How The Record Q1 U.S. Trade Deficit Shrank the Economy

For years, mainstream politicians and economists have pooh-poohed America’s huge and growing trade deficits and tried to argue they don’t matter. In the first quarter of 2022, those commentators got a wake-up call from the Bureau of Economic Analysis.

On April 28, the BEA issued a press release pointing out that U.S. gross domestic product (GDP) fell 1.4% in the first quarter of this year in real (inflation-adjusted) terms. The fall in GDP was entirely due to worsening of the trade deficit to record levels. The other main contributors to U.S. GDP –investment and private consumption – were positive in the quarter. But the trade deficit, at 3.2% of GDP, caused the economy to shrink.

Exports add to GDP because products we produce here, but are purchased by foreign customers, increase our ouput. Imports subtract from GDP because goods consumed here, but not made here, do not add to our productive output.  If we had had balanced trade or a trade surplus in the first quarter, it would have been a strong growth quarter. But with the deficit, trade made it a slump quarter—and possibly the beginning of a new recession.

Over the years, there have been a lot of misleading statements made about the trade deficit, including claims that it does not affect Americans’ wellbeing, so it is worth going over the national income accounts carefully to explain how they work and how exactly the trade deficit works as a subtraction from GDP.

Those readers who took introductory economics in high school or college will remember that gross domestic product is the dollar value of the sum of everything the U.S. produces in a given quarter or year. (See Eq. 1.) The value of GDP, typically labeled Y in academic economics, is directly related to the jobs and incomes of Americans: if GDP rises, then jobs and/or incomes rise, and if GDP falls, then jobs and/or incomes fall.

(Eq. 1) Y= C + I + G + (X-M)

GDP is broken down into four main components: consumption, which is all goods and services consumed by individuals; investment, which includes goods and services purchased for future use such as factory equipment, residential homes, and so forth; government spending, which includes federal, state and local government spending on goods and services, and finally net exports, also known as the trade deficit, which includes exports minus imports.

Table 1 shows what happened in the first quarter of this year, which are the months January through March. All data comes from the Bureau of Economic Analysis. When compared with the immediately preceding quarter (Q4, 2021), personal consumption rose by $93 billion in the quarter. Investment spending rose by $22 billion, almost precisely offsetting the slight fall in government spending. If GDP were limited only to those three categories, then GDP would have risen by $92 billion in the quarter, meaning Americans would have had more income in Q1 than in Q4.

But they did not. GDP fell in Q4, by a total of $70 billion, due to the large deterioration in our trade deficit of $192 billion. The deterioration in the trade deficit was due to a small fall in exports and a large rise in imports. According to this data, our trade deficit in Q1 was running at a $1.5 trillion annual rate in 2012 dollars. In today’s dollars, that would be close to a $2 trillion deficit. Now, Q1 saw unusually strong and record imports, due partly to shippers at our major ports catching up with some of the delays that were generated last year by the supply chain snafus. Our 2022 trade deficit is likely to finish in the $1 trillion range.

Nevertheless, a $1 trillion subtraction from GDP represents a huge loss in terms of missing jobs, production, and income. How huge? One rule of thumb is that every $1 billion in additional imports costs the U.S. 6,000 jobs. By that indicator, a $1 trillion trade deficit this year is roughly responsible for 6,000,000 jobs. And many of those jobs would be high-wage jobs in sectors competitive with imports such as automotive or electronics manufacturing.

Back in the 1990s, globalization advocates argued that increased trade with the rest of the world would bring jobs to the U.S. They argued repeatedly that opening up, whether to Mexico, or China, or other nations, would lead to increased export opportunities for the U.S. Unfortunately, each trade deal, such as the welcoming of China into the World Trade Organization in 2001, led to a worsening of our trade deficit, on both a bilateral and a multilateral basis. So, completely illogically, the globalization lobby began to downplay the argument that increasing net exports would add to jobs, since the opposite is also true: a decline in net exports, in other words an increase in the trade deficit, leads to a loss in net jobs.

A separate popular argument from globalization advocates is that if we import more than we produce, we are enjoying the benefits of those imports without paying for them, at least not now. This is extremely shortsighted. I would call this the drug addict’s view of life. No nation has ever got rich or increased its standard of living over time by borrowing to finance current consumption. At some point in the future the bill always comes due. Data from the BEA shows that at the end of 2021, the U.S. owed a net $18.1 trillion to the rest of the world. That figure rose by $4 trillion over the course of 2021. One day, we or our children or their children will have to pay this huge sum back. It can only be paid back by running a trade surplus. Each year that we run a deficit, or watch another industry depart our shores, it becomes harder to see how we will reverse the 45-year trend of deficits and earn our way out of the hole.

Still another fallacy peddled by globalization apologists is that high imports are correlated with rising GDP and are therefore a good thing, somehow linked to economic growth. It’s true that when American consumers’ incomes rise, that sucks more imports into the economy. But the fundamental fact remains that if those needs were satisfied by domestic production, it would create more jobs, more wealth, and more income here at home. Crucially, that domestic income would be respent on more domestic goods, leading to further jobs and income.

When Donald Trump was elected president in 2016, there was an outpouring of economist vitriol over his argument that the trade deficit was important and that our huge bilateral deficit with China (among others) meant that the U.S. was losing. For economists, this was an easy career move: criticizing Trump would win them points with their university management, with their anti-Trump students, and with the anti-Trump media.

Yet, Trump’s insight, which is common to many businesspeople, was correct. If a business’s sales are increasing, it can afford to hire more workers, pay them better, and invest in the future of the business. If another country’s businesses are instead winning that business, then its workers and business owners benefit. Most economists hate to concede that businesspeople are ever right. Yet that analysis is correct. As I have argued here, long-term economic growth comes from growing businesses, especially in high-value business sectors. First they must dominate their home market, and only after they have secured the home market can they move onto export markets. In the U.S. we have continued to lose our home market year after year and decade after decade.

The good news is that President Biden and many of his key advisors also seem to recognize this reality. They should use the awful message of the Q1 GDP data to argue the case with those in government who still favor the addiction to imports.