![]() trade deficit must automatically decline. That is the nub of the claim Shultz and Feldstein make. For example, if we reduce the fiscal deficit, total savings must rise, in which case the gap between savings and investment must decline with that both the capital account surplus and the trade deficit must decline. If we accept the four as independent then it is obvious what happens if we increase one of the three savings accounts. Relaxing this assumption has no effect on the underlying argument. ![]() This complicates the argument somewhat, but we can safely ignore these linkages without changing the thrust of the argument, and so we will ignore these effects and assume that the four accounts can be independent of each other. Alternatively, we can argue that the fiscal deficit creates stronger demand in the economy, and a reduction will cause U.S. ![]() businesses and households will rise and encourage them to spend more. fiscal deficit, and as the fiscal deficit declines, the confidence of U.S. businesses and households watch and worry about the U.S. For example, we can easily argue that U.S. To be sure, they are not wholly independent of each other, and there is some feedback among them. All four are determined by other conditions that might include the level of interest rates, the growth in household income, the tax rate, and so on. Total investment is also an independent variable. According to Shultz and Feldstein, household savings, business savings, and the fiscal deficit are all more-or-less independent variables. Here is where it starts to become messier. Trade deficit = Total investment – (Household savings + Business savings – Fiscal deficit) Which Is the Independent Variable and Which Dependent? Total savings = Household savings + Business savings – Fiscal deficit Total savings = Household savings + Business savings + Government savingsĪnd because the fiscal deficit is simply the negative amount of government savings, the second formula becomes: Trade deficit = Capital account surplus = Total investment – Total savings This is why Shultz and Feldstein claim that cutting the U.S. investment must fall, bringing down both the capital account surplus and the trade deficit. Reducing the fiscal deficit, according to Shultz and Feldstein, causes total U.S. Governments usually spend more than they receive in revenues, and the fiscal deficit is a measure of this excess, or of government dissaving. savings, of course, consist of the sum of household savings, business savings, and government savings. 1 It also runs a capital account surplus equal to the gap because this is the amount of net foreign capital inflow that bridges the gap, and the trade account and the capital account for any country must always balance to zero. savings, and the United States runs a trade deficit that is by definition equal to the gap between investment and savings. This is where these arguments can get terribly confused. However, accounting identities do not tell us the direction in which causality flows, and so all identity-based arguments must implicitly make assumptions about which of the variables drive the other. The model Shultz and Feldstein use is the same model, on the surface, that I and most other trade economists use, and is built around accounting identities that can never be violated. This view is also the mainstream view, but it is based on implicit assumptions concerning trade that I would argue have become obsolete. The Mainstream View: The Savings Account Drives the Capital Account ![]() Control that spending and you will control trade deficits. If we manage to negotiate a reduction in the Chinese trade surplus with the United States, we will have an increased trade deficit with some other country.įederal deficit spending, a massive and continuing act of dissaving, is the culprit. If a country consumes more than it produces, it must import more than it exports. secretary of labor, treasury, and state, and Feldstein, whose recent article in Project Syndicate I wrote about in a Bloomberg piece two weeks later, is a professor of economics at Harvard University, former chairman of the Council of Economic Advisers, and president of the National Bureau of Economic Research. Shultz and Martin Feldstein explained, according to the headline of their Washington Post article, “everything you need to know about trade economics, in 70 words.” Shultz is a former U.S.
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