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.