Following on from my discussion of trade surpluses and their effects (which lots of people didn't get, sadly), I thought I would talk about the other side of trade - which is capital investment.
This speech by the ECB's Asmussen contained the following intriguing line:
"If more German savings were invested at home, the current account surplus would fall by definition".
Now I can hear you all scratching your heads. What on earth has the behaviour of German savers got to do with the current account surplus?
Nothing, actually. This isn't about German savers. It is about German national savings - the proportion of national income that is not spent or invested at home. Essentially, what Asmussen is saying is that the German national savings rate is too high.
A nation's current account reflects its net foreign income, and its capital account reflects the change in ownership of foreign assets. A nation that is running a trade surplus has an equivalent capital deficit, by definition: money leaves the country and is invested in foreign assets, rather than domestically. So poor domestic investment is a consequence of an export-dominant economic model. That's what Asmussen is talking about. The trouble is, he thinks that by increasing capital investment at home, which would reduce the capital deficit, the trade surplus would automatically fall. But I'm afraid he has this the wrong way round.
In a closed economy,
Y = C + G + I
where Y = national income, C = domestic consumption, G = government spending and I = investment. Rearranging this, we see that
I = Y - G - C
In other words, investment is the bit of income left over after all private and public spending commitments have been met. Strictly speaking, saving (S) is the bit of income left over after all private and public spending commitments have been met, but we assume that all saving is productively invested in some way:
S = I = Y - G - C.
So far so good. But Germany is not a closed economy. In an open economy, the foreign sector matters. Net exports are the difference between exports and imports:
NX = X - M
Germany has a trade surplus, so NX is positive. A positive current account balance is a contribution to national income:
Y = NX + (C + G + I)
where C + G + I = domestic demand.
We can immediately see where the desire to run a trade surplus comes from - Y may be higher if there is a trade surplus. But if Y is constant (or delta Y < delta NX), then a trade surplus crowds out domestic demand. Domestic demand is public and private spending AND INVESTMENT. Therefore, if Y, G & C are all constant, a large trade surplus crowds out domestic investment. So what Asmussen is saying is that Germany should should seek to increase I (domestic investment), which would force NX to fall.
But I'm afraid this is simply impossible. The capital deficit is a consequence of the trade surplus, not a cause, and I is a residual:
I = Y - C - G - NX
Put bluntly, the money has to come from somewhere. In China, of course, there is perhaps excessive domestic investment - but they don't have much in the way of a welfare state and they have significant financial repression, so both C and G are low and most of the national income goes into I. I suspect that attempts to increase I in Germany would be achieved by the same means - cut government spending and depress household incomes - in which case increasing I would have no effect at all on NX. So that is not what is really needed. What Germany really needs to do is to reduce NX in order to increase I, not the other way round. This could be done by cutting exports, but it would be far better if it were done by increasing imports, And actually that would be best achieved by increasing both C and G, so looser fiscal policy, really: despite my caveat in an earlier post, higher wages and lower taxes would probably result in increased imports to some degree. That would diminish net capital flows out of the country and therefore increase the amount of capital available for domestic investment.
Asmussen should have made this clear. Increasing domestic investment would be consequent upon a falling trade surplus, not the other way round. By getting the causation the wrong way round, he has missed a golden opportunity to influence German economic policy for the better.