Trade Balance 1 National Income Accounting YCIGNX Incomeexpenditure
Trade Balance 1
National Income Accounting • Y=C+I+G+NX (Income-expenditure identity) ¨ Y=GDP (gross domestic product) ¨ NX=EX-IM=net exports of goods & services • S=I+CA, where CA=NX+NFP ¨ CA=current account balance ¨ NFP=net factor payments from abroad • If S<I, then CA=S-I<0 ¨ If a country saves less than it invests, it must run a current account surplus. 2
National Income Accounting • Spvt=I+(-Sgovt)+CA (Use-of-saving identity) ¨ When CA is lowered, o. t. s being equal, Spvt is lowered too. (trade deficit and low private saving rate) ¨ When –Sgovt is more positive, o. t. s. being equal, CA becomes lower (more severe gov deficit and worsened trade deficit) • Ignore NFP, focus on NX • Why NX is already zero in our course? 3
Textbook treatment of NX food • Assumed one-shot interaction • A nation always consumes up its value of production (because every agent does) • No reason to consume less • unable to consume more D Q Iso-value line cloth 4
Textbook Treatment of NX Value of production = p. CQC+p. FQF Value of consumption=p. CDC+p. FDF p. CQC+p. FQF=p. CDC+p. FDF Suppose C is exportable good; F is importable good • p. C(QC-DC) - p. F(DF-QF)=0 • Hence, NX=0 • • 5
International Borrowing and Lending • International capital mobility refers to mobility of financial assets, or capital, across countries. ¨ Financial capital is a source of funds used to build physical capital (ex. , factories and equipment). • International capital mobility can be interpreted as intertemporal trade: ¨ trade of goods consumed today by borrowers in return for goods consumed in the future by lenders. 6
International Borrowing and Lending (cont. ) • For any economy, there is a trade-off (opportunity cost) between consuming today and saving for the future: resources can either be consumed or saved. ¨ To save and invest more today typically means that economies need to consume less today. • We represent this concept by drawing a special kind of production possibility frontier, an intertemporal production possibility frontier. 7
Fig. 7 -5: The Intertemporal Production Possibility Frontier 8
International Borrowing and Lending • Some countries will have a comparative advantage in spending current output/income (in current consumption). • Others will have one in saving current output/ income (in future consumption). • A comparative advantage in current consumption ¨ would mean a lower opportunity cost of spending current income. ¨ would be reflected in an intertemporal PPF that is biased toward current consumption. 9
International Borrowing and Lending (cont. ) • Suppose that the domestic country has a comparative advantage in (bias towards) current consumption, while the foreign country has a comparative advantage (bias towards) future consumption. • In the absence of international borrowing and lending, the relative price of current consumption should be lower in the domestic country. • But what is the relative price of current consumption? 10
International Borrowing and Lending (cont. ) • The price of borrowing 1 unit of output/income to consume today is the output/income that needs to be repaid in the future: ¨ principal + interest = 1+r, where r is the interest rate ¨ The price of current consumption relative to future consumption is 1/(1+r) • The opportunity cost of consuming 1 unit of output/ income today is the output/income that could be earned by saving it: ¨ principal + interest = 1+r, where r is the interest rate ¨ The opportunity cost of current consumption relative to future consumption is 1/(1+r) 11
International Borrowing and Lending (cont. ) • If international borrowing and lending are allowed, the domestic country will “export” current consumption (that is, borrow). ¨ The domestic country initially has a lower relative price of current consumption 1/(1+r) ¨ The domestic country initially has a higher interest rate r. ¨ A higher interest rate r implies a higher return to consumption and investment in production processes: they are highly desirable and profitable so that the domestic country should borrow from foreign lenders. 12
Fig. 7 A 2 -1: Determining Home’s Intertemporal Production Pattern 13
Fig. 7 A 2 -2: Determining Home’s Intertemporal Consumption Pattern 14
Fig. 7 A 2 -3: Determining Foreign’s Intertemporal Production and Consumption Patterns 15
Fig. 7 A 2 -2: Determining Home’s Intertemporal Consumption Pattern 16
Demography: Life cycle consideration • Life cycle consideration • A country is likened to a person: save when young & working, de-save when old • Hence, when ageing, a country runs a trade surplus first, followed by a trade deficit 17
A hypothetical example • Suppose each agent lives two periods: young (working) and old (retiring). • Suppose a small country in which all residents are young but they do not decide to have children. • Suppose only one, non-storable good is produced. But one foreign asset is available (call it US treasury bond, with constant interest rate r) • Time 1: all residents are young; trade surplus • Time 2; all residents are old; trade deficit • Time 3: the country disappears; NX=0 18
A hypothetical example Trade balance Trade surplus Period 2 Period 1 Trade deficit Period 3 time 19
A hypothetical example • CA=S-I • Demography explains S. In case I is unrelated to demography or less responsive to it, then the change in S will reveal itself in CA • In China, weak financial markets prevent channeling of savings to those who have good business ideas 20
Median age: China versus US 21
Total Dependency Ratio: China versus US 22
Dependence ratio: China 23
Difficulty • The example predicts CA be negative some day. For Germany and Japan, whose populations have aged for a long time, still there is no sign their CA will become negative. • Way out: to look at richer demography that allows for richer dynamic of CA change 24
Demography Sex ratio in China (males per 100 females) year At birth Population aged 0 -4 1953 104. 9 107. 3 1964 103. 8 106. 5 1982 107. 6 107. 0 1990 111. 8 109. 8 1995 116. 6 118. 8 2000 117. 8 120. 8 2005 122. 0 120. 0 2010 -- 121. 0 (estimated) 25
Demography • Sexual Imbalance (missing women) • one child policy + son preferences • Parents and their single sons save more to increase competitiveness in the marriage market • Evidence: counties with more skewed sex ratio have higher saving rates • It is argued that sexual imbalance may account of up to ½ of the China’s trade surplus with the US. 26
Data/mis-measurement problem • “Dark Matters in China’s Current Account” by Zhiwei Zhang, a staff member of HKMA • One bias due to under-estimated returns on foreign investments in China • all earnings foreign investments should be recorded in current account as a negative item, regardless if the earnings are re-invested in China or repatriated out • Official CA statistics; official stock of FI by end of 2006 is US$1. 03 T; FI earnings US$57. 3 B in 2007 => hence, ROR 5. 5% • The author’s estimate: FI earnings ~ US$109. 6 B • Evidence: ROR should be higher (OECD studies found 14. 3%). 27
Data/mis-measurement problem • 60% of China’s exports are actually made by foreign funded firms • China has been top exporter of cell phones and notebook computers, but the cell phones are mostly made by Nokia and Motorola, and notebooks by Dell and HP. • The importance of foreign capital is asymmetrically reflected in China’s current account ¨ the explosive growth of exports (largely due to foreign firms moving production bases into China) are well recorded, ¨ But the profits foreign firms made into China are substantially under-recorded. 28
Data/mis-measurement problem • Another source of bias: capital inflows misreported as trade surplus. • The expectation for RMB appreciation heightened in mid 2004, and made one-way bet for RMB a profitable arbitrage opportunity. • Firms in China can over-report their exports and under -report their imports. • China’s current account surplus is over-estimated, and capital account surplus is under-estimated. • Misreported capital flows through the trade channel amounts to 1. 9% of GDP in 2007. 29
Data/mis-measurement problem • Accounting for Growth in China’s Exports by Firm Ownership Stateowned Foreignfunded Collective Private 2002 16% 62% 8% 14% 2003 13% 62% 6% 19% 2004 10% 63% 4% 22% 2005 9% 63% 3% 26% 2006 11% 58% 2% 29% 2007 13% 53% 2% 31% 30
Other explanations • S=I+CA • It is China, stupid! ¨ ¨ Currency manipulation (RMB undervalued) Mercantilism (export is good, import is bad) Saving rate too high (culture? ) Poor financial market • It is US, stupid! ¨ Saving rate too low (culture? ) ¨ Developed financial market • J. M. Keynes: “If I owe you a little money and I don’t repay, I have trouble. If I owe you a lot of money and don’t repay, you have trouble!” 31
Prognosis: China as a transformative /de-stabilizing factor • Increasing economic power ¨ Education attainment • 2000: 1 million college students graduated • 2010: more than 6 million college students graduated (c. w. 3. 5 million first year students in US in 2008) • Now 22% of the cohort go to college ¨ Rate of return of capital has no sign to slow down • Destabilizing the global order • But growth will slow down one day… • Income inequality 32
Prognosis: China as a transformative /de-stabilizing factor • Sexual imbalance ¨ 1. 7 million un-marriageable boys being borne each year ¨ =5 times of the total girls borne a year in Canada (around 330 K) ¨ =50 times of the total girls borne a year in HK (around 30 K) • • • Lack of non-material ideals Communist Party an effective autocracy forever? 1949 -1978: passion 1979 -2008: interest 2009 -2039: ? ? 33
Topics • • Trade balance & capital flows Textbook case Data problem Demography Lack of investment opportunity Undeveloped financial market Exchange manipulation Culture—saving glut 34
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