A small theory of trade imbalances

In any closed economy, be it people in a village or countries on the planet, there will always be trade imbalances. For any number of reasons, some people will be more productive than others. Let’s say in one place it rains a lot and that makes people boring and hard-working. In another place it’s sunny and the inhabitants are lazy. The boring people manage to make twice as much stuff each month than the lazy ones. What happens when they try to trade? There are two main options:

  1. They trade at fair prices and even balance (no borrowing). That’s stable and arguably fair, but overall trade is limited by how much the lazy people can produce. Even though the boring people could produce more to sell, the lazy ones can’t produce enough to afford it.
  2. They trade at skewed prices. Everyone produces as much as they can. The boring people essentially barter their suff with the lazy people, so there’s a net transfer of value from boring-land to lazy-land while the money balance stays even.

These are the two overall options. For the first option, which we’ll call “fiscally responsible” there are two variants:

  • The boring and the lazy people actually limit their production and consumption of traded goods to what the lazy people (and therefore everyone) can afford. This is what Germany says that every country ought to do if only they were sensible like Germany.
  • The lazy people borrow from the boring people to pay for the goods they buy, so they accumulate a debt at the rate of their productivity imbalance. Eventually the boring creditor people call in the debt, taking away the bankrupt lazy people’s assets. This makes the lazy people even less productive and less able to afford goods, so in the long run this is just a more traumatic way to keep the total size of the economy small. That’s what the private debt markets try to do, previously in the third world and now in peripheral Europe.

For the second option, which we’ll call “growth oriented”, there are three variants:

  • The boring productive people just sell their stuff at half the price the lazy people sell theirs, or to put it differently prices are set socially (a month’s work fetches a certain price) ignoring the productivity advantages that a group may possess.
  • The lazy people borrow to pay for the stuff they buy, but the debt is nominal only. Debt can accumulate to any amount, interest is effectively zero, and there’s an infinite supply of finance. The Unites States’ debt is like that, since it’s in dollars and the US is able to print dollars and convert it to inflation/devaluation if needed.
  • The lazy people borrow to pay for stuff, and the debt is real. However, when debt becomes too much it is rescheduled: The nominal amount is renegotiated, a payment holiday is agreed whereby interest drops to zero, or something equivalent. This is what Latin America, Southern Europe, and other poor indebted low-net-productivity economies need to do.

Now for the hard bit: Which of the two main options, “fiscally responsible” or “growth oriented” is better?

If you think that production, trade, and consumption is a zero sum cycle then you want to take the fiscally responsible card and trade less. Everyone should consume within their means. For example if the economy is mostly bound by natural resources that’s the right approach, at least for preserving the resources.

If you think the economic flow of production, trade, and consumption has a net positive value on the human beings involved, just by virtue of the economic activity taking place, then you want to take the growth oriented card to maximize it. In a world where the economy is overwhelmingly made by people, and participation in the economy is plainly of vital importance to all, the sane option is to pursue growth and connection through trade, rather than parsimony.

The relationship between Africa and the post-colonial developed world, tragically, has taken the “trade less” route. Perhaps this is because the West thought of Africa as a region of natural resources. When the west quit taking Africans as slaves, we were only interested in logging and mining.

Pretty much everywhere else, especially in Asia, people-oriented economies have flourished. These economies produce and trade as much as possible and forget about balance of payments, or at least it’s a distant second in their considerations. Japan used to have a huge surplus with the US. Now China, Korea, and Taiwan have huge surpluses with the West. The net flow of value from Asia towards the West is much higher than the cash trade imbalance (in the other direction) suggests, because the productive countries of Asia are still for the time being poorer per capita and because the West extracts rents through IP assets. Still, the effects of this vibrant economic production have been overwhelmingly beneficial for Asia, much more than cheap tablets and phones have been beneficial to us in the West.

In Europe, Germany and a few other countries generate a surplus of goods that the periphery absorbs. That’s really good for them. Unless the Germans want to cash in their productivity for leisure, which is unlikely, the best macroeconomic policy for the EU is to be growth oriented. To keep the predatory financial markets at bay, EU states need to use taxation and redistributive grants, rather than market finance, to recycle the funds from the rich center to the poor periphery and keep the engine of production running.

In the long run, any closed economy benefits from maximizing the production of value (assuming we count the full costs, and we don’t destroy the planet for short-term value) and that is best, or rather inevitably, achieved by maintaining a net flow of value from the more productive to the less productive economic participants. The flow of value gradually raises the productivity of all economic participants, including the slow ones, to a higher level.

In a closed economy, parsimony is ruinous. Only the few, richest people benefit from it, while the economy as a whole falls short of its achievable production and becomes less equitable, not more as an even balance of payments might naively suggest.

Related myths

Finally to debunk two myths: In the EU, trade imbalances are of a size modest enough to be financed through redistributive grants. Accumulated debt is one or two orders of magnitude higher. For example, Greece has a running deficit of about €8 bn a year. Accumulated debt is €340 bn. It’s reasonable to ask that the the EU tax the industrial center and subsidize the periphery for the good of overall growth. It’s not reasonable that they tax anyone (center or periphery) to pay off the mountains of debt.

The second myth is that Keynesian growth-oriented policies result in rampant inflation because the government “can’t afford” the money it’s spending. If fiscal stimulus causes inflation, the problem is monetary, not fiscal. If the monetary authority (the government) is too weakly integrated into the economy, for example because they’ve privatized all their assets and services, then when they come to print new money the market senses that the issuer of the money has no assets and effectively “runs” on the newly issued money. The market calls the government’s bluff on the monetary illusion. Keynesian growth economics work, but only with a large state sector, or some other tight coupling of the meonetary authority with the real economy.

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