Machlup on Balance-of-Trade Numbers

by Don Boudreaux on October 22, 2011

in Balance of Payments, Trade

Among the many pieces of good fortune that have blessed my life was learning international economics, during my very early 1980s grad-student days at NYU, directly from Fritz Machlup.  And one of Machlup’s many superb contributions to economics is his 1964 essay “The Mysterious Numbers Game of Balance-of-Payments Statistics.”  (My colleague Dick Wagner recently reminded me of this article.)  With characteristic thoroughness and clarity, Machlup explains the relevance of the fact that international-trade and -finance accounts are not facts of nature like the speed of light or the atomic weight of lithium but, rather, conventions that reflect human decisions (1) to classify and measure the monetary consequences of certain exchanges (here, particularly ones that cross political borders) and (2) about how to classify and measure these exchanges.

To understand the significance, therefore, of, say, a current-account deficit for some period of time requires an understanding of the reasons – the theory – that guided the decision to classify X exchange in one way rather than another way.  Here’s Machlup:

The allocation of an individual item to a particular account is a matter of judgment, and the arrangement of particular accounts as between balance and offsets is a matter of economic theory, or at least a matter of interpretation of observations in light of theory [p. 142].

Machlup then chose a (then) relatively recent year – 1951 – to show how different classifications by different agencies (e.g., the I.M.F. and the U.S. Department of Commerce) can lead to strikingly different dollar figures.

The variety of figures supposedly standing for a very concrete experience, namely, the balance of payments of the United States in the year 1951, is impressive.  The range is enormous: from a surplus of over $5 billion to a deficit of about $1 billion.  Let us note that this is the sort of thing that so many people apparently seek when they say, “let us look at the facts”; these are the “empirical data,” the “records of observation,” which are taken as established facts and are to be explained with the aid of theory or, according to some, are supposed to suggest theories, or to test and verify theories.  It should be understood, however, that these so-called observations, data, or facts really presuppose and contain a substantial amount of theory and that changes in the theoretical presuppositions or preconceptions may result in drastic changes in the observations, of the empirical data, of the supposedly stubborn facts [p. 147; original emphasis].

There may well be good reasons for government to measure, say, the total dollar volume of a country’s imports and exports of goods and services during a year.  (Or, by the way, there may not be a good reason to do so.  Choosing to measure such a thing itself is an exercise in theory, or reflects some theory, whether or not the decision-makers are consciously aware that that is what they are doing.)  Just because, however, measuring the annual dollar value of imports and exports of goods and services is justified by reason A (but what, exactly, should be classified as “imports,” “exports,” “goods,” and “services”?), it does not follow that this measurement would have been justified by reason B.  That is, perhaps (say) domestic business people gain on net from knowing such numbers; it does not necessarily follow that these numbers are relevant for economic theory.

As readers of this blog are all too aware, I loathe the common misunderstanding – even by many economists – of the “trade deficit.”  Machlup’s superb essay points to one reason for my reaction.

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muirgeo October 22, 2011 at 10:13 am

In 1951 our balance of payments could have been anywhere from a surplus of $5 billion to a deficit of $1 billion but that years GDP was up 7.7% after having gone up 8.7% the year before.

Since trade deficit correlates well with true productivity when we become more balanced that is when you will see our economy come back.

Plus the numbers Don accepts without question on manufacturing productivity are those mis-measurements of real concern.

Martin Brock October 22, 2011 at 10:16 am

Read Machlup again.

Greg Webb October 22, 2011 at 12:27 pm

He still won’t get it.

kyle8 October 22, 2011 at 11:06 am

Guess what? We will NEVER see those kind of growth rates again, not unless we are engaged in another speculative bubble fueled by money printing.

Those were very special circumstances caused by the fact that we held the lions share of all heavy industry from 1945 until about 1962.

Trying to base any policy on those unique circumstances is just ignorant.

Invisible Backhand October 22, 2011 at 11:10 am

China is seeing those kind of growth rates…and higher. Those circumstances aren’t as very special as you think.

jjoxman October 22, 2011 at 12:10 pm

So you trust the Chinese government do you? They don’t have any reason to falsify or otherwise mis-measure their GDP growth rates, do they? Heavens no! They just like having whole cities with 33% occupancy rates.Well, that’s those crazy Easterners for you.

Greg Webb October 22, 2011 at 12:25 pm

The Communist Party of China has a history of lying about China’s economic condition. Remember their sales puffing during the Cultural Revolution and Mao’s Great Leap Forward. Also, China Is undergoing a speculative real estate bubble and is currently subsiding the world with its exports (thus making the country poorer). The Chinese communist elite do this to stay in power but, like Japan, the speculative real estate market will go bust and its export-driven economy will run out of steam when the subsidies stop. Then, there will be another revolution.

Leonardo T. October 22, 2011 at 1:54 pm

I believe the chinese real state market will take a while to go bust because it has been driven by different circunstamces than the US housing market was.
Chinese are opting for real state as a store of value, aiming for a very long run, precisely because the State-led financial sector is ripping off chinese savers, stocking cash under low rate US bonds to manipulate exchange rate while devaluing their own currency. In addition, there’s plenty of housing deficit in China.

kyle8 October 22, 2011 at 3:10 pm

China may be exaggerating their growth but that is besides the point, IB is correct in so far that China has had very high growth rates, see my explanation below.

Greg Webb October 23, 2011 at 1:08 am

Leonardo T., I did not say the Chinese real estate market was about to go bust. It normally takes some time, especially when government policies encourage such speculation just like what happened in the US.

Greg Webb October 23, 2011 at 1:12 am

Kyle8, China fudges on its economic data so we don’t know exactly what is going on. And, the US does not try to fudge on its economic data and you see how accurate it is. The real point is that GDP is not a good measure of the wealth of the people living in China. Currently, the Chinese government is exporting their people’s wealth by subsidizing its exports.

Invisible Backhand October 22, 2011 at 2:28 pm

Seriously jjoxman and Greg Webb? You think the only source to find out China’s growth rate is to politely ask the Chinese what it is?

jjoxman October 22, 2011 at 4:48 pm

Where’s your data? What is the primary source?

Greg Webb October 23, 2011 at 1:15 am

Yes, Irritable Bowels. Can you support otherwise?

kyle8 October 22, 2011 at 3:08 pm

NO, you are wrong, China’s growth rates are also very special, they are the growth rates of a newly industrialized economy. Once they begin to slow down then China will never again recapture those growth rates. Same with India and other recently industrialized economies.

Darren October 22, 2011 at 5:41 pm

It seems to me one advantage China has is it will be able to avoid mistakes made by other currently developed nations that have already gone through the same phases of development.

kyle8 October 22, 2011 at 9:14 pm

possible but history shows that people often repeat their own mistakes or the mistakes of others over and over again.

Leonardo T. October 22, 2011 at 11:09 am
Martin Brock October 22, 2011 at 10:13 am

I was just making the same point under Global Cooperation, and you’re right to loathe the conventional spin on “trade deficit”, but the counterspin on “capital account surplus” is also suspect, because conventional measures of “capital” in this account do not effectively distinguish productive investment from rent seeking. At the level of “international trade”, we’re dealing with incredibly vague aggregates. Maybe some of these aggregates are measurable and meaningful within some theory corresponding well to reality, like temperature and the average kinetic energy of particles in an ideal gas, but we must be extremely skeptical of these assumptions.

vikingvista October 22, 2011 at 6:02 pm

“but the counterspin on “capital account surplus” is also suspect, because conventional measures of “capital” in this account do not effectively distinguish productive investment from rent seeking.”

You are missing the point of the counter argument. Revealing that unseen part of the accounting is meant to show tradedeficitistas that they don’t know what they are talking about, or that they have been duped. The result should be a loss of political interest in BoP, not the use of BoP to support other theories. It is just as mistaken to use the BoP to support a theory of rent-seeking.

Forget BoP. Simply argue against rent seeking, because the consequences of rent seeking are adverse, regardless of anything to do with international trade.

Martin Brock October 23, 2011 at 10:11 am

You are missing the point of the counter argument.

I explicitly concede the point of the counter-argument by writing, “you’re right to loathe the conventional spin on ‘trade deficit’.” You then ignore my point.

I do argue against rent seeking, but I don’t ignore rent seeking when discussing the effects of trading entitlement to rents with rent seekers. Trading these rents is not comparable to trading other things.

vikingvista October 23, 2011 at 12:14 pm

Your point, and your explicit claim, is that the counterargument is suspect. It is not suspect, unless you yourself miss the point of the counterargument. That’s *my* point, which *you* ignore. I am well aware that you criticize rent seeking outside of the BoP context. That, of course, is irrelevant to my point.

Martin Brock October 23, 2011 at 10:21 am

Suppose we have a totalitarian, central planning apparatus. We select the planners in completely honest, biannual plebiscites with universal suffrage. The planners control every factor of production without the benefit of market prices, with a single exception. Subjects may trade their votes in the plebiscites for anything else they can obtain from the totalitarian state, and the state does not regulate these transactions in any way.

How much difference does this freedom to trade make? I suppose it makes very little difference, because my critique of central planning involves essentially utilitarian, Hayekian arguments concerning the flow of information in capital markets.

vikingvista October 23, 2011 at 12:24 pm

Why would those people trade? Because they believe it would improve their condition compared to NOT being able to do so. So, yes, it would be an improvent. It may not be significant to you, but it is demonstrably significant to those who choose to partake in those trades.

If you were to say that you can’t get excited about some miniscule improvements, or that you don’t care if improvements occur for others but not you, that would be one thing. But to theorize that such improvements (following some increased liberty) do not exist at all is simply incorrect.

W.E.Heasley October 22, 2011 at 11:09 am

“But just because measuring the annual dollar value of imports and exports of goods and services is justified by reason A, it does not follow that this measurement would have been justified by reason B”. – Don Boudreaux

Then we have reason P [protectionist reason]: The allocation of scarce measurements with alternative fallacious uses.

dsylexic October 22, 2011 at 11:21 am

to paraphrase the great dick cheney, ‘deficits dont matter’ :p
well atleast trade deficits

ELO October 22, 2011 at 12:11 pm

Don – I heard somewhere that when J. Paul Getty died in 1976 it caused a huge capital outflow in the month of June since he was a British citizen and all his heirs were U.S. citizens. It strikes me that this illustrates the point of the insignficance of these measures.

muirgeo October 23, 2011 at 1:50 am

“One recurring delusion in the controversy over America’s free-trade-induced trade mess is the idea that our gigantic trade deficit, which fluctuates around $500 billion a year, somehow “doesn’t matter.””

Ian Fletcher

Greg Webb October 23, 2011 at 1:55 am

It only matters to crony capitalists who want the federal government to intervev in the markets through subsidies and regulations to limit competition and ensure the crony capitalists’ profits.

muirgeo October 23, 2011 at 8:33 am

Yes Greg…. which is exactly what our trade agreements are fdoing. Instead of protecting American business stateside they now recieve protection for their factories that are in China.

Does that make sense to you? You see how slick these corporatins are? If you support our trade agreements as they are YOU are a supporter ofmassive rent seeking that is destroying this country.

Greg Webb October 23, 2011 at 10:56 am

George, that’s wrong. Certain American businesses do not want any competition because that makes making a profit much harder because then they have to serve the needs and wants of the consumer. Those businesses are crony capitalists who get corrupt politicians to enact nice-sounding laws to limit competition so they can take advantage of consumers by essentially saying “take it or leave it” on poor quality merchandise at high prices.

Leonardo T. October 23, 2011 at 10:14 am

You shouldn’t be concerned with trade deficit. Trade deficit has been a free lunch for americans since Bretton Woods and the abandonment of the gold standard. It has nothing to do with “free trade”, but with fiscal deficit and the role of the dollar as a fiat global and reserve currency.

Historical data is clear about the positive correlation between GDP growth and trade deficit.

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