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  • When Is a Trade Deficit a Problem?

‘Problems of coherence plague not only the IMF’s remedies but also its diagnoses. IMF economists worry a lot about balance of payments deficits; such deficits are, in their calculus, a sure sign of a problem in the offing.
But in railing against such deficits, they often pay little attention to what the money is actually being used for. If a government has a fiscal surplus (as Thailand did in the years before the 1997 crisis), then the balance of payments deficit essentially arises from private investment exceeding private savings.
If a firm in the private sector borrows a million dollars at 5 percent interest and invests it in something that yields a 20 percent return, then it’s not a problem for it to have borrowed the million dollars. The investment will more than pay back the borrowing. Of course, even if the firm makes a mistake in judgment, and the returns are 3 percent, or even zero, there is no problem. The borrower then goes into bankruptcy, and the creditor loses part or all of his loan. This may be a problem for the creditor, but it is not a problem that the country’s government —— or the IMF—— need worry about.
A coherent approach would have recognized this. It would have also recognized that if some country imports more than it exports (i.e., it has a trade deficit), another country must be exporting more than it imports  (it has a trade surplus).
It is  an  unbreakable  law of international accounting that the sum of all deficits in the world must add up to the sum of all surpluses.
This means that if China and Japan insist on having a trade surplus, then some countries must have deficits. One cannot just inveigh against the deficit countries; the surplus countries are equally at fault. If Japan and China maintain their surpluses, and Korea converts its deficit into a surplus, the problem of deficit must appear on somebody else’s doorstep.
Still, large trade deficits can be a problem. They can be a problem because they imply a country has to borrow year after year. And if those who are providing the capital change their minds and stop making loans, the country can be in big trouble —— a crisis. It is spending more to buy goods from abroad than it gets from selling its goods abroad.
When others refuse to continue to finance the trade gap, the country will have to adjust quickly. In a few cases, the adjustment can be made easily: if a country is borrowing heavily to finance a binge of car buying (as was the case recently in Iceland), then if foreigners refuse to provide the financing for the cars, the binge stops, and the trade gap closes.
But more typically the adjustment does not work so smoothly. And problems are even worse if the country has borrowed short term, so that creditors can demand back now what they have lent to finance previous years’ deficits, whether they were used to finance consumption splurges or long-term investments.’

Joseph Stiglitz.

Winner of the Noble Prize for Economics 2001.

Extract from his book GLOBALIZATION and its discontents.

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