Question

A government official announces a new policy. The country wishes to eliminate its trade deficit but will strongly encourage financial investment from foreign firms. Explain why such a statement is contradictory.

a) Trade deficit reduction requires increased imports.
b) Encouraging foreign investment leads to a trade deficit.
c) The policy aims for a balanced current account.
d) It depends on the overall economic conditions.

Answer 1

Encouraging financial investment from foreign firms may contradict the goal of eliminating a trade deficit due to increased imports, potential trade deficits, and the aim for a balanced current account.

Step-by-step explanation:

Encouraging financial investment from foreign firms may contradict the goal of eliminating a trade deficit because:

1. A trade deficit reduction requires increased imports: When a country encourages financial investment from foreign firms, it may lead to an increase in imports as these firms bring in goods and services from their home countries.
2. Encouraging foreign investment may lead to a trade deficit: Foreign firms investing in a country may repatriate profits and dividends back to their home countries, leading to a higher outflow of money compared to the inflow from exports.
3. The policy aims for a balanced current account: A trade deficit represents a negative balance of the current account, which includes trade in goods and services. Encouraging foreign investment while aiming to eliminate the trade deficit suggests a contradiction in the policy.

Therefore, the statement is contradictory because the goal of eliminating the trade deficit may conflict with the promotion of financial investment from foreign firms.