Bob Murphy is unhappy with a recent Mark Perry post on the balance of payments. Mark’s point (in summary) is that if the voluntary economic decisions of Americans and foreigners result in a U.S. current-account (“trade”) deficit – which is to say, a U.S. capital-account surplus of the very same amount – Americans should not be upset. The reason is that a U.S. capital-account surplus means that the American economy is a net recipient, not only of imports, but also of capital. And being a net recipient of capital is not only not necessarily a bad thing for Americans, but is likely a good thing.
Now for Bob’s objection:
Now here’s my problem. Suppose a populist politician in Japan starts railing against the fact that they’re “getting killed by the Americans in our trade dealings.” He wants to pass a measure to “keep our savings here in Japan.”
In that case, surely Mark Perry and other economists would say that’s nonsense, that the voluntary transactions of Japanese manufacturers and investors only make the country richer. Nobody in Japan should look at their aggregate statistics about current account surpluses and capital account deficits and conclude that this is somehow dangerous for Japan.
But if that’s true–and it surely is–then Perry’s post above collapses. If a free trader would tell the people with a capital account deficit that they shouldn’t be worried about the situation, then free traders shouldn’t be telling Americans that having a capital account surplus is self-evidently a good thing.
I believe that Bob’s objection misses the mark. A capital-account deficit (that is, a current-account surplus) is indeed more likely than is a capital-account surplus to signal a problem with the national economy. If Japan consistently runs capital-account deficits, this fact is likely evidence that good investment opportunities in Japan are too few – and made too few by poor government policies that make the investment climate in Japan less attractive than it would be absent these poor policies.
There is, however, a second possible interpretation: a capital-account deficit might reflect, not poor policies at home but, instead, such extraordinarily low time preference of the domestic population that domestic savings is so high that much of it is invested abroad – abroad where, at the margin, expected risk-adjusted rates of return on investment opportunities are higher than are those on any possible additional investment opportunities at home.
In the first scenario (in which the capital-account deficit results from, and hence reflects, an ‘artificially’ low number of good domestic investment opportunities), the hypothetical populist Japanese politician that Bob mentions would be mistaken to argue in favor of policies designed to artificially prevent Japanese citizens from investing outside of Japan. Any such restriction would only inflict further economic damage upon the Japanese people: such a restriction on outward investment would prevent the Japanese people from using their savings in the most profitable ways possible. And because, in this case, the capital-account deficit reflects poor government policies toward investors and businesses – and because forcing savings to remain within Japan will likely only further worsen such policies (and will almost certainly not improve them) – this populist policy of ‘keeping our savings at home’ will neither improve the performance of Japan’s economy nor increase the net worth of the Japanese people.
Policy-wise, pretty much the same conclusion is reached about capital controls if the capital-account deficit is plausibly described as resulting from a super-abundance of domestic savings. Even in this second scenario (in which there are no anti-business or anti-investor government policies to blame for the capital-account deficit), domestic savers nevertheless find such a large number of attractive investment opportunities abroad (in addition to what we can assume is a healthy number of attractive investment opportunities at home) that the result is a capital-account deficit. Yet despite there being a happier cause of a capital-account deficit in this second scenario than in the first scenario, Bob’s populist politician would still harm his country by imposing restrictions on outward investments. In this second scenario no less than in the first, the number of relatively attractive investment opportunities at home is less than domestic savers wish to invest in. Forcing domestic savings to stay at home is unlikely to create attractive investment opportunities at home and will, therefore, reduce the net worth of the Japanese people (as those among them who would have invested profitably abroad, but are prohibited from doing so, become worth less than they would have become worth had their investment choices not been interfered with by the state).
But assessment-wise, the first scenario differs notably from the second. In the first scenario, the capital-account deficit is a symptom of poor domestic economic policies – of policies that are hostile to investors and, hence, to economic growth. In the second scenario, the capital-account deficit simply reflects a very high rate of domestic savings. We assess the first scenario with a frown and the second with a smile. Again, though, in neither case would Bob’s populist politician be correct to assert that the country’s capital-account deficit is a sign that the people of the country are “getting killed” by current international-trading arrangements.
Coda: While I cannot speak for Mark Perry, I myself plead guilty to sometimes being unclear in my discussions of trade deficits. As I have said in my more careful moments (if not as often as I should), I well understand that a trade deficit might be a symptom of some domestic economic problem. For example, a U.S. trade deficit might be a symptom of excessive borrowing by Uncle Sam.* Yet even if and when a trade deficit is genuinely symptomatic of domestic economic problems, those problems will not be solved by attacking the symptom.
* Note that even if we all agree that Uncle Sam borrows excessively and spends wastefully, and even if this excessive borrowing and wasteful spending coincides with a U.S. current-account deficit, it might still be the case that the current-account deficit, on net, is evidence of positive economic performance in the U.S. The private U.S. economy might be so strong, and institutions other than the government fisc so attractive relative to those of other countries, that the chief cause of the U.S. trade deficit is not Uncle Sam’s profligacy.