GDP And Imports (Or Net Exports)

G.D.P AND IMPORTS (OR NET EXPORTS)

In 2016, two of Donald Trump's economic advisers wrote a paper titled 'Scoring the Trump Economic Plan'. They were Peter Navarro (an economics professor with a PhD from Harvard) and Wilbur Ross (a businessman). Today, Peter Navarro is Donald Trump's senior trade adviser and Wilbur Ross is America's Commerce Secretary (trade minister).

In it, they wrote:

"The growth in any nation's gross domestic product (GDP) - and therefore its ability to create jobs and generate additional income and tax revenues - is driven by four factors: consumption growth, the growth in government spending, investment growth, and net exports. When *net exports are negative*, that is, when a country runs a trade deficit by importing more than it exports, this *subtracts from growth*."

Now a country's GDP (Gross Domestic Product) is the total economic output produced *inside* that country. This output is consumed by 4 entities: households, firms, government and foreigners - so we have consumption (C), investment (I), govt spending (G) and exports (X) respectively. To get the GDP, we just add these 4 things. But these 4 components also include some things which were made *outside* the country - that is: made in other countries and imported into this country. So these things must be excluded. Hence we subtract imports (M) from these 4 components.

Thus we get the GDP equation:

Y = C + I + G + X - M

or Y = C + I + G + NX (where NX = X - M)

The second form is just for convenience - to reduce the number of terms from 5 to 4. But we are not subtracting imports just from exports - we are subtracting it from all the 4 components. Of course, arithmetically it makes no difference. But the economic meaning is important - and must be understood correctly.

Some people see the '-M' term (or the 'NX' term) and wrongly think that imports *reduce* GDP. This, as we have just seen, is definitely not the case. We subtract imports simply because:

1. They are included in C, I, G and X

2. But they are not made inside the country

So imports do not reduce GDP. And it definitely does not reduce GDP growth either. In fact, research has proved that total trade (exports + imports) increases growth. Therefore Peter Navarro and Wilbur Ross have made a very basic economics mistake . . .

Fun-facts:

# Harvard's economics department is ranked #1 in the world.

# 13 Harvard PhDs have won the Nobel Economics Prize - second only to MIT (14).

# The paper has since then been deleted from Donald Trump's official website.

India's Trade-To-GDP Ratio

The graph shows the trade-to-GDP ratio* versus the logarithm of GDP for 184 countries**. It shows a slight decreasing relationship between the two - as GDP increases, the trade-to-GDP ratio decreases slightly. India is shown by the red dot - and it is below the trendline. That is - its trade-to-GDP ratio (at 45%) is below what it should be as per this relationship (which is 70%). So there is a lot of scope (25% points) for increasing India's trade (both exports and imports) to make it on par with the world's trend relationship . . .

*[Trade = exports + imports]

**[I have left out 9 outliers whose trade-to-GDP ratio is more than 200% - these are small high-trading countries]

Data-source: World Bank

The Effect Of Trade On Growth

THE EFFECT OF TRADE ON GROWTH

Total trade (exports + imports) increases growth. Empirical research has proved this conclusively. But there is no theoretical model that shows this. This is because trade does not increase growth directly - but indirectly. And this indirect relationship between trade and growth is shown by two sets of models: growth models and trade models.

1. Growth models like Romer model and Lucas model show that technology and knowledge increase growth. And an important source of technology and knowledge is trade.

2. Trade models like Ricardo model and Heckscher-Ohlin model show that trade increases specialisation and efficiency. And specialisation and efficiency increase growth.

Thus these two sets of models indirectly show that trade increases growth . . .

Why Trade Is Good (Both Exports And Imports)

WHY TRADE IS GOOD (BOTH EXPORTS AND IMPORTS)

GDP is given by the basic equation:

Y = C + I + G + X - M

or Y = C + I + G + NX

where NX = X - M

These equations *seem* to say that GDP consists of net exports (or trade surplus) and hence:

1. Exports are good

2. Imports are bad

3. Trade surplus is good

4. Trade deficit is bad

1 is correct and 3 is partially correct. But 2 and 4 are fallacies. They are bad in themselves; what is worse is they make people miss an important economic variable: total trade (ie, exports + imports). Research has conclusively proved that total trade has a strong positive impact on economic growth.

Believing fallacies 2 and 4 leads to a zero-sum-game mindset. But trade is not a zero-sum-game. Trade (exports + imports) gives us:

a) A bigger market for our exports

b) Cheap and good-quality products

c) Specialisation and efficiency

d) Knowledge and technology

So we must avoid fallacies 2 and 4 (which are due to a wrong understanding of the GDP equation) and instead look at total trade (exports + imports):

T = X + M

Indian Economy: Oct-Dec 2024

INDIAN ECONOMY: OCT-DEC 2024

The urban employment data has just come out for Oct-Dec 2024. I look at 3 indicators of employment:

1. Worker Population Ratio (WPR)

2. % of workers in industry and services

3. % of regular wage/salaried workers

I make two comparisons - I compare Oct-Dec 2024 with:

a) Oct-Dec 2023 (the same quarter of the previous year)

b) Oct-Dec 2019 (the last normal/pre-Covid Oct-Dec quarter)

The graph shows these comparisons . . .

1. Worker Population Ratio (WPR):

a) This has increased by 0.4% points over the previous year. This is good news.

b) And it has increased by 2.9% points since the pre-Covid period. This is also good news.

2. % of workers in industry and services:

a) This has increased by 0.4% points over the previous year. This is good news.

b) But it is still 0.4% points below the pre-Covid period. This is not good news.

3. % of regular wage/salaried workers:

a) This has increased by 0.7% points over the previous year. This is good news.

b) But it is still 0.6% points below the pre-Covid period. This is not good news.

Thus the Indian economy is recovering from the Covid crisis - but it has not yet recovered fully . . .

India Budget 2025-26: Analysis

INDIA BUDGET 2025-26: ANALYSIS

# Fiscal deficit is decreasing from 4.8% of GDP (2024-25) to 4.4% (2025-26) - a decrease of 0.4% points. This is good.

# Nominal GDP is estimated to grow/increase in 2025-26 by 10.1%.

The 4 Budget components are changing from 2024-25 to 2025-26 like this:

1. Revenue Receipts (good income - ie, taxes)

This is increasing by 11.1% - which is more than the GDP growth rate (10.1%). This is good.

2. Capital Receipts (bad income - ie, loans)

This is *decreasing* by 0.0%. This is very good.

3. Revenue Expenditure (bad spending - salaries, schemes, subsidies)

This is increasing by 3.5% - which is less than the GDP growth rate. This is good.

4. Capital Expenditure (good spending - ie, infrastructure)

This is increasing by 17.4% - which is more than the GDP growth rate. This is good.

So this is a pro-growth and fiscally disciplined Budget . . .

How To Analyse/Evaluate India's Budget

HOW TO ANALYSE/EVALUATE INDIA'S BUDGET

(A framework to analyse/evaluate the Budget)

A. The Budget has 2 flows of money:

1. Inflow (Income) is called 'Receipts'.

2. Outflow (Spending) is called 'Expenditure'.

B. The Budget has 2 types of accounts:

1. Short-term transactions (that do not create assets/liabilities) go into the 'Revenue Account'.

2. Long-term transactions (that create assets/liabilities) go into the 'Capital Account'.

Thus we have:

2 Flows X 2 Accounts = 4 Components

These 4 components are:

1. Revenue Receipts: This is mainly taxes. This does not create any liability for the government. So this is good income.

2. Capital Receipts: This is mainly loans (a liability). Government has to repay this – with interest. So this is bad income.

3. Revenue Expenditure: This consists of salaries, pensions, schemes, subsidies and interest payments. This does not make the economy more productive – so this is bad spending.

4. Capital Expenditure: This is mainly infrastructure (an asset). This makes the economy more productive – so this is good spending.

Thus we have 2 'good' components:

1. Revenue Receipts (good income)

2. Capital Expenditure (good spending)

And 2 'bad' components:

1. Capital Receipts (bad income)

2. Revenue Expenditure (bad spending)

The 4 components must be seen relative to the GDP. So ideally, compared to last year:

1. The 'good' components must increase relative to the GDP.

2. The 'bad' components must decrease relative to the GDP.

That is, ideally:

1. The increase in the 'good' components from last year must be greater than the GDP growth rate (the greater the increase, the better).

2. The increase in the 'bad' components from last year must be less than the GDP growth rate (the lesser the increase, the better).

Finally, the most important number in the Budget is the Fiscal Deficit:

Fiscal Deficit = Spending – Income (excluding loans)

It is expressed as a % of GDP. It must be as low as possible. So the Fiscal Deficit must decrease as much as possible. The greater the decrease, the better.

Thus by:

1. Looking at the Fiscal Deficit

2. Comparing the increase in the four components with the GDP growth rate

We can say how good or bad a Budget is . . .

Caveat: Revenue Receipts must increase by increasing the tax base – not by increasing the tax rates.