Bryan Caplan  

What If Fama Was a Protectionist?

Fama and Fiscal Policy... "30 Rock" Highlights...
Here's a Fama-flavored argument for protectionism.

GDP = Consumption + Investment + Government Spending + Net Exports

Net Exports = Exports - Imports

The larger Imports are, the smaller Net Exports are, and the smaller GDP gets.

Therefore, Imports reduce GDP, and keeping out foreign products will raise GDP.


OK, now find the flaw.

Update:  The answer is that when Imports go up by $X, Consumption (or possibly Investment or Government Spending) automatically and by definition also rise by $X.  Congrats to everyone who got this right.  The rest of you are thinking too hard - this is accounting, not philosophy!

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COMMENTS (24 to date)
Falcon writes:

Exports will also fall when trade partners enact counter-protectionist measures.

MikeP writes:

Consumption includes Imports with a positive sign.

Brian Shelley writes:

Net foreign investment, if included in I, should perfectly offset trade balance (Exp-Imp).

Tom writes:

A Hazlitt-flavored argument would say that exports are the price we pay to get imports. So a reduction in our exports would generally lead to a reduction in our imports. On the flip side, if we kepted foreign products out they would not be able to pay for our exports. A reduction in imports will lead to a reduction in exports. Net exports would get smaller and approach zero.

But one should also remember that trade is beneficial to those who engage in it. By reducing the amount of trade you reduce the welfare gains to those who engage in it.

Additionally, I would say if protectionism was truly beneficial, why stop at raising national GDP by closing our borders to imports? Each state could increase its state GDP by closing its borders to other state's imports. Each county within each state could increase its county GDP by closing its borders. Each city....

zanon writes:

No error.

Imports are better than exports. Terms of trade matter, and it's better to get real stuff and give paper than the other way around.

Caliban Darklock writes:

A rather more subtle point:

If the government simply BUYS all imports, government spending rises by the exact amount imports have reduced net exports, and you have a zero-sum situation. Buy at a premium - paying more than the market price - and you've actually increased GDP.

If the government then gives those imports away to large corporations who resell them, consumption goes up, and GDP rises again. Pay them to take the imports, and government spending rises, so GDP rises some more.

This creates an incentive for corporations to increase imports, i.e. invest in foreign companies - increasing investment, and GDP with it. The higher the premium paid for imports, and the more you pay corporations to take them, the greater the incentive.

So the obvious strategy to maximize GDP is for the government to buy everything at the highest possible price, then pay people as much as possible to take it away from them and sell it themselves on the open market. Choice is unaffected.

Zac writes:

The only reason you subtract imports from GDP is because imports are included (with a positive sign as MikeP pointed out) in C, I, and G and you want to avoid counting foreign supply in domestic product.

I think its an astute analogy with Fama's use of the accounting identity to show that a government deficit crowds out private investment and does not raise output.

Steve writes:

Gross Domestic Product (GDP) is not really gross, it is net.

The C+I includes the consumption and investment (i.e. purchase of capital goods)of imports. However, at the time goods are imported we do not know how the imports will be used.

For example, the purchase of a computer can be either consumption or investment depending on whether you are a household or a business.

In order to avoid double-counting, imports are subtracted from the total.

If imports are less, then so are C+I.

Mike Griswold writes:

Presumably goods that are imported are lower cost substitutes for domestic consumption or investment spending, which would free up real capital for other purposed and increase real GDP. This is why a world with fixed money and increasing productivity (some of which would come from trade) has a natural state of nominal deflation.

El Presidente writes:

Flawed assumption: More is better.

The size of GDP is less relevant to the wellbeing of individuals than the utility they receive from the output they consume. Achieving any level of utility at lower GDP means also (presumptively) achieving it at lower cost and thus greater efficiency with respect to labor. There is no particular reason why a larger GDP is, de facto, desirable. What should matter is whether the particular level and composition of output achieved efficiently meets the needs of the economic participants. The whole of output, like each piece of it, has declining marginal utility because it requires the expenditure of labor, if nothing else, to produce.

That said, where trade is concerned, the equation must take into account the welfare of both the domestic and foreign economies in order to determine whether an efficient solution has been reached. It is not a complete analysis if it is conducted from only one side. It thus cannot tell us if this is an efficient pattern of behavior, much less a beneficial one.

Jason writes:

GDP is a statistic, and non-economists derive little utility from consuming this statistic.

Bob Murphy writes:

My favorite trick in this context is to "prove" that rising depreciation will boost GDP. So gov't should pass a law punishing truckers for changing their oil.

Robert Badzinski writes:

Simple merchantilism. This was essentially the question that Adam Smith raised - while England became the leading exporter of goods the overall standard of living in England did not get any better. The problem is that exports reduce consumption at home. You can't consume what you sell elsewhere. So even if income increases - three is nothing to spend it on (think about Japan since the 1990's). Ultimately the focus on exporting while reducing imports means that individuals will pay more for scare goods. I think economist call that inflation.

GabbyD writes:

re-arranging, we have:

Y-C-G-I=NX=CA, where CA is the current account

S-I=CA, A higher CA means S>I, which can come either from a shrining in I or an increase in S. An increase in S can come from either an increase in Y, lower C or lower G.

hence increase in Y is not necessarily true.

Student writes:

I agree with Tom.

Is this correct?

Grant writes:

Importing goods is the same as exporting dollars. Those dollars must eventually be spent in your country, increasing exports.

This is more or less the same thing Tom said, I think.

The problem is what the problem usually is with Macro: void of any causal relationship.

The GDP equality is an ex-post. It's the sum of things that happened. It doesn't include relationships between any of the objects.

So, block imports and something happens as a result. Could be any/many things in any one of the other categories (even without reciprocal trade practices).

Block imports and there are local substitutes for products. Some are perfect substitutes, many are imperfect. Regardless, you have an increase in cost, either due to a decrease in quality or an increase in price due to a decrease in quantity, or some other cost I can't think of. Dollars spent may (or may not) be equal, but costs increase, therefore causing other crappy things to happen (general increase in cost of living, lower wages, lost jobs, etc) which reduces GDP.

Lower costs increase GDP, increased costs decrease GDP.

Or think about what happens to the other side. We don't import, they can't buy as much of our imports.

"priceless" as the term has been used.

Captain Awesome writes:

There is no flaw, only no point. GDP is one measure of well-being. A measure of well-being on the personal level is disposable income, and let's call that all income after what's spent on Food, in which case: DI=disposable income, Y=personal income, and F=cost of food, so DI=Y-F.

Clearly, decreases in F will raise DI, but so what? You still need to eat.

Jody writes:

The map is not the territory.

Matt Nolan writes:

"The problem is what the problem usually is with Macro: void of any causal relationship."

I wouldn't say Macro is void of causal relationships - I'd say some macroeconomists simply ignore them when it suits their argument.

That is why is post is so good - it clearly indicates that an identity doesn't mean much unless you understand the define the relationship between the variables by making a fallacious argument (namely it implicitly assumes that consumption and investment are not a function of imports, when in fact they are).

Matt Nolan writes:

"namely it implicitly assumes that consumption and investment are not a function of imports, when in fact they are"

Ummm, change that to related to instead of a function of - I got the causation the wrong way round there methinks :)

R. Richard Schweitzer writes:

Did I miss something 60 odd years ago at Uva?

When Imports Exceed Exports, the balance goes to investments. Thus GDP by that formula will not decrease.

Go back and review the writings of Colin Clark.

MikeP writes:

The bottom line is that that this is gross domestic product -- i.e., things produced domestically. Any simple identity such as this must find the contribution due to Imports to be zero.

The most natural identity for GDP would have Exports on the right side, and the other terms would include domestic production only. The only reason this identity has Net Exports on the right side is that the other terms are gross terms that do include Imports.

R Richard Schweitzer writes:

Now consider another aspect:

Given the statistical definition of GDP,what is the effect when U.S. Investments abroad exceed foreign direct investments into the U.S.?

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