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Economist Paul Krugman said this in a 1993 journal paper:

The last 15 years have been a golden age of innovation in international economics. must somewhat depressingly conclude, however, that this innovative stuff is not a priority for today's undergraduates. In the last decade of the 20th century, the essential things to teach students are still the insights of Hume and Ricardo. That is, we need to teach them that trade deficits are self-correcting and that the benefits of trade do not depend on a country having an absolute advantage over its rivals. If we can teach undergrads to wince when they hear some. one talk about "competitiveness,” we will have done our nation a great service.

Now Ricardo showed that the benefits of trade depend on comparative advantage and not absolute advantage. But I’m interested in the part in bold.

My question is, was it Hume or Ricardo who showed that trade deficits are self-correcting? And how did they do this?

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Hume's argument was that when country runs trade surplus the country's currency will have to appreciate through accumulation of specie (Hume worked within gold standard but the same argument can be transplanted to fiat money since trade surplus increases demand for the home country currency).

In turn accumulation of specie (or in modern fiat system higher forex demand) leads to increase prices of country's goods on world markets, which means that other countries will now be much more competitive vis-à-vis home. Hence, eventually trade surpluses are self correcting because no matter how good country is at producing something at some point the trade surplus will lead to such a appreciation of its currency that eventually foreign suppliers will become competitive. The argument was presented in his essay Of the Balance of Trade (1752).

Ricardo had some similar but more complex arguments. You can read the details about the Ricardian approach to balance of trade in Kojima 1951, but if you are layman you will find Of the Balance of Trade more accessible.

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  • $\begingroup$ Interesting historical answer. It seems to me that we don't need to hypothesize a currency appreciation of the trade surplus country. Whatever the trade surplus country accumulates, it's something that is convertible to goods and services in the future. Since they want those future benefits there will be a trade deficit in the indefinite future. Anyway the trade deficit is a unsatisfactory concept. If I import a production machine, it increases the trade deficit. However, the machine has future benefits like a government bond. Why is the trade deficit a useful concept? $\endgroup$
    – H2ONaCl
    Jun 17, 2023 at 7:45
  • $\begingroup$ @H2ONaCl 1. but country could just decide to run permanent surplus (e.g. like what mercantilists advocated) so currency appreciation is actually necessary to force self-correction in long run. 2. Trade deficit or balance of trade in general is still a useful concept to measure trade flows which are included in open-economy DSGE models or other important models. Just because its not measuring something people need to be concerned about does not mean its not useful. $\endgroup$
    – 1muflon1
    Jun 17, 2023 at 9:16

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