Question

Explain why and how net exports and net capital flow are related to each other. Does trade deficit necessarily create trouble for a county’s economic growth? Discuss.

Answer 1

Net exports is the difference between goods exported to foreign countries and goods imported by domestic country.
Net capital outflow is the difference between foreign assets purchased by domestic country or individuals and the domestic assets purchased by foreign country or individuals which in turn implies negative capital account balance .
Net exports and net capital outflow are directly related implying that a current account surplus is accompanied by capital account deficit and vice versa.
Economic growth is dependent on GDP which in turn is affected by net exports and net capital outflows.If Net export is higher it will positively impact the GDP but even if it is lower and the impact of net capital inflow is higher on the the investment component then GDP will improve.So it is the net effect of current account balance and capital account balance that will determine the economic growth of the country. Thus the BoP should be in surplus in order to improve the GDP.