Domestic politicians strive to be re-elected. For that reason, they must work hard to keep their constituents happy. To do this, they must enact policies that result in immediate, measurable benefits with long-term costs, rather than policies with immediate costs and long-term benefits. Therefore politicians tend to avoid policies that encourage free trade since their economic results are general felt immediately by domestic workers and producers who must suddenly compete with new imports (Sawyer & Sprinkle, 2006). When it comes time to vote, those workers tend to remember their current losses and disregard future benefits.

Special interest groups have the most to gain when a government implements protectionist policies rather than embracing free trade. Lobbyists for these special interest groups see to encourage the government to adopt tariffs and other barriers to trade in an effort to decrease the flow of incoming products. Well-funded lobbyists have had a long history of success in the United States including the 2002′s increased trade barriers enjoyed by steel industry (Sawyer & Sprinkle, 2006).

Domestic obstacles prevent countries from engaging in coordinated international economic policy-making. Politicians and special interest groups work against the greater good in order to benefit themselves. Unfortunately, the political clout of consumers is dispersed among many people and can not be effectively brought to bear on such these obstacles.

Sawyer, W. C., & Sprinkle, R. L. (2006). International economics, 2nd ed. Upper Saddle River, New Jersey: Pearson Prentice Hall.

At the end of the 1980s, maquiladoras employed more than 350,000 workers in 1,500 plants. As they struggled to maintain the production necessary to continue attracting more foreign investment, the maquiladoras began hiring young women. These women ended up living in slums. Unfortunately, these young women would not have found jobs elsewhere, so they had no choice but to except these deplorable conditions so they could continue to send money back to their families (Isaak, 2004). This exploitation of women is a problem for maquiladoras that must be addressed.

Working conditions, especially in regard to health, are another concern for maquiladora workers. A survey conducted in the mid-1990s found that 40% of maquiladora workplaces had no health and safety commissions. It was also revealed in this same study that one in five respondents suffered symptoms associated with illnesses developed at work. A high percentage of these workers claimed to not have safety training or access to safety information (“Maquiladora workers”, 1998). Access to safety standards similar to those enjoyed by workers in the U.S. is a concern for maquiladora workers.

Mexico’s maquiladoras are located on the U.S. border. As such, goods and services in this part of the country are generally more expensive. Coupled with the extremely low wages of the maquiladora workers, this is a recipe for disaster. The maquiladora workers’ livelihoods are tied to the stability of the Mexican economy. If the economy comes under hard times and the value of the peso decreases, the workers feel it the most. This is exactly what happened in the mid-1990s when the Mexican economy was so unstable (Davidson, 1995).

Finally, maquiladora workers suffer from a lack of organizational attachment. Organizational attachment is the commitment that workers feel toward their workplace. Absenteeism and turnover are symptoms of lack of commitment. Studies have been done to determine what causes maquiladora workers to feel so distanced from their work environment. First, maquiladoras offer very little opportunities for advancement. Second, maquiladoras often offer alternative forms of compensation rather than increased pay (Pelled & Hill, 1997). In order to decrease the symptoms of organizational detachment, the issues must be addressed.

Jobs in maquiladoras are generally considered to be desirable (Pelled & Hill, 1997). Companies looking to begin operating a plan in Northern Mexico should take the concerns of these workers into consideration before setting up shop. If the concerns of the maquiladora workers is not met, this highly mobile workforce will gladly move to greener pastures.

Davidson, M. (1995). Maquiladora workers hit by Mexican peso drop. Christian Science Monitor, 87(90), 8. Retrieved September 16, 2008, from Academic Search Premier database.

Isaak, R. A. (2004). The globalization gap: How the rich get richer and the poor get left further behind. Upper Saddle River, NJ: FT Press.

Maquiladora workers report unhealthful working conditions. (1998, January). Nation’s Health, Retrieved September 16, 2008, from Academic Search Premier database.

Pelled, L., & Hill, K. (1997). Employee work values and organizational attachment in North Mexican maquiladoras. International Journal of Human Resource Management, 8(4), 495-505. Retrieved September 16, 2008, doi:10.1080/095851997341577

The IMF has developed an unfortunate negative perception in the eyes of many developing countries. The goal of the IMF has always been to provide a safety net for countries with temporary payment imbalances. Unfortunately, the IMF can not lend money unconditionally. To do so would encourage lenders to make riskier loans with knowledge that the IMF would protect the debtor in case of a fault on the loan. This would lead to the IMF propping up commercial investors rather than protecting temporary financial troubles in distressed countries (Sawyer & Sprinkle, 2006).

The conditionality of loans from the IMF has lead to a great deal of controversy. The IMF has a difficult time enforcing the austerity programs tied to the conditionality of loans. If the developing country is unwilling to meet the conditionality of the loans received from the IMF, it may end up in a great deal of debt without foreign reserves. The end result is a depreciation of its currency. In other words, if a developing country is unwilling to adhere to the IMF’s required adjustments to its macroeconomic policies, it may end up in an even worse condition (Sawyer & Sprinkle, 2006).

The IMF has enjoyed many successes and suffered many failures since its inception in 1944. In 1998, the IMF successfully bailed out Thailand and South Korea at a cost of $17.2 billion and $43 billion respectively. Both countries were able to recover from their financial troubles and resume healthy economies (“IMF success”, 1998). Unfortunately, this success has not been mirrored in Pakistan, which has failed on multiple occasions to fulfill the conditionalities imposed by the IMF. After each failure, the IMF has implemented harsher guidelines, but Pakistan still fails to meet the requirements (Asad, 1998).

Asad, S. (1998, September). IMF and Pakistan. Economic Review (05318955), 29(9), 7. Retrieved September 15, 2008, from Business Source Elite database.

IMF success in S. Korea, Thailand. (1998). Christian Science Monitor. Retrieved September 15, 2008, from Academic Search Premier database.

Sawyer, W. C., & Sprinkle, R. L. (2006). International economics, 2nd ed. Upper Saddle River, New Jersey: Pearson Prentice Hall.

Nike, Inc. is one of the world’s top manufacturers of footwear. Nike realized early in its history that it could not possibly handle the manufacture of shoes on its own, and so it has outsourced that function since the 1960s. In the early 1990s, Nice came under fire for its apparent abuse of low-wage workers in developing countries in Southeast Asia (Boatright, 2007). Acme Motors, with its engine manufacturing plant in Nuevo Laredo, can take Nike’s reaction to this situation as a lesson.

Nike has fully embraced globalization. Although Nike is based in the United States, it contracts over 500 manufacturing facilities in 45 countries (Nike, 1999), including 180,000 works in 37 Asian countries (New York Times, 1998). Nike has always operated a strong presence overseas. When Nike co-founder Phil Knight was a student at the Stanford Business School, he realized that the key to success was to outsource all manufacturing to contractors in developing countries. Nike originally contracted with manufacturers in Japan, but has since shifted its business to other Southeast Asian countries such as Indonesia, Vietnam, and China (Boatright, 2007).

Nike wouldn’t outsource the production of its product line if it were not advantageous. Since Nike does not have the technical skill necessary to run a manufacturing plant, it has little choice but to outsource production to a specialist. The developing countries that Nike does business with enjoy the benefit of a low-wage labor force. This allows Nike to effectively “buy” its footwear at very low cost. This also has the benefit of allowing Nike to focus on the skills it is good at, namely marketing and shoe design (Boatright, 2007).

The production of footwear in these developing countries did not come without a price for the host country. Many of chemicals used in the production of shoes include petroleum-based solvents that include volatile organic compounds. Volatile organic compounds are an air pollutant that has been found to be a major contributor ozone. Ozone has an adverse affect on the lungs and can lead to pulmonary disease. Additionally, some studies have found that prolonged exposure to ozone can affect the normal functioning of the human immune system (Parish, n.d.).

The overwhelming evidence of health risks associated with volatile organic compounds was a source of concern for Nike. Since the petroleum-based solvents used in their adhesives and primers are responsible for the volatile organic compounds, Nike decided that it must switch over to water-based solvents as quickly as possible. By 1999, Nike had successfully phased out many of its petroleum-based solvents. In order to protect workers from vapors released by the solvents not yet converted, Nike worked with manufacturing contractors to install advanced ventilation systems in their facilities. The goal was to reach the permissible exposure limits set by the Occupational and Safety Health Administration (OSHA). By the end of 1999, Nike had successfully reached this goal in 37 footwear factories in Southeast Asia (Nike, 1999).

The short run cost of these changes was quite burdensome for Nike. One of the 37 affected factories in Southeast Asia incurred costs up to $500,000 in efforts to install adequate ventilation (Nike, 1999). These short run costs are far outmatched by the long run benefits of the clean up efforts. Since the early 1990s, Nike has been battling an image that it employs “sweatshops” to produce its footwear. Although Nike initially tried to pass the blame to the contract manufacturers truly responsible for the poor working conditions, it eventually decided to change course and use its clout to force manufacturers to comply with its standards (Boatright, 2007). In the long run, the benefits of improved working conditions in developing countries have helped clean up Nike’s image.

The lessons learned by Nike can be applied to Acme Motors’ operation in Nuevo Laredo. The manufacture of automobile engines is not a pollutant-free process, and Acme must take that into consideration as soon as possible. Although Nike was able to utilize low-wage workers for nearly 30 years without worrying about the conditions those workers were toiling under, they eventually were forced to make drastic changes when they came under fire in the early 1990s. Acme would do well to take conditions in and around its Nuevo Laredo plant into consideration long before a public relations disaster occurs.

Boatright, J. (2007). Ethics and the conduct of business, 5th ed. Upper Saddle River, NJ: Pearson Prentice Hall.

New York Times. (1998). Nike reports use of safer solvents. Retrieved September 12, 2008.

Nike, Inc. (1999). Corporate Responsibility. Fiscal year 1999 annual report. Retrieved September 12, 2008.

Parish Maintenance Supply Corp. (n.d.). Volatile organic compounds. Retrieved September 12, 2008.

Trade barriers come in many varieties. They are often overt government policies such as tariffs, quotas, and subsidies. More subtle varieties such as transportation costs also exist. Trade barriers of any kind play a major role in directing international trade.

International trade barriers have a direct impact on the price of imported goods. As barriers are applied, prices tend to rise. Rising prices reduces the quantity of goods purchased by consumers. This results in a negative outcome for local consumers and foreign producers. Both of these groups suffer as less goods are imported and purchased. Consequently, local producers benefit from trade barriers as their goods can be sold at a higher price and enjoy increased profit. In the case of tariffs, the government also benefits from increased revenue (Sawyer & Sprinkle, 2006).

Generally speaking, the import of automobile engines into the U.S. by Acme results in higher priced automobiles. The increased cost of auto engines due to tariffs and sanctions will be reflected in the price of the final product. Since the price of Acme’s automobiles will increase, they will not sell as many. Therefore, Acme must constantly monitor the state of trade barriers and determine if importing auto engines is still a feasible solution (Sawyer & Sprinkle, 2006).

Barriers to trade seem to have a negative impact on the world economy. In every case, the group that loses out the most is the consumer. It seems obvious that free trade would allow jobs to be moved over the border creating unemployment in the country with a comparative disadvantage in labor. Evidence from the aftermath of NAFTA strongly disagrees with this. In fact, it shows that unemployment has not significantly changed since the inception of NAFTA. Also, the real wages of workers has risen significantly in that time (Young, 2005). It would seem that trade barriers pose a real problem to local consumers.

Although trade barriers seem to pose a negative impact on a country’s economy, there are valid reasons to employ them. These reasons are mainly concerned with developing countries trying to increase the productivity of burgeoning local industries. When employed correctly, trade barriers can help to lift up undeveloped industries and give them a chance to compete in the global marketplace. Care must be taken to remove these barriers when the industry is ready. If the barriers are left in place to long, the government runs the risk of crippling the new industry and slowing down its development (Sawyer & Sprinkle, 2006).

Sawyer, W. C., & Sprinkle, R. L. (2006). International economics, 2nd ed. Upper Saddle River, New Jersey: Pearson Prentice Hall.

Young, C. (2005). No significant job or wage loss under NAFTA. Wall Street Journal (Eastern Edition), p. A.19. Retrieved September 6, 2008, from ABI/INFORM Global database. (Document ID: 831871721).

Comparative advantage is the “advantage a nation has by being able to produce products or services more efficiently and at lower cost than a competitor nation” (ENERGEX, n.d.). Without comparative advantage, there would be no reason for international trade. Although this concept is fairly simplistic, the measurement of comparative advantage is no easy matter. Countries and multinational corporations go to great lengths to develop a comparative advantage, or enhance one if it already exists.

All countries are naturally seeking a comparative advantage in trade. The U.S. subsidizes the short run costs of production for tobacco farmers in foreign countries for this reason. Since the U.S. has an abundance, or advantage, in capital, it makes sense to move that capital to capital-scarce countries. In the case of foreign tobacco farmers, they have a labor-rich economy that can benefit from an infusion of capital. The tobacco farmers will see an immediate profit from these investments. The ability to gain immediate access to the means of production, and the guaranteed demand in the U.S., means the tobacco farmers will make money from the beginning. The long-range benefits are slightly decreased since the tobacco farmers will be expected to repay any loans they received, but the result is still beneficial (Sawyer & Sprinkle, 2006).

The flow of capital from trade will influence the cost of labor and goods until equilibrium is reached. The influx of capital into the tobacco growing industry of a foreign country will cause farmers to shift their production to tobacco in search of higher rates of return. The U.S. will continue to shift capital into the foreign country until the rates of return for their investment decrease to a level near that of investing in production domestically. In the foreign country, the cost of tobacco will naturally drop as more of the product becomes available. Conversely, the cost of domestic food items will increase as less is produced. Eventually, the cost of domestic food items will reach a level at which there is no advantage to the farmer in switching from food to tobacco (Sawyer & Sprinkle, 2006).

The international market for food and tobacco will also be affected by the direct investments of the U.S. in foreign tobacco production. The increased availability of tobacco on the market will cause the price for tobacco to drop everywhere, including the U.S. This will be followed by an increase in food prices, as less is available. Similar to the case of price movement in the foreign country, prices will fluctuate until equilibrium is reached (Sawyer & Sprinkle, 2006).

Acme Motors specializes in making Quattro engines at its plant in Nuevo Laredo, Tamaulipas. Rather than produce the entire automobile at this facility, Acme exports the engines to other facilities for inclusion in automobiles. Acme Motors enjoys the comparative advantage of inexpensive labor in Mexico. By specializing in one product at this facility, Acme can ensure the highest rate of return on their investment in the facility. Developing countries often lose highly skilled laborers and professionals to immigration as these individuals seek higher wages in developed countries. Although an automotive engine is a complicated piece of machinery, it is not nearly as technical as the automobile in its entirety. By keeping the production of the Nuevo Laredo facility relatively simple, Acme guarantees a quality product at an inexpensive labor cost (Sawyer & Sprinkle, 2006).

Acme Motors has determined that the best course of action is to assemble engines in Mexico and then ship them to Detroit for final assembly. This international shipping would seem to be a huge cost over assembling the entire automobile in Mexico or Detroit. As previously mentioned, automobile assembly is a highly technical process requiring skilled labor. That labor is readily available in the U.S., albeit at a higher wage. These higher wages mean that foreign laborers have likely immigrated to the U.S. Acme Motors has determined that the cost savings of using cheaper Mexican laborer to assemble the engines outweighs the cost of shipping the engines from Mexico to Detroit (Sawyer & Sprinkle, 2006).

This sort of international trade has a positive impact on consumers. As multinational corporations seek comparative advantages in production, the cost of producing their goods decreases and production increases. This results in an increased supply of the good and lower prices for the consumer. Unfortunately, the flow of capital out of the home country means a tighter economy. As production is shipped over borders, workers in the home country must different jobs. If workers are not easily assimilated into new or different industries, unemployment will rise and there will be less money available for consumers to purchase the cheaper goods (Sawyer & Sprinkle, 2006).

ENERGEX. (n.d.). Glossary. Retrieved September 5, 2008.

Sawyer, W. C., & Sprinkle, R. L. (2006). International economics, 2nd ed. Upper Saddle River, New Jersey: Pearson Prentice Hall.

As these opportunities increase in developing countries, there is a perception in developed countries that their work force is threatened. The fear experienced by most workers is that jobs in developed countries will move to developing countries. Fortunately, these fears are generally not well-founded. As jobs move from developed to developing countries, high-skill and service-oriented jobs appear in developed counties effectively filling the void. Unfortunately, the transition is not perfect and workers in some industries may find it difficult to transition into the new opportunities (IMF Staff, 2000).

The international trading system is not self-regulating. It relies on the World Trade Organization (WTO) to create rules and standards by which countries should trade. Jeffrey J. Schott (1996) describes three areas that present challenges to the WTO and international trade: (1) traditional trade barriers, (2) new forms of protectionism, and (3) regionalism (p. 17). Traditional trade barriers seek to limit trade liberalization and undo any advancements made to increase internation trade. New forms of protectionism are often embedded into domestic policies and must be unraveled to promote trade. Increasing regionalism seeks to diminish support for the WTO and block international trade in favor of inter-regional trade (Schott, 2006). Individually, these challenges are enough to cause concern for members of the international trade community. Together, they present a major threat that must be addressed in order to ensure a healthy market for the entire world.

IMF Staff. (2000). Globalization: Threat or opportunity? Retrieved September 1, 2008.

Schott, J. J., (1996). The World trading system: Challenges ahead. Washington, DC : Institute for International Economics.

Alan Deardorff (2001) defines trade liberalization as the “reduction of tariffs and removal or relaxation of nontariff barriers”. Nontariff barriers to trade include government policies other than tariffs that inhibit trade. The reduction of trade barriers is exactly why NAFTA was adopted. At the time of the agreement, Mexico still employed relatively high tariffs in its trade with the U.S. and Canada (Sawyer & Sprinkle, 2006). For example, the tariff on corn imported into Mexico in 1994 was over 200% (“The Americas”, 2008). Thanks to NAFTA, Mexico has lowered its high tariffs and gained access to increased trade with the U.S. and Canada (Sawyer & Sprinkle, 2006).

Although Mexico has maintained its national sovereignty, its trade policy with the U.S. and Canada has been dictated by NAFTA for the last 14 years. With NAFTA as a guiding principle, Mexico has developed 12 more free-trade agreements with 40 other nations. In fact, 90% of Mexico’s trade is conducted under a free-trade agreement (“Mexico”, 2008). Additionally, acceptance of the free-trade agreement has helped Mexico lock in economic reforms developed in the 1980s. These reforms have led to increased investment and stability (Engardio, Sasseen, Welch, Smith, & Kiley, 2008). Although Mexico obviously maintains its national sovereignty, as a player in the global marketplace, many policies that would normally be the mandate of the government are influenced, or even required, by existing agreements with foreign nations.

One area not addressed by NAFTA is tough labor standards and enforcement. Workers in Mexico do not have the right to form labor unions and bargain collectively. Labor organizers at a Sony plant in Nuevo Laredo were fired to prevent a union from forming. Although the AFL-CIO presented the case to a NAFTA panel, no action was taken. Incidents like this showcase the lack of rights for workers in Mexico. Mexico specializes in industries that benefit most from cheap labor (Engardio et al., 2008). It is quite possible, if not probable, that Mexico is able to maintain such an inexpensive work force because its workers are not guaranteed the same rights as U.S. workers.

The International Monetary Fund (IMF) was formed after World War II to “promote international monetary cooperation and aid countries in maintaining the value of their currencies” (Kunz, 2001, para. 1). In 1994, the IMF was instrumental in bailing Mexico out of a huge financial crisis (Kunz, 2001). The World Trade Organization (WTO) was formed shortly after as a successor to the General Agreement on Tariffs and Trade (GATT). Mexico has used GATT and the WTO in an attempt to circumvent the environmental policies of other nations. For example, in 1991 Mexico complained because a U.S. law banned the import of tuna caught in nets that also entangled dolphins. Although environmental policies like these are meant to protect the environment, they can be perceived as a trade barrier. This trade barrier aspect of the policy is what Mexico was arguing against in its complaint (Babai, 2001).

Since the acceptance of NAFTA, Mexico has experienced tremendous economic development on many fronts. In terms of exports, Mexico’s non-petroleum exports have quadrupled. Farm exports have tripled. Foreign investment from its NAFTA partners has risen 14 times over during this period (“The Americas”, 2008). Even with this staggering growth, Mexico still needs to address several key economic issues including infrastructure upgrades, modernized labor laws, and a privatized energy sector (“Mexico”, 2008).

Despite the opposition in the U.S. and Mexico to NAFTA, it has, in many ways, been a success for all parties. In particular, Mexico has benefited from the increased trade volume with its northern neighbors. In fact, thanks to the increased prices of corn in the U.S., small-scale maize farmers in Mexico are still able to turn a profit in an industry that is becoming increasingly mechanized (“The Americas”, 2008). By understanding the changes Mexico has undergone under this agreement, one can better understand what direction must be taken in the future.

The Americas: Tariffs and tortillas; Mexico and NAFTA. (2008, January). The Economist, 386(8564), 59. Retrieved August 29, 2008, from ABI/INFORM Global database. (Document ID: 1419706511).

Babai, D. (2001). World Trade Organization. The Oxford companion to the politics of the world. Retrieved August 29, 2008.

Deardorff, A. (2001). Deardorff’s glossary of international economics. Retrieved August 29, 2008.

Kunz, D. B. (2001). International Monetary Fund. The Oxford companion to United States history. Retrieved August 29, 2008.

Engardio, P., Sasseen, J., Welch, D., Smith, G., Kiley, D. (2008, March). Refighting NAFTA: This election season, the free-trade deal is taking the blame for huge job losses. But its true effects on workers and competitiveness are far more complicated. Business Week,(4077), 56-59. Retrieved August 29, 2008, from ABI/INFORM Global database. (Document ID: 1452250431).

Mexico: Just the facts. (2008, March 17). Journal of Commerce, Retrieved August 29, 2008, from ABI/INFORM Global database. (Document ID: 1446923541).

Sawyer, W. C., & Sprinkle, R. L. (2006). International economics, 2nd ed. Upper Saddle River, New Jersey: Pearson Prentice Hall.

World Bank Group. (2001). Global development finance 2001. Retrieved August 29, 2008.

Generally speaking, both partners in international trade have something to gain. Generally speaking, Mexico is a country that specializes in inexpensive labor. After NAFTA, the opportunity cost of producing cars in Mexico is reflected in the cost of the cheaper materials that must be imported into the country. Although the increased import of raw materials means that Mexican materials producers will not be able to charge the same pre-NAFTA inflated prices, the increased automotive production of the country will result in an overall growth of Mexico’s Gross Domestic Product (Sawyer & Sprinkle, 2006).

The effect of trade by the U.S. and Mexico will be the opposite for the U.S., but the result, growth, will be the same. Since inexpensive labor is the specialty of Mexico, jobs will be moving out of the United States. The gains from trade of moving production to Mexico will be less expensive automobiles. This would be the result even if labor was the only factor of production (as suggested by the labor theory of value). Since NAFTA has opened trade between the U.S. and Mexico, cheaper raw materials are available to be imported into Mexico for automotive production. The overall benefit to the U.S. is increased imports in the forms of automobiles and increased exports in the form of raw materials (Sawyer & Sprinkle, 2006).

The trade policies of the host country’s government plays a role in the success of a multinational corporation. Trade policies in the form of tariffs affect the cost of materials necessary for production. Although high tariffs have a negative impact on the multinational, they are only truly problematic if they are not stable. In other words, tariffs that are constantly changing present challenges to the multinational including fluctuating prices and instability in the availability of imports the multinational corporation needs (Sawyer & Sprinkle, 2006).

Prior to the NAFTA agreement, it was not efficient for the U.S. to move low-skilled jobs to Mexico. The requirements placed on the automotive industry in regards to import / export levels and the use of domestic resources is an example of the protectionism that makes international trade not work. After the NAFTA agreement, it makes perfect sense for the U.S. to move low-skilled jobs to Mexico. Mexico is able to specialize in low-skilled, inexpensive labor. With the ability to freely move inexpensive raw materials into Mexico, the prices of products exported from Mexico will drop. As the price for the product drops, demand will increase and more units will be sold (Sawyer & Sprinkle, 2006).

Whenever a business begins conducting business in the world economy, questions of ethics will arise. When conducting business in a foreign country, multinational corporations must allow the people of the host country to be involved in decisions that affect them. Assuming the people of the host country have adequate representation in their government, the standards and requirements set by the host government should adequately address these cultural concerns (Boatright, 2007).

Boatright, J. (2007). Ethics and the conduct of business, 5th ed. Upper Saddle River, NJ: Pearson Prentice Hall.

Sawyer, W. C., & Sprinkle, R. L. (2006). International economics, 2nd ed. Upper Saddle River, New Jersey: Pearson Prentice Hall.

The merchandise trade balance is the monetary difference between goods exported and goods imported. If a country imports more goods than it exports, it is said to be running a merchandise trade deficit. This has been the case in the United States since the early 1970s (Sawyer & Sprinkle, 2006). But things really began to pick up in the early 1980s when the U.S. began trading heavily with Japan. In 1984, the merchandise trade deficit nearly tripled its 1982 rate by climbing from $36 billion to $112 billion. Japanese companies were able to trade so successfully with the United States thanks to large subsidies provided to them by the Japanese government (Bown, Crowley, McCulloch, & Nakajima, 2005).

While the merchandise trade balance looks only at goods imported and exported, the current account takes other factors into consideration including goods, services, investment income, and unilateral transfers. The current account balance is the most comprehensive measure of a country’s trade flows. Although it is common to confuse the current account with the merchandise trade balance, there is a difference. For example, in 1980 the U.S. ran a merchandise trade deficit, but still maintained a current account surplus. That being the case, the U.S. has run a current account deficit since the early 1980s (Sawyer & Sprinkle, 2006).

A country’s international investment position reflects capital flows to and from the country. The international investment position reveals the country’s relationship between foreign assets and liabilities. The U.S. international investment position has been declining sharply since the 1980s as a result its current account deficit. This means foreign investors have essentially been loaning the U.S. the money necessary to maintain the excess spending. Although this is not inherently good or bad, it does mean that the U.S. is the largest debtor nation in the world (Sawyer & Sprinkle, 2006).

As a developing country moves from poor to rich, its current account balance moves along with it. When a country has an abundance of labor but a relative scarcity of capital, it must encourage foreign investment in order to grow. This investment creates a financial account surplus resulting in a current account deficit. As the country develops, it begins to pay back the foreign investments. This results in a financial account deficit and current account surplus. Thus, as a county begins sending money overseas in the form of investments, its current account balance rises. As the country pays back its loans, there may be a need for more foreign investments, thus the current account balance once again goes deficit as a financial account surplus is experienced (Sawyer & Sprinkle, 2006).

This example of how the business cycle and current account are related illustrates the relationship between the current account and financial flows. If the current account balance is in deficit, then the financial account must balance with a surplus. Therefore, a deficit in the current account results in more capital being sent out of the country in the form of investments (Sawyer & Sprinkle, 2006).

Total outflows and inflows of money must balance. In other words, for goods to be flowing into the country, money must be flowing out. The reciprocal is also true — incoming money must match outgoing goods. When the U.S. government calculates it’s balance of payments, it knows that incoming plus outgoing must equal zero. Therefore, if there is any issue with the balance of payments, it is likely the result of undercounting exports. Therefore the U.S. has no choice but to mark the issue as a statistical discrepancy (Sawyer & Sprinkle, 2006).

Bown, C., Crowley, M., McCulloch, R., & Nakajima, D. (2005). The U.S. trade deficit: Made in China?. Economic Perspectives, 29(4), 2-18. Retrieved September 25, 2008, from Business Source Elite database.

Sawyer, W. C., & Sprinkle, R. L. (2006). International economics, 2nd ed. Upper Saddle River, New Jersey: Pearson Prentice Hall.