Friday, June 4, 2010

Spain’s trade deficit and real estate

There’s been a lot of talk lately about how Spain runs a large deficit with the rest of Europe and how this is unsustainable.

Something that is missed is that the way the trade deficit is accounted for may not actual mean that deficit = bad.

Here’s an example:

Mr Catalan, Oriol Pujol builds a house in Lloret de Mar, which costs him 80,000 euros to build. He sells it to Mr Germany, Hans Schmidt for 120,000 euro, and buys a shiny new German BMW with his 40,000 euro profit.

Seems like things have balanced out, right?

Nope.

From a trade deficit accounting perspective, Hans Schmidt’s purchase counts as an investment, so it ends up on the deficit side.

After this transaction has completed, Catalunya ends up with a 120,000 (German investment) + 40,000 (purchase of German good) = 160,000 euro deficit.

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