Principles of Economics - 3e Chapter 23 The International Trade and Capital Flows

The Int Trade and Capital FIGURE of Money We are all part of the global system , which includes many different currencies ( Credit of Money from around the world by Images , BY ) CHAPTER OBJECTIVES In this chapter , you will learn about Measuring Trade Balances Trade Balances in Historical and International Context Trade Balances and Flows of Financial Capital The National Saving and Investment Identity The Pros and Cons of Trade and Surpluses The Difference between Level of Trade and the Trade Balance Introduction to the International Trade and Capital Flows BRING IT HOME More than Meets the Eye in the Congo How much do you interact with the global system ?

Do you think not much ?

Think again Suppose you take 558 23 The International Trade and Capital Flows out a student loan , or you deposit money into your bank account . You just affected domestic savings and borrowing . Now say you are at the mall and buy two made in China , and later contribute to a charity that helps refugees . What is the impact ?

You affected how much money flows into and out of the United States . If you open an IRA savings account and put money in an international mutual fund , you are involved in the flow of money overseas . While your involvement may not seem as influential as that of someone like the president , who can increase or decrease foreign aid and , thereby , have a huge impact on money flows in and out of the country , you do interact with the global financial system on a daily basis . The balance of term you will meet like a huge topic , but once you learn the specific components of trade and money , it all makes sense . way , you may have to give up some common misunderstandings about trade and answer some questions If a country is running a trade , is that bad ?

Is a trade surplus good ?

For example , look at the Democratic Republic of the Congo ( often referred to as Congo ) a large country in Central Africa . In 2013 , it ran a trade surplus of billion , so it must be doing well , right ?

In contrast , the trade in the United States was 508 billion in 2013 . Do these suggest that the United States economy is performing worse than the Congolese economy ?

Not necessarily . The trade tends to worsen as the economy strengthens . In contrast , high poverty rates in the Congo persist , and these rates are not going down even with the positive trade balance . Clearly , it is more complicated than simply asserting that running a trade is bad forthe economy . You will learn more about these issues and others in this chapter . The balance of trade ( or trade balance ) is any gap between a nation dollar value of its exports , or what its producers sell abroad , and a nation dollar value of imports , or the products and services that households and businesses purchase . Recall from The Perspective that if exports exceed imports , the economy has a trade surplus . If imports exceed exports , the economy has a trade . If exports and imports are equal , then trade is balanced , but what happens when trade is out of balance and large trade surpluses or exist ?

Germany , for example , has had substantial trade surpluses in recent decades , in which exports have greatly exceeded imports . According to the World Bank , in 2020 , Germany ran a trade surplus of 242 billion . In contrast , the economy in recent decades has experienced large trade , in which imports have considerably exceeded exports . In 2020 , for example , imports exceeded exports by 651 billion . A series of crises triggered by unbalanced trade can lead economies into deep . These crises begin with large trade . At some point , foreign investors become pessimistic about the economy and move their money to other countries . The economy then drops into deep recession , with real often falling up to 10 or more in a single year . This happened to Mexico in 1995 when their fell . A number of countries in East , South Korea , Malaysia , and to the same economic illness in ( called the Asian Financial Crisis ) In the late and into the early , Russia and Argentina had the identical experience . What are the connections between imbalances of trade in goods and services and the of international capital that set off these economic avalanches ?

We will start by examining the balance of trade in more detail , by looking at some patterns of trade balances in the United States and around the world . Then we will examine the intimate connection between international of goods and services and international of capital , which to economists are reallyjust two sides of the same coin . People often assume that trade surpluses like those in Germany must be a positive sign for an economy , while trade like those in the United States must be harmful . As it turns out , both trade surpluses and can be either good or bad . We will see why in this chapter . Access for free at

Measuring Trade Balances 559 Measuring Trade Balances LEARNING OBJECTIVES By the end of this section , you will be able to Explain merchandise trade balance , current account balance , and unilateral transfers Identify components of the current account balance Calculate the merchandise trade balance and current account balance using import and export data for a country A few decades ago , it was common to track the solid or physical items that planes , trains , and trucks transported between countries as a way of measuring the balance of trade . Economists call this measurement the merchandise trade balance . In most economies , including the United States , goods comprise less than half ofa country total production , while services comprise more than half . The last two decades have seen a surge in international trade in services , powered by technological advances in telecommunications and computers that have made it possible to export or import customer services , law , advertising , management consulting , software , construction engineering , and product design . Most global trade still takes the form of goods rather than services , and the government announces and the media prominently report the merchandise trade balance . Old habits are hard to break . Economists , however , typically rely on broader measures such as the balance of trade or the current account balance which includes other international of income and foreign aid . Components ofthe Current Account Balance Table breaks down the four main components of the current account balance for the last quarter of 2015 ( seasonally adjusted ) The line shows the merchandise trade balance that is , exports and imports of goods . Because imports exceed exports , the trade balance in the column is negative , showing a merchandise trade . We can explain how the government collects this trade information in the following Clear It Up feature . Value of Exports ( money flowing into Value of Imports ( money flowing out the United States ) of the United States ) a Goods Services Income receipts and payments Unilateral transfers Current account balance TABLE Components of the Current Account Balance for 2020 ( in billions of dollars ) Source , ITA Table CLEAR IT UP How does the government collect trade statistics ?

Do not confuse the balance of trade ( which tracks imports and exports ) with the current account balance , which includes not just exports and imports , but also income from investment and transfers .

560 23 The International Trade and Capital Flows The Bureau of Economic Analysis ( BEA ) within the Department of Commerce compiles statistics on the balance of trade using a variety of different sources . Merchandise importers and exporters must file monthly documents with the Census Bureau , which provides the basic data trade . To measure international trade in can happen over a telephone line or computer network without shipping any physical BEA carries out a set of surveys . Another set of BEA surveys tracks investment flows , and there are even surveys to collect travel information from residents visiting Canada and Mexico . For measuring unilateral transfers , the BEA has access to official government spending on aid , and then also carries out a survey of charitable organizations that make foreign donations . The BEA then this information on international flows of goods and capital against other available data . For example , the Census Bureau also collects data from the shipping industry , which it can use to check the data on trade in goods . All companies involved in international flows of banks and companies making financial investments like file reports , which the Department of the Treasury ultimately checks . The BEA also can cross check information on foreign trade by looking at data collected by other countries on their foreign trade with the United States , and also at the data collected by various international organizations . Take these data sources , stir carefully , and you have the balance of trade statistics . Much of the statistics that we cite in this chapter come from these sources . The second row of Table 231 provides data on trade in services . Here , the economy is running a surplus . Although the level of trade in services is still relatively small compared to trade in goods , the importance of services has expanded substantially over the last few decades . For example , exports of services were equal to about of exports of goods in 2020 , compared to in 1980 . The third component of the current account balance , labeled income payments , refers to money that investors received on their foreign investments ( money into the United States ) and payments to foreign investors who had invested their funds here ( money out of the United States ) The reason for including this money on foreign investment in the overall measure of trade , along with goods and services , is that , from an economic perspective , income is just as much an economic transaction as car , wheat , or oil shipments it is just trade that is happening in the capital market . The category of the current account balance is unilateral transfers , which are payments that government , private charities , or individuals make in which they send money abroad without receiving any direct good or service . Economic or military assistance from the government to other countries into this category , as does spending abroad by charities to address poverty or social inequalities . When an individual in the United States sends money overseas , as is the case with some immigrants , it is also counted in this category . The current account balance treats these unilateral payments like imports , because they also involve a stream of payments leaving the country . For the economy , unilateral transfers are almost always negative . This pattern , however , does not always hold . In 1991 , for example , when the United States led an international coalition against Saddam Iraq in the Gulf War , many other nations agreed that they would make payments to the United States to offset the war expenses . These payments were large enough that , in 1991 , the overall balance on unilateral transfers was a positive 10 billion . The following Work It Out feature steps you through the process of using the values for goods , services , and income payments to calculate the merchandise balance and the current account balance . Access for free at

Measuring Trade Balances 561 Calculating the Merchandise Balance and the Current Account Balance Exports ( in billions ) Imports ( in billions ) Balance Goods Services Income payments Unilateral transfers Current account balance TABLE Calculating Merchandise Balance and Current Account Balance Use the information given below to in Table , and then calculate The merchandise balance The current account balance Known information Unilateral transfers 130 Exports in goods Exports in services 509 Imports in goods Imports in services 371 Income received by investors on foreign stocks and bonds 561 Income received by foreign investors on assets 472 ep . Focus on goods and services . Enter the dollar amount of exports of both goods and services under the Export column . ep . Enter imports of goods and services under the Import column . ep . Under the Export column and in the row for Income payments , enter the flows of money coming back to the United States . investors are earning this income from abroad . ep . Under the Import column and in the row for Income payments , enter the flows of money going ut of the United States to foreign investors . Foreign investors are earning this money on assets , like stocks . ep . Unilateral transfers are money flowing out of the United States in the form of , for example , military aid , foreign aid , and global charities . Because the money leaves the country , enter it under Imports and in the column as well , as a negative . ep . Calculate the trade balance by subtracting imports from exports in both goods and services . Enter this in the Balance column . This can be positive or negative . ep . Subtract the income payments flowing out of the country ( under Imports ) from the money coming back to the United States ( under Exports ) and enter this amount under the Balance column . ep . Enter unilateral transfers as a negative amount under the Balance column . ep . The merchandise trade balance is the difference between exports of goods and imports of

562 23 The International Trade and Capital Flows first number under Balance . Step 10 . Now sum up your columns for Exports , Imports , and Balance . The balance number is the current account balance . The merchandise balance of trade is the difference between exports and imports . In this case , it is equal to , a trade of 516 billion . The current account balance is 419 billion . See the completed Table . Value of Exports ( money flowing Value of Imports ( money flowing out into the United States ) of the United States ) a ante Goods 516 Services 509 371 138 Income receipts 561 472 89 and payments Unilateral transfers 130 130 current account 419 balance TABLE Completed Merchandise Balance and Current Account Balance Trade Balances in Historical and International Context LEARNING OBJECTIVES By the end of this section , you will be able to Analyze graphs of the current account balance and the merchandise trade balance Identify patterns in trade surpluses and Compare the trade surpluses and to other countries trade surpluses and We present the history of the current account balance in recent decades in several different ways . a ) shows the current account balance and the merchandise trade latter of which is simply the balance on goods exported versus dollar terms . shows the current account balance and merchandise account balance yet again , this time as a share of the for that year . By dividing the trade in each year by in that year , factors out both and growth in the real economy . Access for free at

Trade Balances in Historical and International Context 100 , 400 , 900 Current account balance ME trade balance Year 1960 mesa 1976 1980 ) 1096 2000 2004 7008 2012 ems ?

Billions oi Dollars tail The current and merchandise trade ill nominal dollars 1960 1995 2000 2005 2010 a 201 ?

Percentage ol Year ) The current account and trade balance as a percentage ! FIGURE Current Account Balance and Merchandise Trade Balance , a ) The current account balance and the merchandise trade balance in billions of dollars from 1960 to 2020 . The merchandise trade balance is the trade balance on goods only . If the lines are above zero dollars , the United States was running a positive trade balance and current account balance . If the lines fall below zero dollars , the United States is running a trade and a in its current account balance . This shows the same balance and current account relationship to the size of the economy , or , from 1960 to 2020 . By either measure , the US . balance of trade pattern is clear . From the 19605 into the 19705 , the economy had mostly small trade is , the graphs in Figure 232 show positive numbers . However , starting in the 19805 , the trade increased rapidly , and after a tiny surplus in 1991 , the current account trade became even larger in the late and into the . However , the trade declined in 2009 after the recession had taken hold , then rebounded partially in 2010 and remained stable up through 2019 , before falling again in 2020 . Click to view content ( books Current Account Balance in Billions of Dollars . 563

564 23 The International Trade and Capital Flows Table 234 shows the trade picture in 2013 compared with some other economies from around the world . While the economy has consistently run trade in recent years , Japan and many European nations , among them France and Germany , have consistently run trade surpluses . Some of the other countries listed include Brazil , the largest economy in Latin America , along with South Africa competing to be the largest economy in Africa and China , India , and Korea . The first column offers one measure of an globalization exports of goods and services as a percentage of . The second column shows the trade balance . Usually , most countries have trade surpluses or that are less than of . As you can see , the current account balance is , while Germany is . Exports of Goods and Services Current Account Balance United States Japan Germany United Kingdom Canada Sweden Korea Mexico Brazil China India World TABLE Level and Balance of Trade ( Balance of Payments basis ) in 2020 ( as a percentage of , Source ) Trade Balances and Flows of Financial Capital LEARNING OBJECTIVES By the end of this section , you will be able to Explain the connection between trade balances and capital Calculate comparative advantage Explain balanced trade in terms of investment and capital As economists see it , trade surpluses can be either good or bad , depending on circumstances , and trade can be good or bad , too . The challenge is to understand how the international flows of goods and services are connected with international of capital . In this module we will illustrate the intimate connection between trade balances and of capital in two ways a parable of trade between Robinson Crusoe and Friday , and a circular diagram representing of trade and payments . Access for tree at

Trade Balances and Flows of Financial Capital 565 A Economy Robinson Crusoe and Friday To understand how economists view trade and surpluses , consider a parable based on the story of Robinson Crusoe . Crusoe , as you may remember from the classic novel by Daniel published in 1719 , was shipwrecked on a desert island . After living alone for some time , he is joined by a second person , whom he names Friday . Think about the balance of trade in a economy like that of Robinson and Friday . Robinson and Friday trade goods and services . Perhaps Robinson catches and trades them to Friday for coconuts , or Friday weaves a hat out of tree fronds and trades it to Robinson for help in carrying water . For a of time , each individual trade is and complete . Because each trade is voluntary , both Robinson and Friday must feel that they are receiving fair value for what they are giving . As a result , each exports are always equal to his imports , and trade is always in balance between the two . Neither either a trade or a trade surplus . one day Robinson approaches Friday with a proposition . Robinson wants to dig ditches for an irrigation system for his garden , but he knows that if he starts this project , he will not have much time left to and gather coconuts to feed himself each day . He proposes that Friday supply him with a certain number of an coconuts for several months , and then after that time , he promises to repay Friday out of the extra he will be able to grow in his irrigated garden . If Friday accepts this offer , then a trade imbalance comes into being . For several months , Friday will have a trade surplus that is , he is exporting to Robinson more than he is importing . More precisely , he is giving Robinson and coconuts , and at least for the moment , 19 is receiving nothing in return . Conversely , Robinson will have a trade , because he is importing more from Friday than he is exporting . This para ale raises several useful issues in thinking about what a trade and a trade surplus really mean in economic terms . The issue that this story of Robinson and Friday raises is this Is it better to have a trade surplus or a trade ?

The answer , as in any voluntary market interaction , is that if both parties agree to the transaction , then they may both be better off . Over time , if Robinson irrigated garden is a success , it is certainly that both Robinson and Friday can from this agreement . The parable raises a second issue What can go wrong ?

Robinson proposal to Friday introduces an element of uncertainty . Friday is , in effect , making a loan of and coconuts to Robinson , and Fridays happiness with this arrangement will depend on whether Robinson repays that loan as planned , in full and on time . Perhaps Robinson spends several months and never builds the irrigation system , or perhaps Robinson has been too optimistic about how much he will be able to grow with the new irrigation system , which turns out not to be very productive . Perhaps , after building the irrigation system , Robinson decides that he does not want to repay Friday as much as he previously agreed . Any of these developments will prompt a new round of negotiations between Friday and Robinson . Why the repayment failed is likely to shape Friday attitude toward these renegotiations . If Robinson worked very hard and the irrigation did not increase production as intended , Friday may have some sympathy . If Robinson or if he just refuses to pay , Friday may become irritated . A third issue that the parable raises is that an intimate relationship exists between a trade and international borrowing , and between a trade surplus and international lending . The size of Friday trade surplus is exactly how much he is lending to Robinson . The size of Robinson trade is exactly how much he is borrowing from Friday . To economists , a trade surplus literally means the same thing as an of capital , and a trade literally means the same thing as an of capital . This last insight is worth exploring in greater detail , which we will do in the following section . The story of Robinson and Friday also provides a good opportunity to consider the law of comparative advantage , which you learn more about in the International Trade chapter . The following Work It Out feature steps you through calculating comparative advantage for the wheat and cloth traded between the United States and Great Britain in the .

566 23 The International Trade and Capital Flows Calculating Comparative Advantage In the , the United States and Britain traded wheat and cloth . Table shows the varying hours of labor per unit of output . Wheat ( in Cloth ( in Relative labor cost of wheat Relative labor cost of cloth bushels ) yards ) United States Britain TABLE Step . Observe from Table that , in the United States , it takes eight hours to supply a bushel of wheat and nine hours to supply a yard of cloth . In contrast , it takes four hours to supply a bushel of wheat and three hours to supply a yard of cloth in Britain . Step . Recognize the difference between absolute advantage and comparative advantage . Britain has an absolute advantage ( lowest cost ) in each good , since it takes a lower amount of labor to make each good in Britain . Britain also has a comparative advantage in the production of cloth ( lower opportunity cost in cloth ( versus ) The United States has a comparative advantage in wheat production ( lower opportunity cost of versus ) Step . Determine the relative price of one good in terms of the other good . The price of wheat , in this example , is the amount of cloth you have to give up . To this price , convert the hours per unit of wheat and cloth into units per hour . To do so , observe that in the United States it takes eight hours to make a bushel of wheat , so workers can process of a bushel of wheat in an hour . It takes nine hours to make of cloth in the United States , so workers can produce of a yard of cloth in an hour . If you divide the amount of cloth ( of a yard ) by the amount of wheat you give up ( of a bushel ) in an hour , you the price ( of one good ( wheat ) in terms of the other ( cloth ) The Balance of Trade as the Balance of Payments The connection between trade balances and international of capital is so close that economists sometimes describe the balance of trade as the balance of payments . Each category of the current account balance involves a corresponding of payments between a given country and the rest of the world economy . Figure shows the of goods and services and payments between one United States in this the rest of the world . The top line shows US . exports of goods and services , while the second line shows payments from purchasers in other countries back to the economy . The third line then shows imports of goods , services , and investment , and the fourth line shows payments from the home economy to the rest of the world . Flow of goods and services ( lines one and three ) show up in the current account , while we of funds ( lines two and four ) in the account . The bottom four lines in Figure 233 show the of investment income . In the of the bottom lines , we see investments made abroad with funds from the home country to the rest of the world . Investment income stemming from an investment abroad then runs in the other direction from the rest of the world to the home country . Similarly , we see on the bottom third line , an investment from the rest of the world into the Access for free at

The National Saving and Investment Identity 567 home country and investment income ( bottom fourth line ) from the home country to the rest of the world . We the investment income ( bottom lines two and four ) in the current account , while investment to the rest of the world or into the home country ( lines one and three ) is in the account . This does not show unilateral transfers , the fourth item in the current account . Exports Payment for exports Imports Payment for imports Rest of the world Foreign investment Investment income received Home country Investment from abroad Investment income paid FIGURE Flow of Investment Goods and Capital Each element of the current account balance involves a flow of payments between countries . The top line shows exports of goods and services leaving the home country the second line shows the money that the home country receives for those exports . The third line shows imports that the home country receives the fourth line shows the payments that the home country sent abroad in exchange for these imports . A current account means that , the country is a net borrower from abroad . Conversely , a positive current account balance means a country is a net lender to the rest of the world . Just like the parable of Robinson and Friday , the lesson is that a trade surplus means an overall of investment capital , as domestic investors put their funds abroad , while a in the current account balance is exactly equal to the overall or net of foreign investment capital from abroad . It is important to recognize that an and of foreign capital does not necessarily refer to a debt that governments owe to other governments , although government debt may be part of the picture . Instead , these international of capital refer to all of the ways in which private investors in one country may invest in another buying real estate , companies , and investments like stocks and bonds . The National Saving and Investment Identity LEARNING OBJECTIVES By the end of this section , you will be able to Explain the of trade and current account balance Identify and calculate supply and demand for capital Explain how a nation own level of domestic saving and investment determines a nation balance of trade Predict the rising and falling of trade based on a nation saving and investment identity The close connection between trade balances and international of savings and investments leads to a analysis . This approach views trade their associated of

568 23 The International Trade and Capital Flows the context of the overall levels of savings and investment in the economy . Understanding the of the Trade and Current Account Balance The national saving and investment identity provides a useful way to understand the of the trade and current account balance . In a nation capital market , the quantity of capital supplied at any given time must equal the quantity of capital demanded for purposes of making investments . What is on the supply and demand sides of capital ?

See the following Clear It Up feature for the answer to this question . CLEAR IT UP What comprises the supply and demand of financial capital ?

A country national savings is the total of its domestic savings by household and companies ( private savings ) as well as the government ( public savings ) If a country is running a trade , it means money from abroad is entering the country and the government considers it part of the supply of capital . The demand for capital ( money ) represents groups that are borrowing the money . Businesses need to borrow to their investments in factories , materials , and personnel . When the federal government runs a budget , it is also borrowing money from investors by selling Treasury bonds . Therefore , both business investment and the federal government can demand ( or borrow ) the supply of savings . There are two main sources for the supply of capital in the economy saving by individuals and , called , and the of capital from foreign investors , which is equal to the trade ( or imports minus exports . There are also two main sources of demand for capital in the economy private sector investment , I , and government borrowing , where the government needs to borrow when government spending , is higher than the taxes collected , We can express this national savings and investment identity in algebraic terms Supply of financial capital Demand for financial capital ( Again , in this equation , is private savings , is taxes , is government spending , is imports , is exports , and I is investment . This relationship is true as a matter of because , for the macro economy , the quantity supplied of capital must be equal to the quantity demanded . However , certain components of the national savings and investment identity can switch between the supply side and the demand side . Some countries , like the United States in most years since the , have budget , which mean the government is spending more than it collects in taxes , and so the government needs to borrow funds . In this case , the government term would be , showing that spending is larger than taxes , and the government would be a demander of capital on the side of the equation ( that is , a borrower ) not a supplier of capital on the righthand side . However , if the government runs a budget surplus so that the taxes exceed spending , as the government did from 1998 to 2001 , then the government in that year was contributing to the supply of capital ( and would appear on the left ( saving ) side of the national savings and investment identity . Similarly , ifa national economy runs a trade surplus , the trade sector will involve an of capital to other countries . A trade surplus means that the domestic capital is in surplus within a country and can be invested in other countries . The fundamental notion that total quantity of capital demanded equals total quantity of capital supplied must always remain true . Domestic savings will always appear as part of the supply of capital and domestic investment will always appear as part of the demand for capital . Access for free at

The National Saving and Investment Identity 569 However , the government and trade balance elements of the equation can move back and forth as either suppliers or of capital , depending on whether government budgets and the trade balance are in surplus or . Domestic Saving and Investment Determine the Trade Balance One insight from the national saving and investment identity is that a nation own levels of domestic saving and investment determine a nation balance of trade . To understand this point , rearrange the identity to put the balance of trade all by itself on one side of the equation . Consider first the situation with a trade , and then the situation with a trade surplus . In the case ofa trade , the national saving and investment identity can be rewritten as Trade Domestic investment Private domestic saving Government ( or public ) savings ( In this case , domestic investment is higher than domestic saving , including both private and government saving . The only way that domestic investment can exceed domestic saving is if capital is into a country from abroad . After all , that extra capital for investment has to come from someplace . Now consider a trade surplus from the standpoint of the national saving and investment identity Trade surplus Private domestic saving Public saving Domestic investment ( In this case , domestic savings ( both private and public ) is higher than domestic investment . That extra capital will be invested abroad . This connection of domestic saving and investment to the trade balance explains why economists view the balance of trade as a fundamentally phenomenon . As the national saving and investment identity shows , the performance of certain sectors of an economy , like cars or steel , do not determine the trade balance . Further , whether the nations trade laws and regulations encourage free trade or protectionism also does not determine the trade balance ( see Globalization and Protectionism . Exploring Trade Balances One Factor at a Time The national saving and investment identity also provides a framework for thinking about what will cause trade to rise or fall . Begin with the version of the identity that has domestic savings and investment on the left and the trade on the right Domestic investment Private domestic savings Public domestic savings Trade deficit ( Now , consider the factors on the side of the equation one at a time , while holding the other factors constant . As a example , assume that the level of domestic investment in a country rises , while the level and public saving remains unchanged . Table shows the result in the row under the equation . Since the equality of the national savings and investment identity must continue to is , after all , an identity that must be true by rise in domestic investment will mean a higher trade . This situation occurred in the economy in the late . Because of the surge of new information and communications technologies that became available , business investment increased substantially . A fall in private saving during this time and a rise in government saving more or less offset each other . As a result , the capital to fund that business investment came from abroad , which is one reason for the very high trade of the late and early .

570 23 The International Trade and Capital Flows Domestic Private Domestic Public Domestic , Trade Investment Savings Savings I ( Then must Up No change No change , rise No change Up No change Then must fall Th No change No change Down , en must rise TABLE Causes of a Changing Trade Balance As a second scenario , assume that the level of domestic savings rises , while the level investment and public savings remain unchanged . In this case , the trade would decline . As domestic savings rises , there would be less need for foreign capital to meet investment needs . For this reason , a policy proposal often made for reducing the US . trade is to increase private exactly how to increase the overall rate of saving has proven controversial . As a third scenario , imagine that the government budget increased dramatically , while domestic investment and private savings remained unchanged . This scenario occurred in the US . economy in the . The federal budget increased from 79 billion in 1981 to 221 billion in increase in the demand for capital of 142 billion . The current account balance collapsed from a surplus of billion in 1981 to a of 147 billion in increase in the supply of capital from abroad of 152 billion . The connection at that time is clear a sharp increase in government borrowing increased the US . economy demand for capital , and foreign investors through the trade primarily supplied that increase . The following Work It Out feature walks you through a scenario in which private domestic savings has to rise by a certain amount to reduce a trade . Solving Problems with the Saving and Investment Identity Use the saving and investment identity to answer the following question Country A has a trade of 200 billion , private domestic savings of 500 billion , a government of 200 billion , and private domestic investment of 500 billion . To reduce the 200 billion trade by 100 billion , by how much does private domestic savings have to increase ?

Step . Write out the savings investment formula solving for the trade or surplus on the left ( Step . In the formula , put the amount for the trade in as a negative number ( The left side of your formula is now ( Step . Enter the private domestic savings ( of 500 in the formula ( Step . Enter the private domestic investment ( I ) of 500 into the formula ( 500 Access for free at

The National Saving and Investment Identity Step . The government budget surplus or balance is represented by ( Enter a budget amount for ( of 500 ( 500 Step . Your formula now is ( 500 ( 500 The question is To reduce your trade ( of to ( in billions of dollars ) by how much will savings have to rise ?

Step . Summarize the answer Private domestic savings needs to rise by 100 billion , to a total of 600 billion , for the two sides of the equation to remain equal ( Movements in the Business Cycle and the Trade Balance In the short run , whether an economy is in a recession or on the upswing can affect trade imbalances . A recession tends to make a trade smaller , or a trade surplus larger , while a period of strong economic growth tends to make a trade larger , or a trade surplus smaller . These are not rules , however . As an example , note in Figure that the trade declined by almost half from 2006 to 2009 . One primary reason for this change is that during the recession , as the economy slowed down , it purchased fewer of all goods , including fewer imports from abroad . However , buying power abroad fell less , and so exports did not fall by as much . On the other hand , during the 2020 recession , the trade expanded ( current account balance plummeted ) as the economy became more reliant on other countries for goods and services . Conversely , in the , when the trade became very large , a contributing reason is that the economy was growing . As a result , there was considerable aggressive buying in the economy , including the buying of imports . Thus , a trade ( or a much lower trade surplus ) often accompanies a rapidly growing domestic economy , while a trade surplus ( or a much lower trade ) accompanies a slowing or recessionary domestic economy . Regardless of whether the trade falls or rises during or , when the trade rises , it necessarily means a greater net of foreign capital . The national saving and investment identity teaches that the rest of the economy can absorb this of foreign capital in several different ways . For example , reduced private savings could offset the additional of capital from abroad , leaving domestic investment and public saving unchanged . Alternatively , the of foreign capital could result in higher domestic investment , leaving private and public saving unchanged . Yet another possibility is that greater government borrowing could absorb the of foreign capital , leaving domestic saving and investment unchanged . The national saving and investment identity does not specify which of these scenarios , alone or in combination , will that one of them must occur .

572 23 The International Trade and Capital Flows The Pros and Cons of Trade Deficits and Surpluses LEARNING OBJECTIVES By the end of this section , you will be able to Identify three ways in which borrowing money or running a trade can result in a healthy economy Identify three ways in which borrowing money or running a trade can result in a weaker economy Because of trade always involve of payments , of international trade are actually the same as of international capital . The question of whether trade or surpluses are good or bad for an economy is , in economic terms , exactly the same question as whether it is a good idea for an economy to rely on net of capital from abroad or to make net investments of capital abroad . Conventional wisdom often holds that borrowing money is foolhardy , and that a prudent country , like a prudent person , should always rely on its own resources . While it is certainly possible to borrow too anyone with an overloaded credit card can at certain times can also make sound economic sense . For both individuals and countries , there is no economic merit in a policy of abstaining from participation in capital markets . It makes economic sense to borrow when you are buying something with a payoff that is , when you are making an investment . For this reason , it can make economic sense to borrow for a college education , because the education will typically allow you to earn higher wages , and so to repay the loan and still come out ahead . It can also make sense for a business to borrow in order to purchase a machine that will last 10 years , as long as the machine will increase output and by more than enough to repay the loan . Similarly , it can make economic sense for a national economy to borrow from abroad , as long as it wisely invests the money in ways that will tend to raise the nation economic growth over time . Then , it will be possible for the national economy to repay the borrowed money over time and still end up better off than before . One vivid example ofa country that borrowed heavily from abroad , invested wisely , and did perfectly well is the United States during the nineteenth century . The United States ran a trade in 40 of the 45 years from 1831 to 1875 , which meant that it was importing capital from abroad over that time . However , that capital was mostly invested in projects like railroads that brought a substantial economic payoff . See the following Clear It Up feature for more on this . A more recent example along these lines is the experience of South Korea , which had trade during much of the so was an importer of capital over that time . However , South Korea also had high rates of investment in physical plant and equipment , and its economy grew rapidly . From the into the , South Korea often had trade is , it was repaying its past borrowing by sending capital abroad . In contrast , some countries have run large trade , borrowed heavily in global capital markets , and ended up in all kinds of trouble . Two sorts of trouble are worth examining . First , a borrower nation can itself in a bind if it does not invest the incoming funds from abroad in a way that leads to increased productivity . Several of Latin America large economies , including Mexico and Brazil , ran large trade and borrowed heavily from abroad in the , but the of capital did not boost productivity , which meant that these countries faced enormous troubles repaying the money borrowed when economic conditions shifted during the . Similarly , it appears that a number of African nations that borrowed foreign funds in the and did not invest in productive economic assets . As a result , several of those countries later faced large interest payments , with no economic growth to show for the borrowed funds . Access for free at

The Pros and Cons of Trade and surpluses CLEAR IT UP Are trade deficits always harmful ?

For most years of the nineteenth century , imports exceeded exports and the economy had a trade . Yet the string of trade did not hold back the economy at all . Instead , the trade contributed to the strong economic growth that gave the economy the highest per capita in the world by around 1900 . The trade meant that the economy was receiving a net inflow of foreign capital from abroad . Much of that foreign capital flowed into two areas of and public infrastructure like roads , water systems , and were important to helping the economy grow . We should not overstate the effect of foreign investment capital on economic growth . In most years the foreign capital represented no more than of the funds that the government used for overall physical investment in the economy . Nonetheless , the trade and the accompanying investment funds from abroad were clearly a help , not a hindrance , to the economy in the nineteenth century . A second trouble is What happens if the foreign money in , and then suddenly out again ?

We raised this scenario at the start of the chapter . In the , a number of countries in East , Indonesia , Malaysia , and South large trade and imported capital from abroad . However , in 1997 and 1998 many foreign investors became concerned about the health of these economies , and quickly pulled their money out of stock and bond markets , real estate , and banks . The extremely rapid departure of that foreign capital staggered the banking systems and economies of these countries , plunging them into deep recession . We investigate and discuss the links between international capital , banks , and recession in The Impacts of Government Borrowing . While a trade is not always harmful , there is no guarantee that running a trade surplus will bring robust economic health . For example , Germany and Japan ran substantial trade surpluses for most of the last three decades . Regardless of their persistent trade surpluses , both countries have experienced occasional and neither country has had especially robust annual growth in recent years . Read more about Japan trade surplus in the next Clear It Up feature . LINK IT UP Watch this on whether or not trade is good for the economy . The sheer size and persistence of the trade and of foreign capital since the are a legitimate cause for concern . The huge economy will not be destabilized by an of international capital as easily as , say , the comparatively tiny economies of Thailand and Indonesia were in . Even an economy that is not knocked down , however , can still be shaken . American should certainly be paying attention to those cases where a pattern of extensive and sustained current account and foreign borrowing has gone only as a cautionary tale . CLEAR IT UP Are trade surpluses always beneficial ?

Considering Japan since the . Perhaps no economy around the world is better known for its trade surpluses than Japan . Since 1990 , the size of these surpluses has often been near 100 billion per year . When Japan economy was growing vigorously in the and , many , especially , described its large trade surpluses either a cause or a result of its robust economic health . However , from a standpoint of economic growth , Japan economy has been teetering in and out of recession since 1990 , with real growth averaging only about per year , and an unemployment rate

574 23 The International Trade and Capital Flows that has been creeping higher . Clearly , a whopping trade surplus is no guarantee of economic good health . Instead , Japan trade surplus reflects that Japan has a very high rate of domestic savings , more than the Japanese economy can invest domestically , and so it invests the extra funds abroad . In Japan slow economy , consumption of imports is relatively low , and the growth of consumption is relatively slow . Thus , Japan exports continually exceed its imports , leaving the trade surplus continually high . Recently , Japan trade surpluses began to deteriorate . In 2013 , Japan ran a trade due to the high cost of imported oil . By 2015 , Japan again had a surplus and continues to run one today . The Difference between Level of Trade and the Trade Balance LEARNING OBJECTIVES By the end of this section , you will be able to Identify three factors that a country level of trade Differentiate between balance of trade and level of trade A nation of trade may at sound like much the same issue as the balance of trade , but these two are actually quite separate . It is perfectly possible for a country to have a very high level of by its exports of goods an services as a share of its it also has a between exports and imports . A high leve of trade indicates that the nation exports a good portion of its production . It is also possible for a country trade to be a relatively low share of , relative to global averages , but for the imbalance between its exports and its imports to be quite large . We emphasized this general theme earlier in Ba , which offered some illustrative on trade levels and balances . A country level of trade tells how much of its production it exports . We measure this by the percent of exports out of . It indicates the degree of an economy globalization . Some countries , such as Germany , have a high level of export almost 50 of their total production . The balance of trade tells us if the country is running a trade surplus or trade . A country can have a low level of trade but a high trade deficit . For example , the United States only exports around 10 of its , but it has a trade of over 600 billion . Three factors strong a nation level of trade the size of its economy , its geographic location , and its history of trade . Large economies like the United States can do much of their trading internally , while small economies like en have less ability to provide what they want internally and tend to have higher ratios of exports and imports to . Nations that are neighbors tend to trade more , since costs of transportation and communication are ower . Moreover , some nations have long and established patterns of international trade , while others do not . Consequently , a relatively small economy like Sweden , with many nearby trading partners across Europe and a long history of foreign trade , has a high level of trade . Brazil and India , which are fairly large economies that have often sought to inhibit trade in recent decades , have lower levels of trade whereas , the United States and Japan are extremely large economies that have comparatively few nearby trading partners . Both countries actually have quite low levels of trade by world standards . The ratio of exports to in either the United States or in Japan is about half of the world average . The balance of trade is a separate issue from the level of trade . The United States has a low level of trade , but had enormous trade for most years from the into the . Japan has a low level of trade by world standards , but has typically shown large trade surpluses in recent decades . Nations like Germany and the United Kingdom have medium to high levels of trade by world standards , but Germany had a moderate trade surplus in 2020 , while the United Kingdom had a moderate trade . Their trade picture was roughly in balance in the late . Sweden had a high level of trade and a moderate trade surplus in 2020 , while Canada had a high level of trade and a moderate trade that same year . In short , it is quite possible for nations with a relatively low level of trade , expressed as a percentage , to Access for free at

The Difference between Level of Trade and the Trade Balance have relatively large trade . It is also quite possible for nations with a near balance between exports and imports to worry about the consequences of high levels of trade for the economy . It is not inconsistent to believe that a high level of trade is potentially to an economy , because of the way it allows nations to play to their comparative advantages , and to also be concerned about any instability caused by a pattern of large trade . The following Clear It Up feature discusses how this sort of dynamic played out in Colonial India . CLEAR IT UP Are trade surpluses always beneficial ?

Considering Colonial India . India was formally under British rule from 1858 to 1947 . time , India consistently had trade surpluses with Great Britain . Anyone who believes that trade surpluses are a sign of economic strength and dominance while trade are a sign of economic weakness must this pattern odd , since it would mean that colonial India was successfully dominating and exploiting Great Britain for almost a was not true . Instead , India trade surpluses with Great Britain meant that each year there was an overall flow of capital from India to Great Britain . In India , many heavily criticized this capital flow as the drain , and they viewed capital drain as one of the many reasons why India would from achieving independence . Final Thoughts about Trade Balances Trade can be a good or a bad sign for an economy , and trade surpluses can be a good or a bad sign . Even a trade balance of just means that a nation is neither a net borrower nor lender in the international be either a good or bad sign . The fundamental economic question is not whether a nation economy is borrowing or lending at all , but whether the particular borrowing or lending in the particular economic conditions of that country makes sense . It is interesting to on how public attitudes toward trade and surpluses might change ifwe could somehow change the labels that people and the news media to them . Ifwe called a trade attracting foreign capital accurately describes what a trade trade might look more attractive . Conversely , if we called a trade surplus shipping capital abroad accurately captures what a trade surplus trade surpluses might look less attractive . Either way , the key to understanding trade balances is to understand the relationships between flows of trade and flows of international payments , and what these relationships imply about the causes , and risks of different kinds of trade balances . The step along this journey of understanding is to move beyond reactions to terms like trade surplus , trade balance , and trade . BRING IT HOME More than Meets the Eye in the Congo Now that you see the big picture , you undoubtedly realize that all of the economic choices you make , such as depositing savings or investing in an international mutual fund , do influence the flow of goods and services as well as the flows of money around the world . You now know that a trade surplus does not necessarily tell us whether an economy is performing well or not . The Democratic Republic of the Congo ran a trade surplus in 2013 , as we learned in the beginning of the chapter . Yet its current account balance was billion . However , the return of political stability and the rebuilding in the aftermath of the civil war there has meant a flow of investment and capital into the country . In this case , a negative current account balance means the country is being that is a good thing .

576 23 Key Terms Key Terms balance of trade ( trade balance ) the gap , if any , between a nation exports and imports current account balance a broad measure of the balance of trade that includes trade in goods and services , as well as international of income and foreign aid exports of goods and services as a percentage of the dollar value of exports divided by the dollar value ofa country capital the international of money that facilitates trade and investment merchandise trade balance the balance of trade looking only at goods national savings and investment identity the total of private savings and public savings ( a government budget surplus ) unilateral transfers payments that governments , private entities , or individuals make that they sent abroad with nothing received in return Key Concepts and Summary Measuring Trade Balances The trade balance measures the gap between a country exports and its imports . In most economies , goods comprise less than half ofa country total production , while services comprise more than half . The last two decades have seen a surge in international trade in services however , most global trade still takes the form of goods rather than services . The current account balance includes the trade in goods , services , and money into and out of a country from investments and unilateral transfers . Trade Balances in Historical and International Context The United States developed large trade surpluses in the early , swung back to a tiny trade surplus in 1991 , and then had even larger trade in the late and early . As we will see below , a trade necessarily means a net of capital from abroad , while a trade surplus necessarily means a net of capital from an economy to other countries . Trade Balances and Flows of Financial Capital International of goods and services are closely connected to the international of capital . A current account means that , after taking all the of payments from goods , services , and income together , the country is a net borrower from the rest of the world . A current account surplus is the opposite and means the country is a net lender to the rest of the world . The National Saving and Investment Identity The national saving and investment identity is based on the relationship that the total quantity of capital supplied from all sources must equal the total quantity of capital demanded from all sources . If is private saving , is taxes , is government spending , is imports , is exports , and is investment , then for an economy with a current account and a budget Supply of financial capital Demand for financial capital ( A recession tends to increase the trade balance ( meaning a higher trade surplus or lower trade ) while economic boom will tend to decrease the trade balance ( meaning a lower trade surplus or a larger trade ) The Pros and Cons of Trade Deficits and surpluses Trade surpluses are no guarantee of economic health , and trade are no guarantee of economic weakness . Either trade or trade surpluses can work out well or poorly , depending on whether a government wisely invests the corresponding of capital . Access for free at

23 Questions The Difference between Level of Trade and the Trade Balance There is a difference between the level ofa country trade and the balance of trade . The government measures its level of trade by the percentage of exports out of , or the size of the economy . Small economies that have nearby trading partners and a history of international trade will tend to have higher levels of trade . Larger economies with few nearby trading partners and a limited history of international trade will tend to have lower levels of trade . The level of trade is different from the trade balance . The level of trade depends on a history of trade , its geography , and the size of its economy . A country balance of trade is the dollar difference between its exports and imports . Trade and trade surpluses are not necessarily good or depends on the circumstances . Even if a country is borrowing , if it invests that money in investments it can lead to an improvement in economic growth . Questions . If foreign investors buy more stocks and bonds , how would that show up in the current account balance ?

If the trade of the United States increases , how is the current account balance affected ?

State whether each of the following events involves a flow to the Mexican economy or a out of the Mexican economy Mexico imports services from Japan Mexico exports goods to Canada investors receive a return from past investments in Mexico . In what way does comparing a country exports to its degree of globalization ?

At one point Canada was billion and its exports were 542 billion . What was Canada export ratio at this time ?

The for the United States is billion and its current account balance is 484 billion . What percent of is the current account balance ?

Why does the trade balance and the current account balance track so closely together over time ?

State whether each of the following events involves a flow to the economy or away from the economy a . Export sales to Germany Returns paid on past investments in Brazil Foreign aid from the government to Egypt Imported oil from the Russian Federation Japanese investors buying real estate . 57 . How does the bottom portion of Fig showing the international of investments and capital , differ from the upper portion ?

10 . Explain the relationship between a current account or surplus and the flow of funds . 11 . Using the national savings and investment identity , explain how each of the following changes ( will increase or decrease the trade balance a . A lower domestic savings rate . The government changes from running a budget surplus to running a budget The rate of domestic investment surges

578 23 Review Questions 12 . Ifa country is running a government budget surplus , why is ( on the left side of the investment identity ?

13 . What determines the size of a country trade ?

14 . investment increases , and there is no change in the amount and public saving , what must happen to the size of the trade ?

15 . Why does a recession cause a trade to increase ?

16 . Both the United States and global economies are booming . Will imports exports increase ?

17 . For each of the following , indicate which type of government spending would justify a budget and which would not . a . Increased federal spending on Medicare . Increased spending on education Increased spending on the space program ( Increased spending on airports and air control 18 . How did large trade hurt the East Asian countries in the mid ?

Recall that trade are equivalent to of capital from abroad . 19 . Describe a scenario in which a trade surplus an economy and one in which a trade surplus is occurring in an economy that performs poorly . What key factor or factors are making the difference in the outcome that results from a trade surplus ?

20 . The United States exports 14 while Germany exports about 50 of its . Explain what that means . 21 . Explain whether each of the following would be more likely to lead to a higher level of trade for an economy , or a greater imbalance of trade for an economy . a . Living in an especially large country Having a domestic investment rate much higher than the domestic savings rate Having many other large economies geographically nearby Having an especially large budget Having countries with a tradition of strong protectionist legislation shutting out imports . Review Questions 22 . If imports exceed exports , is it a trade or a trade surplus ?

What about if exports exceed imports ?

23 . What is included in the current account balance ?

24 . In recent decades , has the trade balance usually been in , surplus , or balanced ?

25 . Does a trade surplus mean an overall of capital to an economy , or an overall of capital ?

What about a trade ?

26 . What are the two main sides of the national savings and investment identity ?

27 . What are the main components of the national savings and investment identity ?

28 . When is a trade likely to work out well for an economy ?

When is it likely to work out poorly ?

29 . Does a trade surplus help to guarantee strong economic growth ?

30 . What three factors will determine whether a nation has a higher or lower share of trade relative to its ?

31 . What is the difference between trade and balance of trade ?

Access for free at 23 Critical Thinking Questions Critical Thinking Questions 32 . 33 . 34 . 35 . 36 . 37 . 38 . 39 . 40 . 41 . 42 . Occasionally , a government will argue that a country should strive for both a trade surplus and a healthy of capital from abroad . Explain why such a statement is economically impossible . A government official announces a new policy . The country wishes to eliminate its trade , but will strongly encourage investment from foreign . Explain why such a statement is contradictory . country is a big exporter , is it more exposed to global crises ?

If countries reduced trade barriers , would the international of money increase ?

is it better for your country to be an international lender or borrower ?

Many think that the size ofa trade deficit is due to a lack of competitiveness sectors , such as autos . Explain why this is not true . lfyou observed a country with a rapidly growing trade surplus over a period of a year or so , would you be more likely to believe that the country economy was in a period of recession or of rapid growth ?

Explain . Occasionally , a government will argue that a country should strive for both a trade surplus and a healthy of capital from abroad . is this possible ?

What is more important , a country current account balance or growth ?

Why ?

Will nations that are more involved in foreign trade tend to have higher trade imbalances , lower trade imbalances , or is the pattern unpredictable ?

Some economists warn that the persistent trade deficits and a negative current account balance that the United States has run will be a problem in the long run . Do you agree or not ?

Explain your answer . Problems 43 . 44 . In 2001 , the United Kingdom economy exported goods worth billion and services worth another billion . It imported goods worth billion and services worth billion . Receipts of income from abroad were billion while income payments going abroad were billion . Government transfers from the United Kingdom to the rest of the world were billion , while various government agencies received payments billion from the rest of the world . a . Calculate the merchandise trade deficit for . Calculate the current account balance for Explain how you decided whether payments on foreign investment and government transfers counted on the positive or the negative side of the current account balance for the United Kingdom in 2001 . Imagine that the economy itself in the following situation a government budget of 100 billion , total domestic savings of billion , and total domestic physical capital investment of billion . According to the national saving and investment identity , what will be the current account balance ?

What will be the current account balance if investment rises by 50 billion , while the budget and national savings remain the same ?

530 23 Problems 45 . Table provides some hypothetical data on accounts for three countries represented by A , and and measured in billions of currency units . In Table , private household saving is SH , tax revenue is , government spending is , and investment spending is I . A SH 700 500 600 00 500 500 600 350 650 I 800 400 450 TABLE Accounts a . Calculate the trade balance and the net of foreign saving for each country . State whether each one has a trade surplus or ( or balanced trade ) State whether each is a net lender or borrower internationally and explain . 46 . Imagine that the economy of Germany itself in the following situation the government budget has a surplus of of Germany private savings is 20 of and physical investment is 18 of . a . Based on the national saving and investment identity , what is the current account balance ?

If the government budget surplus falls to zero , how will this affect the current account balance ?

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