In a recent article for the Wall Street Journal, which was itself adapted from a speech given by Navarro to the U.S. National Association of Business Economists, the UC Irvine professor went on at great length about the national income equation and how reducing imports or increasing exports, because it would add to the sum total from this accounting formula, would amount to a higher rate of U.S. GDP growth.
The relationship pretended by Navarro is, of course, spurious. The formula he was referring to is a simple identity representing GDP by component of expenditure:
Y = C + I + G + X – M,
where Y is income, C is consumption, I is investment, G are government purchases, X stands for exports and M for imports. What this formula is telling us is that the sum total of a country’s annual output is equal to household consumption, business investment, government expenditures and exports, minus the amount that is consumed or invested but not produced domestically, namely M. The only reason why M is subtracted from the equation is that imports are already included in consumption, investment and government spending.
The formula above is intended to account for the annual output of an economy, but it tells us nothing about the stock of wealth in that economy, nor about the rate of growth of GDP. In other words, if we reduced M we would also have C, I and G fall, and the economy would be no bigger as a result.
Dan Ikenson at the Cato Institute has dealt at length with the theoretical objections to what cannot really be called economics but is better described as ‘Navarroism’ or ‘Trumpism’ (though the latter might be used to refer to a range of other erratic and suspect behaviours). Here I intend to give some empirical texture to the rebuttal, by showing the relationship between current account deficits – the number that Navarro thinks we should be worried about – and growth rates – which Navarro claims would increase if the U.S. cut said deficits – in four representative countries.
The four charts below depict current account deficits and growth for the U.S., Mexico, the UK and Germany, from left to right and top to bottom. The reason I picked those countries is that they are the most likely to be mentioned in present discussions around trade. Furthermore, the UK is often said to suffer from a chronic current account deficit, whilst Germany is increasingly chastised for its large current account surplus which is alleged to benefit her at the expense of other Eurozone economies.
A number of observations can be made in light of the data above. Firstly, rather than there being a negative relationship between current account deficits and growth rates, the arrow seems to point in the opposite direction: the larger the deficit, the higher the growth rate. This should not come as a surprise. The healthier an economy, the more likely households are to spend and businesses to invest, using both domestic and foreign goods and services in the process. Moreover, a growing economy attracts foreign capital and, since the current account balance is always matched by a balance with the opposite sign on the capital account, this means that, the more foreigners invest in a country, the more that country will import in goods and services.
Secondly, current account deficits (surpluses) are not associated with consistently low (high) rates of GDP growth. The U.S. recorded periods of high growth at a time when its current account deficit was increasing, whilst German GDP has grown only modestly in the aftermath of the sovereign debt crisis in Europe, even as its current account surplus burgeoned. Thirdly, and perhaps most surprisingly, Trump’s nemesis in the form of the U.S.’s southern neighbour has itself been running persistent current account deficits over most of the period recorded by the OECD (where the figures come from). Given Trump’s rhetoric depicting Mexico as living at the expense of the U.S. worker, this may come as a shock, but when we consider that the country has seen record foreign investment inflows since the mid-2000s – indeed, since the entry into force of NAFTA in 1994 – it is only natural that the current account deficit would widen commensurately.
The upshot is that Peter Navarro, ominously the chief economic advisor to President Trump, is wrong – very wrong – on the relationship between deficits in traded goods and services, and the growth rate of the U.S. economy. The historical record suggests that the relationship is almost exactly the opposite of the one he posits. That he is a graduate of Harvard and a professor of economics makes one wonder whether he is simply mistaken or attempting to mislead the public. After all, it is difficult to stand out in a discipline as crowded and filled with brilliant people as economics. But if one happens to be the one trade-sceptic in the whole pack, one might well gain the favour of a U.S. President who, more than any other since the time of Herbert Hoover, is led by protectionist and nativist instincts.
As Hayek warned in The Road to Serfdom, in government, the worst often get on top.