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Wednesday December 8th, 2021

Trade deficits caused by foreign borrowings; Harvard economist at Sri Lanka forum

ECONOMYNEXT – Trade and current account deficits are a result of foreign borrowings, a US economist told a forum in Sri Lanka as US President Donald Trump mistakenly attacked trade deficits based on false Mercantilist doctrine.

Exporting more will not reduce a trade deficit, Robert Lawrence, a professor at Harvard University’s Kennedy School of Business told an economic forum organized by Advocata Institute, a Colombo-based think tank.

“Fundamentally a trade balance – basically the current account – is a reflection of the spending patterns of the nation," Lawrence said.

“And it tells you that a country with a (current account) deficit is borrowing. So it tells you that it is not saving enough domestically and it can’t finance its domestic investment, it has to borrow.

“One component of that will be fiscal policy. If the government runs a surplus, the country will have a smaller trade deficit. If private citizens save the country will have a smaller trade deficit.”

He was responding to a question by moderator Murtaza Jafferjee, Chief Executive of J B Securities that in Sri Lanka many people and writers claimed that raising exports will reduce a trade (or current account) deficit.

That exports are ‘good’ (exports represents delayed consumption and people get the benefit when the money earned is spent on imports) is a false idea that was spread by classical Mercantilists of Europe, before Adam Smith and others came up with reasoned analysis, which is now called ‘economics’.

Most people who believe that exports are ‘good’ and imports are ‘bad’ and countries should aim for trade surpluses are echoing the false doctrine of the likes of Thomas Mun, a classical Mercantilist of the 17th century who was also a director of the British East India Company.

“The ordinary means therefore to increase our wealth and treasure is by Forraign Trade, wherein wee must ever observe this rule; to sell more to strangers yearly than wee consume of theirs in value,” he wrote in 17th century English.

Countries like Germany and others East Asia such as Taiwan which run trade surpluses have tight government budgets with even surpluses in some years. In Malaysia, state enterprises run large surpluses.

East Asian central banks also collect reserves (sterilizing domestic liquidity) and invest them in the US, reducing credit and spending within the country. The money invested in the US come back as export demand, when spent in America.

Japanese and Korean firms have been investing heavily abroad and have foreign aid budgets, which tend to reduce domestic spending and transfer capital out. China has shifted some of its investments in US debt to its ExiBank and similar foreign projects.

The US, which has a chronic current account deficit, used to run a trade surplus after World War II, when Marshall Law aid was given to Europe.

The US is the world’s largest recipient of foreign direct investment and central banks in countries that operate dollar pegs buy US government bonds at low rates.

Trump’s plans to deficit spend on infrastructure, cut taxes and also invite foreign firms to invest in the US, which run counter to his obsession with reducing the trade deficit has left economists between despair and laughter.

“My own country – the United States – is currently following utterly contradictory policies”; Lawrence said.

“The Trump administration is obsessed with bilateral deficits we have with individual countries So they to make the aggregates trade deficits smaller.”

“At the same time what the US government has done is to pass large tax cuts and is currently sweet talking about increasing spending on defence and non-defence.

“So the government is going to run a bigger budget deficit.”

The Trump administration is talking about reducing deficits on one side and taking action which will lead to a bigger trade gap, Lawrence said.

“So when it comes to the (trade) deficit, it seems to be much more about spending patterns in the country, its savings and investment behaviour, than whether it is going to export more or import less.”

If someone wants to reduce the trade deficit a ‘good way’ to do it would be to cut budget deficits, and a ‘bad way’ would be to reduce investments, Lawrence said. (Colombo/Feb09/2018)


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