A place for reflections, some healthy fun,
critical and experiential learning.
Thursday, May 6, 2010
Foreign Exchange & BOP - HBL (S43)
Referring to HBL activity #2, respond to the question below: Why might some countries have a sustained surplus or deficit on their current account? Refer to specific countries whenever possible.
China in particular has been highlighted in the source to have been sustaining, in fact increasing, their current account surplus since 1998. China's stance of fixing its currency (Yuan) and preventing its appreciation is likely to play a large role in this trend. By doing so, its exports are relatively cheaper and price-competitive compared to the rest of the world and export expenditure for China would then rise. (assuming Marshall Lerner condition applies) On the flip side, an undervalued Yuan causes the prices of imports to local Chinese to be relatively more expensive than domestic goods. As such, exacerbated by Asian thrift (not spending much of their additional income from the huge export revenue) quantity demanded for imports will fall or rise a lot less significantly than the rise in exports and hence the combined value of (X-M) will increase, leading to this sustained surplus kept alive by the fixed exchange rate.
For the case of U.S, they have consistently been in a current account deficit situation since 1998. This is likely to be due to their spendthrift nature. Until recently (sub-prime crisis), consumer spending had been on the rise in the U.S, due to a booming housing market. With a very significant rise in expendable income of consumers and the progress toward globalized production, there was a large influx of exports with a disproportionate sale of domestic products. Furthermore, low interest rates, tax cuts for the wealthy and an already high tendency to import (especially luxury goods like stereos and cars) further worsened the current account situation where (X-M) decreased. Furthermore, China's relatively cheap exports (due to their undervalued currency as discussed above) worsened the US' current account situation as US consumers switch to China's imports rather than domestically produced good thus adding on to China's current account surplus and their own deficit.
China has been facing a sustained and increasing surplus in recent years. There are mainly two reasons for this current account surplus – high export volume and low import volume. There are high exports as China is able to produce goods at a very low cost due to cheap labour costs thus their price of goods can be set at very low, making their goods more price competitive. Furthermore, China has been keeping an undervalued exchange rate, thus further making goods more price competitive, as goods are relatively cheaper in foreign countries than their own local goods so foreign consumers switch to using China’s exports so demand for China’s exports increase, increasing export revenue (assuming Marshall-Lerner condition holds where demand for exports are price elastic and there is spare capacity). Imports are kept low as undervalued exchange rates make their imports more expensive so quantity demanded for imports is low so import expenditure is low. With a high export revenue and low import expenditure, net (X-M) is high, contributing to the current account surplus.
US have been facing a sustained deficit. This is because their import expenditure is very high. The low interest rate and availability of credit in US encourage borrowing and so US households do not save a lot and instead consume a lot, both domestic goods and imports. Hence they import a lot of goods and services. Domestically produced goods in US are also expensive as they have high costs of production (high wages due to strong union power labour) and inefficiencies of industries due to protectionistic measures (import tariffs). Since China’s goods are relatively cheaper than US goods, US consumers switch to using China goods, further stressing the point that imports volume is high. Furthermore, exports is also low as US is generally unwilling to trade high end technology equipment that they have a comparative advantage in due to security reasons and that their export prices are high due to the above reason. Hence, with a falling net (X-M), this leads to a sustained deficit.
The type of exchange rate of the country is one reason for sustained deficit or surplus of a country’s current account. In the source provided, the example of China is highlighted. From 1998 to 2009, China not only sustained a surplus in their current account but also increased it by more than 900%. China fixes her currency, the Yuan, and prevents it from appreciating. This is the main reason behind the sustained and increasing surplus of China’s current account. Since the Yuan is fixed, China’s exports are relatively cheaper and more price-competitive compared to domestic goods of other countries. This would cause China’s export revenue to remain high, assuming Marshall Lerner condition applies. On top of that, the undervalued Yuan makes prices of imported goods more expensive relative to China-made products. Hence, local consumers would choose local products over imported goods. This will mean that import expenditure remains low. The value of (X-M) will remain high resulting in the sustained surplus in China’s current account.
The reverse phenomenon can be seen in the US where their current account has been in deficit since 1998. One main reason for this is the spendthrift nature of Americans. Over the past few years, until the recent sub-prime crisis and the resulting the global economic recession, consumer spending in the US has been on the rise. Exports of US made goods is high as there is a high worldwide demand for US goods. Furthermore, low interest rates, tax cuts for the wealthy and an already high tendency to import (especially luxury goods like stereos and cars) further worsened the current account situation where (X-M) decreased. To make the situation worse, imported goods, particularly China-made, are relatively cheaper and so the tendency to import such goods are high. This results in (X-M) to remain negative resulting in a sustained current account deficit.
China has a sustained current account surplus as China as low cost of production, thus it is more price competitive as compared to other countries. Therefore demand for china goods is high. With a high demand for China goods, there is also high demand for China's currency. Moreover, China currency is kept at an undervalued level. this further increases the price competitiveness of China's goods. However the undervalued Yuan would also mean that imports to China would be more expensive as compared to the local goods in China. Hence China would have a high export and a low import volume, thus leading to a sustained current account surplus.
US on the other hand has a sustained current account deficit. This could be due to the spendthrift nature of the Americans, and this could be cultured by the low interest rate and ease of credit. Hence Americans are likely to spend more and import goods. This could be made worse by the availability of cheap China products. This further increase their import volume. Hence their current account is constantly in deficit.
China have a sustained surplus on its current account mainy because its goods and services are relatively cheaper compared to other countries. This could be due to the lower costs of production and low wages for workers. As a result, its goods and services become price competitive and foreign countries will import a lot of goods and services from China, assuming demand for imports is price elastic, China will experience a high export revenue. Even though the demand for RMB is increasing, Chinese government fixes the value of Yuan within a very small range, causing Yuan to be undervalued. In this way, foreign goods and services may seem to be more expensive to Chinese people and they will prefer to buy local goods and services. Besides, the Asian thrift nature discourages Chinese people to purchase the more expensive imported goods. Hence, the import expenditure will be low and (X-M) will remain high leading to sustained surplus on China’s current account.
America, on the other hand, have a sustained deficit on its current account. This is because the local goods in America is relatively more expensive compared to other countries like China due to the high costs of production and high labour costs. As a result, America tends to import a lot of cheap goods and services from China and has a high import expenditure. However, due to the high prices of local goods and services, few countries are willing to import American goods and services leading to low export revenue. (X-M) remains negative and current account deficit is created. This situation is worsened by the American spendthrift nature, low interests rate and the easily available credites from the bank. With these tradition and incentive to spend, Americans will demand more foreign goods which further lead to America’s current account deficit.
As China has a large labour force, this means that they have a comparative advantage in labour, and this allows them to be able to keep labour costs down. This will lead to a low cost of production, making its goods cheaper relative to other substitutes in the market. In other words, it is more price-competitive. This means that demand more Chinese goods would be higher and therefore there would be a large amount of exports to other countries. In addition, with high saving rates due to the Asian thrift nature, imports would be kept to a lower level than that of exports, causing China to be a net exporter. With their export revenue exceeding import expenditure, this would mean that China would have a current account surplus. Also, since the Yuan is undervalued, this would cause its goods to be cheaper compared to substitutes from other countries in the market, and hence there would be a greater volume of exports. This also causes the price of imports to increase, and Chinese consumers would switch to its own domestically produced goods, which are cheaper. As the Yuan is artificially kept low, the constant undervaluation would also contribute to the sustained current account surplus.
As for Japan, another Asian country, it too has the Asian thrift nature, and hence imports little, especially since domestic producers are able to produce enough to cater to the domestic consumers, be it necessities or luxury goods. On the other hand, there is large external demand for Japanese goods due to its deemed high quality. For example, the strong overseas demand for Japanese cars. In addition, this external demand is growing owing to rising wages of consumers in India, China, and these consumers in turn have the greater purchasing power to buy more expensive luxury goods that make up a large proportion of Japanese exports. With growing export expenditure and a largely stagnant domestic sector, Japan’s current account would experience a sustained surplus.
However, as for US having a current account deficit, this is due to the excessive consumption owing from the easy availability of credit, as financial institutions allow consumers to borrow on credit. These borrowed loans are then used to supplement the US consumer’s purchasing power, allowing them to buy more imports without these loans. As US has a large domestic sector and because US has a low savings rate, this means that US has a large volume of imports. However, as US has countries like China and Japan as major trade partners, but who have the Asian thrift nature, US is not able to have an export volume as large as its import volume. Hence its import expenditure outweighs its export revenue, leading to a current account deficit. This is further sustained by the growing pool of consumers in the US.
Balance of Payment (BOP) equilibrium is a macroeconomic goal in an economy, and the current account balance is one that refers to trade balance (import expenditure and export revenue).
China has a sustained surplus on their current account from US$29 billion in 1998 to an amazing peak of US $426.1 billion 10 years later in 2008. With China and other countries like Japan and Germany having a massive domestic market with many firms being set up in China to produce goods and services, these firms will exploit Economies of Scale to meet the demands of the huge domestic market and reduce the cost of production. With the goods being sold at a cheaper price than other firms producing in other countries, it would make the price of China's exports very price competitive and hence, the quantity demanded for China's exports increases. With the goods that China produce ranging from goods with many substitutes around the world, the demand for exports is price elastic, meaning that an increase in quantity demanded leads to a more than proportionate decrease in price. Export revenue increases.
With regards to imports coming into China, Japan or Germany, prices of imports may seem more expensive as compared to prices of goods and services in the domestic market, making prices of imports price uncompetitive. Many locals switch from imported goods to local goods, hence quantity demanded for imports decreases and hence M expenditure decreases.
With that, there is an increase in net exports (X-M) and with that, there is a sustained current account surplus in Japan, China and Germany. Other factors such as the Asian thrift and compulsory savings programmes possibly implemented by the government could also lead to a reduction in import expenditure.
However, in the UK and US, there is a sustained current account deficit due to the nature of their consumers being more aggressive in spending. Hence, with the higher purchasing power of an average citizen in either country, there would be a higher marginal propensity to spend on imported goods and hence, leading to a higher import expenditure.
Also, in the UK and US, certain policies have been implemented by the government in order to protect local firms and producers from the wrath of cheap exports coming from China and India. Such a policy is the use of American steel to make cars to support the steel producers, and also tariffs being set on fabrics coming from China. This is not cost efficient and makes American more price uncompetitive compared to Chinese goods. Hence this reduces the export revenue for America and UK due to the reduction in quantity demanded for exports from these countries. Hence the net exports (X-M) decreases and remains in deficit due to an increase in import expenditure and reduction in export revenue.
The most obvious case of current account surplus can be seen in China’s current account balance. There are many factors that could result in this current account surplus. Firstly, the cost of production in China is relatively lower than most other countries, because of the availability of cheap labour. This is in turn because of the fact that China has a very large population (China is the most populous country in the world). The low cost of production in China, means that Chinese goods are relatively cheaper than its counter-parts and this makes demand for Chinese goods even more higher, resulting in high exports in China. Secondly, because of the Asian thrift nature, the Chinese tend to spend lesser on imports and prefer to save more instead, resulting in low imports. Thirdly, China has an undervalued Yuan that makes its exports even more price competitive, leading to an even higher demand for Chinese goods since they are comparatively cheaper. Lastly, China has a large domestic market that allows it to enjoy the advantages of Economies Of Scale(EOS), and hence even lower costs of production with higher efficiency. This makes Chinese goods even cheaper and demand for it even higher. Hence, China has high exports and low imports, resulting in a high net exports (X-M) that is the cause of the current account surplus. On the other hand, some countries like the US (United States) has a current account deficit because of their spendthrift nature. Unlike people in Asia, the Americans spend a lot and save a little. This is because of the availability of credit and the easy access to money. Banks and financial institutions in the US are slack in lending money and allow almost anybody to borrow. This means that Americans tend to spend more and hence inevitably, demand for imports will be high. Contrastingly, the exports sector of US is not as vibrant as that of the imports sector. For example, US manufactured cars (e.g General Motors) are losing appeal overseas and is losing competitiveness as compared to Japanese cars, this means that exports of the US is low, as compared to other countries like China. Moreover, prices of American goods are relatively higher than those made in other countries like China, where goods are cheaper due to cheap labour. Hence, American goods are less price competitive as compared to goods from other countries, and demand for American exports are low. This results in high imports and low exports, and hence, net exports is negative {(X-M) <0 }, and countries like the US face current account deficits as such.
Some countries such as the USA and the UK have sustained current account deficits while other countries like China and Japan have sustained current account surpluses. This could be due to certain factors. Firstly, the prices of goods at home and abroad. USA might run a current account deficit because the prices of their goods may be more expensive than their trading partners like China and this makes their exports more price uncompetitive compared to local Chinese produce. This will decrease the export revenue and hence the BOT deteriorates, leading to current account deficit. The stronger dollar may also contribute to this deficit. Secondly, the foreign exchange rate. The yuan is reported to be undervalued. This means that Chinese exports are now more price competitive in US$, so demand for them rises and export revenue rises, whilst the US imports become more price uncompetitive in Chinese yuan, so quantity demanded drops and import expenditure drops. Hence, in recent years, China’s balance of trade became a huge surplus as it opened its economy, leading to huge current account surplus. In the case of the UK, the reasons for its persistent deficit could include the high consumer spending due to 14 years of economic growth, falling savings ratio and low interest rates. A significant portion of this consumer spending is spent on imports, especially luxury manufactured goods, so import expenditure, PmQm will rise substantially, worsening balance of trade. The fact that the Sterling pound has appreciated against the dollar will only worsen this deficit. Some other reasons could include the loss of comparative advantage in UK’s export manufacturing sector, in the face of globalisation and competition with low wage countries like China. Hence its export revenue falls and worsens BOT.
The depreciating Yen has also helped to bolster Japan’s current account surplus according to the analysis used for China above. The excerpt below from Bloomberg supports this.
“Japan's currency has fallen 8.5 percent against the dollar and 13 percent per euro in the past 12 months. ``Yen depreciation has been a major support for Japanese corporations and, together with gradually strengthening domestic demand, is helping to underpin Japan's economic expansion,'' said Takuji Aida, chief Japan economist at Barclays Capital in Tokyo.” – 14th May 2007, Bloomberg
The above also reflects a change in consumer preference for domestic goods in Japan, with “gradually strengthening domestic demand”. This would indicate an increase in domestic consumption as well as a fall in import expenditure, thus boosting BOT and current account for Japan, as seen by it “helping to underpin Japan’s economic expansion”. For Germany, being the Euro zone’s largest exporter, it would have a very huge BOT surplus. In addition, the euro depreciated against the US$ this year due to the Greek fiscal crisis. Hence, the determinant this time was also a weak euro which helped to improve balance of trade for Germany and hence its current account was in surplus. Another factor could also be due to the relative incomes of consumers. USA has been badly hit by the financial crisis in 2008 and its economy slipped into recession. Hence, the national income of the country has fallen and there is increased unemployment. All these will affect the disposable income and consumer and import expenditure, export and investment components of AD, thus USA’s BOT deteriorates.
Asia on the other hand, has been growing very rapidly, with China as the noticeable leader due to huge government stimulus packages involving huge infrastructure building projects in Shanghai etc, thus boosting AD. With national income rising, the disposable income of Chinese will also rise and increase demand for Japanese goods (mainly electronics, luxury goods) and domestic goods as well, but not for US goods as the US$ is much stronger which would make them price uncompetitive to the Chinese consumers. Japan's exports to China, which overtook the U.S. as its largest trade partner last year, surged 15 percent to a record in March. This can be explained by a depreciating Yen which was also mentioned above. ``Strong growth in Asia proves Japan's economy can withstand a U.S. slowdown,'' said Mamoru Yamazaki, chief Japan economist at RBS Securities Japan Ltd. in Tokyo. ``The current account surplus will keep expanding as exports and overseas investments remain solid. Companies are investing overseas because of a low interest rate in Japan,'' said Noriaki Haseyama, an economist at Dai-Ichi Life Research in Tokyo. Revenue from foreign equities, bonds and debt securities accounts for about 80 percent of the income gap.” – 14th May 2007, Bloomberg The solid overseas investments, which stems from low interest rates in Japan will mean there is high capital outflow in Japan. The supply of Yen in the forex market is increased and causes the Yen to depreciate.
As seen from the graph and the table, UK and US have a sustained current account deficit, while China and Japan have a sustained current account surplus. Japan has been experiencing a sustained current account surplus throughout the years due to deflation occurring in its economy, which has lead to lower general price levels in its economy, making its goods and services relatively cheaper than those of US and UK (main exporters of Japan’s goods and services) and more price competitive. Hence, there is a rise in demand for Japan’s exports by US and UK. On the other hand, quantity demanded for imports of US and UK by Japan has decreased due to goods and services of US and UK being more expensive as compared to Japan’s domestic goods and services.
This will result in Japan’s export revenue to increase and its import expenditure to decrease, causing a current account surplus for Japan as net export revue increases. A current account surplus for Japan is accompanied with the assumption that the combined price elasticity of demand and price elasticity of supply are both elastic. On the other hand, US and UK’s import expenditure will rise and export revenue will decrease, resulting in net import expenditure, resulting in a worsening of current account and leading to a current account deficit.
The situation between China and US, UK is similar to that of the Japan, as explained earlier. However, for China, it is the undervalued Yuan that resulted in a current account surplus for China and current account deficit for the US and UK. The value of the Yuan is kept below market rate due to intervention by China’s central bank, so as to enhance the price competitiveness of China’s exports.
Net trade in goods and services plus net investment income from overseas assets and net transfers add up to give the current account of balance of payments. China has experienced a rising and sustained surplus.This could be due to certain factors. For example, China may have a current account surplus when the price of their exported goods is lower than of those domestic goods in a foreign market. Their prices are more price competitive. Or China's domestic goods may be cheaper than those of imports from other countries such as the US. This allows for an increase in export revenue, thus leading to current account surplus.
Also, China has a currency that is undervalued. Thus exports are sold at a cheaper price, making goods more affordable to foreign consumers than domestic goods, therefore China's exports are more price competitive. Demand for these goods rise, export revenue for China rises, thus balance of trade experiences a large surplus.
Also because of the Asian thrift nature, the local Chinese prefer to not spend on imported goods. Thus quantity demand for imported goods is not high.
Therefore because of high export and low import, net export (X-M) rises, therefore current account surplus.
Whereas in the USA, current account deficit is experienced. This could be because of more aggressive spending by the people in the USA, where thrift is upheld less commonly. Also because of the strong US dollar, the USA turns towards cheaper imports more, where countries like China can provide cheaper substitues of a good. Therefore, there is high import level in the USA. Also, there is low export level because the import goods are less price competitive. Therefore net export actually remains at a negative value, current account deficit is experienced.
China in particular has been highlighted in the source to have been sustaining, in fact increasing, their current account surplus since 1998. China's stance of fixing its currency (Yuan) and preventing its appreciation is likely to play a large role in this trend. By doing so, its exports are relatively cheaper and price-competitive compared to the rest of the world and export expenditure for China would then rise. (assuming Marshall Lerner condition applies) On the flip side, an undervalued Yuan causes the prices of imports to local Chinese to be relatively more expensive than domestic goods. As such, exacerbated by Asian thrift (not spending much of their additional income from the huge export revenue) quantity demanded for imports will fall or rise a lot less significantly than the rise in exports and hence the combined value of (X-M) will increase, leading to this sustained surplus kept alive by the fixed exchange rate.
ReplyDeleteFor the case of U.S, they have consistently been in a current account deficit situation since 1998. This is likely to be due to their spendthrift nature. Until recently (sub-prime crisis), consumer spending had been on the rise in the U.S, due to a booming housing market. With a very significant rise in expendable income of consumers and the progress toward globalized production, there was a large influx of exports with a disproportionate sale of domestic products. Furthermore, low interest rates, tax cuts for the wealthy and an already high tendency to import (especially luxury goods like stereos and cars) further worsened the current account situation where (X-M) decreased. Furthermore, China's relatively cheap exports (due to their undervalued currency as discussed above) worsened the US' current account situation as US consumers switch to China's imports rather than domestically produced good thus adding on to China's current account surplus and their own deficit.
China has been facing a sustained and increasing surplus in recent years. There are mainly two reasons for this current account surplus – high export volume and low import volume. There are high exports as China is able to produce goods at a very low cost due to cheap labour costs thus their price of goods can be set at very low, making their goods more price competitive. Furthermore, China has been keeping an undervalued exchange rate, thus further making goods more price competitive, as goods are relatively cheaper in foreign countries than their own local goods so foreign consumers switch to using China’s exports so demand for China’s exports increase, increasing export revenue (assuming Marshall-Lerner condition holds where demand for exports are price elastic and there is spare capacity). Imports are kept low as undervalued exchange rates make their imports more expensive so quantity demanded for imports is low so import expenditure is low. With a high export revenue and low import expenditure, net (X-M) is high, contributing to the current account surplus.
ReplyDeleteUS have been facing a sustained deficit. This is because their import expenditure is very high. The low interest rate and availability of credit in US encourage borrowing and so US households do not save a lot and instead consume a lot, both domestic goods and imports. Hence they import a lot of goods and services. Domestically produced goods in US are also expensive as they have high costs of production (high wages due to strong union power labour) and inefficiencies of industries due to protectionistic measures (import tariffs). Since China’s goods are relatively cheaper than US goods, US consumers switch to using China goods, further stressing the point that imports volume is high. Furthermore, exports is also low as US is generally unwilling to trade high end technology equipment that they have a comparative advantage in due to security reasons and that their export prices are high due to the above reason. Hence, with a falling net (X-M), this leads to a sustained deficit.
The type of exchange rate of the country is one reason for sustained deficit
ReplyDeleteor surplus of a country’s current account. In the source provided, the example of China is highlighted. From 1998 to 2009, China not only sustained a surplus in their current account but also increased it by more than 900%. China fixes her currency, the Yuan, and prevents it from appreciating. This is the main reason behind the sustained and increasing surplus of China’s current account. Since the Yuan is fixed, China’s exports are relatively cheaper and more price-competitive compared to domestic goods of other countries. This would cause China’s export revenue to remain high, assuming Marshall Lerner condition applies. On top of that, the undervalued Yuan makes prices of imported goods more expensive relative to China-made products. Hence, local consumers would choose local products over imported goods. This will mean that import expenditure remains low. The value of (X-M) will remain high resulting in the sustained surplus in China’s current account.
The reverse phenomenon can be seen in the US where their current account has been in deficit since 1998. One main reason for this is the spendthrift nature of Americans. Over the past few years, until the recent sub-prime crisis and the resulting the global economic recession, consumer spending in the US has been on the rise. Exports of US made goods is high as there is a high worldwide demand for US goods. Furthermore, low interest rates, tax cuts for the wealthy and an already high tendency to import (especially luxury goods like stereos and cars) further worsened the current account situation where (X-M) decreased. To make the situation worse, imported goods, particularly China-made, are relatively cheaper and so the tendency to import such goods are high. This results in (X-M) to remain negative resulting in a sustained current account deficit.
China has a sustained current account surplus as China as low cost of production, thus it is more price competitive as compared to other countries. Therefore demand for china goods is high. With a high demand for China goods, there is also high demand for China's currency. Moreover, China currency is kept at an undervalued level. this further increases the price competitiveness of China's goods. However the undervalued Yuan would also mean that imports to China would be more expensive as compared to the local goods in China. Hence China would have a high export and a low import volume, thus leading to a sustained current account surplus.
ReplyDeleteUS on the other hand has a sustained current account deficit. This could be due to the spendthrift nature of the Americans, and this could be cultured by the low interest rate and ease of credit. Hence Americans are likely to spend more and import goods. This could be made worse by the availability of cheap China products. This further increase their import volume. Hence their current account is constantly in deficit.
China have a sustained surplus on its current account mainy because its goods and services are relatively cheaper compared to other countries. This could be due to the lower costs of production and low wages for workers. As a result, its goods and services become price competitive and foreign countries will import a lot of goods and services from China, assuming demand for imports is price elastic, China will experience a high export revenue. Even though the demand for RMB is increasing, Chinese government fixes the value of Yuan within a very small range, causing Yuan to be undervalued. In this way, foreign goods and services may seem to be more expensive to Chinese people and they will prefer to buy local goods and services. Besides, the Asian thrift nature discourages Chinese people to purchase the more expensive imported goods. Hence, the import expenditure will be low and (X-M) will remain high leading to sustained surplus on China’s current account.
ReplyDeleteAmerica, on the other hand, have a sustained deficit on its current account. This is because the local goods in America is relatively more expensive compared to other countries like China due to the high costs of production and high labour costs. As a result, America tends to import a lot of cheap goods and services from China and has a high import expenditure. However, due to the high prices of local goods and services, few countries are willing to import American goods and services leading to low export revenue. (X-M) remains negative and current account deficit is created. This situation is worsened by the American spendthrift nature, low interests rate and the easily available credites from the bank. With these tradition and incentive to spend, Americans will demand more foreign goods which further lead to America’s current account deficit.
As China has a large labour force, this means that they have a comparative advantage in labour, and this allows them to be able to keep labour costs down. This will lead to a low cost of production, making its goods cheaper relative to other substitutes in the market. In other words, it is more price-competitive. This means that demand more Chinese goods would be higher and therefore there would be a large amount of exports to other countries. In addition, with high saving rates due to the Asian thrift nature, imports would be kept to a lower level than that of exports, causing China to be a net exporter. With their export revenue exceeding import expenditure, this would mean that China would have a current account surplus. Also, since the Yuan is undervalued, this would cause its goods to be cheaper compared to substitutes from other countries in the market, and hence there would be a greater volume of exports. This also causes the price of imports to increase, and Chinese consumers would switch to its own domestically produced goods, which are cheaper. As the Yuan is artificially kept low, the constant undervaluation would also contribute to the sustained current account surplus.
ReplyDeleteAs for Japan, another Asian country, it too has the Asian thrift nature, and hence imports little, especially since domestic producers are able to produce enough to cater to the domestic consumers, be it necessities or luxury goods. On the other hand, there is large external demand for Japanese goods due to its deemed high quality. For example, the strong overseas demand for Japanese cars. In addition, this external demand is growing owing to rising wages of consumers in India, China, and these consumers in turn have the greater purchasing power to buy more expensive luxury goods that make up a large proportion of Japanese exports. With growing export expenditure and a largely stagnant domestic sector, Japan’s current account would experience a sustained surplus.
However, as for US having a current account deficit, this is due to the excessive consumption owing from the easy availability of credit, as financial institutions allow consumers to borrow on credit. These borrowed loans are then used to supplement the US consumer’s purchasing power, allowing them to buy more imports without these loans. As US has a large domestic sector and because US has a low savings rate, this means that US has a large volume of imports. However, as US has countries like China and Japan as major trade partners, but who have the Asian thrift nature, US is not able to have an export volume as large as its import volume. Hence its import expenditure outweighs its export revenue, leading to a current account deficit. This is further sustained by the growing pool of consumers in the US.
Balance of Payment (BOP) equilibrium is a macroeconomic goal in an economy, and the current account balance is one that refers to trade balance (import expenditure and export revenue).
ReplyDeleteChina has a sustained surplus on their current account from US$29 billion in 1998 to an amazing peak of US $426.1 billion 10 years later in 2008. With China and other countries like Japan and Germany having a massive domestic market with many firms being set up in China to produce goods and services, these firms will exploit Economies of Scale to meet the demands of the huge domestic market and reduce the cost of production. With the goods being sold at a cheaper price than other firms producing in other countries, it would make the price of China's exports very price competitive and hence, the quantity demanded for China's exports increases. With the goods that China produce ranging from goods with many substitutes around the world, the demand for exports is price elastic, meaning that an increase in quantity demanded leads to a more than proportionate decrease in price. Export revenue increases.
With regards to imports coming into China, Japan or Germany, prices of imports may seem more expensive as compared to prices of goods and services in the domestic market, making prices of imports price uncompetitive. Many locals switch from imported goods to local goods, hence quantity demanded for imports decreases and hence M expenditure decreases.
With that, there is an increase in net exports (X-M) and with that, there is a sustained current account surplus in Japan, China and Germany. Other factors such as the Asian thrift and compulsory savings programmes possibly implemented by the government could also lead to a reduction in import expenditure.
However, in the UK and US, there is a sustained current account deficit due to the nature of their consumers being more aggressive in spending. Hence, with the higher purchasing power of an average citizen in either country, there would be a higher marginal propensity to spend on imported goods and hence, leading to a higher import expenditure.
Also, in the UK and US, certain policies have been implemented by the government in order to protect local firms and producers from the wrath of cheap exports coming from China and India. Such a policy is the use of American steel to make cars to support the steel producers, and also tariffs being set on fabrics coming from China. This is not cost efficient and makes American more price uncompetitive compared to Chinese goods. Hence this reduces the export revenue for America and UK due to the reduction in quantity demanded for exports from these countries. Hence the net exports (X-M) decreases and remains in deficit due to an increase in import expenditure and reduction in export revenue.
The most obvious case of current account surplus can be seen in China’s current account balance. There are many factors that could result in this current account surplus. Firstly, the cost of production in China is relatively lower than most other countries, because of the availability of cheap labour. This is in turn because of the fact that China has a very large population (China is the most populous country in the world). The low cost of production in China, means that Chinese goods are relatively cheaper than its counter-parts and this makes demand for Chinese goods even more higher, resulting in high exports in China. Secondly, because of the Asian thrift nature, the Chinese tend to spend lesser on imports and prefer to save more instead, resulting in low imports. Thirdly, China has an undervalued Yuan that makes its exports even more price competitive, leading to an even higher demand for Chinese goods since they are comparatively cheaper. Lastly, China has a large domestic market that allows it to enjoy the advantages of Economies Of Scale(EOS), and hence even lower costs of production with higher efficiency. This makes Chinese goods even cheaper and demand for it even higher. Hence, China has high exports and low imports, resulting in a high net exports (X-M) that is the cause of the current account surplus.
ReplyDeleteOn the other hand, some countries like the US (United States) has a current account deficit because of their spendthrift nature. Unlike people in Asia, the Americans spend a lot and save a little. This is because of the availability of credit and the easy access to money. Banks and financial institutions in the US are slack in lending money and allow almost anybody to borrow. This means that Americans tend to spend more and hence inevitably, demand for imports will be high. Contrastingly, the exports sector of US is not as vibrant as that of the imports sector. For example, US manufactured cars (e.g General Motors) are losing appeal overseas and is losing competitiveness as compared to Japanese cars, this means that exports of the US is low, as compared to other countries like China. Moreover, prices of American goods are relatively higher than those made in other countries like China, where goods are cheaper due to cheap labour. Hence, American goods are less price competitive as compared to goods from other countries, and demand for American exports are low. This results in high imports and low exports, and hence, net exports is negative {(X-M) <0 }, and countries like the US face current account deficits as such.
Some countries such as the USA and the UK have sustained current account deficits while other countries like China and Japan have sustained current account surpluses.
ReplyDeleteThis could be due to certain factors. Firstly, the prices of goods at home and abroad. USA might run a current account deficit because the prices of their goods may be more expensive than their trading partners like China and this makes their exports more price uncompetitive compared to local Chinese produce. This will decrease the export revenue and hence the BOT deteriorates, leading to current account deficit. The stronger dollar may also contribute to this deficit.
Secondly, the foreign exchange rate. The yuan is reported to be undervalued. This means that Chinese exports are now more price competitive in US$, so demand for them rises and export revenue rises, whilst the US imports become more price uncompetitive in Chinese yuan, so quantity demanded drops and import expenditure drops. Hence, in recent years, China’s balance of trade became a huge surplus as it opened its economy, leading to huge current account surplus.
In the case of the UK, the reasons for its persistent deficit could include the high consumer spending due to 14 years of economic growth, falling savings ratio and low interest rates. A significant portion of this consumer spending is spent on imports, especially luxury manufactured goods, so import expenditure, PmQm will rise substantially, worsening balance of trade. The fact that the Sterling pound has appreciated against the dollar will only worsen this deficit.
Some other reasons could include the loss of comparative advantage in UK’s export manufacturing sector, in the face of globalisation and competition with low wage countries like China. Hence its export revenue falls and worsens BOT.
The depreciating Yen has also helped to bolster Japan’s current account surplus according to the analysis used for China above. The excerpt below from Bloomberg supports this.
“Japan's currency has fallen 8.5 percent against the dollar and 13 percent per euro in the past 12 months. ``Yen depreciation has been a major support for Japanese corporations and, together with gradually strengthening domestic demand, is helping to underpin Japan's economic expansion,'' said Takuji Aida, chief Japan economist at Barclays Capital in Tokyo.”
– 14th May 2007, Bloomberg
The above also reflects a change in consumer preference for domestic goods in Japan, with “gradually strengthening domestic demand”. This would indicate an increase in domestic consumption as well as a fall in import expenditure, thus boosting BOT and current account for Japan, as seen by it “helping to underpin Japan’s economic expansion”.
For Germany, being the Euro zone’s largest exporter, it would have a very huge BOT surplus. In addition, the euro depreciated against the US$ this year due to the Greek fiscal crisis. Hence, the determinant this time was also a weak euro which helped to improve balance of trade for Germany and hence its current account was in surplus.
Another factor could also be due to the relative incomes of consumers. USA has been badly hit by the financial crisis in 2008 and its economy slipped into recession. Hence, the national income of the country has fallen and there is increased unemployment. All these will affect the disposable income and consumer and import expenditure, export and investment components of AD, thus USA’s BOT deteriorates.
Cont'd...
ReplyDeleteAsia on the other hand, has been growing very rapidly, with China as the noticeable leader due to huge government stimulus packages involving huge infrastructure building projects in Shanghai etc, thus boosting AD. With national income rising, the disposable income of Chinese will also rise and increase demand for Japanese goods (mainly electronics, luxury goods) and domestic goods as well, but not for US goods as the US$ is much stronger which would make them price uncompetitive to the Chinese consumers.
Japan's exports to China, which overtook the U.S. as its largest trade partner last year, surged 15 percent to a record in March. This can be explained by a depreciating Yen which was also mentioned above.
``Strong growth in Asia proves Japan's economy can withstand a U.S. slowdown,'' said Mamoru Yamazaki, chief Japan economist at RBS Securities Japan Ltd. in Tokyo. ``The current account surplus will keep expanding as exports and overseas investments remain solid. Companies are investing overseas because of a low interest rate in Japan,'' said Noriaki Haseyama, an economist at Dai-Ichi Life Research in Tokyo. Revenue from foreign equities, bonds and debt securities accounts for about 80 percent of the income gap.”
– 14th May 2007, Bloomberg
The solid overseas investments, which stems from low interest rates in Japan will mean there is high capital outflow in Japan. The supply of Yen in the forex market is increased and causes the Yen to depreciate.
sorry this is supposed to be my screen name but i posted as the group name "anything" instead. forgot.
ReplyDeleteAs seen from the graph and the table, UK and US have a sustained current account deficit, while China and Japan have a sustained current account surplus. Japan has been experiencing a sustained current account surplus throughout the years due to deflation occurring in its economy, which has lead to lower general price levels in its economy, making its goods and services relatively cheaper than those of US and UK (main exporters of Japan’s goods and services) and more price competitive. Hence, there is a rise in demand for Japan’s exports by US and UK. On the other hand, quantity demanded for imports of US and UK by Japan has decreased due to goods and services of US and UK being more expensive as compared to Japan’s domestic goods and services.
ReplyDeleteThis will result in Japan’s export revenue to increase and its import expenditure to decrease, causing a current account surplus for Japan as net export revue increases. A current account surplus for Japan is accompanied with the assumption that the combined price elasticity of demand and price elasticity of supply are both elastic. On the other hand, US and UK’s import expenditure will rise and export revenue will decrease, resulting in net import expenditure, resulting in a worsening of current account and leading to a current account deficit.
The situation between China and US, UK is similar to that of the Japan, as explained earlier. However, for China, it is the undervalued Yuan that resulted in a current account surplus for China and current account deficit for the US and UK. The value of the Yuan is kept below market rate due to intervention by China’s central bank, so as to enhance the price competitiveness of China’s exports.
Net trade in goods and services plus net investment income from overseas assets and net transfers add up to give the current account of balance of payments. China has experienced a rising and sustained surplus.This could be due to certain factors. For example, China may have a current account surplus when the price of their exported goods is lower than of those domestic goods in a foreign market. Their prices are more price competitive. Or China's domestic goods may be cheaper than those of imports from other countries such as the US. This allows for an increase in export revenue, thus leading to current account surplus.
ReplyDeleteAlso, China has a currency that is undervalued. Thus exports are sold at a cheaper price, making goods more affordable to foreign consumers than domestic goods, therefore China's exports are more price competitive. Demand for these goods rise, export revenue for China rises, thus balance of trade experiences a large surplus.
Also because of the Asian thrift nature, the local Chinese prefer to not spend on imported goods. Thus quantity demand for imported goods is not high.
Therefore because of high export and low import, net export (X-M) rises, therefore current account surplus.
Whereas in the USA, current account deficit is experienced. This could be because of more aggressive spending by the people in the USA, where thrift is upheld less commonly. Also because of the strong US dollar, the USA turns towards cheaper imports more, where countries like China can provide cheaper substitues of a good. Therefore, there is high import level in the USA. Also, there is low export level because the import goods are less price competitive. Therefore net export actually remains at a negative value, current account deficit is experienced.