In a Conversation with Possum Part 1, I used the Accounting Identity for a closed system as if Australia for example was isolated from international trade and did not have open trade with other nations which as we all know it does. Even when the Identity is extended to include trade, it does not subtract from the argument I made. The only difference it makes is where I stated “private sector” in part 1, it should now be read as the non-government sector (private sector + foreign sector). I continue to use this shorthand of “private sector” in the remainder of the series.
For open economies (i.e. individual trading nations), the analysis can be extended to include external sources of revenue and expenditure. The accounting identity becomes:
(G – T) = (S – I) – NX
Here, NX denotes net exports (exports minus imports). In words, we have:
Budget Deficit = Net Private Saving – Net Exports
If we rearrange this expression, it becomes clear that there are now two possible sources of private domestic saving:
Budget Deficit + Net Exports = Net Private Saving
If domestic citizens sell more goods and services to foreigners than they buy in return, export revenue will exceed import spending and there will be a build up of financial assets. So, in an open economy, private net saving can come either from government deficit expenditure or net exports.
In many countries though, net exports are typically negative, which means the external sector subtracts from net private saving. This leaves the budget deficit as the only source of net private saving. For trade deficit countries such as the US, in other words, it is impossible for the private sector to net save (in aggregate) unless the government runs a budget deficit.