How does the National Savings Identity relate to Trade Deficits?

The national saving and investment identity also provides a framework for thinking about what will cause trade deficits to rise or fall. Begin with the version of the identity that has domestic savings and investment on the left and the trade deficit on the right:

Domestic investment – Private domestic savings – Public domestic savings  = Trade deficit

I – S – (T – G) = (M – X)

Now, consider the factors on the left- hand side of the equation one at a time, while holding the other factors constant.

As a first example, assume that the level of domestic investment in a country rises, while the level of private and public saving remains unchanged. Since the equality of the national savings and investment identity must continue to hold—it is, after all, an identity that must be true by definition—the rise in domestic investment will mean a higher trade deficit. 

As a second scenario, assume that the level of domestic savings rises, while the level of domestic investment and public savings remain unchanged. In this case, the trade deficit would decline. As domestic savings rises, there would be less need for foreign financial capital to meet investment needs. For this reason, a policy proposal often made for reducing the U.S. trade deficit is to increase private saving—although exactly how to increase the overall rate of saving has proven controversial.

As a third scenario, imagine that the government budget deficit increased dramatically, while domestic investment and private savings remained unchanged. 

Related Topics

• Trade Balance: Surplus and Deficit
• Mercantilism
• J Curve
• National Trade Data Bank
• Capital Account (Economics)
• Merchandise Trade Balance
• Current Account 
• Income Payments
• Unilateral Transfer
• Is it better to have a trade surplus or a trade deficit? 
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• Linder Hypothesis
• The Balance of Trade as a Balance of Payments
• National Savings and Investment Identity
• Circular Flow of Money
• Financial Capital
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• Flow of Capital
• Domestic Saving and Investment Determine the Trade Balance
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• How the Business Cycle Affects Trade Balances
• Trade Balance or Trade Surplus
• Level of Trade
• Comparative Advantage
• Absolute Advantage
• Specialization and Gain from Trade
• Absolute Advantage in All Goods
• Production Possibilities Frontier and Comparative Advantage
• Comparative Advantage and Mutually Beneficial Trade
• Gain from Trade
• Opportunity Costs and International Trade
• Intra-Industry Trade
• Splitting Up the Value Chain
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• Protectionism
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• Double Column Tariff
• Infant Industry Theory
• National Interest Argument
• Race to the Bottom
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• Trade War
• Race to the Bottom
• Non-Tariff Barriers
• Effects of Trade Barriers
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• Infant Industry Theory for Restricting Imports
• What is the Anti-Dumping Argument for Restricting Imports?

• Anti-Dumping Laws
• Dumping

• What is the Environmental Protection Argument for Restricting Imports?
• Race to the Bottom
• Unsafe Consumer Products Argument for Restricting Imports?
• National Interest Argument for Restricting Imports
• What is the WTO?
• What is the GATT?
• What are Free Trade Agreements?
• North American Free Trade Agreement
• Central European Free Trade Agreement
• General Agreement on Free Tariff and Trade (GATT)
• Common Market
• Common Market for Eastern and Southern Africa
• Central American Common Market
• Caribbean Community and Common Market
• What are Economic Unions?
• WTO
• International Monetary Fund
• World Economic Forum
• Inter-American Development Bank
• Davos World Economic Forum 
• Chamber of Commerce
• Jackson Hole Economic Symposium