April 11, 2011 1:26PM

Challenging the Trade‐​Deficit Orthodoxy

Tomorrow morning the U.S. Commerce Department will release its monthly report on U.S. exports, imports, and the trade balance. That’s a safe bet, barring some unforeseen calamity. An almost equally safe bet is that if the trade deficit in February shrank, it will be hailed as good news for the economy, and if the deficit grew, it will be greeted as bad news.

Either way, the consensus will be wrong. As I explain in a Cato study released today, the prevailing creed that “Exports are good, imports are bad,” and therefore a rising trade deficit is a drag on the U.S. economy, is wrong in theory and in practice.

The creed is wrong in theory because imports do not “subtract from growth in GDP,” as a simplified version of Keynesianism would lead us to believe. In fact, imports are not a factor in calculating GDP, which after all measures gross domestic product. Nor do imports represent a “leakage” of demand abroad. The same dollars that flow abroad to buy imports quickly return to purchase either U.S. exports or U.S. assets.

It’s wrong in practice because the past 30 years show no negative effect of a rising trade deficit on U.S. economic performance. In fact, my analysis finds that

Since 1980, the U.S. economy has grown more than three times faster during periods when the trade deficit was expanding as a share of GDP compared to periods when it was contracting. Stock market appreciation, manufacturing output, and job growth were all significantly more robust during periods of expanding imports and trade deficits.

You can read the full study here: “The Trade‐​Balance Creed: Debunking the Belief that Imports and Trade Deficits are a ‘Drag on Growth.”