Net Exports Equal Net Foreign Investment - Online Tutor, Practice Problems & Exam Prep

When a country imports more than it exports, it must finance the difference through net foreign investment, which can come from selling assets or borrowing. This investment is categorized into foreign direct investment (physical assets) and foreign portfolio investment (financial assets). Net exports equal net foreign investment, reflecting the balance between exports and imports. For example, selling a surfboard abroad increases net exports, while using the proceeds to buy a foreign bond increases net foreign investment, illustrating the interconnectedness of global trade and finance.

Net Exports Equal Net Foreign Investment

So, when you go on a spending spree, you're going to need to finance that, right? If you're spending more than your salary, you go out there and you buy a new car, you buy a new house, you're going to need to borrow some money. The same thing happens on a macroeconomic scale for countries. Okay? Let's see how that works. So let's think about the relationship here between net exports and Net Foreign Investment. So on a macroeconomic scale when we think about this, we think about countries that are importing more than they export, right? So, they're bringing in more stuff. They're buying stuff from other countries but they're not selling that much stuff to other countries, right? They're importing stuff but not exporting. So they're going to have to finance these extra purchases, right? They're going to have to make up the difference between these exports and these imports. And the financing comes from 1 of 2 places, right? So it's the same thing as you. If you go and you buy this new car and you've got to make these car payments, you might sell your Nintendo, you sell your guitar to be able to make the payments, right? You'll sell some assets to be able to make the payment or you borrow money. You just borrow money. So that's the same thing for countries. The country can sell their assets such as land or factories to foreigners, right? So now, it's the foreigners who we need to make up this difference to or they can borrow from foreigners as well, right? Remember, we're trying to make up this difference between our imports and our exports. So this money has to come in from overseas. So we break this up into 2 categories. We call what's called foreign direct investment physical capital, right? Buy domestic citizen in a foreign country or by a foreigner in a domestic domestically. This is physical capital. So we're thinking about something like Pizza Hut. A US company builds a restaurant in Romania. Right? They now own a restaurant in Romania. So we're thinking about physical capital like something physically there like a building, something like that. Compare that to foreign portfolio investment. So, and this happens both ways, right? This can be BMW building a factory in the US, right? BMW being a foreign country foreign company building something in the US or a US citizen building something overseas. Where foreign portfolio investment, well, this is financial assets by purchase of a financial asset by domestic citizen in a foreign country or vice versa. So Johnny America buys stock in Telmex, a Mexican telecommunications corporation, right? Now, a US citizen is buying a financial investment in a foreign country, Okay? So those are, that's the 2 ways we break it up is the direct investment of physical capital like land or factories and then the portfolio investment when it comes to buying stocks or bonds, okay? So when we think about net foreign investment, right? The net foreign investment, this is that difference we're trying to make up between exports and imports. It's the difference between these two things. So, the foreign assets bought by US citizens such as this Pizza Hut building a restaurant in Romania or Johnny America buying these stock in Telmex and then the opposite, right? When some foreign company like the BMW building the factory in the US or some foreign citizen buying US stock or US bonds, something like that. Okay? So the difference between those two is our net foreign investment. So what we're going to see here is that net exports has to equal net foreign investment because of this balance. The difference between the exports and the imports needs to be made up through this foreign investment, okay? So let's see how this works in an example. So we've got Marco Saltlife, a US citizen shapes surfboards. He sells a surfboard to a customer in Japan for 10,000 yen. Okay. So he sold this surfboard in Japan for yen. So he didn't receive dollars, he received yen. So the sale of the surfboard, well, what does this do to net exports? We sold a surfboard, we exported a surfboard. So we increase net exports, right? Because a US citizen sold something overseas, that is an export. It increases net exports. And then the yen that Marco got, it increases net foreign investment. Right? Because now he owns yen. Marco acquired a foreign asset, right? So in this case, what he acquired is the yen itself. The yen itself is a foreign investment because he's not holding dollars anymore, a U. S. Asset. He's holding a foreign asset which are yen. He is using his income, so the money he earned, by shaping a surfboard and selling it to invest in yen at this point, right? He bought, he sold it in yen instead of selling it in dollars, so he invested in yen. He expects this yen to hold its value. Now, let's take it a step further. Suppose that Marco decides to use his 10,000 yen to purchase a Japanese bond investment, okay? So now, instead of holding yen, he's going to use that yen to buy an investment increases our net exports while the purchase of the bond increases our net foreign investment, right? Because this is the same thing. He's made a portfolio investment. He's bought Japanese bond right here. This Japanese bond is a foreign asset owned by now a U. S. Citizen, Marco. Okay? Now, finally is the last one is where Marco yen 10,000 to instead purchase the latest Nintendo system, right? So now instead of buying a bond, he took that 10,000 yen and bought a Nintendo. Well, now the sale of the surfboard increases net exports still, right? But what happens with the purchase of the Nintendo? Now, a US citizen is purchasing a foreign asset, right? He's or excuse me, purchasing a foreign good, right? This isn't a long term asset anymore. He's buying a good and importing it to the US. So this decreases our net exports. So it kinda washes out in this case. He exported something worth 10,000 and then imported something worth 10,000. So there was a net 0 in that case. However, in all cases, the net exports equals the net foreign investment even in this last one because it was just a 0, right? There was no net foreign investment. There was just an increase in net exports and a decrease in net exports. Okay? So in all cases, what we're seeing is that any sale of a good overseas increases the net foreign investment, right? And this happens on, we had studied one transaction here, but it expands to the whole economy. If we imported something, well now a foreigner is holding US dollars and they've invested in US dollars in their portfolio there, okay? So our net exports is always going to equal that net foreign investment because of making up that difference, right? When we export something, well, now we're holding a foreign asset in return for that export. Cool? Alright. Let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What is the relationship between net exports and net foreign investment?

Net exports and net foreign investment are intrinsically linked. When a country exports more than it imports, it accumulates foreign assets, increasing its net foreign investment. Conversely, if a country imports more than it exports, it must finance this deficit by either selling domestic assets to foreigners or borrowing from them, which also affects net foreign investment. Essentially, the balance between a country's exports and imports is mirrored in its net foreign investment. This relationship ensures that any trade surplus or deficit is offset by corresponding financial flows, maintaining equilibrium in the international financial system.

How do countries finance a trade deficit?

Countries finance a trade deficit, where imports exceed exports, through net foreign investment. This can be achieved in two primary ways: selling domestic assets to foreign investors or borrowing from foreign entities. Selling assets might involve foreign direct investment, such as selling land or factories, or foreign portfolio investment, like selling stocks or bonds. Borrowing can take the form of loans from foreign banks or issuing government bonds purchased by foreign investors. These financial inflows help balance the deficit by providing the necessary funds to pay for the excess imports.

What is the difference between foreign direct investment and foreign portfolio investment?

Foreign direct investment (FDI) involves acquiring physical assets, such as land, factories, or businesses, in a foreign country. For example, a U.S. company building a factory in China is an FDI. In contrast, foreign portfolio investment (FPI) involves purchasing financial assets, such as stocks or bonds, in a foreign country. An example of FPI is a U.S. investor buying shares in a Japanese company. FDI typically implies a long-term interest and control over the asset, while FPI is more about financial returns and can be more easily liquidated.

How does selling a product abroad affect net exports and net foreign investment?

Selling a product abroad increases net exports because it counts as an export, adding to the total value of goods and services sold internationally. The proceeds from this sale, if held in foreign currency or used to purchase foreign assets, increase net foreign investment. For instance, if a U.S. company sells a surfboard to Japan and receives yen, the net exports rise. If the company then uses the yen to buy a Japanese bond, it increases net foreign investment, illustrating the interconnectedness of trade and financial flows.

Why must net exports equal net foreign investment?

Net exports must equal net foreign investment to maintain the balance of payments equilibrium. When a country exports more than it imports, it accumulates foreign assets, increasing net foreign investment. Conversely, if it imports more than it exports, it must finance this deficit by selling domestic assets or borrowing from abroad, which also affects net foreign investment. This equality ensures that any trade surplus or deficit is offset by corresponding financial flows, maintaining the overall balance in the international financial system.