Can a radical reinterpretation of GDP numbers explain voter rage and the failure of establishment ideology and academic economics? I believe it can.
Let’s start the analysis with the traditional macroeconomics text book GDP equation measured in dollar amounts:
Y(GDP) = C (Consumption) + I (Investment) + G (Government Spending) + X (Exports) – M (Imports)
This equation is a bit trickier than it appears. The Consumption component includes purchases of imports. So the net impact of a trade deficit amounts to zero in this equation as Noah Smith outlines in the following link:
It is also not obvious how debt enters here, but again Noah Smith does a nice job introducing this issue in the following link
Though there is nothing wrong with a clean textbook analysis of the equation, I feel the equation itself suffers from a serious problem. In prior essays, I’ve attempted to expose what I perceived as serious logic problems with the Investment portion of the equation. Here I will focus on the imports variable M in the equation and reintroduce my interpretation of China’s GDP.
Before we look at the numbers, let me try to illustrate my key point of concern. Let’s use a very simple model of a nation that is a closed economy (no imports or exports) and has a GDP of $4Trillion. We will take Government and Investment out of the discussion to keep it simple for the moment.
GDP = Consumption=$4T
In short, this closed economy consumes what it produces as one would expect.
Now let’s allow a low cost foreign competitor into the equation so to speak. Say the foreign competitor produces half of everything the nation produced ($2T) at a half of the cost ($1T). What would the new equation look like?
GDP=Consumption ($2T domestic remains + $1T Imports) – Imports $1T = $2T
The effect of these imports is not zero in my opinion as a textbook leads you to believe, because imports generally speaking displace the domestic competitor , thus we went from $4T to $2T. Half the GDP vanished as a result. But if the textbook interpretation is to believed, the sky is the limit in terms of imports. We could have something like this:
GDP=Consumption ($4T domestic goods + $10T imported goods) – Imports ($10T) = $4T
In other words, a $10T deficit has no impact on the economy. I reject this logic, because the equation implies the domestic and imported goods are non-competitive (e.g. geographically limited goods). In reality, the whole point of cheap imports is to put your apparently inefficient neighbor out of work.
If this is really a model of unemployment, then where will these unemployed workers migrate too? One place might be government jobs which could mask the industrial decline.
GDP = Consumption $3T-Imports $1T+Government $2T = $4T
In this case, real industrial wealth production is vanishing (shifting to government services) and all is still seems fine with the GDP. It is with this mindset, I have become concerned with the scope of the damage being done and will take a closer look are our nation’s deficits.
Since I’ve never been a stickler for precise numbers, I’m going to round down the US GDP (Y) to $16 Trillion and focus on a portion of the annual trade deficit (a portion of the X-M total). In particular, I will round up our trade deficit with China to $400 billion to keep the math simple. Thus, as the mainstream business editor will point out, our trade deficit amounts to not much more than 2.5 percent of our GDP. Hard to imagine voter outrage driven by an 2.5% shift in GDP.
Who would have sleepless nights over this drop in the economic bucket? I would. As an engineer whose new model of economics restores the traditional cost of production based on labor units, I take a completely different perspective to adding apples to oranges (foreign wage content vs domestic wage content embedded in an import). Let’s for argument’s sake simply assume the average Chinese factory worker makes $2 per hour and the average American factory worker makes $20 per hour to keep the math simple. As a result, $1 of worth of imports actually means it will displace $10 of American labor. As result, what appears to be $400 billion of imports, will actually displace $4 Trillion worth of American labor (100 million man years at $40K/yr). In other words, instead of 2.5% GDP, we have 25% of GDP lost from China alone. With nearly 50 million Americans near the poverty level, perhaps this is not such a far fetched suggestion to make.
For good measure, lets add Mexico’s nearly $300 billion of exports to the USA. Again with a roughly 10 to 1 wage differential, we have a $3 Trillion loss of labor equivalency. That’s another 18% of GDP. This brings us to 43%. Let’s take it a step further. Let’s consider the support structure that surrounds manufacturing. Consider the deli who fed the workers, the truck drivers who delivered supplies, the accounting industry which supported the book keepers, and so on. Would it be to much to suggest another 10% of GDP hinges on manufacturing. Thus we have 53% of GDP that has been shell shocked.
A point to keep in mind here is that a certain portion of USA exports to Mexico for example could be imported back to the USA (send metal to make a car). I have not managed to find data on this scenario yet. But say for discussion sake, this was true of 50% of USA exports to Mexico. First we run with about $230B exports to Mexico, which at say $40K/yr would be roughly equivalent to 6 million man years. Now if we divide $150 billion Mexico exports (we subtracted 50%) to the US by $4K/yr wage, we have roughly 37 million man years of labor being displaced in the USA. It also means the Mexican worker cannot consume a huge portion of the fruit of his labor. This is the classical school subsistence wage story of the 1700 and 1800s again (plantation economics).
Note also this argument pulls the rug out of the capital account argument as a panacea (i.e. Chinese return the dollars back to the USA by buying Treasuries, homes, etc). To see this, you simply have to image that the $1 dollar worth of imports that displaced the $10 of American labor cannot undue the damage by returning the $1 dollar and reinvesting it, because it only restores 1/10 of the damage it inflicted.
Finally, free trade throws a wrench into the gears of a sound government taxation model. To see this, imagine a highly simplified economy consisting of bakers, cheese producers, and a government sector building the roads between bread and cheese factories. Each sector makes up 1/3 of the economy. The bread and cheese output is sufficient to feed everyone. Thus the government can tax away 1/3 of the bread and cheese to feed themselves and provide the roads in exchange. Eventually, the politicians fall under the spell of a free trade economist and allow very cheap bread and cheese to be imported, putting the domestic industries out of business. Two thirds of the economy is unemployed. The government in order to “stay in business” and feed itself floats bonds (creates debt) which it uses to buy the imported bread and cheese for itself. The cheese and bread importer buys these bonds to maintain the currency manipulation which gave it the price advantage in the first place. Since the government does not tax the importer (this is the definition of free trade) and no longer has a healthy tax base (2/3 of the economy is unemployed), it has no means to pay the bonds off. Nor will the rich have anywhere to hide their financial assets from this Weimar hyper inflation scenario waiting to happen (print money to pay off the bonds). Game over.
So how does one manage to inflict such damage against a superpower? You simply carry a bigger stick. Consider China’s GDP from another perspective. China had roughly 100 million workers in manufacturing 2009 (a quick search). Let’s fudge the number in the hopes to be conservative in our estimate: Say 60% are at the level of the hinterland (i.e. blacksmiths). This leaves 40 million using modern technology, and thereby achieving modern productivity levels. That’s roughly 3 to 4 times the USA number. As an engineer I would argue that means China’s GDP is 3 to 4 time the size of ours. If that sounds crazy, simply look at raw industrial output in terms of quantity of steel, chemicals, concrete, or anything else you can think of if you doubt this. The academics suggest China’s GDP is just barely bigger than ours. If that is true, how then do they explain this story:
UPDATE (7/8/2106): One of my heroes in this struggle to save American prosperity is Richard McCormack and his excellent website. Serendipitously he posted the following excellent analysis of China’s manufacturing #’s after I posted this essay: http://www.manufacturingnews.com/news/2016/China-Manufacturing-Employment-0630161.html
If this analysis is anywhere close to being accurate, then I suspect America is heading for an economic train wreck of epic proportions. With federal, state, and local spending in the ball park of $50K per full time American worker, it is government spending, not industrial wealth production, holding our duct-taped economy together. When that party comes to an end, watch out.
How did we end up in such a fantastic mess? The answer: There has never been a sound theory of economics (see “Just Measures” tab). As an engineer, this is the root cause analysis. Superpowers have risen on the backs of its industries which they historically have protected. A nation’s wealth and prosperity stems from 200 years of genius hidden behind the industrial, chemical, and electronic revolutions. The blue collar worker becomes a member of a middle class by leveraging fruits of this rare genius in the form of productivity gains in a closed economy. In other words, a waitress who dropped out of high school is able to enjoy the comforts of a car built on cutting edge science and technology.
Nor is history is on the side of the academics. Daniel Webster argued the primary purpose behind the creation of the Constitution was to stop free trade (tariffs could not be laid under the Articles of Confederation). Lincoln and his party were protectionists (nationalists), while the big dollar cotton plantation owners were the party of free trade (globalists). The only way to make sense of the historical success of protectionism is with a new theory of economics.
This analysis also implies that even my “balanced-trade-friends” who have been raising the red flag over the damage done by free trade for years, are not really on the same sheet of music as I am. I am singing this song by myself, because as I attempt to show with a simple example in the link below, even balanced trade can cause great damage. Thus protectionism becomes a matter of necessity.
It’s time to get your head out of your ideology (and your textbook), before it destroys our country.
As always, critique welcome.
The Establisment is not the party of Lincoln:
Why balanced trade is not a panacea:
A new model of economics to make sense of the historical success of protectionism:
Is modern capital theory flawed (money and machines; saving and investment myth)?
See my Kindle Book: Just Measures by Van Geldstone.