Question

If we write the national savings and investment identity equation as (M – X) = I – S – (T – G) where imports exceed exports, but the government is running a balanced budget (meaning taxes cover all government expenses), then we can expect the following to be true:

a. There is direct investment by foreigners in this economy.
b. There is direct investment by this country in foreigner economies.

Answer 1

With imports exceeding exports and a balanced government budget, the trade deficit suggests that domestic investment is higher than domestic savings, which points to direct investment from foreigners to bridge the gap.

Step-by-step explanation:

The national saving and investment identity equation, when simplified under the conditions of imports exceeding exports (M - X) and the government running a balanced budget (T - G = 0), allows us to analyze the flow of capital in an economy.

With a trade deficit, if the equation is (M - X) = I - S - (T - G), and the government budget is balanced (hence, T - G = 0), it simplifies to (M - X) = I - S. A positive (M - X) indicates a trade deficit, meaning that domestic investment (I) is greater than domestic savings (S). This deficit must be financed by capital from abroad, indicating that there is direct investment by foreigners in the economy to fill the gap between investment and savings.

In the given scenario where imports exceed exports and the government has a balanced budget, we can expect that there is direct investment by foreigners in this economy (option a) rather than direct investment by this country in foreign economies (option b).