The latest GDP report has Washington officials buzzing. Growth hit 3.0 percent for Q2, which is a staggering reversal of the dismal -0.5 percent growth in Q1. The White House claims that this is evidence that their trade policies are “an absolute blockbuster.”
New Right pundits are pointing out that it beat expectations and that it “has good internals.” Some are even suggesting that economics is a “dismal pseudoscience” and that Trump has “smashed one of the supposedly iron laws of economics.”
“Collapsing imports,” these pundits say, “saved the day” with regard to GDP figures, just as they were quick to use a surge in imports to explain the Q1 shrinkage.
Both are dead wrong. This latest report is just more evidence that tariffs are a disaster, and the economists who warned about them were correct.
Let’s cut through the noise and unpack this report. Trade deficits, as I’ve written, are among the most misunderstood concepts in all of economics. The reality is that imports do not affect GDP at all. To explain this, we need to understand that GDP is meant to measure the amount of production that happens in a country. Since “production” is difficult to measure in and of itself, the Bureau of Economic Analysis instead measures “expenditures.” This makes sense because, if we think about it, any time we spend money on a good, someone else must have produced that good that we bought.
But what about people who buy American-made products who do not actually live in America? Clearly, we should count that spending, too. Lo and behold, we do, which is why we add exports to American spending totals, reflecting the production that happened here despite the spending happening elsewhere.
Because the BEA, however, tallies all the spending that Americans do in a given period, and Americans also spend money on imported goods, that spending on imports would also be included in this expenditure method. To fix this, the BEA simply subtracts the value of all the goods that we import from other countries.
So what does all this mean? All else being equal, when spending on imports rises, GDP will remain unchanged. When spending on imports falls, GDP will remain… unchanged. The simple reality is that spending on imports does nothing to GDP whatsoever.
But does this mean that tariffs, which reduce imports, do not affect GDP? Not in the slightest.
When raw materials like steel and aluminum, as well as intermediate goods such as automotive components, become more expensive, production costs rise. When the cost of production increases, firms respond by producing less. That reduced production shows up in GDP figures as reductions in consumption, investment, government spending, or exports.
Note here the distinction: imports affect GDP insofar as they are used as inputs into domestic production. Spending on imports, however, does not affect GDP in and of itself. If anything, the relationship between “imports” and “GDP” should be the exact opposite that people allege: when firms buy more imported raw materials or intermediate goods, GDP should actually rise in subsequent reports, not fall. The opposite is also true.
So what should we make of this latest report, especially in light of the first quarter numbers? Frankly, we should conclude that economists warning about the effects of tariffs on business were right.
Consider the fact that in the first quarter, which ended March 31, Trump used IEEPA to actually change tariff rates dozens of times and to implement new tariffs. This, as plenty of economists pointed out, created tremendous uncertainty in what the tariff rates were going to be on a day-by-day basis. When uncertainty rises, businesses slow down and reduce output. Some even close altogether.
Contrast this with the second quarter, which began on April 1. There was “Liberation Day” on April 2, then the famous 90-day pause, a trade war with China (and only with China), and a lot of threats of tariffs. But no actual new tariffs were raised. We also had delays and reductions in previously announced tariffs.
In other words, in the quarter when Trump was imposing tariffs, GDP growth fell into negative territory. In the quarter where Trump was pausing, delaying, or reducing tariffs, GDP growth rose.
But let’s make one thing clear: GDP did not fall in the first quarter because firms were busy stockpiling imports ahead of the tariffs. It fell because actual, bona fide production fell. Likewise, GDP is not rising today because imports have fallen.
Economists have been raising this point for months. Tariffs are not a trade victory. They are a tax on the American people, making it harder for consumers (and businesses) to afford goods and services. This latest report is not a vindication for the White House or the New Right. It’s a case study of the simple truism that free markets work and tariffs do not.