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An editorial writer for the Washington Times yesterday made a fundamental error — although, in his or her defense, it’s a mistake more common than pigeons in Central Park.
Worrying about the so-called ‘twin deficits,’ this editorialist wrote [2] that ""rising trade deficits, as a simple arithmetic fact, exert a negative effect on the economic growth rate."
This assertion is wrong, and the fact that it is wrong should be obvious upon just a bit of reflection.
I know (I think) what the editorialist means — namely, that GDP [3] is calculated by subtracting any excess of imports over exports from domestic consumption and investment expenditures. So, in the familiar equation [GDP = Consumption Expenditures + Investment Expenditures + Government Expenditures + (Exports – Imports)], the greater the excess of imports over exports, the lower the calculated GDP figure.
But whatever dollars foreigners don’t spend on American exports, they invest in dollar-denominated assets. So ask: why would such investment (which is the flip-side of the so-called ‘trade deficit’) hamper economic growth? Isn’t such investment likely to promote economic growth?
Put differently, if we correctly recognize that American economic growth is likely enhanced if Mr. Davis of Dallas saves and invests this savings in dollar-denominated assets, why do we suppose that if Mr. Shi of Shanghai does the very same — spends his dollars not on consumption goods but, instead, invests them in dollar-denominated assets — economic growth is hampered?