GDP, Free Trade, and Prosperity

In my recent social media discussions on the subject of free trade, a certain thread of argument related to GDP has become more common. The argument, such as it goes, asserts that international trade is not very important as a component of GDP. The net impact of trade is a small impact on GDP, with imports and exports generally “balancing” each other out, leaving just a few percentage points either way. Trade (and immigration) restrictions seem like a small price to pay, economically, according to this framework.

Despite its superficial validity, this is a wholly erroneous way to look at the problem of generating prosperity and rests primarily on two economic fallacies. The first is the use of the GDP aggregate as a viable measure of national prosperity, which has been heavily criticized in other contexts.

Many criticisms of the concept of GDP focus on the concept’s formulaic assumption that government spending is inherently productive. This assumption has resulted in many errors, including economists and laymen alike in the 1970s and 80s looking at the growing GDP of the USSR and assuming the Soviets would economically overtake the West as a result. To a lesser degree, the same fallacy has driven concerns about China’s growing economy in the last couple of decades. However, in the context of international trade, the aggregate GDP fails to measure human welfare in yet another way. GDP’s focus on the supposed “net production” of a country fails to see the absolute production of a country and how much is involved in trade. 

This is easiest to see with small countries, which derive their subsistence mainly from international trade. Hong Kong, for instance, had a trade-to-GDP ratio of 375 percent in 2017. One hundred eighty-eight percent of its GDP was exported out of the country and 187 percent percent was imported into it. Billions of dollars of goods flow in and out of Hong Kong every year, much of it in trade with China. Much of this trade is not in exclusive goods: roughly 8 percent of imports and exports alike are categorized as broadcasting equipment. Without international trade, Hong Kong would collapse economically; Hong Kong’s great wealth is attributable to nothing but generally free trade. Despite the fact that the net trade deficit/surplus is a small fraction of GDP, the vast majority of the economy is either producing things for export or selling imports.

This remains true of larger countries with more production that ends up in internal markets. Without international trade, which covers a trade-to-GDP ratio of 26 percent in the United States each year, the people of the US would be significantly poorer materially. It would not be a simple marginal loss around the edges, with perhaps clothing or some food items costing a bit more, but a drastic reduction in the standard of living of the average American. Those who erroneously feel they have been most harmed by international trade would, in fact, be the most harmed by its restriction, as increases in prices and supply reductions for various goods would strike them the hardest. Restricting trade with higher tariffs or import quotas might not produce an obvious effect on GDP figures, but it would make the actual prosperity of the country significantly lower.

The second error is rooted in the monetization of trade as a metric, such that, for example, exporting $100 billion of wool and importing $100 billion of computers is considered offsetting trade, missing the mutually beneficial value increases inherent to the activity of trade. Because imports are subtracted from GDP and exports are added to it, the naïve GDP approach assumes that there is little impact from ceasing them—the exports (in monetary terms) are assumed to simply replace the imports (also in monetary terms). Thereby, it seems superficially plausible that restricting or banning the import of a good would simply result in production moving “onshore” (as opposed to the “offshoring” common when production is cheaper in foreign countries). This ignores the fact that labor and capital resources have to shift to meet the demand. It is simply not the case that there can be no losses obtained by shifting production away from exported goods into industries that were otherwise imported. Sheep farmers producing wool in Ireland for export could not readily shift to producing computer equipment to make up for lost imports.

What is missed by the naïve GDP approach is the mutually beneficial aspect of trade. If I purchase a good from a Chinese company for $100, I am better off by however much I value that good over the $100 I spent. Likewise if a Chinese person buys something from an American company. The same is true of the purchase and sale of capital goods, which are bought precisely because the company buying them—in any country—considers it a mechanism to increase the value they will produce in the future by more than they’ll spend. The capital structure produced thereby is a complex web of inputs and outputs spanning national borders; while dynamic adjustment of capital interchange is constantly ongoing, knocking out pieces of it intentionally as policy makes people on both sides of the transactions worse off in a way that cannot simply be equated in monetary terms.

Exports and imports cannot be simply equated in terms of the money spent on them precisely because the value obtained by the buyers (and thus introduced into their economy) is greater than the money spent, and because the exporter has gained value by accepting the monetary income in exchange. On a broader level, total money spent is not a valid metric of value produced or obtained.

In short, GDP is not a useful measure of the material prosperity of a nation, and judging the value of free international trade by its effects on GDP is to wholly miss the benefits. We should leave off the use of aggregate monetary figures to judge the prosperity of a country and instead look to less quantifiable understandings of freedom and capacity to trade. These will prevent us from getting locked on to a measure that is increased by making ourselves, in actual fact, poorer.

Originally published at Disinthrallment.

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