Faculty of management inb 001

Trade Deficit

In the section on net exports we learned that net exports equal exports minus imports. The difference between exports and imports is referred to as the trade deficit or the trade surplus. When exports exceed imports, a trade surplus exists. When imports exceed exports, a trade deficit exists.

There often talk about the effects of the trade deficit on the economy. What is the actual effect of the trade deficit though? Remember that when there is a trade deficit, net foreign investment fills the gap between exports and imports, as NX = NFI. Thus, if a large trade deficit exists, foreign investment must be high. This is slightly problematic as domestic companies often enjoy domestic ownership--a large trade deficit threatens this condition. A trade deficit is often matched with a large governmental budget deficit. Though the specific effects of a trade deficit are nebulous, in general a large trade deficit is thought to stunt long-term economic growth slightly.

How can the trade deficit be resolved? First, exports can be increased to make annual net exports positive. When employed, this method will cause a trade deficit decrease over time. Second, funds can be used to pay off foreign investors, reducing balance due from trade and causing a lower trade deficit.

Government Policy Instruments for Managing Foreign Direct Investment (FDI)

Government Policy Instruments for Managing Foreign Direct Investment (FDI)
By their choice of policies, home countries can both encourage and restrict FDI by local firms. We look at policies designed to encourage outward FDI first. These include foreign risk insurance, tax incentives, and political pressure. Then we will look at policies designed to restrict outward FDI.
Home Country Policies to Encourage Outward FDI
Many investor nations now have government backed insurance programs to cover major types of foreign investment risks. The types of risks insurable through these programs include risks of expropriation (nationalization), war losses and the inability to transfer profit back home. Such programs are particularly useful in encouraging firms to undertake investments in politically unstable countries.
Home Country Policies to Restrict Outward FDI
Virtually all investor countries, including the US, have tried to exercise some control over outward FDI from time to time. One common policy has been to limit capital outflows out of certain concern for the country’s balance of payment. From the early 1960s until 1979, for example, Britain had exchange control regulations that limited the amount of capital a firm could take out of the country. Although the main intent was to improve the British balance of payments, an important secondary intent was to make it more difficult for British firms to undertake FDI.
In addition countries have manipulated tax rules to encourage their firms to invest at home. The objective behind such policies is to create jobs at home rather than in other nations. At one time the British taxed companies’ foreign earnings at a higher rate than their domestic earnings, creating an incentive for British companies to invest at home.
Finally, countries sometimes prohibit national firms from investing in certain countries for political reasons. Such restrictions can be formal or informal. For instance, formal rules have prohibited US firms from investing in countries such as Cuba, Libya and Iran, whose political ideology and actions are judged to be contrary to US interests.
Host Country Policies to Encourage Inward FDI
it is increasingly common for governments to offer incentives to foreign firms to invest in their countries. Such incentives take many forms, but the most common are tax concessions, low interest loans, grants or subsidies. Incentives are motivated by a desire to gain from the resource-transfer and employment effects of FDI. They are also motivated by desire to capture FDI away from other potential host countries. Not only do countries compete with each other to attract FDI, but so do regions of countries.