Net exports and capital outflows

– [Instructor] Let’s take a look at our GDP equation for an open economy. So GDP is equal to national income. And that’s going to be
equal to consumption plus investment, plus government spending. And since this is an open
economy, plus net exports. Now, the first thing I want to do is let’s solve for net exports. So I’m gonna subtract all of
this stuff from both sides. So I could get national
income minus consumption, minus government spending,
minus investment, is equal to the next exports. This is just a manipulation
of what we just saw. Now, what is national
income minus consumption, minus government spending? Well, this right over
here is national savings. This is S. So another way we can think about it is national savings minus investment is equal to net exports. So let’s use this to
think about capital flows. So first of all, let’s just make sure we know what a capital flow is. So let’s think about a capital inflow. What does that mean? That means that foreigners
are taking capital and taking it into our country
to buy assets in our country. And then outflow, that
means that residents of our country are taking
capital out of the country and buying foreign assets. And so do you think our
savings minus our investment is going to be a capital
inflow or a capital outflow? Well, we’ve saved a bunch of stuff, and we are spending some
of it on investment. And so what do we do with the rest of it? Well, it’s gonna have to
go outside of the country. Because if it was being
invested inside the country, it would be in this I right over here. And so this is a net
capital, capital outflow. And you’ll sometimes see
this abbreviated NCO. And so that sets up the identity that net capital outflows
are equal to net exports. Let me just right it again for emphasis. Net capital outflows are
equal to net exports. Now, why does this make sense? Well, let’s say net exports are positive. That means more foreigners
are buying our goods than we are buying their goods. Now how are they going
to pay for those goods? Well, they’re going to have
to pay for those goods, and we’re not going to go into the details of currency exchange and all of that, but one way to think about
how they pay for those goods is that they need to
sell their foreign assets to folks in our country. So if it’s folks in our country who are buying foreign assets so that the foreigners can buy our goods, that would be a net capital
outflow from our point of view. So hopefully that makes intuitive sense. Now, another way to think about this is we could rearrange this equation where if we subtract net
exports from both sides and then add investment to both sides, we could get national savings minus net exports, minus net exports, is equal to investment. Now, if net exports is equal
to net capital outflows, what would be the negative
of net exports be? Well, this would be net capital inflows. So we could set up another equation. And these are all fairly
straightforward algebra, but they give us a little bit of intuition of how to think about
these different levers. So we could say savings plus,
I’ll write the word out, net capital inflow is equal to investment. Is equal to investment. And think about why this makes sense. If we have investment in our country, maybe we’re building factories,
we’re building roads, where is the capital for
that investment coming? It’s either coming from domestic savings, national savings right over here, or it’s coming from foreigners bringing capital into our country which can be used for investment. So I will leave you there. The big takeaway is is
we can just manipulate the GDP equation for an open economy here to get to this notion
that net capital outflows are equal to net exports. Or that the negative of net exports, which would be net imports, is equal to net capital inflows. And hopefully this makes
some intuitive sense.

12 thoughts on “Net exports and capital outflows

  1. tysm I was confused for so long why NCO was equal to NX cause I was thinking we would have more inflows of capital since they are buying our goods. Thanks for clearing it up!

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