Regular reader Alan Goldhammer wrote:
I fully understand how tariffs work and know that the calculation for the reciprocal tariffs was something pulled out of a hat (or some malfunctioning AI tool). However, I don’t know if imports are fully modeled for how much they add to the US economy. Any small business that brings in Chinese products to sell adds value by creating jobs, and the money generated from sales goes to the Federal, State, and Local governments in the form of taxes. Why shouldn’t this added value be subtracted from the trade deficit? Isn’t this also added to the US GDP? Maybe these are just naïve questions, but as you know, I am not an economist.
I responded to Alan via email, assuring him that his questions are not naĂŻve, and I do have some insights to share.
I won’t delve into the dubious role of AI in determining “reciprocal tariffs” since that’s not the crux of Alan’s inquiry.
Let’s focus on his pivotal observation:
Any small business that brings in Chinese products to sell adds value by creating jobs, and the money generated from sales goes to the Federal, State, and Local governments in the form of taxes.
This statement is largely accurate. Some of the revenue from those sales does indeed flow to government entities. However, a significant portion benefits the sellers themselves, and they certainly deserve recognition. We gauge their profit by the difference between their sales revenue and costs, ensuring that we consider all expenses, not just those tied to imported Chinese goods.
Moreover, it’s true that these sales create jobs. Yet, economists measure the benefit to workers not merely by their job status or even their wages. We must consider the opportunity cost—what those workers could earn in their next-best job. Therefore, their actual gain is their wages, salaries, and benefits minus what they could have earned elsewhere.
Let’s not forget another crucial stakeholder: the ultimate consumers of these goods. Economists refer to their advantage as “consumer surplus,” which represents the difference between what consumers are willing to pay and what they actually pay.
Now, let’s address Alan’s two pressing questions:
Why shouldn’t this added value be subtracted from the trade deficit? Isn’t this also added to the US GDP?
The reason this added value isn’t deducted from the trade deficit is that the trade deficit was never designed to quantify value; rather, it tracks monetary transactions. The U.S. trade deficit with China reflects the difference between what Americans spend on Chinese goods and what the Chinese spend on American products. It doesn’t convey the value derived from those goods and services, other than to imply that their value exceeds the price we pay; otherwise, we wouldn’t be purchasing them. Simply put, trade enriches us.
Alan’s “naĂŻve” question actually highlights a significant flaw in the discourse surrounding trade deficits. If the value of our imports exceeds what we spend, how detrimental can a trade deficit truly be?
Alan wisely senses the benefits and wonders, “What’s the fuss about?” He’s right to question this.
Now, regarding his second question: “Isn’t this [value] also added to the U.S. GDP?” The increase in wages, benefits, and salaries resulting from imports does contribute to GDP. In fact, GDP would be lower if individuals were employed in less productive roles. However, taxes collected by American governments at all levels do not count towards GDP since they are essentially reallocated from American producers and consumers. Lastly, consumer surplus is not included in GDP calculations, as GDP measures economic output at market prices, excluding consumer surplus itself.
