open economy

5. "The only reason the US runs a trade deficit is because its people and its government don't have the willpower to save enough." Do you agree with this claim that savings and the trade deficit are linked? Explain.

The national income accounting identity for an open economy is given by
    Y = C + I + G + B.
We define national saving, S, as the sum of private saving,
     S^p = (Y - T) - C,
and government saving,
     S^G= T - G.
Combining these three equations, we get
     S = I + B.
That is, if national saving is lower than investment, the country will run a trade deficit.

Every dollar of investment that is not financed by national saving must be financed by an inflow of capital from abroad (i.e. foreigners are doing the investment, and taking ownership of assets). In a very real sense, this is how a trade deficit is financed. With a trade deficit, we are consuming goods from abroad in excess of the goods we are providing to them. Somehow, foreigners need to ensure that they will be repaid for this "lending" of goods. Effectively, this is done by taking ownership of US assets. Until such time as the US runs trade surplus, these assets will be held by foreigners and earning them a rate of return.