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Things That Smart People Don't Know

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by: Scott Sumner
Scott Sumner
Professor, bonds, economy

It would be interesting to make a list of things that smart people don't know. Unfortunately, I don't have enough paper or barrels of ink. One of my favorites is trade, where smart people think China is an outlier. Actually, only tiny Belgium has more balanced trade than China:

Screen Shot 2018-07-09 at 2.16.19 PM

Why don't smart people know this? Because they don't bother looking at the data.

Another misconception is that trade deficits are bad. This article at National Interest caught my eye:

Trump is right to push on trade. A simple return to anything resembling a balanced international trading system would result in massive gains for the United States. What presidential advisors Peter Navarro and Wilbur Ross call the deficit drag depresses the American economy by about 3 percent overall. That is to say, if international trade were balanced, the American economy would be 3 percent larger than it is now.

I had to read this twice, to make sure my eyes weren't deceiving me. The Navarro/Ross argument is based on this equation:

GDP = C + I + G + (X-M)

They assume that if X-M is negative 3% of GDP, then this causes GDP to fall by 3%. Actually it has no effect, because the negative caused by subtracting M (imports) is exactly balanced by a positive to C + I (consumption and investment). Every time you buy an imported car, consumption rises by the amount of the purchase. Every time someone buys an imported truck, investment rises by the amount of the purchase.

If you switch from imports to domestic cars, the labor to produce those domestic cars doesn't just magically appear on the scene, it gets diverted from some other type of production. Can reducing the trade deficit boost total aggregate demand? No, for standard monetary offset reasons. But even if I'm wrong, higher AD has no long run impact on employment, for standard "natural rate" reasons.

Yup, this is all just EC101. And yes, Trump's top economic officials do not know this stuff. It reminds me of when freshmen in economics get lost trying to write an answer to an essay question: "Demand goes up so price rises. The higher price causes demand to fall. The fall in demand then lowers the price, which causes demand to increase..." Eventually they give up and stop writing, hoping for the curve to allow them to pass the course.

Irving Kristol, who was a supply-sider, founded The National Interest back in 1985. Perhaps it's fortunate he passed away in 2009, and did not have to see what happened to his neoconservative journal. The article was titled:

Trump Is Right: The U.S. Can't Lose a Trade War

BTW, Trump supporters who care about trade deficits (do they even exist?) might be interested in knowing that Trump's policies are making the US trade deficit larger. Or maybe they don't care. In fairness, it's not growing as fast as the budget deficit, which is now rising rapidly. During an expansion.

PS. The comment section after my previous post reminded me of an old joke. A guy tells his friend that he has an uncle who insists that there's an alien from Alpha Centauri who wears a sport coat with pink polka dots, and that lives in a tiny teapot on his fireplace mantle. The friend responds, "Oh come on, how likely is it that someone from Alpha Centauri would wear pink polka dots."

Commenters thought the best way to respond to Trump's latest outrage was to discuss the merits of breastfeeding.