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Home Publications Blogs Beat the Press Trade Imbalances: More Economics 101 for Business Reporters

Trade Imbalances: More Economics 101 for Business Reporters

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Friday, 12 November 2010 05:10

The discussion of the trade imbalances continues to be muddled even beyond the failure to realize that changes in relative currency prices are the main mechanism for adjustment in a system of floating exchange rates. Many news articles and columns have lumped together Germany and China as troublemakers due to their large trade surpluses. This is wrong.

The principle here is very simple. China is an extremely fast growing country where the return on capital is very high. Germany is a relatively slow growing country, where the return on capital is much lower. In standard trade models, capital is supposed to flow from countries where the return is low to countries where the return is high.

The implication of this simple point is that we should expect relatively wealthy slow growing countries like Germany to have trade surpluses. Their capital could in principle be better used in fast-growing developing countries. This would imply a trade surplus.

By contrast, it would be expected that a fast-growing country like China would be an importer of capital. This is due to the fact that capital gets a much higher return in China than in wealthy countries. This would correspond to a trade deficit, not a trade surplus.

The fact that China and many other developing countries are running trade surpluses does not mean that they have done something wrong. The real problem in this story has been the system of international finance designed primarily by the I.M.F. and therefore the United States. This system has not allowed developing countries to feel comfortable in accumulating foreign debt, forcing them to build up reserves to avoid being subjected to dictates from the I.M.F.. But, reporters should recognize what economic theory says about the current world trade imbalances.

 

Comments (5)Add Comment
Cause of China's dollar accumulation
written by Ben Ross, November 12, 2010 7:16
Hasn't the dollar accumulation in China gone beyond what can be explained by a rational fear of the IMF? A full explanation needs to take account of China's internal politics. It seems to me that they can't raise consumption because in the absence of an independent judicial & administrative system, higher wages can't be imposed from above. It would require a shift of power away from business owners & local governments (overlapping categories) to workers. That would threaten the entire existing power structure.
Chinese case
written by AMJ, November 12, 2010 10:00
I think Ben Ross is right: fear of the IMF's heavy hand doesn't seem to work as an explanation for China's reserve accumulation. IIRC, China's capital controls kept the wolf of currency instability far from the door during the late-90s East Asian financial crisis.

It seems more plausible that the reserve accumulation in this particular case is being driven by a desire for export-led growth (merchantilism), rather than that the current account surplus is a side-effect of a desire for excess reserve accumulation as such.
...
written by liberal, November 12, 2010 11:07
I agree with Ben Ross and AMJ.
...
written by Emin Orhan, November 12, 2010 12:56
"Their capital could in principle be better used in fast-growing developing countries."

The crucial term here is "in principle". In reality, capital inflows into developing countries only make filthy rich speculators even filthier rich, and destroy the industrial base of the country by destabilizing its currency.
real interest rates
written by Ignacio, November 13, 2010 12:41
But according to M. Pettis, in China real rates are negative and, due to overinvestment, many companies are hardly profitable. China looks poised to slower growth.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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