Question

The bold part is what I don't understand.

A country with a negative current account is because NX < 0

• loanable fund mrkt; open econ.
• If country M>X, NX=<0 so
• S-l=<0 which means there is more investment into the country than domestic savings because NX is matched with a counter-flow that is NFI (Net Foreign Investment). There is going to be NFI in a country that imports more than it exports
• Ex: US. They import more than they export. Meaning there is a large inflow of NFI into the US.

the other words that are not bolded are just there for some context. it's just I don't understand how if a country imports more than exports, foreign investors prefer to invest into that country (+NFI).

Thanks

Answer 1

When a country is importing more than it is exporting, then it would run a trade deficit. This could be explained with an example below.

Suppose there are two countries trading ie USA and Canada.

USA exports 1 billion worth of clothes to Canada and imports 2 million worth of shoes from Cananda. This implies that the exports of USA are less than imports ie it is buying more from outside world and selling less. If this continues for a longer period of time, then USA would be bound to pay some interest or that Canada would want to invest in USA, so that it gets returns from investment and is able to balance the negative trade that USA is owing to Canada. Hence Canada becomes net investor in USA.

Hence when a country is having trade deficits for long terms, then the domestic savings would be less than domestic investments. Also the exports would be less than imports, so net exports would be negative and since doemstic investments are less and foreign firms are investing, the net foreign investment would also be negative. Therefore NX= NFI in every case.

Foreign investors would invest in a country where imports are more to recover the debt that the country has. Thererfore where the imports are more, the foreign investments would also be more.

(You can comment for doubts)