pace of globalization is much slower than many people imagine. It was, after all, a global financial market meltdown that caused the economic quagmire we’re in. Not anything else.

          • The Industrial Age changed the world, and produced huge booms….it’s doing the same thing in China, and they are very pleased about it. They are going the same route we did….they already have unions, but at the moment they are eager to get rich and far less concerned about social amenities.

            Don’t talk to me about toasters please, and kindly remember China has a space program…..they are not low end, they are doing all of it.

            Globalization has been going on since 1989 in the current era. The crash of the USSR producing another major recession, and then the rise of China.

            All of this is now meeting new technologies….robots, and additive manufacturing. The world is changing massively and rapidly

          • How happy are the Chinese, really? Usually happiness is measured in things like freedom and high living standards, which the average Chinese person doesn’t have. Chinese workers have been known to commit suicide because their work schedule is so grueling.

            The reality is China is a totalitarian oligarchy with very low social mobility. They certainly make high-tech products like HDTVs. But they are using technology developed in other countries. Western countries have high levels of productivity because they are democratic meritocracies with high social mobility utilizing talent the best. The high-end of the value-added spectrum is innovation-based. Which is why the US designs iPhones and the Chinese make them; it’s also why US productivity is 10 times what China’s is.

            It takes a lot more bridging the productivity gap than building sweatshops. The BRIC countries have a long way to go; and not all of it will be smooth sailing.

            We are in a economic quagmire similar to the Great Depression which was caused when a stock market bubble burst. This time it was caused by a US-housing and financial-market bubble. Last time we solved the crisis and created modern living standards in the post-war era.

            BTW, Russia suffered a great depression when it adopted free-market ideology (“Washington Consensus”) after abandoning communism. If it had adopted the northern European mixed-market model it would not be a BRIC country today; it would be a democratic developed nation…

          • The Chinese are VERY happy….it’s a different culture, and they don’t see or measure things the way you do.

            China still has peasants, and they live in utter poverty…..which is why they go off to the big cities and line up outside those factories trying to get a job.

            Then you try and compare that to Joe Lunchpail living here who’s had a good union job wage over 3-4 generations? [We've always used technology developed in other countries btw]

            No, the west doesn’t have any great level of productivity either, although some are better than others. We are not remotely meritocracies, or innovation based.

            Individuals create iPhones etc….others, no matter the country, are factory workers.

            Our economic quagmire wasn’t caused by any stock market/housing crisis nonsense. A few houses in the US are nothing in a global economy….they just got hit in the crash.

            The industrial revolution in the west started in 1750…..it didn’t start until the 1990s in China…..we are just all on different timelines.

            Eventually it’ll be a level playing field….but not yet.

            As to Russia, they didn’t adopt any free market ideology….they simply crashed and floundered about. Had Clinton helped them at the time, they would be better off now, and so would the world…..but he didn’t. Neither did we.

  2. Like Uncle Milty said, there is no free lunch. A big trade deficit essentially means a country is consuming more in imports than it is earning with exports. Where does the money come from? It has to come from somewhere.

    The most likely answer is debt.

    If one checks out the bankrupt US PIIGS (100% debt/GDP club) they all ran massive current account (trade) deficits before the debt crises came.

    If one checks out Canada’s recent history, we ran huge -3.5% GDP trade deficits in the early 1990s. Then came the massive budget deficits. During the Chretien-Martin era, we produced 2% GDP trade surpluses and the budget balance turned to big surpluses.

    Since Harper came to power, the trade balance has plummeted to -3% GDP (3 years in a row.) And what’s happening with budget balances? ON has a huge deficit problem. The federal surplus is gone and Harper is gutting essential services to try an eliminate a big deficit.*

    So in short: big trade deficits are not sustainable; trade balance is best; trade surplus is better if you have a debt problem: helps pay the bills.

    *The real federal budget numbers are a mystery. Harper has been refusing to release public budget documents since 2010. The Budget Officer he appointed is now suing for access. When Flaherty was finance minister in ON, he said a $5.6B deficit was a balanced budget… So’ll we’ll need a new government before finding out the actual numbers…

  3. The first Stats Can link has a summary that suggests the numbers (imports/exports) are very sensitive to energy products.

    And today’s front page story on the G&M “U.S. boom in oil production spells peril for Canadian crude” suggests not such a rosy future, either.
    http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/us-boom-in-oil-production-spells-peril-for-canadian-crude/article4535525/

    I could say a whole lot more. I won’t.

    • This is certainly related to the Dutch Disease: foreign investment in the oil sands reduces the current account balance and puts and upward pressure on the dollar; the rising overvalued dollar kills value-added exports and tourism; this kills hundreds of thousands of jobs; tax revenues fall; governments go into deficit.

      Canadians are also amassing record levels of personal debt supporting the imports. When we begin to pay down our debts, this will certainly affect GDP growth. GDP growth is already anemic: 2.4% in 2011, forecast lower over the next 3 years. Forget the eurozone crisis and the US fiscal cliff; the Canadian economy has plenty of its own weaknesses to worry about…

      Suffice it to say, going all-in on resources in the 21st century is not exactly the smartest wager…

      • Two things kill major capital investment in the O&G sector:

        1)high capital costs
        2)uncertainty over prices

        Already have #1. Increasingly having #2.

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