We are hoping that - as more Economics teachers migrate to Google Wave - we will be able to schedule collaborative sessions (typically lasting between 45 to 60 minutes) where we can generate ideas, arguments and perspectives in real time and support eachother’s teaching on chosen topics or issues.

Reasons why a trade imbalance is a problem

* May reflect marked change in pattern of trade (e.g. Eastern EU countries preparing for and then joining the Single Market and finding the adjustment difficult in the short term, sharp rise in imports from richer EU neighbours)
* Or unexpected changes in export/import prices (movement of terms of trade) - link to Prebisch-Singer Prebisch-Singer here
* Petro-dollars for net oil and gas exporters in 2007-08
* Improvement in the terms of trade for food exporters in 2007-08
* But these changes in terms of trade can have wider macroeconomic consequences
* e.g. Agflation in 2007-08 forced national governments to limit exports through export taxes, quotas to maintain domestic supply

* A persistent trade surplus can reflect a lack of domestic consumption or relatively closed economy
* China - household consumption only 50% of GDP compared to close to 70% in the USA
* 4/5ths of the trade surpluses in the world can be found in China, Japan, Germany and the oil-exporting nations of the gulf.
* Some countries have a low share of national income taken up by imports
* Contrast between China’s high domestic savings rate and the near zero savings of US consumers prior to the sub-prime crash

* Depends if it is a structural deficit (a result of underlying productivity problems)
* E.g. UK manufacturing decline (sector exports 60% of its output but only accounts for 13% of GDP)
* Weaknesses in product development, innovation, failure to produce higher-value products whose income elasticity of demand is high
* Supply-side education/universities issue (e.g. supply of graduates in engineering, physics, material sciences)

* Is the deficit/surplus being caused by “beggar-thy-neighbour policies”
* China - yuan devaluation - deliberate currency manipulation - yuan has been held at around 6.83 to the dollar for about 18 months as China has defended itself against the financial crisis
* ‘Hidden subsidies’ for exporting businesses
* Rise in number of claims made to WTO about export dumping to offload spare capacity

* Composition of imbalance (e.g. surplus on services but bigger deficit on goods such as the UK - just a case of comparative advantages)

* Persistent trade imbalances can sour trade relationships - rise of protectionism /a big threat to globalisation
* Skewed benefits from trade, perceptions that trade is favouring one country over another
* Links to game theory and the incentives for mutual cooperation based on specialisation and exchange

* May be indicative of poor non-price competitiveness in goods/services due to lack of R&D/Investment.
* OECD figures for R&D as share of GDP: Finland 4%, South Korea 5%, Israel 7%, UK 1.3%
* R&D has long-term importance in oligopolistic global markets, driver of innovation, high value export industries
* Lack of govt policies to encourage entrepreneurship (e.g. lack of tax breaks)

Wider consequences of a trade deficit
* Net leakage of demand from the circular flow of income
* AD/AS analysis: If (X-M) increasingly negative then AD falls, thus real GDP falls, compounded by a negative multiplier effect (depends on what is happening to other components of AD).
* Fall in export demand / rise in import penetration will affect the labour market (derived demand)
* Slower growth of demand from export sector will hit business profits and planned investment (and business confidence) - a negative accelerator effect

Wider consequences of a trade surplus
* Contribute to demand-pull inflation
* Build up of foreign currency reserves - opportunities for sovereign wealth funds
* Norway
* Dubai International Capital
* China Investment Corporation
* Over-dependence on external markets (vulnerable to exogenous shocks)

Structural surpluses of many emerging nations / commodity exporters may have contributed to the credit crunch - how are the surpluses being spent?
* Exports of cheaper products lower world inflation
* Build up of surplus savings (a global glut)
* Drives down world interest rates
* Reduces the return on conventional investments - prompts a surge in higher-risk lending (searching for yield)
* Big rise in off-balance sheet lending
* Gerard Lyons (Economist at Standard Chartered) “if countries with savings keep their money at home and don’t spend, world growth will be weaker, poverty higher, living standards lower.”

Depends on composition of surplus
* What is the economy exporting vs importing
* is it losing its raw materials / commodities (e.g. China exporting its iron ore).
* Sustainability issues

Reasons why a trade imbalance may not be a problem

May be a cyclical deficit (e.g. temporary recession in RoW causing value of X to plummet)
* Sharp fall in German trade surplus in 2008-09 Sharp fall in German trade surplus in 2008-09 - the world’s biggest exporter
* Japan moved into trade deficit in 2008 Japan moved into trade deficit in 2008 (unusual in the post-war period)
* Countries with sizeable capital goods industries really badly affected by this global recession - slump in investment demand

Caused by an exogenous shock
* E.g. Oil price hike in 2008 impacted net oil importers e.g. UK)

Composition of the deficit:
* part of the trade deficit may reflect imports of capital equipment and technology - implications for long run aggregate supply
* boosting SoL within the economy
* consumption of high quality imports: plasma TVs and PS3’s and Yamaha motorbikes
* Export-led growth (China - Over 30% of 2008’s GDP growth came from exports)
* Deficit as a % of GDP is more relevant
* e.g. U.S over 6%; Spain over 10% (Spanish deficit now falling due to the slump)
* Can be financed on the financial account through foreign ownership of financial assets
* China is buying American debt whilst America buys Chinese goods
* But UK failed gilt auction (Mar, 2009) for first time since 2002 shows that this may not always be possible in long term

Question: What happens when Chinese appetite for $ moves to Euro?
* China has world’s largest reserves of US $s - they are sitting on huge losses if the dollar collapses
* Likely depreciation of the US dollar would also have implications for the Euro (likely appreciation) - could easily undermine an economic recovery in the Euro Zone.
* Stephen King (Independent, Oct 2009) “If the US adopts a policy of benign neglect towards the dollar – through low interest rates, a large budget deficit and the gentle hum of the printing press – the risk for these creditor countries is a fall in the dollar which would leave them nursing losses on their huge dollar assets, mostly held in the form of foreign exchange reserves. For the US, this would mark a convenient shift in the pain of economic adjustment from domestic debtors to foreign creditors.”

* Unsustainable trade deficits can spook the financial markets and cause currency flight - e.g. Ireland and Iceland
* Collapse in currency raises interest rates on bonds - may cause some crowding out of the domestic economy
* Steep rise in import prices - creates cost-push inflation problems, deterioration in terms and trade and negative for SoL.
* Although the financial markets will look at a number of factors, such as size of budget deficits/national debt, projected growth rate of economy, forecast consumption, inflation; that the trade position may not be as important
* Could be some partial auto-correction of a deficit / surplus
* Via exchange rate movements (surplus should cause some appreciation in the ER - much depending on price elasticity of demand and supply, Marshall Lerner condition (If sum of PED for X and PED of M > 1 etc...)
* Natural corrective effects of the economic cycle
* Recession: Decline in real incomes, fall in consumption, decrease in import volumes
* Falling deficit in USA, Spain and (to a lesser degree) the UK; China’s deficit falling too as export growth slows (hence the need for a compensating rise in domestic spending, especially given the huge supply-side capacity of their economy)
* Vertically integrated supply chains in a globalised world inevitably means goods go through many countries and add/subtract to/from trade balances all over the world

Overall thoughts

* Trade imbalances are inevitable because of differences in growth rates, trade patterns, volatile commodity prices
* Imbalances demonstrate just how inter-connected/globalised is the world economy
* Ultimately, trade performance is a key determinant of growth,, relative per capita incomes and employment
* Degree of auto correction and sustainability of a trade position (deficit/surplus) seem to be crucial here
* And also the size of an economy in the global system e.g. fragility of capital flows for smaller countries such as Ireland and Spain
* US economy has managed to finance current account deficit for years, UK too (partly because of strong net inflows of FDI and short-term banking flows)
* Essentially not a big problem if can be financed.
* The problem will come when the FDI dries up. 

Suggested reading

Half of UK firms plan a pay freeze (Telegraph)
Pay freeze in deal to save car plants (Independent)
Osborne plans one-year public sector wage freeze (Independent)
Outlook for jobs will remain grim for several years (The Times)
Wage cuts might condemn the economy to more misery (Telegraph)
FTSE bosses get big salary rise (BBC news)

Examine some ways in which a move towards wage cuts or pay freezes might affect the macroeconomic performance of the UK economy

The forum posting is designed to encourage students to read around the subject, develop a concise written style and build evaluation skills. The Moodle system is set up so that students can only see the postings of others once they have submitted their only entry. I will post a couple of replies later on in the week.