National Income Accounting Gives a Mistaken Impression

by Don Boudreaux on October 6, 2018

in Balance of Payments, Myths and Fallacies, Trade

Here’s an admittedly too-long letter to the New York Times; the understanding that I’m trying here to articulate runs so hard against conventional wisdom that I’ve yet to find a pithier manner of expression.

Don
…….

While Greg Mankiw helpfully clarifies some confusions about trade deficits, he further fuels a confusion by repeating economists’ common claim that U.S. trade deficits necessarily reflect “dissaving” by Americans (“Surprising Truths About Trade Deficits,” Oct. 5). This claim derives from the impression, given by national income accounting, that each nation is an economic entity equivalent to – if only much larger than – a household. This impression is mistaken.

The economic activity and net worth of each household is determined exclusively by the economic decisions of its formal members – for example, how much mom and dad work, and how much they save. And as Prof. Mankiw correctly notes, no household can long afford to spend more than it earns. The household is an entity that legally owns its net worth – which, if negative, necessarily means that the household is legally indebted to people outside of it.

In at least two subtle but important ways a nation is different. First, unlike a household, citizens of a nation are not responsible as a group for repaying any private debts that they incur. If the Mankiw household is $10,000 in the red, neither I nor any other American (other than the Mankiw household) is responsible for repaying this debt.

Second and more importantly, unlike in a household, the carrying out of the economic activities of each nation is not confined to its formal members – that is, to the political citizens of that nation.

Consider non-Americans building businesses in America. Nothing equivalent exists for households. No one outside of the Mankiw household unilaterally launches a business within the Mankiw household. Yet within the U.S. such unilateral action – which increases the U.S trade deficit – is commonplace. This reality means that the economic membership of the U.S. differs from its political membership. When non-Americans invest in America, they become economic citizens of the U.S.

When Ikea builds a store in Boston, the U.S. trade deficit rises. This fact, however, implies neither that America’s economic citizens are saving too little nor that America’s political citizens are saddled with additional debt. The savings that Ikea uses to build stores here, while not those of America’s political citizens, are those of one of America’s economic citizens; they should be reckoned as such. And when so reckoned, the value of these savings offsets the value of their contribution to the measured rise in the U.S. trade deficit. On such a reckoning, U.S. trade deficits are no longer mistakenly interpreted as being always and necessarily evidence of us Americans spending more than we earn.

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030

……

I am not 100 percent sure that I’m correct here, but I have a very strong sense that I am. The fact that my point runs utterly counter to conventional wisdom, even that held by very good economists, should warn you to dismiss my argument and to warn me not to tread here. But tread here I nevertheless do.

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