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Do Imports Hinder or Help Economic
Growth?
by
Owen F. Humpage
Although Americans spent $1.3 trillion on foreign goods and services
last year, many regard imports with hostility, preferring to
“buy American.” But do imports really hurt the American
economy? This
Economic Commentary argues they do not. If anything, imports
promote growth.
Americans
generally seem confused, and even doubtful, about the value of
imports to the U.S. economy. Last year, they spent nearly $1.3
trillion on foreign goods and services, presumably prefering
these expenditures to any other use of their money. Importing
not only provided Americans with a wider array of products than
they otherwise could have enjoyed, but by stretching their budgets,
importing enabled them to buy more goods and services—domestic
and foreign—than would have been possible under autarky.
In this way, imports improved America’s collective standard
of living.
Yet, when queried about imports
in the abstract, Americans express attitudes ranging from ambivalence
to hostility. Many regard them as a necessary evil, noting with
grudging resignation that a nation cannot long export if it does
not import. Some find no fault with importing foreign products
that are not made or grown at home, but they otherwise claim
to favor a buy-American policy. Often, these people do not realize
the foreign contribution to the everyday items they buy. Most
Americans express concern about the rapid overall expansion of
imports but fail to connect this aggregate pattern to the welfare-enhancing
behavior of individuals.
For their part, economists bear
the responsibility for much of the muddle. When asked about the
economic impact of imports over the past year, a business economist
might explain that brisk gains in imports exerted a drag on overall
GDP growth. If pressed to explain their rapid rise, this same
analyst might cite—with little concern for the seeming contradiction—the
fast pace of U.S. business expansion. When asked about the long-term
impact of imports, however, a development expert, echoing Adam
Smith, might explain that they contribute importantly to the
creation of wealth. Can all these explanations be right?
As this Economic Commentary
points out, imports do not lower economic growth. Imports
and economic growth are positively correlated, with causality
running in both directions. Faster economic growth does indeed
lead to higher imports, but countries that are open to trade—imports
and exports—tend to grow faster than countries that are
closed or less accessible.
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Imports and the GDP Accounts |
Every news account that accompanies
a quarterly GDP release reinforces, or so it seems, the common
misperception that import spending lowers output. The source
of the fallacy is understandable: Imports enter the GDP tally
with a negative sign (see table 1). Because
GDP measures the overall dollar value of final goods and services
produced in the U.S. during a specific quarter or year, items
bought from abroad must be removed from the tally. In 1999, for
example, GDP was $9.3 trillion dollars, and Americans bought
almost $1.3 trillion of foreign goods. It does not follow, however,
that GDP would have totaled $10.6 trillion if we had bought only
domestic goods and services. Similarly, between 1998 and 1999,
total GDP advanced 5.6 percent while imports advanced 12.3 percent.
It is not the case, however (as is frequently claimed), that
GDP would have grown faster had people spent their incomes on
domestically produced goods instead of imports. Imports do not,
in fact, depress the GDP total because of the way they are financed.
As a nation, we pay for our imports
either with exports of our current output or with financial claims
against our future output. When exports rise (or fall) in line
with imports, GDP remains unaffected. Exports add to the output
tally—exactly what imports subtract—and net exports
(the trade balance) do not change.
Since 1992, however, exports
have fallen short of imports by a widening margin. In 1999, the
trade deficit amounted to $256 billion. When this happens, we
must finance the trade shortfall either by reducing previously
acquired claims on foreign output or by offering foreigners claims
on our future output. This is accomplished largely through the
exchange of various types of financial securities and bank accounts.
A foreigner who holds a dollar-denominated security or bank account
can eventually use those funds, plus any accrued interest or
dividends, to buy U.S. goods and services. Hence, these financial
instruments represent claims on future output. On balance, this
exchange of financial instruments creates an inflow of foreign
capital that exactly offsets the trade deficit.
Inflows of foreign capital do
not sit idle. The corporations or governments that issue the
securities and the banks that offer the deposits use the funds
to finance domestic investments, government spending, or private
consumption. All of these appear as expenditures elsewhere in
the GDP accounts. In all cases, the process of paying for our
imports contributes to domestic output. The U.S. bought $1.3
trillion of foreign goods and services last year; we paid for
these with $1.0 trillion in exports and by issuing $256 billion
in net financial claims to foreigners. The corresponding inflow
of foreign capital supported $256 billion in expenditures that
appeared elsewhere in the 1999 GDP accounts. If imports had been
lower last year, the GDP accounts undoubtedly would have had
a different configuration. Personal consumption might have been
higher, but business fixed investment might have been lower.
The $9.3 trillion nominal GDP total and the 5.6 percent nominal
GDP growth rate, however, would not have changed.
The need to finance imports with
exports that add directly to output or with capital inflows that
sustain other types of expenditures ensures that imports do not
lower GDP or its growth rate. Instead, a positive relationship
exists between imports and economic growth (see figures
1 and 2). Less certain, however, is the
direction of influence between imports and economic growth. Do
higher imports cause faster economic growth, or does faster economic
growth lead to expanding imports?
At quarterly frequencies, the
direction of causality seems to run predominantly from income
to imports, not the other way around. The intuition is straightforward:
When incomes rise, as is the case during a business expansion,
people tend to buy more domestic and foreign goods and services.
Similarly, countries whose incomes are high for other reasons
import more. Economists estimate that a 1 percent increase in
real GDP in the U.S. will lead to a 2 percent rise in U.S. import
spending.1
Nevertheless, the causal relationship
underlying import spending and economic growth is more intricate
than statistical tests of quarterly data reveal. Countries that
remove trade barriers and encourage openness gain from specialization
and from cross-border technological transfers, all of which promote
economic growth. In a recent cross-country study, economists
Jeffrey Frankel and David Romer found evidence that higher trade
contributes to long-term economic growth, after accounting for
the effect of growth on trade. Although they consider total trade
(exports plus imports), their research methodology attributes
the same response to imports that it applies to exports; that
is, imports cause economic growth.2
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Specialization and Markets |
At least since Adam Smith’s
time, economists have realized that nations grow rich through
the process of specialization and trade. The extent to which
countries can feasibly specialize in certain types of production,
however, depends on the scope of markets. Because bigger, broader
markets permit access to a wider range of goods and services,
they enable a greater degree of specialization among individual
countries.
Engaging in economic exchange,
however, entails real resource costs that ultimately constrain
the span of markets. Often, advances in international commerce
have followed innovations that reduced the cost of engaging in
trade. Globalization progressed fairly steadily throughout the
second half of the twentieth century on advances in transportation
and communications, and with a lowering of trade barriers.3
Specialization stems from two
sources, comparative advantage and economies of scale. Although
these bases for specialization have similar implications for
economic growth, they may have dissimilar effects on how growth
affects specific segments of an economy.
Nations are endowed with a diverse
array of physical characteristics, natural resources, and indigenous
human skills, which enable each of them to produce certain goods
more cheaply than others. Developing countries, for example,
tend to have a lot of low-skilled labor relative to capital and
highly skilled labor. Because the abundant factor—low-skilled
labor—is cheap to procure in these countries, they can produce
goods that require relatively large amounts of low-skilled labor
less expensively than they could produce goods requiring high
proportions of physical and human capital. Economists contend
that developing nations have a comparative advantage in the production
of labor-intensive goods and services. More developed countries,
which have a lot of capital relative to labor, tend to have comparative
advantages in capital-intensive goods. The U.S. seems to have
a comparative advantage in the production of civilian aircraft
and medical equipment because we have a lot of capital and a
well-trained workforce.4
When each country specializes
in the production of goods for which it has a comparative advantage
and trades these goods for the output of other countries, everyone
can consume more goods and services than in the absence of trade.
This process creates wealth by enabling countries to acquire
more through importation than could be attained from domestic
production. Imports, then, are key to improving standards of
living.
When specialization and trade
occur because of comparative advantage, resources and workers
are drawn into the expanding export sector and away from the
contracting import-competing sector. Since demand will be greatest
for the abundant factor—the underlying source of the comparative
advantage—the economic returns to this factor will rise
relative to the returns to the scarce factor with international
trade. Trade will consequently distort the distribution of income
in favor of the abundant factor of production. This tension can
act as a friction against the nation’s continued movements
toward specialization and trade. Owners of the scarce resource—or
owners of any resources that cannot migrate easily to the expanding
export sector—will typically object to further expansions
of international trade.5
As an explanation of trade, comparative
advantage predicts that countries will export and import distinct
types of goods; that is, we should not observe countries importing
and exporting the same (or similar) products. If the U.S., for
example, has a comparative advantage in the production of airplane
parts and medical equipment, it will never import airplane parts
and medical equipment. Economist Roy Ruffin, however, estimates
that in 1996, 57 percent of U.S. trade took place within the
same industrial classifications, rather than between industrial
classifications. Corresponding numbers for Europe and Japan were
60 percent and 20 percent, respectively. Ruffin’s data suggest
that comparative advantage fails to account for a great deal
of international trade.6
A likely explanation for this
observed intra-industry trade is that although the products appear
similar and fall within the same industrial classification, they
are actually different in some real or perceived respect. To
the purchaser of a minivan, for example, a Toyota Sienna is different
from a Dodge Caravan. Specialization still occurs within these
industries, but it is based on product differentiation and, most
importantly, on economies of scale.7
Economies of scale refer to reductions
in the unit cost of producing goods that result from increasing
the scale of production. They stem largely from high fixed costs
of production (overhead) whose recovery gets spread out over
greater amounts of production as the scale of operation increases.
As a firm expands, its economies of scale may reach a limit,
beyond which a rise in the average variable costs of production
exceeds the decline in the average fixed costs of operation—but
this point may be a very large plant size. Because international
trade expands the scope of the market, it enables specific industries
to take advantage of greater economies of scale in production.
The gains from trade appear as a savings of real resources that
society can devote to alternative uses.
Whereas under comparative advantage
the international pattern of trade reflects the global distribution
of resources, it may be a matter of historical accident when
economies of scale drive specialization. In an industry characterized
by extensive economies of scale, once a firm becomes well established,
it has a clear cost advantage over new entrants to the industry.
Economies of scale, then, act as a barrier to competition. Under
such circumstances, the direction of exports and imports will
depend principally on which countries contain the firms that
first achieved wide-ranging economies of scale.
Gains from trade associated with
greater economies of scale do not change the relative price of
the abundant and scarce factors of productions, as occurs with
comparative advantage. As trade expands, labor and capital will
be affected as some domestic firms and industries lose in the
competition with foreign producers. Although they will eventually
shift to other activities, the process need not distort the distribution
of income across types of labor or between labor and capital.
Consequently, clearly defined and influential groups opposed
to free trade may be less likely to arise.
A country’s long-term, sustainable
rate of economic advance depends on the growth of its labor force
and capital stock, the education of its workers, and its willingness
to adopt political and legal institutions consistent with free
markets. But a country’s ability to generate persistent
gains in its standard of living—output per capita—depends
critically on its rate of technological advance. Competition
and exposure to new products seem to promote innovation and diffusion
of technology. Moreover, technological gains generate knowledge
“spillovers” that reduce the costs of future scientific
advances. Consequently, technology tends to build on itself.
International trade expands markets and global competition, and
firms achieving substantial economies of scale may be best poised
to adapt to new technologies. Importation, particularly of capital
goods, facilitates the transfer of technology and encourages
the development of new products and production processes. Exports
can similarly promote technological transfer through the exposure
to foreign markets.
Technological transfers should
enhance the productivity and, therefore, the real wages of all
workers, but the biggest gains should accrue to the more highly
skilled since they are best able to adapt new technologies. Hence,
technological transfers may increase wage inequalities within
countries, and these can slow the growth of trade.8
Trade is always a two-way exchange,
but when undertaken freely, both parties are better off. This
is as true when participants reside in different countries as
it is when they live in the same place.9
Imports do not reduce or slow economic growth. By fostering specialization
and the transfer of technology, they lead directly to faster
economic growth and improved standards of living. Unfortunately,
the benefits of specialization and technological progress do
not accrue equally to everyone, and may worsen the economic lot
of some people. No one, however, seriously scorns economic advancements.
Should we, then, disparage imports?
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Table 1 GDP
and Its Components, 1999 |
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|
1999 dollars
(billions) |
Percent change
from 1998 |
1996 dollars a
(billions) |
Percent change from
1998 |
|
GDP
Personal consumption
expenditures
Gross private domestic
investment
Government consumption
expenditures/gross investment
Exports of goods and services
Imports of goods and services |
9,254.6
6,257.3
1,622.9
1,629.8
997.4
-1,252.9
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5.6
7.0
6.0
6.5
3.2
12.3 |
8,867.0
6,000.9
1,637.7
1,535.4
1,043.6
-1,366.5
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4.1
5.3
5.8
3.7
3.6
11.8
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a. Components
of GDP need not add to totals because current dollar values are
deflated at the most detailed level for which all required data
are available.
SOURCE: U.S. Department of Commerce, Bureau of Economic
Analysis. |
a. Annual percent
change, 1930–98.
b. Average of annual percent changes for 54 countries, 1985–95.
SOURCE: International Monetary Fund, International
Financial Statistics.
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Figure 1 U.S.
Imports and Economic Growtha |
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Figure 2 Foreign
Imports and Economic Growthb |
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1. See Peter Hooper, Karen Johnson, and
Jaime Marquez, “Trade Elasticities for G-7 Countries,”
Board of Governors of the Federal Reserve System, International
Finance Discussion Paper no. 609, April 1998.
2. Jeffrey A. Frankel and David Romer, “Does
Trade Cause Growth?” American Economic Review, vol.
89, no. 3 (June 1999),
pp. 379–99.
3. See Kevin H. O’Rourke and Jeffrey
G. Williamson, Globalization and History: The Evolution of
a Nineteenth-Century Atlantic Economy, Cambridge, Mass.:
MIT Press, 1999.
4. See Robert J. Carbaugh, International
Economics, 7th ed., Cincinnati, Oh.: South-Western College
Publishing, 2000, p. 30.
5. See O’Rourke and Williamson (1999).
6. See Roy J. Ruffin, “The Nature
and Significance of Intra-industry Trade,” Federal Reserve
Bank of Dallas, Economic and Financial Review, 1999 Quarter
4, pp. 2–9.
7. The discussion assumes that economies
of scale are firm-specific; however, they may also be industry-specific.
On the distinction, see Paul R. Krugman and Maurice Obstfeld,
International Economics, Theory and Policy, 4th ed., Reading,
Mass.: Addison-Wesley, 1997.
8. See Ishac Diwan and Michael Walton, “How
International Exchange, Technology, and Institutions Affect Workers:
An Introduction,” World Bank Economic Review,
vol. 11, no. 1 (January 1997), pp. 1–15.
9. In some cases, countries may be able
to improve their economic welfare by instituting trade restraints
or by retaliating against foreign-trade restrictions. Such gains,
however, typically come at other countries’ expense. Moreover,
tailoring such policies to specific firms and industries is problematic.
See Douglas A. Irwin, Against the Tide: An Intellectual History
of Free Trade, Princeton, N.J.: Princeton University Press,
1996.
Owen
F. Humpage is an economic advisor at the Federal Reserve Bank
of Cleveland.
The views stated herein are those of the authors and not necessarily
those of the Federal Reserve Bank of Cleveland or of the Board
of Governors of the Federal Reserve System.
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