Sunday, June 22, 2014

Peter Dorman — Net Savings and Trade: Krugman is Simply Wrong

I was going to let Paul Krugman’s aside about the trade deficit being “determined” by net national savingspass, but Dean Baker has unintentionally prodded me into action.
It’s actually worse than what Dean says. The sum of a country’s domestic budgets, private and public, is not “equal” to its current account (mostly trade) position; it is the current account position. The two are the same thing. It’s as if my team played your team and you won while we lost. Your victory didn't “determine” our defeat or vice versa: they are one and the same. It’s such a simple idea, but top flight economists like Krugman (who knows trade and open economy macro about as well as anyone on the planet) mess it up just as readily as my introductory students. I've wondered why this is, but it is. (You can read some speculation about why economists don’t distinguish between identity and equality here; see p. 169.)


Dan Kervick said...

I don't understand this. Why can't a single closed economy with no external sector save more than it invests?

circuit said...

Dan, not sure this answers your question but any unsold products resulting from unspent income (ie saving) is deemed to be a form of investment in the national accounts (officially called business investment in inventories).