Balance of payments problems are not (just) about trade

As someone who spent a long time working in trade and industrialization, I grew up with the view that comparative advantage is everything. If our exports of a particular good, say computers, are small or even net imports, it means we are not good at making that product. In other words, Indonesia’s comparative advantage is not in computers. As a result, we tend to treat exports as the key indicator of our industrial prowess.

Of course, this is not wrong. Comparative advantage is indeed a very powerful reason to trade, and the main reason why 9 out of 10 doors of fortune lie in commerce, heh. It is also why I became a lecturer rather than some other profession: I can afford more rice by working as a lecturer than by being a farmer. I hope the government can better appreciate something as simple as comparative advantage.

But the models that explain comparative advantage come with their own assumptions, which may not hold in the real world. As a master’s graduate in economics at the time, this was obviously something I understood, but my grasp was insufficient to connect it to the broader macroeconomy. I only truly got it after following Michael Pettis from Peking University. Prof. Pettis explains it using an extremely basic concept: the accounting identity. Simple arithmetic that we all learned in undergrad: the infamous $Y=C+I+G+(X-M)$.

The key point is that the current account, or balance of payments, must always balance. If it runs a surplus or deficit, it will be offset by the financial account. In other words, if there is an imbalance in the financial account, the current account will adjust to balance it out.

One of the assumptions in the most primitive comparative advantage model (by which I of course mean the Ricardian model, the first one you learn in undergraduate international economics) is that current account = 0. In other words, in that model, exports = imports, which implies saving = investment.

From Pettis (2013)¹