Saturday, December 23, 2006

Econ vs. Marketing

From an email from an MBA student: The textbook for our MBA marketing class says: "A negative balance of trade is considered harmful because it means U.S. dollars are supporting foreign economies at the expense of U.S. companies and workers." She also cites my blog posting the other day about trade and the balance of payments, where I state that there is no "trade imbalance" once we account for trade flows and capital flows.

"I find it interesting that these two ideas seem to conflict one another. It appears that the marketing book does not take the flows of capital into account. I am curious about your thoughts on this."

It's a very interesting question, and here are some thoughts:

1. As you mention, the marketing textbook has not considered the capital inflow that accompanies the "negative balance of trade." There is ALWAYS a positive balance on the capital account to offset any "negative balance of trade" on the current account (merchandise), as the graph above clearly demonstrates.

2. About the second part of the sentence, you could ask the question "harmful to whom?" Keep in mind that both U.S. consumers and U.S. firms shop wisely (ruthlessly?), and buy imports when those products give them the best value. If you buy a cashmere sweater from China, or travel on vacation to Canada, or Starbucks buys coffee from Brazil, those transactions make the buyers better off and the foreign sellers better off, so I don't think any of those traders consider their behavior to be "harmful."

3. About the last part of the sentence - "US dollars supporting foreign companies at the expense of U.S. companies," - not true when you consider the total picture: merchandise and capital.

Think about a U.S. company exporting to Japan, and invoicing for 100m yen. Upon receipt of the 100m yen, the U.S. firm realizes that the yen are "worthless" in the U.S. in terms of purchasing power. You cannot spend Japanese yen at Target, Macys, Wal-Mart or McDonald's. You cannot purchase U.S. stocks or bonds or mutual funds with yen.

A firm in China or Japan exporting to the U.S. and invoicing for $1m finds itself in the same situation of holding currency that is "worthless" in terms of domestic purchasing power in those countries. The Japanese firm holding $1m in Japan has only 3 choices:

a. Hold and hoard the dollars. This would actually be the best of all possible options, but is also the most unlikely option. If Japanese companies would accept, hold and hoard "green pieces of paper with dead presidents' pictures" in return for their production of merchandise, we could just print an infinite supply of dollars and acquire their output for green pieces of paper. So although that is one possible option, we'll assume that is unlikely to happen, which leaves two realistic options.

b. Buy U.S. merchandise, or U.S. financial securities. We will buy about $125 billion of Japanese imports this year, which would put $125 billion of dollars in the hands of Japanese firms. The firms in Japan will buy about $75 billion of merchandise from the U.S. and $50 billion of U.S. financial assets (stocks, bonds, real estate, foreign direct investment (FDI) in US firms, treasury bonds, etc.). In that sense again, there is a “negative balance of trade” with Japan of $50 billion for MERCHANDISE ONLY, but a capital inflow of $50 billion, and the balance of payments with Japan is ZERO.

c. The firms receiving the dollars could also sell those dollars for Yen, in which case somebody else in Japan, has the same two options above. That is, if the firm that originally received the dollars has no interest in U.S. merchandise or assets, it could sell the dollars to somebody else in Japan who DOES have an interest in buying U.S. products or securities. But the dollars spent overseas ALWAYS COME BACK TO THE US to buy our merchandise or assets.

Bottom Line: The view that a “negative balance of trade is considered harmful,” is incomplete at best, and probably more likely inaccurate from an economic way of thinking.

For one concrete example: Toyota directly employs nearly 40,000 people in the U.S. and Toyota's investment in the U.S. is valued at more than $18 billion, and it purchases $30 billion of parts annually from U.S. companies. To say that our “negative balance of trade with Japan of about $50 billion annually (merchandise only)” totally ignores the $50 billion of capital inflow INTO the U.S. supporting jobs, output and production IN the U.S.


At 9/09/2007 10:55 PM, Anonymous Missy said...

Hey, thanks for that explanation. So the picture is not as dark as it's made out to be.


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