The Globe and Mail's Kevin Carmichael called me yesterday to talk about the idea that Canada's recovery won't be fully underway until exports started to increase at a significant rate. My comments didn't make the cut for the print edition, but they are in the online version of the story:
Not all economists are convinced Canada's economy is so reliant on exports.
Stephen Gordon, an economics professor at Laval University in Quebec City, noted that the economic growth of the boom years before the crisis was mostly the result of higher commodity prices, which generated income that fed a growing services industry.
Export volumes were little changed, and manufacturing production has been declining for years, he said.
“If people are willing to give us a lot of money for our raw materials, we should be cashing the cheques and saying, ‘Thank you,' ” Prof. Gordon said. “There's nothing wrong with a services-based economy.”Nevertheless, the more common view is that Canada will need a thriving export industry to maintain stronger growth rates.
I'm now going to explain why the more common view is wrong.
We'll start with the expression for aggregate demand:
AD = C + I + G + NX
- C is domestic private expenditures on consumption goods and services,
- I is domestic private expenditure on capital goods,
- G is public expenditures on goods and services, and
- NX is net exports: exports minus imports.
Clearly, if net exports increase and everything else stays the same, then aggregate demand increases. But this isn't a necessary condition. In fact, the contribution of net exports to total GDP growth has been negative in two of the last three expansions:
Not every expansion is a variation of the one we had in the 1990s. So why the obsession with exports?
Part of the problem is the way net exports enter into that expression for aggregate demand: exports have a positive sign, and imports have a negative sign. But that's exactly opposite to how we should be thinking about what the costs and benefits of international trade are:
- Imports are benefits: We engage in international trade to get things more cheaply than it would cost to make it ourselves.
- Exports are costs: We send exports to foreigners so that they will give us the imports we want.
Suppose we live in an economy where our international trade consists of exchanging truckloads of trees for truckloads of bananas. Some workers spend their time cutting down trees to send to foreigners, and the rest work on producing goods and services for domestic consumption.
Now let's suppose that foreigners are no longer satisfied with trees in exchange for bananas: they will now only exchange a truckload of bananas for a truckload of furniture. Since we must have bananas, some workers must shift out of the domestic production sector and start transforming trees into furniture for export. Even though the national accounts would record an increase in exports (that is, an increase in the value-added), this development is clearly bad news. The shift of workers to the export sector and away from domestic production means that fewer are available to provide the same level of goods and services we used to enjoy.
Now suppose things shift back to what they were before: foreigners are now willing to accept trees for bananas. Since the people who cut down trees are able to get bananas on their own, the workers who had been making furniture for export can go back to producing goods and services for local consumption. Although the national accounts would show a decrease in the value-added of exports, we are clearly better off.
These two stories are pretty much what happened in the last two expansions. In the early 1990's, commodity prices fell, and the only way for us to obtain the imports we wanted was to shift workers to the manufacturing sector, and to increase the value-added of exports. But devoting more of our productive capacity to making things that are to be consumed by foreigners isn't a path to prosperity, and workers' real buying power stagnated.
In 2002, commodity prices rose, and we were able to get the imports we wanted with fewer productive resources allocated to the export sector. The expansion of 2002-2008 was characterised by a shift out of export-oriented manufacturing, and these workers were able to produce more for domestic consumption. Exports stagnated, but real incomes increased.
In this context, the idea that "Canada will need a thriving export industry to maintain stronger growth rates" seems rather odd. I don't see how paying more for imports is going to make us better off.