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

Exports minus imports are called net Exports.

Capital inflow minus capital Outflow is called net capital flow (if positive it means there is net capital inflow qnd if negative it means that there is net capital Outflow)

Suppose, Net unilateral Transfers and Net Factor incomes are 0. It means that Current Account Balance= Trade Balance= Net Exports.

If Net Exports are postive it means that there is trade surplus and If net Exports are Negative it means that there is trade deficit.

Now, Suppose Financial Account Balance consists of only Net Capital flows.

Now, for Balance of payments to balance,

Current account balance+ financial account balance+ official reserve transactions= 0

Suppose official reserve transactions are 0

Current account balance+financial account balance= 0

Net Exports+ Net Capital Flows= 0

Net Exports= –Net Capital Flow.

From the above equation it can be ascertain that if a country has positive net Exports then it will have a net capital outflow of Equal amount

Hence, postive net exports are always equal to net capital outflow and negative net exports are always equal to net capital inflow.

Trade Deficit means negative net Exports which leads to an equal amount of net capital inflow. This capital inflow(which are Foreign savings) helps sustain investment even when the savings in the economy is low, leading to Economic growth. This is the case with the United States. Therefore it can be said that trade deficit does not necessarily create trouble for country's economic growth.