According to economic theory, fast-growing countries should be running
[ Select ]
trade surpluses
trade deficits
balanced trade accounts
, but the evidence suggests that in some of the fastest-growing countries
[ Select ]
the permanent-income hypothesis holds and people smooth their consumption
people and governments save more than they invest
governments borrow heavily from the rest of the world
.

Question

According to economic theory, fast-growing countries should be running 
[ Select ]
trade surpluses
trade deficits
balanced trade accounts
 , but the evidence suggests that in some of the fastest-growing countries 
[ Select ]
the permanent-income hypothesis holds and people smooth their consumption
people and governments save more than they invest
governments borrow heavily from the rest of the world
 .

BlackTom AI · Accepted Answer

The question examines two linked ideas from economic theory about fast-growing economies and what the empirical evidence shows.
First consideration for the initial blank: what should fast-growing countries be running in theory? One common expectation is that rapid expansion is associated with higher imports as domestic demand and investment rise, which tends to yield a trade deficit rather than a surplus. 
Option A: trade surpluses. This would imply exports consistently exceed imports, which is less consistent with the typical pattern of accelerating demand and investment in fast-growing economies that often borrow or import capital goods. So this is less plausible as the general theoretical expectation.
Option B: trade deficits. This aligns with the intuition that rapid growth involves growing imports for capital goods, technology, and consumer goods, often outpacing exports in the growth phase. If imports outpace exports, the country runs a trade deficit.
Option C: balanced trade accounts. While some economies maintain near-balance, the standard theory of rapid growth does not require perfect balance, and empirical patterns frequently show deficits or surpluses depending on financing and investment flows. So this option is not the textbook expectation.

Second consideration for the second blank: what does evidence suggest about fastest-growing countries and consumption-saving behavior? The alternative pairs describe different implications for saving and investment behavior by private individuals and the government.
Option A: the permanent-income hypothesis holds and people smooth their consumption. This is a classical theory about consumption smoothing over time in response to income changes, but it doesn’t directly address the macro pattern of deficits or financing behavior in fast-growth episodes. It’s a plausible micro-level mechanism, but not the clearest macro-empirical statement accompanying growth episodes.
Option B: people and governments save more than they invest. If saving exceeds investment, the economy tends to lend abroad or accumulate claims, which can be observed in fast-growing countries where fiscal or current account dynamics involve saving levels that exceed investment. This pairing matches the empirical observation that surges in saving can accompany rapid growth, sometimes financed by external borrowing or by capital inflows while saving behavior remains robust.
Option C: governments borrow heavily from the rest of the world. While governments in fast-growth contexts may borrow, the description “governments borrow heavily” emphasizes financing patterns rather than the broader saving/investment balance. It is not as direct a general statement about the typical empirical pattern as the saving-versus-investment angle, and it could misrepresent cases where private saving dominates.

Putting the pieces together, the two blanks are best filled with: the first being trade deficits, and the second being that people and governments save more than they invest. The combination describes a macro pattern in many fast-growers: imports outpace exports, and saving behavior (across private and public sectors) exceeds investment, shaping external accounts and long-run sustainability.

FA25 ECON 302 002 Final Exam

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