Here’s a note to an economics student in Taiwan.
Ms. Chen:
Thanks for your kind words about my blog post that Alex Tabarrok generously shared at Marginal Revolution.
You’re astute to recognize that an increase in national savings – which you understandably call “the text book solution to trade deficits” – won’t necessarily eliminate a country’s trade deficits. Equally astute is your observation that “the text book solution takes investment in a country as something which just happens, leaving the only thing to be determined is who is going to fund the investments with their savings.”
Yes! This point is fundamental but distressingly ignored, even by many economists. The amount of investment in a country is conventionally treated as a macroeconomic phenomenon. That’s a mistake. The amount of investment in a country is, in my view as in yours, far less a macroeconomic phenomenon than a microeconomic one.
Investment is determined by countless microeconomic forces at work, including the weight of regulations and taxes, the security of property and contract rights, the quality of infrastructure, the efficiency of financial and labor markets, and the size and openness of the domestic economy. A country that scores relatively well on these fronts will attract large amounts of global capital – and much of this capital comes along as complements to entrepreneurial ideas.
Domestic investment – whether done by fellow citizens or foreigners – is not, contrary to how it’s too often treated, an exogenous variable that’s funded with foreign savings only because domestic citizens don’t save enough (as is often said) “to fill the gap.” It follows that an increase in domestic savings is just as likely to increase the domestic trade deficit – say, by making the domestic economy even more productive – as to decrease it.
Alex rightly writes that “the trade accounts are among the most pernicious statistics ever collected” – perniciousness that’s fed by flabby macroeconomic thinking. (Although he’s hardly alone, one of the worst offenders on this front is Michael Pettis.)
I’m encouraged that an economist-in-training such as yourself thinks smartly about trade and trade ‘deficits.’ Keep it up!
Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030
