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I Goofed (but My Goof Still Doesn’t Mean that Trump Didn’t)

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My friend Bob Gelfond pressed me on my recent letter to Trump [2] in which I argued that he – Trump – is inconsistent in wanting both (1) the U.S. trade (or current-account) deficit to fall and (2) foreigners to invest more in the U.S.  I stand by the charge of inconsistency.  As a practical matter, these two desires – a lower US trade deficit and more foreign investment in the US – are indeed at odds with one another.  Ceteris paribus, a greater desire of foreigners to invest in the US leads to an increase in the US trade deficit.  And it certainly remains true that a rising US trade deficit – contrary to Trump’s constant assertions – is neither necessarily a sign of US economic malaise nor a source of future economic troubles for Americans.

But (and this is Bob’s point) I was mistaken to claim that it’s impossible for foreigners to invest more in the US and at the same time have the US trade deficit fall.  When I made that argument, I implicitly assumed that American investment abroad remains unchanged.  Yet if American investment abroad increases, then it is possible for the US trade deficit to fall even if foreigners invest more in the US.  (I believe that my implicit assumption is defensible for purposes of analyzing stated policy goals such as those made by Trump.  Nevertheless, that assumption is necessary to make my earlier claim strictly correct – and it’s an assumption that need not hold in reality.)

Consider the following example involving the world’s only two countries: US and Foreign.

Period 1: US exports $800 and imports $1000; Foreign invests the $200 (that it doesn’t spend on US exports) in land in Texas.  US has a current-account deficit of $200 and a capital-account surplus of $200.  Foreign has the opposite.

Period 2: US exports $800, imports $950, and sends to Foreign $100 to buy land in Shanghai.  Foreign invests the $250 (that it doesn’t spend on US exports) buying more land in Texas.  US has a current-account deficit of $150 and a capital-account surplus of $150.

In period 2 compared to period 1, the U.S. both (1) has a lower current-account deficit and (2) is receiving more foreign investment.

In period 2, US sent a total of 1,050 dollars to Foreign (950 to buy foreign goods and 100 to invest in Foreign).  Foreign used 800 of these dollars to buy US exports.  Foreign invested the remaining 250 dollars in the US.  Because the US $100 investment in Foreign must be subtracted from the Foreign $250 investment in the US in order to derive the net capital-account figure for the US, when that subtraction is done the US, in period 2, has a capital-account surplus of $150.

Note that the only way for the US trade deficit to fall when foreigners increase their investments in the US is for us Americans to increase our investments abroad such that the net of foreign investment in the US over US investment abroad falls – an outcome that Trump almost certainly didn’t have in mind when delivering his speech in Davos.

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