Imports, Exports, and Economic Identities

Do imports reduce the size of our economy?

Source: Econstories

It’s not as simple as you think. Yes, C+I+G+X-M = Y. Consumer spending plus business Investment plus Government spending plus eXports minus iMports equals the total economy. On its face, if you reduce what you’re subtracting, the sum total should be bigger, right? It’s a little more subtle than that, though. It’s unclear which comes first, the size of the inputs or the size of the economy. Just because an equation describes something doesn’t mean you can change one element without affecting the others.

Think of it like this: suppose you run a computer company that sells hardware and support services. Revenues equals Hardware plus Service: R=H+S. But the hardware division uses some of your support services, and the service people use your hardware: you need to subtract intra-company sales to get total revenue. So R=H+S-I.

As CEO, you want your sales numbers to grow. You look at this equation and think, gee, if we got rid of these intra-company transactions, we’d boost total sales, right? That’s what the equation tells me. So you tell the hardware people to use outside support, and you tell your support people to use non-company computers. You prohibit intra-company transactions. Would that increase revenues?

Photo: Victor Hanacek. Source: Picjumbo

Of course not. Your sales numbers come from how much outside demand there is for your goods and services. Telling your divisions that they can’t do business with one another won’t change that any more than trying to boost sales by selling more products inside the company. In fact, it will probably hurt performance, as folks would be forced to use products and services they’d rather not.

You can’t change an economic or accounting identity by focusing on one of the inputs. A CEO that wanted to boost revenues by cutting intra-company transactions would get a quick lesson from the market. And a country that tries to improve its economy by limiting imports will likely be disappointed. 

Douglas R. Tengdin, CFA 

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