I like my student Zane Salem’s post because it applies the principles I talk about in my post “International Finance: A Primer” and the related tools I talk about in my “Monetary and Financial Theory” class, particularly this “International Finance” Powerpoint file. The policy perspective is distinctively his. I am not signing on to all of it, but starting with sound theory makes what he says coherent in a way in a way most commentators who talk about trade are not.
Note that a Twitter thread disputes Zane’s claim of a positive correlation between net exports and GDP. I think when Zane said “GDP is directly correlated with the country’s net exports" he simply meant that net exports is a component of aggregate demand. But "directly correlated” has a different technical meaning. The overall correlation between net exports and GDP depends on many other causal forces in addition to the effect of net exports on GDP as a component of aggregate demand.
Here is what Zane has to say:
Last December’s export data revealed the United State’s trade deficit sunk deeper than expected. This was caused by both an increase in its imports and decrease in its exports. Since GDP is directly correlated with the country’s net exports, the recovering US economy will keep taking dents if this is not turned around.
Background for Improving Exports
The current administration has worked at improving exports numbers since the recession. This was done by attempting to remove trade barriers with other countries and by offering financial assistance with ease of information. While the data suggests there have been some successes, numbers are not where they could be. A subsidy or tax break in any way, shape, or form doesn’t provide a suitable solution for this problem the short run.
That being said, I see two possible ways to improve a country’s exports:
- Invest in assets abroad
- Protect intellectual property abroad
A most effective way to increase exports is by having a relatively weak currency. This makes a country’s goods/services look relatively cheaper and thus a worthwhile purchase to others. By applying the basic principles of international finance we covered in lecture, I’ve devised an algorithm to create a relatively weaker currency and thus more attractive prices for being imported. This could be applied to the United States or any other country.
Investment in Foreign Assets
- Invest in foreign funds – (ideally assets with HIGH rates of return)
- In exchange for their intentional IOUs, they receive unintentional IOUs (US dollars)
- The bouncing around unintentional IOUS (US dollars) overseas leads to an increase in the purchasing of our exports (from their perspective our goods look cheaper and they have dollars to exchange)
- In addition to the return on the investment, NX increases for the US
The reason this works is because of the currency exchange that takes place after the initial investment. The unintentional US dollars that foreign countries incur will be used to purchase goods and services from the US, effectively making the investment an exchange of assets for goods and services. The shortcoming here is that this algorithm requires a simplified model. And, in addition to large number of unconsidered factors, this method is susceptible to high taxes/fees that foreign funds could charge foreign investors. Its implementation could potentially be a controversial political gesture as well.
But we have seen small examples of this. For instance, the Czech republic, staying clear of the Euro-zone, can be seen as doing something similar to this strategy to boost its exports. By investing abroad, they have been able to increase their exports. We have also seen examples with larger impacts, specially from China. China invests huge sums in US and Japanese funds, and in return the US and Japan imports a large number of Chinese goods.
In fact, Japan has recently really been on the suffering end of this strategy, with their net exports have seeing a downturn due to this paradigm. China (along with the US), seeking higher returns on investments, invest in Japan. Logically, Japan increases its imports of Chinese goods and services. In fact, foreign direct investment (FDI) skyrocketed last month from China to Japan:
“The rise in outbound FDI in January was led by a 500 percent jump in investment in Japan, the ministry said without elaborating.”
Trading Economics (and Fed) shows data on Japan’s balance of trade over the past year (see below). Notice how after China’s 500% investment jump in January, leads to a heavy drop in Japan’s balance of trade that same month:
So things do look troubling in Japan. A good question you might be asking yourself: is the US being affected by this too? The short answer is yes. Even as the world’s richest country, we rank 2nd to China in exports as of 2012 (latest data). In fact, it makes plenty of sense that China is ranked 1st in exports.
Intellectual Property Protection
So this strategy seems like a trouble inducing arms race for lower interest rates across many countries. Is there anything else the US or other countries could do to improve its exports? Yes, especially for the US! The United States could protect its IP abroad. It certainly does have a lot of unique valuable exports that other countries demand. Some high demand products come from the entertainment (movies, music, etc) and technology industry (machinery, electronics, etc). But both of these products don’t get their fair share of purchases because of heavy media pirating and patented designs being exploited or stolen (ex: iPhone). Enforcing piracy and protection at home and especially abroad has been a difficult challenge that the country is still trying to resolve. This is an area that I think deserves more attention.
While all of this would help us recover from the economic downturn and have a healthy GDP, we would be doing a disservice to the “victim” countries by competing with their local businesses (shifting the supply curve upward) and enforcing protection of IP. If performing such actions cripples another nation’s economy, this has negative moral and political repercussions that shouldn’t be taken lightly. I think its important to realize what could be done to provide solutions, not necessarily to impulsively act upon them.