Imports are National Saving used for Investment
In the circular flow model that I use, as imports rise so does gross saving. And does that increased saving show up in increased investment? How would imports lead to more investment?
Here is the model as a closed economy without imports and exports using 1st quarter-2011 data as an example.
This graph simply takes out imports and exports from the data. Now start at gross saving, $3,059 billion. Part of that money is then lent to the government, $1,391 billion. The remainder is used for investment, $1,668 billion. So we have the equality…
S – I = G – T
3059 – 1668 = 3012 – 1621
G = govt. spending… T = net taxes… S = gross saving… I = investment
There is another way to get the same equation in the model. The row for leakages is equal to the row for injections. Here is the equation and then simplified. (C = consumption)
C + T + S = C + G + I
C + T + S (leakages)… C + G + I (injections)
Cancel out C from both sides and rearrange…
T + S = G + I
(S – I) = (G – T)
Now we will open up this model to foreign markets. Here is the data from 1st quarter 2011 including imports and exports.
I want you to see that gross saving increased from $3,059 billion to $5,370 billion. The increase was $2,311 billion… the same amount as imports.
So how do imports directly raise gross saving?
When we buy an import, where does our money go? It goes into the foreign exchange market. The foreign exporter then receives their own currency from the foreign exchange market. And our dollars remain in the foreign exchange market.
But now what happens with the dollars sitting in the foreign exchange market? Theoretically they must come back to the United States to either purchase US assets, goods and services (exports) or to be invested in the United States. Theoretically, those dollars sitting in the foreign exchange markets are part of the gross saving of the United States. Thus, gross saving in graph #2 includes money in the foreign exchange market.
So what do we see happen in graph #2? Of the $2,311 billion that went into the foreign exchange market from imports, $1,855 billion came back from the foreign exchange market when foreigners bought US goods and services. We see that $1,855 billion leaving the financial sector “Lend (-)/borrow” entry going to the export entry.
So what happened with the $456 billion difference between imports and exports that was still left in the foreign exchange market? That $456 billion moved right down into the investment entry of $2,124 billion. That $456 billion was eventually invested in the United States. Notice that investment rose $456 billion from graph #1 to graph #2 (from $1,668 billion to $2,124 billion).
So then what does the entry for net exports of -$456 billion mean? In effect, the entry of -$456 billion of net exports is an accounting entry to close the books at the end of the year representing the money that flowed back from the foreign exchange market for investment in the US. In actuality, that $456 billion stayed in US gross saving account, even though it was transferred back by transactions with foreigners. The accounting entry simply balanced the books with the foreign sector.
They don’t call it National Income Accounting for nothing.
Correcting the Twin Deficits Hypothesis
In the circular flow model above, look at the row where the leakages are. The row has the equation…
C + T + S – M
C = consumption… T = net taxes… S = gross saving… M = imports
Now look at the row for “injection returns/expenditures”. The row has the equation…
C + G + I + X – M
C = consumption… G = govt spending… I = investment… X – M = net exports
Now the two equations above are equal.
C + T + S – M = C + G + I + X – M
We cancel out C and M from both sides.
T + S = G + I + X
(S – I) + (T – G) = X
Some of you should be saying… “That can’t be right, the correct equation is…”
(S – I) + (T – G) = (X – M)
This is the equation usually seen from the Twin Deficits Hypothesis. The implication of this equation is that as the govt budget deficit increases, G>T, holding saving constant, that either investment must fall, or the trade deficit must increase. Basically, government deficits worsen the economy.
However, once you realize that imports create an equal amount of savings for investment, you realize that the correct equation is…
(S – I) + (T – G) = X
Imports are inside gross saving, S, by way of the foreign exchange market. From the above graph, the equation comes out like this…
(5370 – 2124) + (1621 – 3012) = 1855
1855 = 1855
The equation is like this… If you increase the government deficit by raising G in the equation, holding exports constant since it is determined by foreign demand, investment would fall. However, a country does have the option to raise gross saving by importing more. Imports are gross saving used for investment. Consequently, investment would not fall.
Currently, people want to support investment. Maybe by increasing imports, we can support investment. But really, raising labor income is still the best way to raise domestic investment. More labor income would increase consumption and it would increase saving through more personal savings and more purchases of imports.
This makes no sense.
You’re saying that if we import a dollar of capital goods that raises S?
The problem here is that you have redefined S to be something other than the sense of the national accounts, not that the national accounts identity is wrong.
NA: S = Y-C-T
EL: S = Y-C-T+M
Here is the rub… You cannot change imports without changing Saving. Imports directly become saving.
It’s in the balance of payments.
“When all components of the BOP accounts are included they must sum to zero with no overall surplus or deficit.”
Keep two things in mind…
1) Every dollar of imports becomes exactly a dollar sitting in the foreign exchange market waiting to be used in the US economy. Just like putting a dollar into a savings account in your local bank.
2) Money is then taken out of the foreign exchange “savings account” and spent of US products (exports), assets or investment..
Imports are national saving.
If you take S to mean personal/domestic saving (s), not national saving (S), which includes foreign saving, then the equation is this…
s + M = Y-C-T
But S should represent gross saving for the nation, domestic and foreign. Thus, S = s + M.
Good lord, no.
First, you are wrong about the dollar in the account. If I take a $100 bill and hand it to a bank teller, I haven’t saved anything. I’ve simply swapped one asset (the bill) for another (higher balance on my deposit account)
Now, suppose I trade $100 I would have otherwise saved for $100 worth of imports. That $100 abroad? That’s an additional demand on future domestic output… a liability… and you want to call it “savings?”
Even if you still call imports savings, then exports are surely dissavings.
Yes, of course you can change imports without changing savings. I think you misunderstand BoP. Additional imports count against the current account, and this must be balanced by the capital account– that’s true.
But if I hand over $100 to get my imports, then the net change in foreign ownership of domestic assets goes up by $100. This counts FOR the capital account.
Think about it: can I now consume more, or less, in the future than I could have otherwise? Less. So I am dissaving by importing.
If I use the additional imports to increase investment then by both increasing imports and investments I have not changed savings.
If I use the additional imports to increase consumption the imports, then I am just dissaving.
In your last comment, you say you are dissaving by importing, because you can consume less, but now realize that foreigners have funds to spend or invest in the US. And they use those funds.
Look at the graph above, you have different sectors which unfortunately are not identified. In the first column, you have households. Second column you have the government. Third column you have the financial sector. Fourth column you have the foreign sector.
All columns add up perfectly.
Look at the center where it says, “lend(-)/borrow”. This is the financial sector. This is the hub of the system. To the left, you have a govt deficit. So the financial sector has to lend $1,391 billion to the govt.
Now look to the right, what does the financial sector lend to the foreign sector? They lend dollars for exports, so that foreigners can buy our products. But the financial sector already has dollars on deposit in the foreign sector due to imports.
There is an accounting entry to show that funds were lent to the foreign sector. In fact, account balances are adjusted.
In case you are still there.
GDP wants to determine domestic production. So we start with this closed economy equation… Saving is deferred consumption.
Y = C + S
1000 = 900 + 100
People have $1000 to spend or save.
Now we open up the economy to foreign markets…
Consumption will now include imports in all spending. Since GDP counts domestic production, we have to subtract imports off to the side. Thus,
GDP = consumption + saving – imports
1000 = 1000 + 100 – 100
Looks good right? This is what you are saying. But above people had $1000 to spend or save. Now all of a sudden, they have $1100 to spend or save. Where did they get that extra $100? GDP is not increasing. Nobody gave them the extra $100.
Well, people are spending their savings on imports. So then why does the equation show $100 in savings if people spent their savings?
It’s not personal savings that you see there, it’s national savings from the imports. Which are deferred consumption in the hands of foreigners.
Think about it…
I do not care one whit that your columns add up. It’s your definitions which concern me. I can make anything add up if I get to define what the symbols represent.
I had a whole rant here about how mal-structured your model is, making it obvious that what you call “Savings” is not what the rest of the world calls savings. But then I went back and saw this:
“Note: The difference between imports and saving is what a person actually saves.”
So WHY call it “Savings” if you KNOW it’s not what “a person actually saves”???
If you want to label your “Savings” by “S” that’s fine. And yes, you get the “identity” (S-I)+(T-G)=X. But this says absolutely nothing which is not conveyed by (S-I)+(T-G)=(X-M) where S in this case is the usual meaning of savings.
You’re simply conflating your own meaning with the usual one. If we rewrite your identity in standard notation…
[(S+M)-I] + (T-G) = X
it’s obvious that you are just rearranging the usual identity as an appeal to your own model. To make people think that imports cause investment. You say “once you realize that imports create an equal amount of savings for investment, you will realize…”
… that imports, like usual savings, increase investment. But it’s your MODEL which says this, not the accounting identity, which is exactly the same as the old accounting identity.
By your own admission, “Savings” is not what a person actually saves. So what makes your model so great? What happens to your model if, as with foreign borrowing, foreign lending happens outside of the personal sector? (As it usually does!) Then imports move back to the right hand side, right? You get back to the old identity.
Or what happens– so long as you are assuming foreign borrowing happens in the personal sector– if foreign lending also happens in the personal sector? Then
[(S-X+M)-I] + (T-G) = 0
Right? So do exports destroy investment? The model may be garbage in, garbage out. But the identities will go on.
You are seeing it clearly now. The advantage to putting imports into savings is that when it comes time to draw upon savings for the government, there is enough there, plus enough for exports. What is left over matches the investment in the national account.
We all know that foreigners lend money to our government. But in many cases, it is money that we gave them by buying their products, and that money is meant to come back home. The foreigners cannot use that money for consumption in their own country, technically. The dollars they have is stored value, deferred consumption, that must return to the US.
There is an advantage to moving that money through the financial sector in the model. Because even the financial sector is at the hub of international capital flows.
“Looks good right?”
Keep it simple and take away the government sector
S = Y-C = I+X-M, or if you prefer
Y = C+S = C+(I+X-M)
If you import for consumption while holding investment and exports constant then national savings is reduced.
1000 = 900 + (100+0) becomes
1000 = 1000 + (100-100)
You increased consumption at the cost of savings, which is investment plus net exports.
If you import for investment, then savings is unchanged.
1000 = 900 + (100+0) becomes
1000 = 900 + (200-100)
i have tried to find a circular flow chart using real data on the internet. I have not found anything. All the circular flows have arrows but no numbers. There are no charts.
Are you able to provide one that balances out? I would like to see your way of presenting the numbers for the circular flow. Apparently no one else has done it. When i do a search on google for it, I see mine there, but no others.
“The dollars they have is stored value, deferred consumption, that must return to the US”
Deferred consumption owed to FOREIGNERS. If we import, it’s the foreigners who are deferring consumption (by sending us the stuff they produce) It is we who are liable for it. That’s foreign savings, not national savings!
You don’t understand. You can model the flows sectorally any way you wish. So long as you use standard accounting definitions for the aggregate flows, the accounting identity MUST hold.
I’m not saying your model is wrong. I’m saying your identities must hold just like any other model.
Voila, a working circular flow. So what?
You want something better? I was writing it up when I found your note about savings not being savings and erased it, because why bother.
But if you want to see something, send me your file and I’ll edit it. I’ll contact you off-site.
I have to go help a friend who had the wrong tooth pulled by the dentist. i will respond later.
With respect to maintaining accounting fidelity , you might want to check out Keen’s use of “Godley tables” for data entry in his Minsky model. The idea is to catch any accounting irregularities before they get buried in the flowchart.
The last video in this list has a relevant discussion :