12.5 International Imbalances

An open economy is an economy that trades goods and services with other countries.

The United States is an open economy: an economy that trades goods and services with other countries. There have been times when that trade was more or less balanced—when the United States sold about as much to the rest of the world as it bought. But this isn’t one of those times.

A country runs a trade deficit when the value of goods and services bought from foreigners is more than the value of goods and services it sells to them. It runs a trade surplus when the value of goods and services bought from foreigners is less than the value of the goods and services it sells to them.

In 2014, the United States ran a big trade deficit—that is, the value of the goods and services U.S. residents bought from the rest of the world was a lot larger than the value of the goods and services American producers sold to customers abroad. Meanwhile, some other countries were in the opposite position, selling much more to foreigners than they bought.

Figure 12-9 shows the exports and imports of goods for several important economies in 2014. As you can see, the United States imported much more than it exported, but Germany, China, and Saudi Arabia did the reverse: they each ran a trade surplus. A country runs a trade surplus when the value of the goods and services it buys from the rest of the world is smaller than the value of the goods and services it sells abroad. Was America’s trade deficit a sign that something was wrong with our economy—that we weren’t able to make things that people in other countries wanted to buy?

Figure 12.9: FIGURE 12-9 Unbalanced Trade
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Figure 12.9: In 2014, the goods and services the United States bought from other countries were worth considerably more than the goods and services we sold abroad. Germany, China, and Saudi Arabia were in the reverse position. Trade deficits and trade surpluses reflect macroeconomic forces, especially differences in savings and investment spending.
Data from: CIA World Factbook.

No, not really. Trade deficits and their opposite, trade surpluses, are macroeconomic phenomena. They’re the result of situations in which the whole is very different from the sum of its parts. You might think that countries with highly productive workers or widely desired products and services to sell run trade surpluses but countries with unproductive workers or poor-quality products and services run deficits. But the reality is that there’s no simple relationship between the success of an economy and whether it runs trade surpluses or deficits.

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In Chapter 2 we learned that international trade is the result of comparative advantage: countries export goods they’re relatively good at producing and import goods they’re not as good at producing. That’s why the United States exports wheat and imports coffee. What the concept of comparative advantage doesn’t explain, however, is why the value of a country’s imports is sometimes much larger than the value of its exports, or vice versa.

So what does determine whether a country runs a trade surplus or a trade deficit? In Chapter 20 we’ll learn the surprising answer: the determinants of the overall balance between exports and imports lie in decisions about savings and investment spending—spending on goods like machinery and factories that are in turn used to produce goods and services for consumers. Countries with high investment spending relative to savings run trade deficits; countries with low investment spending relative to savings run trade surpluses.

ECONOMICS in Actionimage

Spain’s Costly Surplus

image | interactive activity

In 1999 Spain took a momentous step: it gave up its national currency, the peseta, in order to adopt the euro, a shared currency intended to promote closer economic and political union among the nations of Europe. How did this affect Spain’s international trade?

Figure 12.10: FIGURE 12-10 Spain’s Current Account Balance,
1999-2015
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Data from: International Monetary Fund.

Figure 12-10 shows Spain’s current account balance—a broad definition of its trade balance—from 1999 to 2013, measured as a share of gross domestic product, the country’s total production of goods and services. A negative current account balance, as shown here, means the country is running a trade deficit. As you can see, after Spain switched to the euro it began running large trade deficits, which at their peak were more than 10% of gross domestic product. After 2008, however, the trade deficit began shrinking rapidly, and by 2013 Spain was running a small surplus which continued into early 2016.

Did this mean that Spain’s economy was doing badly in the mid-2000s, and better thereafter? Just the opposite. When Spain adopted the euro, foreign investors became highly optimistic about its prospects, and money poured into the country, fueling rapid economic expansion. At the heart of this expansion was a huge housing boom, led in particular by the construction of holiday homes along Spain’s famed Mediterranean coast.

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Unfortunately, this epic boom eventually turned into an epic bust, and the inflows of foreign capital into Spain dried up. One consequence was that Spain could no longer run large trade deficits, and by 2013 was forced into running a surplus. Another consequence was a severe recession, leading to very high unemployment—including the unemployment of Javier Diaz, the jobless graduate we described at the start of this chapter.

Quick Review

  • Comparative advantage can explain why an open economy exports some goods and services and imports others, but it can’t explain why a country imports more than it exports, or vice versa.

  • Trade deficits and trade surpluses are macroeconomic phenomena, determined by decisions about investment spending and savings.

Check Your Understanding 12-5

Question 12.8

1. Which of the following reflect comparative advantage, and which reflect macroeconomic forces?

  1. Thanks to the development of huge oil sands in the province of Alberta, Canada has become an exporter of oil and an importer of manufactured goods.

    This situation reflects comparative advantage. Canada’s comparative advantage results from the development of oil—Canada now has an abundance of oil.

  2. Like many consumer goods, the Apple iPod is assembled in China, although many of the components are made in other countries.

    This situation reflects comparative advantage. China’s comparative advantage results from an abundance of labor; China is good at labor-intensive activities such as assembly.

  3. Since 2002, Germany has been running huge trade surpluses, exporting much more than it imports.

    This situation reflects macroeconomic forces. Germany has been running a huge trade surplus because of underlying decisions regarding savings and investment spending with its savings in excess of its investment spending.

  4. The United States, which had roughly balanced trade in the early 1990s, began running large trade deficits later in the decade, as the technology boom took off.

    This situation reflects macroeconomic forces. The United States was able to begin running a large trade deficit because the technology boom made the United States an attractive place to invest, with investment spending outstripping U.S. savings.

Solutions appear at back of book.