2. Assume only two countries, China and the US. If China decides to stimulate gr
ID: 1194819 • Letter: 2
Question
2. Assume only two countries, China and the US. If China decides to stimulate growth through a policy of running a large export trade surplus, does China’s national savings increase? Show the relationship between China’s national savings, domestic investment and net capital outflow (NCO). 2. Assume only two countries, China and the US. If China decides to stimulate growth through a policy of running a large export trade surplus, does China’s national savings increase? Show the relationship between China’s national savings, domestic investment and net capital outflow (NCO). 2. Assume only two countries, China and the US. If China decides to stimulate growth through a policy of running a large export trade surplus, does China’s national savings increase? Show the relationship between China’s national savings, domestic investment and net capital outflow (NCO).Explanation / Answer
The policy of running a large Export trade surplus will not have any economic benefit. The reason lies in the basic national income calculation, which is calculated by
Savings - Investment = Exports – Imports (Net Capital Outflow)
The capital will flow from US to China, enabling the latter nations to invest more than their domestic savings by relying on foreign capital to make up the difference. So for US, the left side of the equation is negative. At the same time, China will export more than they import, making the right hand side of the equation positive. Since, both conditions cannot hold simultaneously and still satisfy Equation, if China generates large trade surpluses it must be because they are exporting large quantities of capital to The US. This is an unlikely scenario. In response to the concern over low-wage competition and trade deficits is that as capital and technology flow to China, their wage rates will rise along with their productivity. As their incomes rise with their productivity, local workers will buy more of the goods in the market from the US and services. At the same time, the China must import capital and materials to apply the new technology they are acquiring. As a result, they will not run large trade surpluses; rather they will run trade deficits as the counterpart to their capital surpluses. And, hence for an open market economy stimulating a large trade surplus may not prove to be an effective measure to stimulate growth.
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