Net Exports Equal Net Foreign Investment: Videos & Practice Problems

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.

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.

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.

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.

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.