Written for the Peterson Institute for International Economics (PIIE), Dr. ir. Maurice Obstfeld has one Great, non-technical piece Tackling some of the claims of Michael Pettis (among other things) that a trade deficit must be ‘managed’. Obstfeld describes the theoretical and empirical issues with the claims of Pettis very concisely. Allow me to supplement Obstfeld’s comments with mine.
First, a technical comment: there is a difference between the trade balance (the difference between export and import) and the current account (export, import and some financial transactions such as income from investments and transfers). For the purposes here, however, I will not worry too much about that difference; It doesn’t matter much for the point that I make. With that out of the way, let’s start.
In National Income Accounting, the current account is the difference between national savings and national investments (for those interested in the algebra, you can find it here). We have mathematically:
Current account = savings – investments.
This accounting identity is deceptively simple. If someone thinks a shortage in the current account (that is, investment is greater than savings, is a problem (an unjustified claim that we will achieve in a moment), then the solution is simple: increasing the savings or reducing investments. Do that and the problem is solved.
But realistic What can a government do? I emphasize “realistic” because there seems to be some confusion at that point. Reformers are happy to propose actions that are completely separate from reality. From a realistic point of view, there are not many governments can Doing. Most elements of savings and investments are determined exogenously. It is not like a person who makes a budget. On the contrary, national savings and national investments are determined by factors that are far beyond the control of a government: desires of people within the border, desires of those outside the country, plans made by companies and countless other factors. Savings and investments, in other words, are come up. They are not things that can be manipulated, no levers to be drawn and adjusted. It is not that it is difficult to manage them. It is impossible To manage them. That simple accounting comparison hides the complexity of complexity.
Of course, governments can influence one aspect of identity: savings. National savings consists of private savings and government savings. Governments can increase their savings (that is, not working in a deficit) that, everything else that is equal, can reduce the shortage in the current account. Although, even that method has its limitations, as Obstfeld discusses. Furthermore, governments have sometimes tried to influence private savings and investments through different stimuli and capital controls, but incentives are not a mind control. They do not always work and often have unintended consequences.
All this assumes that a shortage in the current account is a bad thing, something to avoid. However, nothing could be further from the truth. More often than not, trade shortages are a sign of good things, as central professor in Washington University Economics Robert Carbaugh explains:
Often enjoy countries fast Has economic growth in the current account in the long term shortenwhile that with weaker Economic growth has a long run in the current account surpassed. This relationship probably stems from the fact that rapid economic growth and strong investments often go hand in hand. Where the driving force is the discovery of new natural resources, technological progress or the implementation of economic reforms, periods of rapid economic growth are probably periods in which new investments are unusually profitable. Investments must be financed with saving, and if the national saving of a country is not sufficient to finance all new profitable investment projects, the country will rely on foreign save to finance the difference. It therefore experiences a net financial inflow and a corresponding shortage in the current account. As long as the new investments are profitable, they will generate the extra income needed to repay the contracted claims to do them. When shortages in the current account are a reflection of strong, profitable investment programs, they work on increasing output and employment growth, not to destroy jobs and production. ((International economy18th ED, PG 302, emphasis in original).
Be in the current account not A bad thing if they reflect profitable investment options such as in the US. That is why the US has been able to go to the current account for more than 40 years and often becomes new record levels for industrial production and remains one of the world’s most productive places. But that could change with Trump’s trade war. If countries move to the US to avoid rates, it is because, almost by definition, they are less profitable in the US than abroad. Consequently, there are trade shortages that arise from the trade war Are A worrying sign.