July 31, 2009 3:03PM

Since When Is Plunging Trade ‘Good News’ for GDP?

This morning’s Commerce Department report on second‐​quarter GDP contained what passes for good news these days: the U.S. economy shrank at an annual rate of only 1.0 percent in the April‐​to‐​June quarter. And in the twisted logic of conventional thinking, a drastic fall in international trade was supposedly part of the good news.

An Associated Press report beautifully captures the conventional wisdom. Buried deep in the story was this gem: “An improved trade picture also added to economic activity in the spring. Although exports fell, imports fell more, narrowing the trade gap. That added 1.38 percentage points to second‐​quarter GDP.”

Behind that statement is the Keynesian assumption that exporting goods adds to GDP, while importing subtracts because every car, shirt, or DVD player we import is supposedly one less that we make ourselves. So never mind that exports have fallen sharply in the past year; imports have fallen even faster, leaving us supposedly better off.

The mistake is seeing imports as a subtraction from GDP. The fact that we import $1 million worth of t‐​shirts does not mean our GDP is therefore $1 million less than it would be if we did not import the shirts. In fact, the $1 million we sent abroad to buy the shirts quickly comes back to buy something valuable in our own economy.

The money foreigners earn selling in our market can be used to buy U.S.-made goods, but it can also be used to buy U.S. assets, such as stocks, real estate, or Treasury bonds. This investment also creates economic activity, and if the investment inflow is used wisely, it will actually raise our productivity and GDP. A rising level of trade allows us to deploy our economic resources more efficiently, boosting output and economic growth.

As I explain in a previous Free Trade Bulletin, rising imports are not a drag on growth but in fact usually signal rising demand in the domestic economy, just as falling imports are a reliable sign of slumping demand. That is why an “improved” (i.e., shrinking) trade deficit has accompanied every recent recession, including the one we’re still mired in.

If we want our economy to recover and grow, we should be rooting for more trade, not less.