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Let’s Abandon the Misleading Language Conventionally Used in Discussions of the Balance-of-Payments

Here’s a slightly modified version of a comment that I left on a recent EconLog post by Scott Sumner:


I love your recent EconLog post titled “How much leverage does America have in trade?”  It’s full of important and original insights.  But I pick a nit.  Although your claim that trade (or current-account) deficits are “caused by a saving/investment imbalance” is consistent with the conventional manner of describing such deficits, I believe that this conventional manner is highly misleading.  I urge you to abandon it.

It’s true that when the U.S. runs a trade deficit during some month, the amount of investment that occurs in the U.S. during that month exceeds the amount saved by Americans during that month.  It’s this difference that is conventionally called an “imbalance.”  Yet what, exactly, is not in balance?  I know of no principle of economics, of finance, or of accounting that suggests that something is ‘imbalanced’ if domestic citizens save less than foreigners.  Just as Smith and Jones each might well be acting perfectly prudently with respect to each of their own interests even if Jones saves more than Smith, so, too, might Americans and non-Americans each, as groups, be acting perfectly prudently with respect to each of their own interests even if non-Americans save more than Americans. In short, a difference in savings isn’t an “imbalance” in savings.

Much more fundamentally, though, is the fact that many of these foreign investments in the U.S. are entrepreneurial acts: these investment opportunities exist (and get funded) only because the opportunities for such investments in the U.S. are created by the foreigners who fund them.  It is therefore not the case that such investments would have been funded by Americans if only we Americans had saved more.  But describing trade deficits as “imbalances” gives the strong misimpression that these investment opportunities are somehow already out there and are funded by foreigners only because we Americans failed to save enough to fund them ourselves.  This horribly mistaken notion – which is a never-ending source of fuel for protectionist policies that both you and I deplore – will never disappear if we stick with the convention of describing trade deficits as “imbalances” caused by, or that reflect, inadequate domestic savings.



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