Balance of Trade
Merchandise Trade Balance
• The gap between exports and imports if goods
only
–
–
–
–
–
Not services
Not other payments between countries
Exports > Imports—Trade Surplus
Exports < Imports—Trade Deficit
About 30 years ago we had ship and planes filled with
cargo and this was important
• But today we have call centers in India, movies over the
internet and others that make the merchandise trade
balance seem limitd
Current Account Balance
• The single statistic that captures the most
comprehensive picture of a nation’s balance of
trade
– Goods
– Services
• Net Exports or Commercial Balance
– Net primary income or factor income
• Earnings on foreign investments
– Net unilateral transfers
Current Account Balance for 2003
www.bea.gov
Exports/Credit
Imports/Debit
Balance
Merchandise trade
$713 billion
$1,261 billion
-$548 billion
Services trade
$307 billion
$256 billion
$51 billion
Investment income
$294 billion
$261 billion
$33 billion
Unilateral transfers
-$67 billion
TOTAL
-$531 billion
Trade
• Trade is very closely related to national saving
• Everything on the surplus side of the trade
balance involves money flowing into a county
– Like exports and investment income
• The deficit side of the balance involve money
flowing out of the country
– Like when we buy imports or paying some other
country investment income
Trade Deficit
• When the trade balance is zero then the flow
of funds out is equal to the flow of funds in
• We have a deficit which mean dollar are
flowing out of the country
– We were importing and there was not a
corresponding flow back in sufficient to offset our
imports
What Happened to Those Extra
Dollars?
• They are not coming back so something must
have happened—we know what did not
happen
– Not used to buy US goods
– Not used as payment for investments purchased
by Americans
– Not given back as a gift
• You need to remember that US dollars are
only legal tender in the US (well sort of)
More
• That Honda purchased in the 80s involved a transfer of dollars
• And Honda does not want dollars—it needs yen to pay its workers
• Honda will want to trade dollar with someone who has yen in the
foreign exchange market
• In one way or another they end up invested in US assets
– Either it goes to someone who buys stocks or bonds directly
– Or property
– Or put in a dollar denominated bank account—and then the bank will
loan out the dollars
• The money is returning as a flow of investment—it is the US
economy, as a whole, borrowing from foreigner who have earned
dollars and are not investing
National Savings and Investment
Identity
• Domestic Savings + Inflows of Foreign Capital
•
=
• Domestic Investment + Government Borrowing
• The left side is the sources of financial capital and
the right side is the demand for financial capital
•
S=D
Trade Deficit
• An extra source of money flowing into the
economy; an extra source of capital which can
be borrowed by firms or by the US
government
Identity
• This is an identity and it must be true
• If one side changes, something else must
change to bring it back into equality
– Say the government budget deficit increases
– It must be one of the three—do not know which
one
– In the 80s it was an inflow of capital and the US
became a net debtor to the world
Remember the CA
• This translates into the US owns foreign assets
and the Rest Of World owns US assets—in fact
they own more of us than we own of them
• People that own assets expect a rate of return
– Remember the current account—this is where the
investment income comes from
Is This Good?
• Relying on foreign capital may be better than not
having financial capital
• Did you know that we ran trade deficits year after
year through the 19th century—we had large
inflows of international funds—they help us
grow—helped us build the canals and the
railroads
• Korea had huge trade deficits in the 60s and 70s
and look at the result
Is This Bad?
• Yes! You can borrow too much. You can borrow
expecting to build up your economy and then not
be able to sell
– Argentina, Mexico, Russia
• You can borrow to fund consumption
– Greece
• You need to borrow in a way that generates
sufficient benefit so that you can repay—like your
student loans
What Are The Causes of a Large Trade
Deficit
• National Savings and Investment Identity
• Domestic Savings + Inflows of Foreign Capital
•
=
• Domestic Investment + Government Borrowing
• If the trade deficit went up, it must be that something
else went up as well
– One reason could be large budget deficits
• Money could be sucked in by large government borrowing
– One reason could be a surge in investment in the US
– One reason could be a drop in private savings
80s and early 2000s
• We were running large budget deficits
– In some cases the government was borrowing from
abroad
– In some cases they were soaking up the domestic
investment and firms went abroad to seek funds
• A budget surplus is not always a trade surplus—
the late 90s had budget surpluses but the dot
com boom was pulling money from abroad and
we still had a trade surplus
Agenda for Trade Deficits and Agenda
for Long-Term Growth
• Reducing the trade deficit, if we are going to
try to keep domestic investment high, this will
require higher domestic savings
• If you want to increase the growth rate you
also need to keep the investment rate high
• In both cases the policy response to
encourage increasing domestic savings
What is the Trade Deficit About?
• We just talked about it
– They are macroeconomic in nature
• National savings
• National investment
• Budget deficits
• Most of the stuff I hear people complaining
about are just myths
Myths
• The trade deficits is because of unfair foreign
trade
• Foreign countries are shutting out US goods
• There are unfair exports to the US
• They have nothing to do with the trade deficit
– Look at the pattern—you trying to tell me that in
recent years foreign trade has gone from fair to
unfair back to fair and then back to unfair
Myths
• Protectionism—restricting imports from
abroad
– This will neither cause nor fix trade deficits
– Yes, you can restrict imports from abroad
• But if there is a big gap between national saving and
national investment it will show up somehow in a trade
imbalance
• Beside it deprives the country of the benefits of trade
Myths
• Trade deficits are not determined by the level
of international trade
• World exports are about 25% of world GDP
– Do countries that export more than 25% have
greater trade deficits or surpluses
– Do countries that have exports less than 25% (less
exposed to international trade) have smaller trade
deficits or surpluses
• There is no pattern
Look at US and Japan
• The US has exports at about 10-12% of GDP,
significantly lower that the world level of 25%,
and it currently has a trade deficit
• Japan also has exports at about 10% of GDP
but has a high surplus because of its high
saving rate
Bilateral Trade Deficits
• You hear more about bilateral trade deficits or
trade deficits with one country like China
– They may be a large trading partner, although
Canada is larger, but this does not have
macroeconomic importance
– We should expect the US to have surpluses with
some countries and deficits with others it is the
macro view that is important
High Income Countries
• High income countries over time have tended
to run trade surpluses
– And thus have been net investors abroad investing
in low income countries
• Today the rest od the world is investing in us,
the richest economy in the world
– I wonder if this will continue—at some point we
will need to pay our bills
If it Does Change
• Will we continue to be a net borrower
– Will foreigner continue to want to hold our assets
– What will need to adjust
• Either
– A lower budget deficit
» Higher taxes or less spending
– Higher domestic savings (difficult with low interest rates)
which means less consumption
– Or less investment by firms in plants and equipment