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OPINION

Trade and savings

Trade and savings
March 23, 2017
Trade and savings

I say this because of basic accounting identities. In both the UK and the US, the trade deficit is very similar to the current account deficit, and the current account deficit is, by definition, equal to the excess of domestic investment over domestic savings. This tells us that trade deficits can only narrow significantly if domestic savings rise relative to investment. It's for this reason that countries that have needed to cut their trade deficits (such as the UK after the 1967 devaluation or Asian countries after the 1997 crises) have tightened fiscal policy: lower domestic borrowing is the counterpart to cuts in external deficits.

But will the UK and US see higher savings and lower investment? Perhaps so in the UK. Government borrowing here is forecast by the OBR to fall from 2.6 per cent of GDP in 2016-17 to 1 per cent by 2019-20. There are two reasons to suspect this will not be fully offset by lower domestic savings.

One is that rising inflation might well cause increased household savings, not least because some people will want to save more to offset the loss of wealth caused by negative real returns on cash.

Also, the same cut in expectations for future economic growth that have caused sterling to fall might also depress capital spending. The OBR expects business investment to fall slightly this year. We might see evidence of this in next week's economic accounts. These could show that corporate net savings rose in the fourth quarter as profits rose but capital spending fell.

In the US, however, it's harder to foresee such changes. Quite the opposite. Most observers expect President Trump to increase government borrowing by spending more on infrastructure spending - a move that probably won't be offset by higher net private sector savings.

There is, though, one possible mechanism whereby protectionism (or simply the threat thereof) might raise net savings and so cut the trade deficit. Pol Antras, Teresa Fort and Felix Tintelnot point out that cheaper imports allow US companies to cut costs and hence expand. Anything that raises import prices would thus raise companies' costs of production and so deter them from investing and expanding. Lower investment would cut the trade deficit.

And here's the point. Significant declines in trade deficits are usually accompanied by weaker domestic demand, because higher savings and lower investment depress demand.

Which raises the question: are big trade deficits really a problem? Personally, I think it a stretch to claim, as has Trump advisor Peter Navarro, that they are a threat to national security. However, a current account deficit does mean that a country needs to attract capital inflows from overseas. And the famous Feldstein-Horioka puzzle warns us that such inflows aren't always easily forthcoming; it might require depreciations of domestic asset prices or higher interest rates to attract them. This is probably less of a danger for the US, with its "exorbitant privilege" of having a reserve currency than it is for the UK. In this sense, trade deficits can be an issue. But the cure can be as bad as the disease.