In commenting on tariffs and the trade balance, Paul Krugman
states that, in the "simple story", tariffs result in an exchange
rate appreciation which leaves the trade balance unchanged.
A critical point here (which Krugman goes on to explore) is
the idea that neither tariffs nor any associated exchange rate appreciation has
any impact on capital account flows (or for that matter on the net flow of investment
income). However, the simple story also
contains an implicit assumption that the level of output is unchanged. If instead tariffs are accompanied by an
increase in domestic activity, demand for imports may be unchanged and there
may be no change in the exchange rate. It
all depends on what else we think might be going on.
What interested me more here though was Krugman's assertion
that trade deficits must eventually be replaced by surpluses (and thanks to Matias Vernengo for drawing my attention to this comment). The idea he is appealing to is that a country
cannot have a negative net international investment position (NIIP) that grows
indefinitely.
In fact this comes down to an r versus g
question. g here is the rate of
growth of the economy. r
is the average rate of return on the NIIP.
If r is less than g, then even with balanced trade, the
NIIP will be declining as a percentage of GDP.
No trade surplus is ever needed to correct a negative NIIP.
The thing about r here is that it is an average
return and the NIIP is the difference between two larger numbers. For example the US NIIP of around negative $8
trillion is the difference between assets of $25 trillion and liabilities of
$33 trillion. This means that the
average return can vary greatly and can look nothing like a normal asset
return. For example, in the US case, if
the return on assets is sufficiently greater than the return on assets liabilities, the average
return on the NIIP can easily be negative.
This means that, in cases where the NIIP is small relative
to the gross positions, we cannot generally say anything meaningful about r
and it is quite possible that a country can run a trade deficit for ever
without any need for eventual surpluses.
This is not, of course, the same as saying that a country can run any
level of trade deficit for ever.
good one
ReplyDeletethe old USA as hedge fund effect
it's the relative size and the returns on the two gross pieces that is the key
a curious case of innumeracy on the part of the K-man, but not the first time
where theory clouds arithmetic
Thank you.
DeleteI think the problem here is that the possible variation in r makes it difficult to make predictive statements and more mainstream economists are less comfortable with that.
PK in particular is handicapped by the fact that his academic work is on trade, which tends to crowd out the common sense he displays in other areas.
Delete"... if the return on assets is sufficiently greater than the return on assets,..."
ReplyDeleteA typo here?
Thanks - corrected now.
DeleteThis comment has been removed by a blog administrator.
ReplyDeleteGood post.
ReplyDeleteOf course another issue for the US (and a few others) is that depreciation automatically improves the NIIP since foreign liabilities are mostly denominated in domestic currency. In effect this ensures that r moves to whatever level required by "sustainability."
There's also the fact that international financial positions are endogenous to trade in all kinds of ways.
Thank you.
Delete"Of course another issue for the US (and a few others) is that depreciation automatically improves the NIIP since foreign liabilities are mostly denominated in domestic currency."
I think this must be the case, but oddly I can't find this effect when I look at the data for the UK. I haven't looked for the US.
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ReplyDelete