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The Accounting Misleads

Eric Boehm of Reason is one of today’s very best journalists; he’s unfailingly insightful and on top of important issues. Here’s an e-mail that I just sent to him (very slightly modified from the original).


I continue to learn from and enjoy your consistently excellent analyses at Reason. You’re one of the very best in the business. Don’t stop!

But I write with a wonky request – namely, that you do not follow what is admittedly economists’ conventional practice of describing a country’s trade deficit (as you put it in your splendid recent piece) as “the gap between a country’s collective savings and investments.” As an accounting matter, this conventional description works. But here the accounting masks important economic realities, especially the economic impetus to investment. This accounting convention conveys the impression that the amount of investment that occurs in the U.S. is an exogenously determined sum that somehow just happens and one that must be funded from either domestic savings or foreign savings. If domestic savings fall short of this sum, so goes the conventional account, foreign savings arrive to fill the gap. This conventional account then concludes that if only Americans’ savings were greater, this gap – the U.S. trade deficit – would be smaller.

Economically, this manner of conceiving of trade deficits is mistaken and misleading. The amount of investment in the U.S. isn’t an exogenously determined sum passively awaiting investors to fill it. Instead, this sum is determined by a combination of the attractiveness of the U.S. as an investment destination and the willingness of global investors to invest in the U.S. If, say, U.S. tax policy becomes more favorable to entrepreneurship, America’s attractiveness to global investors would be enhanced. These investors would then create in the U.S. many of the investment opportunities in which their funds are used – uses of funds that contribute to U.S. trade deficits. These investment opportunities would not exist without the entrepreneurial vision of the global investors who create and fund them – meaning that, contrary to the implication of the conventional account, these opportunities would not be funded by Americans if only Americans saved more.

Put differently, suppose we Americans increased our monthly savings by the amount of monthly U.S. trade deficits. In the conventional view, U.S. trade deficits would disappear. But in reality they almost certainly would not disappear. In fact, they might increase. If more American savings makes the U.S. economy even more attractive to global investors, global investors will create even more investment opportunities in the U.S. The increased flow of global investment funds into the U.S. might well result in higher U.S. trade deficits.

Apologies if I’m too pedantic. But as you know, few concepts match the trade deficit at sowing economic confusion and fueling destructive economic policies. The conventional habit of describing trade deficits as reflecting a shortfall of domestic savings gives unwarranted ammunition to those who point to U.S. trade deficits as evidence that something is amiss with America’s economy – something that must then be ‘solved’ with government intervention. Many things are amiss with America’s economy, but failure to save enough to close the trade-deficit gap isn’t among these things.


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