Trade Balance
7-1
National Income Accounting
• Y=C+I+G+NX (Income-expenditure identity)
 Y=GDP (gross domestic product)
 NX=EX-IM=net exports of goods & services
• S=I+CA, where CA=NX+NFP
 CA=current account balance
 NFP=net factor payments from abroad
• If S<I, then CA=S-I<0
 If a country saves less than it invests, it must run a
current account surplus.
7-2
National Income Accounting
• Spvt=I+(-Sgovt)+CA (Use-of-saving identity)
 When CA is lowered, o.t.s being equal, Spvt is
lowered too. (trade deficit and low private saving
rate)
 When –Sgovt is more positive, o.t.s. being equal, CA
becomes lower (more severe gov deficit and
worsened trade deficit)
• Ignore NFP, focus on NX
• Why NX is already zero in our course?
7-3
Textbook treatment of NX
food
• Assumed one-shot
interaction
• A nation always
consumes up its value
of production (because
every agent does)
• No reason to consume
less
• unable to consume
more
D
Q
Iso-value line
cloth
7-4
Textbook Treatment of NX
•
•
•
•
Value of production = pCQC+pFQF
Value of consumption=pCDC+pFDF
pCQC+pFQF=pCDC+pFDF
Suppose C is exportable good; F is
importable good
• pC(QC-DC) - pF(DF-QF)=0
• Hence, NX=0
7-5
International Borrowing and Lending
• International capital mobility refers to mobility
of financial assets, or capital, across countries.
 Financial capital is a source of funds used to build
physical capital (ex., factories and equipment).
• International capital mobility can be
interpreted as intertemporal trade:
 trade of goods consumed today by borrowers
in return for goods consumed in the future
by lenders.
7-6
International
Borrowing and Lending (cont.)
• For any economy, there is a trade-off
(opportunity cost) between consuming today
and saving for the future: resources can either
be consumed or saved.
 To save and invest more today typically means that
economies need to consume less today.
• We represent this concept by drawing a
special kind of production possibility frontier,
an intertemporal production possibility
frontier.
7-7
Fig. 7-5: The Intertemporal
Production Possibility Frontier
7-8
International Borrowing and Lending
• Some countries will have a comparative
advantage in spending current output/income
(in current consumption).
• Others will have one in saving current output/
income (in future consumption).
• A comparative advantage in current
consumption
 would mean a lower opportunity cost of spending
current income.
 would be reflected in an intertemporal PPF that is
biased toward current consumption.
7-9
International
Borrowing and Lending (cont.)
• Suppose that the domestic country has a comparative
advantage in (bias towards) current consumption,
while the foreign country has a comparative
advantage (bias towards) future consumption.
• In the absence of international borrowing and lending,
the relative price of current consumption should be
lower in the domestic country.
• But what is the relative price of current consumption?
7-10
International
Borrowing and Lending (cont.)
• The price of borrowing 1 unit of output/income to
consume today is the output/income that needs to be
repaid in the future:
 principal + interest = 1+r, where r is the interest rate
 The price of current consumption relative to future
consumption is 1/(1+r)
• The opportunity cost of consuming 1 unit of output/
income today is the output/income that could be
earned by saving it:
 principal + interest = 1+r, where r is the interest rate
 The opportunity cost of current consumption relative to future
consumption is 1/(1+r)
7-11
International
Borrowing and Lending (cont.)
• If international borrowing and lending are
allowed, the domestic country will “export”
current consumption (that is, borrow).
 The domestic country initially has a lower relative
price of current consumption 1/(1+r)
 The domestic country initially has a higher
interest rate r.
 A higher interest rate r implies a higher return to
consumption and investment in production
processes: they are highly desirable and profitable
so that the domestic country should borrow from
foreign lenders.
7-12
Fig. 7A2-1: Determining Home’s
Intertemporal Production Pattern
7-13
Fig. 7A2-2: Determining Home’s
Intertemporal Consumption Pattern
7-14
Fig. 7A2-3: Determining Foreign’s Intertemporal
Production and Consumption Patterns
7-15
Fig. 7A2-2: Determining Home’s
Intertemporal Consumption Pattern
7-16
Demography: Life cycle consideration
• Life cycle consideration
• A country is likened to a person: save
when young & working, de-save when
old
• Hence, when ageing, a country runs a
trade surplus first, followed by a trade
deficit
7-17
A hypothetical example
• Suppose each agent lives two periods: young
(working) and old (retiring).
• Suppose a small country in which all residents are
young but they do not decide to have children.
• Suppose only one, non-storable good is produced.
But one foreign asset is available (call it US treasury
bond, with constant interest rate r)
• Time 1: all residents are young; trade surplus
• Time 2; all residents are old; trade deficit
• Time 3: the country disappears; NX=0
7-18
A hypothetical example
Trade balance
Trade
surplus Period 2
Period 1
Trade
deficit
Period 3
time
7-19
A hypothetical example
• CA=S-I
• Demography explains S. In case I is
unrelated to demography or less
responsive to it, then the change in S
will reveal itself in CA
• In China, weak financial markets prevent
channeling of savings to those who have
good business ideas
7-20
Median age: China versus US
Median Age
50
45
40
35
30
25
20
15
10
5
0
50
55
60
65
70
75
80
85
90
95
China
Median age (Years)
Medium variant
0
5
10
15
20
25
30
35
40
45
50
U.S.A.
Median Age
(Years)
Medium variant
7-21
Total Dependency Ratio: China versus US
Total Dependency Ratio
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
50
55
60
65
70
75
80
85
90
USA: Total Dependency Ratio
95
0
5
10
15
20
25
30
35
40
45
50
China: Total (Young+Old)dependency ratio
7-22
Dependence ratio: China
7-23
Difficulty
• The example predicts CA be negative
some day. For Germany and Japan,
whose populations have aged for a long
time, still there is no sign their CA will
become negative.
• Way out: to look at richer demography
that allows for richer dynamic of CA
change
7-24
Demography
Sex ratio in China (males per 100 females)
year
At birth
Population aged
0-4
1953
104.9
107.3
1964
103.8
106.5
1982
107.6
107.0
1990
111.8
109.8
1995
116.6
118.8
2000
117.8
120.8
2005
122.0
120.0
2010
--
121.0 (estimated)
7-25
Demography
• Sexual Imbalance (missing women)
• one child policy + son preferences
• Parents and their single sons save more to
increase competitiveness in the marriage
market
• Evidence: counties with more skewed sex
ratio have higher saving rates
• It is argued that sexual imbalance may
account of up to ½ of the China’s trade
surplus with the US.
7-26
Data/mis-measurement problem
• “Dark Matters in China’s Current Account” by Zhiwei
Zhang, a staff member of HKMA
• One bias due to under-estimated returns on foreign
investments in China
• all earnings for foreign investments should be
recorded in current account as a negative item,
regardless if the earnings are re-invested in China or
repatriated out
• Official CA statistics; official stock of FI by end of 2006
is US$1.03T; FI earnings US$57.3B in 2007 =>
hence, ROR 5.5%
• The author’s estimate: FI earnings ~ US$109.6B
• Evidence: ROR should be higher (OECD studies
found 14.3%).
7-27
Data/mis-measurement problem
• 60% of China’s exports are actually made by foreign
funded firms
• China has been top exporter of cell phones and
notebook computers, but the cell phones are mostly
made by Nokia and Motorola, and notebooks by Dell
and HP.
• The importance of foreign capital is asymmetrically
reflected in China’s current account
 the explosive growth of exports (largely due to foreign firms
moving production bases into China) are well recorded,
 But the profits foreign firms made into China are substantially
under-recorded.
7-28
Data/mis-measurement problem
• Another source of bias: capital inflows misreported as
trade surplus.
• The expectation for RMB appreciation heightened in
mid 2004, and made one-way bet for RMB a
profitable arbitrage opportunity.
• Firms in China can over-report their exports and
under-report their imports.
• China’s current account surplus is over-estimated,
and capital account surplus is under-estimated.
• Misreported capital flows through the trade channel
amounts to 1.9% of GDP in 2007.
7-29
Data/mis-measurement problem
• Accounting for Growth in China’s Exports by Firm
Ownership
Stateowned
Foreignfunded
Collective
Private
2002
16%
62%
8%
14%
2003
13%
62%
6%
19%
2004
10%
63%
4%
22%
2005
9%
63%
3%
26%
2006
11%
58%
2%
29%
2007
13%
53%
2%
31%
7-30
Other explanations
• S=I+CA
• It is China, stupid!




Currency manipulation (RMB undervalued)
Mercantilism (export is good, import is bad)
Saving rate too high (culture?)
Poor financial market
• It is US, stupid!
 Saving rate too low (culture?)
 Developed financial market
• J.M. Keynes: “If I owe you a little money and I don’t repay, I have
trouble. If I owe you a lot of money and don’t repay, you have
trouble!”
7-31
Prognosis: China as a transformative
/de-stabilizing factor
• Increasing economic power
 Education attainment
• 2000: 1 million college students graduated
• 2010: more than 6 million college students graduated
(c.w. 3.5 million first year students in US in 2008)
• Now 22% of the cohort go to college
 Rate of return of capital has no sign to slow down
• Destabilizing the global order
• But growth will slow down one day…
• Income inequality
7-32
Prognosis: China as a transformative
/de-stabilizing factor
• Sexual imbalance
 1.7 million un-marriageable boys being borne each year
 =5 times of the total girls borne a year in Canada (around
330K)
 =50 times of the total girls borne a year in HK (around 30K)
•
•
•
•
•
Lack of non-material ideals
Communist Party an effective autocracy forever?
1949-1978: passion
1979-2008: interest
2009-2039: ??
7-33
Topics
•
•
•
•
•
•
•
•
Trade balance & capital flows
Textbook case
Data problem
Demography
Lack of investment opportunity
Undeveloped financial market
Exchange manipulation
Culture—saving glut
7-34