Explaining the Bilateral Trade Deficit
We begin by laying out the determination of the overall current account (CA) position, within which the overall trade balance is the most important component. Broadly speaking, the primary determinants of the overall trade balance are macroeconomic and structural in nature,
So, for a given pegged value of the exchange rate, contractionary fiscal policy increases CA directly by increasing (S – I)govt; and contractionary monetary policy increases CA by decreasing the investment spending of private and state-owned enterprises (SOEs).
Any structural factor that increases Spnvale without increasing ipnvate correspondingly would raise CA. This is the situation in China after the initiation of economic deregulation in 1978. Past central planning, closure to international trade, and promotion of local self-sufficiency created many highly profitable production niches and arbitrage possibilities, but private businesses cannot undertake the required investment immediately because they cannot get loans either from the wholly state-owned banking monopoly or from off-shore foreign financial institutions. Because the state banks do not channel much of the private savings to private investors, the only way that a private Chinese businessman can invest is to accumulate enough savings to start his own workshop-factory. This is a feasible option because the threshold size for the average Chinese enterprise is small. In an economy that is open to trade but closed to private capital movements, the failure of the domestic banks to match the available private saving flow with desired private investment creates the twin phenomena of a high private saving rate, and a persistent CA surplus and they work through saving and investment behavior.18 This can be seen from the following decomposition: payday loan no credit check