A Trade TheoristÕs Take on Global Imbalance

This paper uses simple trade theory to interpret global imbalance. A world equilibrium in which one country runs a trade surplus and the other a deficit can be interpreted as the welfare improving outcome of free inter-temporal trade. However, comparative advantage would predict that the surplus would arise in the more slowly growing economy, unless consumer preferences differ sufficiently to reverse that. In order to explain the apparent situation of the United States and China in the world today without resorting to such differences in preferences, the paper suggests that both countries may be using policies that, in effect, subsidize the export of the goods in which they have comparative inter-temporal disadvantage. If this is the case, the resulting trade reduces world welfare compared to autarky, and it can easily make both countries worse off.