Peter Navarro, Harvard Ph.D. Economist, Trade Warrior

Peter Navarro, director of the newly-established White House National Trade Council, gave a speech last week to the National Association for Business Economics, which he condensed into an opinion piece for the Wall Street Journal. The analytical errors and the fallacies portrayed as facts in that op-ed are so numerous that it is bewildering how a person with a Ph.D. in economics from Harvard University—and a potentially devastating amount of influence within the White House—could so fundamentally misunderstand basic tenets of introductory economics.

Almost every paragraph in the op-ed includes an error of fact or interpretation.  I’ll focus on a few, deferring to others’ noble efforts (Phil Levy, Don Boudreaux, Linette Lopez) at wading through the rest of Navarro’s confused and misinformed diatribe.

Consider Navarro’s portrayal of the national income identify as an economic growth formula.  He claims:

The economic argument that trade deficits matter begins with the observation that growth in real GDP depends on only four factors: consumption, government spending, business investment and net exports (the difference between exports and imports).

The sentence betrays a deep and troubling misunderstanding of the factors of economic growth. Real GDP growth (growth in the total value produced in the economy) depends on increases in the factors of production and increases in the productive use of those factors, which trade and specialization facilitate. What Navarro refers to as the drivers of growth are actually the channels that account for the disposition of our output – what we do with our output.

The national income identify is expressed as: Y=C + I + G + X – M.  It tells us that our national output is either consumed by households (C); consumed by business as investment (I); consumed by government as public expenditures (G); or exported (X). Those are the only four channels that can account for the disposition of national output.  We either consume our output as households, businesses and government or we export it.

Imports (M) are not a channel through which national output is disposed.  We don’t import our output. But M appears in the identity and is subtracted because we consume – as C, I, and G – both domestically produced and imported goods and services.  If we didn’t subtract M in the national income identity, we would overstate GDP by the value of our imports.

But Navarro believes – or wants the public to believe – that the national income identity is an economic growth formula or function, where Y (GDP) is the dependent variable, C,I,G, X, and M are the independent variables, and the minus sign in front of M means that imports are inversely related to (or detract from) GDP.  That’s wrong and a Harvard Ph.D. economist should know that.

Reducing a trade deficit through tough, smart negotiations is a way to increase net exports—and boost the rate of economic growth.

The evidence is overwhelming – month after month, quarter after quarter, year after year – that the trade deficit and GDP rise and fall together. The largest annual decline in the trade deficit ever recorded was between 2008 and 2009, during the trough of the Great Recession. The largest annual increase in the trade deficit occurred between 1999 and 2000, when the economy grew by 4.7 percent – the strongest annual economic growth in the past 33 years.

When the economy grows, households, businesses, and government tend to spend more, and they spend more on both domestic and imported goods and services.  When the economy contracts, there is less spending on both domestic and imported goods and services.  For the past 42 straight years, the United States has registered trade deficits.  In 40 or those 42 years, annual changes in the value of imports and the value of GDP moved in the same direction.

Navarro either believes, or would have the public believe, that imports detract from GDP and that our national security requires all of the gears of U.S. trade policy be put to the service of eliminating our trade deficit. This is a fool’s errand and a Harvard Ph.D. economist should know that.

Suppose America successfully negotiates a bilateral trade deal this year with Mexico in which Mexico agrees to buy more products from the U.S. that it now purchases from the rest of the world. This would show up in government data as an increase in U.S. exports, a lower trade deficit, and an increase in the growth of America’s GDP.

First, note the implication that Navarro expects U.S. trade agreements to include commitments by our trade partners to meet certain outcomes – “…Mexico agrees to buy more products from the U.S.”  This kind of managed trade is unprecedented and utterly defies the purpose and spirit of trade liberalization.  Trade agreements are intended to reduce barriers to competition, not to preempt competition by anointing the winners at the outset.  But, okay, the administration believes it has a mandate to blow things up on the trade front.

But, here’s another problem with Navarro’s scenario.  If Mexico agrees to buy from the United States some of what it now purchases from other countries (Navarro’s key to decreasing the bilateral trade deficit with Mexico), then won’t those other countries have fewer dollars with which to purchase U.S. exports?  Wouldn’t that, all else equal, increase bilateral trade deficits or reduce bilateral surpluses the United States has with those other countries?  Yes and yes.  What Navarro is suggesting is a game of trade policy whack-a-mole. Bilateral trade accounting is utterly meaningless, and a Harvard Ph.D. economist should know that.

Now, what about the investment term in the GDP equation? When U.S. companies offshore their production because of America’s high taxes or burdensome regulations, that shows up in government data as reduced nonresidential fixed investment—and a growth rate lower than it would be otherwise.

Intentionally or not, Navarro is presenting only part of the picture in this example.  If a U.S. company completely shutters operations in the United States and moves those operations offshore, then the expenditures of that business that registered this year in the investment term of the national income identity will not register next year.  Granted.  But Navarro’s example is unrepresentative of the true nature of offshoring, outsourcing, or – as it is called by the Bureau of Economic Analysis – outward foreign direct investment.

First, while shuttering a factory in Indiana and moving the operation rafter-by-rafter, bolt-by-bolt down to Mexico to produce and export back to the United States is the common portrayal and popular perception of outsourcing, such examples are highly unrepresentative of the nature and purpose of outsourcing.  Even though such examples capture the public’s attention, they are the exception and not the rule. 

At the enterprise level, outsourcing and domestic production are not substitutes.  They are complements.  The BEA data reveal that when U.S. multinational corporations invest more in foreign operations (production, assembly, R&D, hospitality service provision, etc.), they invest more in the parent operations at home.  My research shows positive correlations between a U.S. parent companies’ and its foreign affiliates’ capital expenditures (i.e., when a U.S. MNC spends more/less on capital investment in its foreign affiliates, it spends more/less on capital investment in its parent operations), value-added, R&D expenditures, compensation, employment, and compensation per employee. 

The data suggest that when companies shift particular operations abroad, resources are freed up to invest in other company operations stateside.  When U.S. multinationals expand their operations abroad, greater demand is placed on headquarters and other complementary operations in the United States, which results in new domestic investments as well.

Meanwhile, Navarro’s example precludes discussion of the opposite of outsourcing – insourcing.  The trade deficits Navarro so desperately wants to curtail are the sources of massive amounts of inward foreign direct investment.  When we run trade deficits, foreign companies have more resources to invest in U.S. operations, which increase the value of the investment component of the national income identity.  In 2016, the stock of foreigners’ (mostly Western Europeans, Canadians, and Japanese) investments in U.S. manufacturing was valued at $1.2 trillion – more than twice the amount of FDI in Chinese manufacturing.  And foreign companies operating in the United States directly employed over 6.4 million American workers.

When writing about the effects of trade and investment on GDP, it is inadequate and misleading to focus on one part of one side of the ledger. A Harvard Ph.D. economist should know that.