09 Mar 2009

Yet More Evidence on the Harm of GDP Figures

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Oh man. While promoting his new book (at least two weeks on NYT bestseller list, btw) on a radio show, Tom Woods fielded a caller who said Smoot-Hawley was in effect only for a year. Tom asked if this were true, I said I had no friggin idea, and I resorted to my trusty source of economic knowledge, Google.

This site says Smoot-Hawley was effectively repealed in 1934, and since the author hates free trade, I have no reason to doubt him. But check this out:

No, there is practically NO evidence that Smoot-Hawley hurt our economy. The US was already in a Depression when Smoot-Hawley was enacted. Prior to Smoot-Hawley, the 1929 Trade Surplus was +0.38% of our GDP. In other words, it contributed less than 1/200th to our economy.

What happens if we focus on exports alone? Exports were $5.9 billion in 1929, and had declined to $2.0 billion in 1933, for a -$3.9 billion decline. This $3.9 billion decline was roughly 3.8% of our 1929 GDP, which had already declined by a whopping 46% over the same period of time. Thus, of the -46% GDP decline, only 3.8% of it was due to a fall in exports.

But the effects on trade must also include the reduction in Imports, which ADDS to GDP. (A decline in imports increases GDP). If the import decline is added back to the GDP total (to measure the net trade balance), the “loss” becomes only -$0.2 billion from our GDP — or less than ½ of 1% of the total GDP decline. In other words, the document-able “loss” from the Smoot-Hawley Tariff — the “net export” loss — contributed less than ½ of 1% of our our -46% GDP decline.

Oh man. This is the problem with the whole mainstream macro approach. People assume that if you tinker with one variable in the Y=C+I+G+(X-M) formula, the other stuff remains the same.

Suppose we have a small island (think of Manhattan or Hong Kong if you want) that has millions of people who are utterly dependent on importing food, gasoline, etc. The island has no natural resources to speak of, and there’s not enough room for farming. There are big skycrapers and the people are all software engineers, novelists, musicians, and other things that are exported electronically to the rest of the world.

Suppose further that it just so happens that year after year there is a no balance or deficit in the trade accounts. The islanders import, say, $100 billion a year in food, gasoline, compact cars, etc., and they export $100 billion a year in electronic goods and services.

Now there is a war, and the island gets surrounded by warships that completely seal off incoming cargo ships. Further, the enemy has airplanes flying overhead that scramble communications so they islanders can’t send emails abroad.

According to our author, this should have no effect on the island real GDP, since X=$100 billion and M=$100 billion right before the enemy forces reduce both values to $0.

UPDATE: Just to make sure you folks really “see” it, let me elaborate: Before the war, the islanders’ real GDP was $100 billion, and the macro guys at Harvard would tell you the following breakdown:

C = $74 billion
I = $10 billion
G = $15 billion
X = $100 billion (exports)
M = $99 billion (imports)

Right so doublecheck: Y = C+I+G+(X-M) = $100 billion. The people spend 74% of their income on private consumption, they invest 10% back into their economy, and the government takes its cut of 15%. International trade “contributes” 1% of GDP.

Now after the blockade is imposed, the Harvard economists come back and report the following:

C = $15 billion
I = $0
G = $5 billion
X = $0
M = $0

A lot of idiot free market economists blame the depression on the blockade, but that’s crazy talk. See, GDP dropped 80% in one year, from $100 billion down to $20 billion. But of that drop, only 1/80th of it is attributable to the blockade. The rest is due to the enormous fall in private consumption and investment, as well as the government’s stupid decision to slash its own spending. What idiots! These people need to call up Krugman pronto. If the government simply borrowed and spent $80 billion more, it could close the output gap.

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