Page 645 - The Principle of Economics

CHAPTER 29 OPEN-ECONOMY MACROECONOMICS: BASIC CONCEPTS 663
Mexican government has imposed, or might impose in the future, on foreign investors in Mexico.
THE EQUALITY OF NET EXPORTS AND NET FOREIGN INVESTMENT
We have seen that an open economy interacts with the rest of the world in two ways—in world markets for goods and services and in world financial markets. Net exports and net foreign investment each measure a type of imbalance in these markets. Net exports measure an imbalance between a country’s exports and its imports. Net foreign investment measures an imbalance between the amount of foreign assets bought by domestic residents and the amount of domestic assets bought by foreigners.
An important but subtle fact of accounting states that, for an economy as a whole, these two imbalances must offset each other. That is, net foreign investment (NFI) always equals net exports (NX):
NFI 􏰀 NX.
This equation holds because every transaction that affects one side of this equation must also affect the other side by exactly the same amount. This equation is an identity—an equation that must hold because of the way the variables in the equa- tion are defined and measured.
To see why this accounting identity is true, consider an example. Suppose that Boeing, the U.S. aircraft maker, sells some planes to a Japanese airline. In this sale, a U.S. company gives planes to a Japanese company, and a Japanese company gives yen to a U.S. company. Notice that two things have occurred simultaneously. The United States has sold to a foreigner some of its output (the planes), and this sale increases U.S. net exports. In addition, the United States has acquired some foreign assets (the yen), and this acquisition increases U.S. net foreign investment.
Although Boeing most likely will not hold on to the yen it has acquired in this sale, any subsequent transaction will preserve the equality of net exports and net foreign investment. For example, Boeing may exchange its yen for dollars with a U.S. mutual fund that wants the yen to buy stock in Sony Corporation, the Japan- ese maker of consumer electronics. In this case, Boeing’s net export of planes equals the mutual fund’s net foreign investment in Sony stock. Hence, NX and NFI rise by an equal amount.
Alternatively, Boeing may exchange its yen for dollars with another U.S. com- pany that wants to buy computers from Toshiba, the Japanese computer maker. In this case, U.S. imports (of computers) exactly offset U.S. exports (of planes). The sales by Boeing and Toshiba together affect neither U.S. net exports nor U.S. net foreign investment. That is, NX and NFI are the same as they were before these transactions took place.
The equality of net exports and net foreign investment follows from the fact that every international transaction is an exchange. When a seller country transfers a good or service to a buyer country, the buyer country gives up some asset to pay for this good or service. The value of that asset equals the value of the good or ser- vice sold. When we add everything up, the net value of goods and services sold by a country (NX) must equal the net value of assets acquired (NFI). The international