Saturday, December 3, 2016

The Identity-Equals-Causation Fallacy, Yet Again

You’d think a trade deficit would be a trade deficit, but you’re wrong.  For many economists, a trade deficit is actually a capital account surplus in disguise.  Yes, US imports exceed exports, but according to this crowd it is not due to what the US does and doesn’t produce, or the cost or quality of our goods and services, or any other such factor, but simply reflects the net inflow of finance.  First we have policies that cause US financial assets to be more attractive, then we end up with a trade deficit.  This is the “insight” behind the view that bolstering national savings will fix the trade problem.

You can see this machinery at work in Gregory Mankiw’s latest opinion piece for the New York Times, which instructs us, “Don’t Worry About the Trade Deficit”.  It patiently explains that the money leaving the country on the current account (via trade) equals the money entering the country on the capital account (via financial flows), and that the latter drives the former.  The key paragraph reads:
The trade deficit is inextricably linked to this capital inflow.  When foreigners decide to move their assets into the United States, they have to convert their local currencies into American dollars.  As they supply foreign currencies and demand dollars in the markets for currency exchange, they cause the dollar to appreciate.  A stronger dollar makes American exports more expensive and imports cheapers, which in turn pushes the trade balance toward deficit.
So here we have a theory of the relationship between international capital flows and trade: a shift in net financial inflows causes an appreciation of the dollar, which then causes a greater trade deficit.  Where does this theory come from?

The ultimate source is the national income and product identity, augmented by the accounting relationship between savings and consumption.  From NIPA we have

Y ≡ C + I + G + NX

where Y is national income, C is consumption, I is private investment, G government spending (purchases of goods and services by government) and NX is the trade balance.  That “≡” sign means “is identical to”, which is subtly different from simple equality, “=”.  With equality, the stuff on the left hand side has the same value as the stuff on the right hand side.  With identity, the stuff on the left hand side is the same stuff as on the right hand side, just expressed differently.  If A = B, A and B could be different but for some reason aren’t.  If A ≡ B, A and B are two different ways of writing the same thing, so it is impossible for them to be different, even for an instant.

Now let’s add a second identity that represents the truism that all income is either consumed, publicly or privately, or saved or paid in taxes:

Y ≡ C + S + T

with S being savings and T being taxes.  Putting them together, we see that

C + I + G + NX ≡ C + S + T

Subtracting C from both sides and rearranging gives us

NX ≡ (S-I) + (T-G)

Read this as “the trade balance (net exports) is identical to the sum of net savings (savings minus investment) and the government’s budget surplus or deficit (taxes minus spending).”  This is not a theory of what causes what; it’s an identity, different ways of expressing the same “what”.

How can this be?  An important source of identity relationships in economics is the two-sided nature of economic transactions.  If I pay you $10 for something, this can be seen as $10 of spending (mine) as well as $10 of income (yours).  My spending is not equal to your income; it is your income: one transaction, two ways of recording it.  Add up these identities over a whole economy, subdivide income or spending into different categories, and you get a set of macroeconomic identities.

So now consider what an export or import means.  An export signifies the receipt of income by people in the exporting country but not the corresponding spending.  An import signifies spending without the corresponding income.  So a trade deficit has to take the form of national spending exceeding income, which means net borrowing.  This borrowing can occur either in the private sector (less saving relative to investment) or in the public sector (government borrowing).  And net borrowing on a national scale is what we mean by the capital account, so there we have it.

All of this is in the realm of identity.  There is no causation at work here.  Net exports does not cause net borrowing, nor is it the other way around; they are identical to one another, different ways of recording the same economic events.  Any measured discrepancy would be a problem of measurement, not a problem of whether the identity is true.  (This is an oversimplification, since it leaves out transfers, asset incomes and currency flows.  The main adjustment would be to add transfer payments and net asset income to the current account.  A further adjustment would need to be made for changes in holdings of currency, the reserve account, which is a non-borrowing method of finance.  That would add more algebraic symbols, but it wouldn’t alter the essential logic.)

So now reread the above paragraph from Mankiw.  This is telling a story of causation over time, not identity. First we have increased inflows of finance, then the dollar appreciates, then the trade deficit widens.  The first process could be virtually instantaneous, because currency markets are comprised of exactly these demands for and supplies of foreign exchange.  The second process, however, takes place over months, depending on the shape of the J-curve that depicts the change in trade balances over time in response to an exchange rate shock.  But we know from the identities that the trade balance is identitical to net borrowing at each moment; that’s what it means to be an identity.

The only valid theory of trade deficits and capital inflows would be one that looked at all the determinants of this identity simultaneously.  It would have to consider the factors that determine what goods a country produces, what it exports and imports, the terms of trade, differences in international growth rates and the demand and supply of financial assets.  One way of looking at the current account-capital account identity does not cause the other; the international position of the US economy, which can be measured either way, is caused by the balance of all the influences on trade and finance.  And yes, that includes the choices made by firms in the US to increase or offshore their productive capacity, along with everything else.  The relative importance of these factors is an empirical question, not a theoretical one.

The flaws in Mankiw’s analysis do not come from inaccurate data or a faulty assumption here or there, but a basic misunderstanding of Econ 101.  The guy needs to take an intro class.  Of course, if the textbook isn't very good it won't help him much.

25 comments:

ProGrowthLiberal said...

I suspect Mankiw would agree one needs to have a model behind what one is saying. I certainly have been saying that for a long time. Mankiw spends too little time on articulating what his underlying model is and too much time lecturing us on all sorts of equations that mean the same thing. Who knew Mankiw had turned all MMT on us? I'd give a little slack as I think he is trying to use the very basic international macroeconomic model that Mundell-Fleming gave us 50 years ago. Maybe a little rewrite would have be in order to make this more clear.

Peter Dorman said...

But isn't M-F itself a bit of misdirection? Trade is already packed into the IS curve, which means the curves are not independent of one another. I don't think the model is logically defensible.

Actually, we don't yet have a defensible theory of simultaneous trade and capital flow determination that takes into account both "real" and "financial" factors. Mankiw's fallacy is thinking we don't need one.

Unknown said...

Mankiw knows exactly what he's doing: assuming the causal primacy of the financial account side of the identity. He massively oversimplifies, but is more right than wrong.

ProGrowthLiberal said...

"we don't yet have a defensible theory of simultaneous trade and capital flow determination that takes into account both "real" and "financial" factors."

Dornbusch tried to incorporate these factors in the 1970's. Whether he succeeded is a matter of debate. But I would suggest he did a better job at this than Navarro. OK - a really low bar.

Nick Rowe said...

Typo, I think: "For many economists, a trade deficit is actually a current account surplus in disguise." Should be "capital" account surplus.

George H. Blackford said...

I really do think you are missing something here, namely, the possibility of currency manipulation: http://www.rweconomics.com/htm/WDCh_2.htm

George H. Blackford said...

"Free Trade can nowise guarantee the maintenance of industry, or of an industrial population upon any particular country, and there is no consideration, theoretic or practical, to prevent British capital from transferring itself to China, provided it can find there a cheaper or more efficient supply of labour, or even to prevent Chinese capital with Chinese labour from ousting British produce in neutral markets of the world. What applies to Great Britain applies equally to the other industrial nations which have driven their economic suckers into China. It is at least conceivable that China might so turn the tables upon the Western industrial nations, and, either by adopting their capital and organisers or, as is more probable, by substituting her own, might flood their markets with her cheaper manufactures, and REFUSING THEIR IMPORTS IN EXCHANGE MIGHT TAKE HER PAYMENT IN LIENS UPON THEIR CAPITAL, REVERSING THE EARLIER PROCESS OF INVESTMENT UNTIL SHE GRADUALLY OBTAINED FINANCIAL CONTROL OVER HER QUONDAM PATRONS AND CIVILISERS. This is no idle speculation. If China in very truth possesses those industrial and business capacities with which she is commonly accredited, and the Western Powers are able to have their will in developing her upon Western lines, it seems extremely likely that this reaction will result." Hobson,1902 https://archive.org/details/imperialismastu00goog

rayward said...

Mankiw wrote that the trade deficit is "inextricably linked" to capital inflow. His point (to a broad audience not to economists) seems to be that money used to purchase imports doesn't somehow disappear into the ether, but circles back through capital flows (as well as exports). His intent seems to be to disprove those who mistakenly claim or believe that imports cause money to disappear into the ether. I'm reminded (and this is for Trump) of the developer's creed: money borrowed is money earned; a loan refinanced is money saved; and a loan repaid is money lost forever.

Peter Dorman said...

Nick: Many thanks; I've made the correction. You're a careful reader.

Everyone: I am not, of course, disputing that policies in the US or elsewhere that strengthen the dollar will widen the trade deficit. We all know this. What I am disputing is the "logic" that (a) the current and capital account have to be "equal", (b) changes in the capital account "cause" this equality to eventuate, and (c) exchange rate adjustments are the mechanism by which this happens.

I understand why a lot of economists, and not only Mankiw, make this sort of argument. They want to downplay direct interventions to alter the trade balance, especially the various forms of industrial policy. They also believe in the essential goodness of savings, whether by the private or public sector, and are attracted to the claim that greater net savings will "cause" better trade outcomes. The problem is, even if you accept the political objectives that motivate these people, the argument is logically invalid.

FWIW, mainstream international political economy (IPE) understands the simultaneous determination inference I drew from the BOP identity. Surplus countries have distinctive regimes that differ from the regimes of deficit countries, where a regime includes policies (relating to both trade and finance), a structure of political economic interests, and contextual circumstances. This bleeds into the varieties of capitalism literature and even deep culture in some versions. I think that's essentially correct, although the economist in me is frustrated by the lack of a model that can be implemented empirically. In the perfect world of my imagination, teams of economists are busily at work on this, right now. The journals are buzzing with their ideas. Sort of like DSGE, but theoretically sound and actually useful.

AXEC / E.K-H said...

Economists still don’t get Econ 101 right
Comment on Peter Dorman on ‘The Identity-Equals-Causation Fallacy, Yet Again’

Peter Dorman criticizes Gregory Mankiw’s latest piece titled ‘Don’t Worry About the Trade Deficit’. He observes: “The flaws in Mankiw’s analysis do not come from inaccurate data or a faulty assumption here or there, but a basic misunderstanding of Econ 101. The guy needs to take an intro class. Of course, if the textbook isn’t very good it won’t help him much.” (See intro)

The discussion shows that economists still do not understand the elementary mathematics of accounting. And all this started 80 years ago with Keynes’s famous identity of saving and investment.#1, #2

The formal description of the economy is given by Dorman with two equations:

(1) Y ≡ C + I + G + NX

(2) Y ≡ C + S + T

Legend: Y is national income, C is consumption, I is private investment, G is government spending, NX is the trade balance X-M, S is savings and T is taxes.

This gives the interrelation of balances:

(3) NX ≡ (S-I) + (T-G)

When government is taken out of the picture, i.e. T=0, G=0, then (3) reduces to:

(4) NX ≡ S – I

Conclusion: “the trade balance (net exports) is identical to the sum of net savings (savings minus investment).” If the trade balance is zero one arrives at the good old I≡S of Keynes’s General Theory (p. 63). This identity is false since its inception but among all After-Keynesians only Allais has realized it.#3

The error/mistake/blunder of this approach is in the definition of total income and total saving and in the absence of total profit and distributed profit.

It is well known that Keynes had no idea of what profit is: “His Collected Writings show that he wrestled to solve the Profit Puzzle up till the semi-final versions of his GT but in the end he gave up and discarded the draft chapter dealing with it.” (Tómasson et al.)

See part 2

AXEC / E.K-H said...

Part 2

Keynes’s error/mistake/blunder carries over to the equations (1) and (2). It is pretty obvious that they do not contain profit. This blunder in turn carries over to trade balance accounting.

In order to see this one has to go back to the MOST ELEMENTARY configuration, that is, the pure consumption economy which consists only of the household and the business sector.#4

In this elementary economy three configurations are logically possible: (i) consumption expenditures are equal to wage income C=Yw, (ii) C is less than Yw, (iii) C is greater than Yw.

In case (i) the monetary saving of the household sector Sm=Yw-C is zero and the monetary profit of the business sector Qm=C-Yw, too, is zero.

In case (ii) monetary saving Sm is positive and the business sector makes a loss, i.e. Qm is negative.

In case (iii) monetary saving Sm is negative, i.e. the household sector dissaves, and the business sector makes a profit, i.e. Qm is positive.

It always holds Qm+Sm=0 or Qm=-Sm, in other words, at the heart of national income accounting is an identity — the business sector’s deficit (surplus) equals the household sector’s surplus (deficit). Put bluntly, loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the Profit Law.

When foreign trade is added then it holds under the condition of zero investment of the business sector and zero saving of the household sector Qm=X-M, that is, the overall monetary profit of the business sector is positive if the rest of the world runs a deficit and negative if the rest of the world runs a surplus.

The balances of the business sector, the household sector, the government sector and the rest of the world are interrelated as follows: Qm≡(I-Sm)+(G-T)+(X-M), and THIS is the correct accounting identity for an open economy without distributed profit.

Not only Mankiw’s economics is brain dead rubbish, the textbook misery started already with Samuelson.#5 Economics students swallow every junk hook, line and sinker since generations. It seems that scientific incompetence is hereditary in the dismal proto-science. Lucas once confessed that “... he was bewitched by the beauty and power of Samuelson’s Foundations of Economic Analysis.”#6 You cannot make this stuff up.

Egmont Kakarot-Handtke

#1 For details see cross-references Refutation of I=S
http://axecorg.blogspot.de/2015/01/is-cross-references.html

#2 See ‘The Common Error of Common Sense: An Essential Rectification of the Accounting Approach’
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2124415

#3 See ‘How Keynes got macro wrong and Allais got it right’
http://axecorg.blogspot.de/2016/09/how-keynes-got-macro-wrong-and-allais.html

#4 The elementary consumption economy is given by three systemic axioms: (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

#5 See ‘The father of modern economics and his imbecile kids’
http://axecorg.blogspot.de/2016/11/the-father-of-modern-economics-and-his.html

# The correct foundations of economic analysis are shown on Wikimedia
https://commons.wikimedia.org/wiki/File:AXEC88.png

Don Coffin said...

I my retirement, I am teaching part-time. The econ faculty at that school have adopted Mankiw's text, so I get to teach from it. It is a good thing that I have managed to avoid teaching intro macro; there is so much wrong with the macro half of that book that it's hard to know where to begin. (For example, I loath his treatment of money and financial markets.) But the confusion between identities and causal relationships is as good a place as any.

ProGrowthLiberal said...

Don - my undergraduate intermediate class used the 1974 Macroeconomic text by William Branson who had an excellent discussion of what we call the Mundell-Fleming model (albeit Branson did not mention them). When Dornbusch and Fischer came out a few years later, I used it to teach macroeconomics as I thought they did as well as anyone addressing the international macro issues. I would not use Mankiw on this topic as his forte is more domestic macro.

Bill said...

"That “≡” sign means “is identical to”, which is subtly different from simple equality, “=”. With equality, the stuff on the left hand side has the same value as the stuff on the right hand side. With identity, the stuff on the left hand side is the same stuff as on the right hand side, just expressed differently."

Sorry, that is a misunderstanding of mathematical identity. With material identity the stuff is the same. With mathematical identity the "stuff" on the left or right side if the identity sign is a variable or variables. It could be the same stuff, as in X ≣ X. Or the variables could indicate the same stuff, as in P ≣ M + W + C, where P stands for the number of people, M stands for the number of men, W stands for the number of women, and C stands for the number of children. The stuff indicated on the left side are humans, as are the stuff indicated on the right side. But the stuff could easily be different. For instance, at a concert if each (human) member of an audience must occupy one and only one seat, and nothing else may occupy a seat, then the number of members of the audience must equal the number of occupied seats. That is an identity, but seats are not people.

What distinguishes an identity from other equations is that an identity is always true. Example: For every action there is an equal and opposite reaction (Newton's third law). I don't know if modern physics has found small violations of this law, but Newton intended it to be an identity, i.e., always true.

As for Mankiw's argument, the identities in question are true only for one period of time, and Mankiw's argument seems to me to require at least three periods of time. I don't know if it holds water, but, while Mankiw mentions national accounting, it is not clear to me that he assumes that identity is causality, nor do I see that Dorman has shown that Mankiw does.

Let me study Mankiw's argument, and see if I have anything of possible interest to say.

Peter Dorman said...

Thanks, Bill. This could be semantic, but I would think of your seating example as "butts on seats" which could be measured either by counting the number of butts or the number of occupied seats.

A different way to get at it is to ask what it means for something to be "always true". My naive understanding, which you are welcome to correct, is that this is either the result of definition (as in accounting) or multiple representations of the same thing (as in economic transactions seen from the two sides). The butt example is #2. (sorry) I'm not an expert on Newtonian mechanics, but aren't the terms defined in relation to one another?

Bill said...

Thanks, Peter. :) Yes, I was making a semantic point.

IIUC, the GDP identities are true within each specified period of time. It is not always clear what periods of time Mankiw has in mind, whether things happen in the same time period or in more than one time period. Anyway, I at least have some questions about what he says. :)

Don Coffin said...

PGL--I agree that there are alternatives. Unfortunately, I do not select the textbook (as I noted)--it's a common adoption that everyone teaching intro (micro or macro) uses, and I have no ability to change it. The good news is I can avoid teaching macro...

Bill said...

OK, on to Mankiw.

Mankiw: "A major theme of the report is concern about the trade deficit. In recent years, American imports have exceeded exports by about $500 billion a year. Mr. Navarro and Mr. Ross argue that if better policies eliminated this “trade deficit drag,” gross domestic product would be higher and more people would be employed.

"That conclusion is correct, but only in a superficial sense."

I think that Mankiw is being too generous.

Mankiw: "Gross domestic product is, by definition, the sum of consumption spending, investment spending, government purchases and the net exports of goods and services."

Didn't Mankiw leave out "newly produced"? He is writing for a general audience.

Mankiw: "If net exports rose from their current negative value to zero, and the other three components stayed the same, . . ."

Earth to Mankiw: If net exports rose to zero, how in hell are other components going to stay the same?

Mankiw: "domestic production would increase and, consequently, so should employment."

Isn't that a non-sequitur? It may be likely, but the other components of GDP could rise in dollar terms without any change in the actual goods and services. (Highly unlikely that that would happen, right? An economic slump may be more likely in the real world, eh? It's nuts to assume ceteris paribus.)

Sorry, gotta run. More questions later, I expect. :)

Bill said...

More Mankiw:

Mankiw: "The most important lesson about trade deficits is that they have a flip side. When the United States buys goods and services from other nations, the money Americans send abroad generally comes back in one way or another."

"Send abroad" is a metaphor, OC. The dollars remain mostly in US banks, in New York or Las Vegas or somewhere. Some may circulate in Zimbabwe or Ecuador, but that trade is not part of our GDP. "Come back" is a metaphor, too, I suppose, meaning that the ownership of the money returns to domestic hands. (But did it ever leave domestic hands? If I pay dollars to import Japanese artwork from Japan, the artist is paid in yen, so somebody else gets my dollars. Is that other somebody domestic or foreign? Can we tell?)

Mankiw: "One possibility is that foreigners use it to buy things we produce, and we have balanced trade. The other possibility, which is relevant when we have trade deficits, is that foreigners spend on capital assets in the United States, such as stocks, bonds and direct investments in plants, equipment and real estate."

Unfortunately, Mankiw is not being altogether clear. My guess is that he is talking about foreigners buying existing assets, not about their opening a plant in Tennessee, for instance, so that these purchases do not count towards GDP. Even so, what happens when dollars "come back" in this fashion? Does a lot of it not circulate domestically, increasing GDP? What is the endpoint of the time period in question? It matters, doesn't it?

Mankiw: "In practice, these capital inflows from abroad have been large. Net foreign ownership of American capital assets has risen to about $8 trillion from $2.5 trillion at the end of 2010. American companies moving production overseas get a lot of attention, but this data shows that capital has, over all, moved in the opposite direction. . . .

"The trade deficit is inextricably linked to this capital inflow. When foreigners decide to move their assets into the United States, they have to convert their local currencies into American dollars."

Mankiw sows more confusion. First, he was talking about dollars "coming back" to the US. Now he is talking about foreigners buying even more dollars than were "sent abroad" to buy exports. Of what relevance, then, is the trade deficit, except to reduce the amount of the dollars that foreigners need to buy up US assets?

Even worse, though, is that he is comparing apples and oranges, by comparing the foreign purchase of existing domestic assets with moving production abroad. The purchase of existing assets does not (directly) increase our GDP, while moving production abroad decreases it. Is it like someone saying, too bad you lost you job, but that's OK, since somebody bought your house and car?

I am going to stop here. I don't want to try anyone's patience with all my questions.

Bill said...

Sorry, I think I can cut to the chase with Mankiw. And I said exports instead of imports. :(

Mankiw: "Rather than reflecting the failure of American economic policy, the trade deficit may be better viewed as a sign of success. The relative vibrancy and safety of the American economy is why so many investors around the world want to move their assets here."

More confusion. {sigh} Foreigners do not want to move their assets here, they want to buy assets that are already here. Mankiw said as much before.

But I think that this clarifies Mankiw's argument, which I do not think rests upon any identity. Here is what I think it is. The US domestic economy is relatively strong, so foreigners want to buy US assets, as they are safer here than elsewhere. To make those purchases the foreigners buy US dollars, which strengthens the dollar. The stronger dollar makes imports cheaper and exports dearer, which leads to a trade deficit. Thus, the continuing trade deficit is an indicator of the strength of the US economy, and nothing to worry about.

I think that the talk about dollars leaving the country and coming back is a side show.

AXEC / E.K-H said...

The false foundations of economics
Comment on Peter Dorman on ‘The Identity-Equals-Causation Fallacy, Yet Again’

“We know from the history of science that entrenched classificatory schemes and misleading descriptive vocabularies have impeded scientific advance as much or more than the complexities and observational inaccessibility of the subject matter.” (Rosenberg, 1980, p. 114)

“In fact, the history of every science, including that of economics, teaches us that the elementary is the hotbed of the errors that count most.” (Georgescu-Roegen, 1970, p. 9)

Economics is a failed science and the ultimate reason is that economists did not get the conceptual foundations of their subject matter right. More specifically, both Walrasian microfoundations and Keynesian macrofoundations are false. As a consequence, not only Mankiw’s textbook is scientific rubbish but ALL textbooks from Samuelson’s classic onward.

The preceding discussion between Dorman, ProGrowthLiberal, Unknown, Nick Rowe, George H. Blackford, rayward, Don Coffin, Bill, gives a vivid impression of utter confusion about the elementary concepts of economics.

The distinction between equality/identity/equilibrium has already been discussed at great length in the 1930s. It is not well understood until this day as Peter Dorman’s post demonstrates. For the definitive clarification see (2011, Sec. 11-18).

There is no use at all to discuss Mankiw’s textbook or his balance of payments theory in particular because Mankiw et al. apply false microfoundations and false macrofoundations. As Keynes already realized: “For if orthodox economics is at fault, the error is to be found not in the superstructure, which has been erected with great care for logical consistency, but in a lack of clearness and of generality in the premises.” (1973, p. xxi)

This is the current state of economics in Hume’s words: “... when the road ends at a coal-pit, he [the traveler] doesn’t need much judgment to know that he has gone wrong, and perhaps to find out what has led him astray.”

What has to be done? “For it can fairly be insisted that no advance in the elegance and comprehensiveness of the theoretical superstructure can make up for the vague and uncritical formulation of the basic concepts and postulates, and sooner or later ... attention will have to return to the foundations.” (Hutchison, 1960, p. 5)

After more than 200 years economists cannot tell the difference between the foundational concepts profit and income. This is comparable to medieval physics before the concepts of energy, mass, force, etcetera were clearly defined and properly understood.

Egmont Kakarot-Handtke

References
Georgescu-Roegen, N. (1970). The Economics of Production. American Economic
Review, Papers and Proceedings, 60(2): 1–9. URL http://www.jstor.org/stable/
1815777.
Hutchison, T.W. (1960). The Significance and Basic Postulates of Economic Theory. New York, NY: Kelley.
Kakarot-Handtke, E. (2011). Keynes’s Missing Axioms. SSRN Working Paper Series, 1841408: 1–33. URL http://ssrn.com/abstract=1841408
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. London, Basingstoke: Macmillan.
Rosenberg, A. (1980). Sociobiology and the Preemption of Social Science. Oxford: Blackwell.

Spencer England said...


I am amazed that all these economic comments completely ignoring prices.

Yes, it is an identity that the current account equals the savings investment gap.
But there are two prices that act to cause this identity to prevail.
The first price is the dollar. Look at what happened to the dollar when Reagan cut taxes. We had crowding out, but it just worked through the dollar, not interest rates.

Remember, the surge in capital under Reagan came from Japan where they had a savings surplus. But that has gone away and the foreign capital now comes from China where they now have a savings surplus. But what will happen when Trump cuts taxes. We will need more foreign capital and where will it come from. Maybe this time in addition to a strong dollar the tax cuts will lead to a wider spread between US and foreign countries interest rates . Look at what is already happening where the dollar is rising and the spread between US and German yields has widened sharply.

To an international economist there should be little or no doubt that the underlying cause of poor US manufacturing is Republican tax cuts, not the various trade deals like NAFTA, Tax cuts by Trump will just cause US manufacturing employment to get worse.

Dan said...

ughhhh

Economics is really an amazingly difficult topic.

Is there another field where an author of a text book who is a professor at a prestigious school and generally famous for being an expert in his field is accused of being essentially ignorant and incorrect regarding some fairly trivial and common place analysis?

Its a curious situation where essentially the smartest and brightest in the field are most critical of the entire discipline.

oh well

ProGrowthLiberal said...

"The first price is the dollar. Look at what happened to the dollar when Reagan cut taxes. We had crowding out, but it just worked through the dollar, not interest rates. Remember, the surge in capital under Reagan came from Japan where they had a savings surplus. But that has gone away and the foreign capital now comes from China where they now have a savings surplus. But what will happen when Trump cuts taxes. We will need more foreign capital and where will it come from. Maybe this time in addition to a strong dollar the tax cuts will lead to a wider spread between US and foreign countries interest rates . Look at what is already happening where the dollar is rising and the spread between US and German yields has widened sharply."

Spencer - thanks. This is what I've been saying for a long time. And in his own way - Mankiw did talk about this key aspect.

AXEC / E.K-H said...

ProGrowthLiberal, Spencer England

Each falling apple is an unique historical event. There are arbitrary many causes for an apple to fall: a hailstorm, playing children, an exploding meteorite, material fatigue, an earthquake, and so on. That is so OBVIOUS that no physicist ever lost many words about the historicity of falling apples.

Accordingly, when the apple fell on Newton’s head he did NOT run to his neighbor in order to tell him the story but he wrote down the COMMON principle that underlies the motion of ALL falling bodies including the moon and the stars, i.e. the Law of Gravity.

This, in a nutshell, is the difference between storytelling and science. Science is NOT interested in singular historical events as such but in the underlying invariances (Nozick) or ‘eternal laws’.

What is at issue here is the theory of foreign trade and the interrelation of balances and their representation in national accounting and the fact that economists in general and textbook writers in particular do not understand the elementary mathematics of accounting.

So, your newspaper wisdom about Reagan’s tax policy is absolutely out of place.

Egmont Kakarot-Handtke