This equation shows that a nation’s saving must equal its domestic investment plus its net capital outflow. In other words, when US. citizens save a dollar of their income for the future, that dollar can be used to finance accumulation of domestic capital or it can be used to finance the purchase of capital abroad.
TABLE 1 International Flows of Goods and Capital: Summary
The converse logic applies to a country with a trade deficit (such as the u.s. economy in recent years). By definition, a trade deficit means that the value of exports is less than the value of imports. Because net exports are exports minus imports, net exports NX are negative. Thus, income Y = C + I + G + NX must be less than domestic spending C + I + G- But if income Y is less than spending C + I + G. then saving S = Y – C – G must be less than investment I. Because the country is investing more than i t is saving, it must be financing some domestic investment by selling assets abroad. That is, the net capital outflow must be negative.
A country with balanced trade is between these cases. Exports equal imports, so net exports are zero. Income equals domestic spending, and saving equals investment. The net capital outflow equals zero.
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