Capital Scarcity

In this 7 minute YouTube video, US Trade Representative Robert Lighthizer is unable to answer Senator John Kennedy’s question. Kennedy asks why a current account deficit is bad for America if the dollars are later recycled to fund investment in America. The key question from Senator Kennedy is as follows:

If we are running a negative in our current account, our financial account has got to be positive, right? Which means that those dollars are coming back to the United States and they’re being invested.

 

Mr. Lighthizer should have said that Senator Kennedy’s example is assuming that foreign investment is productive and has no ill effect on the US economy.  If capital in America was scarce, foreign funds could fund the gap between domestic investment needs and low domestic savings. The problem here is that America has the deepest, most liquid, open capital markets in the world. American banks are industry leaders and capable of funding America’s investment needs.  If America’s domestic financing needs are met by American financial institutions, what are the effects of America’s consistent capital account surplus?

1.) Excess capital could find its way into asset bubbles. Asset bubbles in real estate, particularly regarding Chinese investment, have become normal. Speculative flows of money into assets can make households feel richer. For example, if you perceive the value of your house as increasing due to living in an asset bubble, you may be more willing to spend more or take on additional debt. Lastly, if American firms lessen their investment or productive investments are funded by foreign capital, America is outsourcing its capital allocation mechanisms to foreigner institutions. This could have great ramifications for a country if the foreign institution is run by communists, building military islands in the South China Sea, or responsible for the slavery of its ethnic citizens. Becoming a part of the capital allocation mechanism may also let a foreign institution interrupt democratic debate, because those who benefit or have the best relationship with said institution may be unwilling to abandon their patron.

2.) Good FDI, fairly logically, means that a foreign entity has industry knowledge or practices that make them competitive in a domestic market. A win-win is created by the foreign entity being competitive in a large market and the foreign market learning new knowledge/practice. Why would a developing country so regularly invest in a developed country considering the developing country is much less likely to have best practices?

capital_epa_net

I think there are a few reasons that Robert Lighthizer didn’t give Senator Kennedy a satisfactory answer. However, if he did give him an answer in which he stated that America’s problem isn’t its trade account but its open capital account, he would have to admit that tariffs won’t fix the problem and his administration is failing.

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