Balance of trade


Balance of trade is the difference between the monetary value of a nation's exports and imports of goods over a certain time period. Sometimes, trade in services is also included in the balance of trade but the official IMF definition only considers goods. The balance of trade measures a flow variable of exports and imports over a given period of time. The notion of the balance of trade does not mean that exports and imports are "in balance" with each other.
If a country exports a greater value than it imports, it has a trade surplus or positive trade balance, and conversely, if a country imports a greater value than it exports, it has a trade deficit or negative trade balance. As of 2016, about 60 out of 200 countries have a trade surplus. The world's largest trade surpluses are held by China, Germany, and Singapore, while the largest trade deficits are held by the United States, United Kingdom, and India.
Economists reject the idea that a trade deficit is detrimental to a nation's economy, and the idea that a bilateral trade deficit is inherently bad.

Explanation

The balance of trade forms part of the current account, which includes other transactions such as income from the net international investment position as well as international aid. If the current account is in surplus, the country's net international asset position increases correspondingly. Equally, a deficit decreases the net international asset position.
The trade balance is identical to the difference between a country's output and its domestic demand.
Measuring the balance of trade can be problematic because of problems with recording and collecting data. As an illustration of this problem, when official data for all the world's countries are added up, exports exceed imports by almost 1%; it appears the world is running a positive balance of trade with itself. This cannot be true, because all transactions involve an equal credit or debit in the account of each nation. The discrepancy is widely believed to be explained by transactions intended to launder money or evade taxes, smuggling and other visibility problems. While the accuracy of developing countries' statistics would be suspicious, most of the discrepancy actually occurs between developed countries of trusted statistics.
Factors that can affect the balance of trade include:
  • The cost of production in the exporting economy vis-à-vis those in the importing economy;
  • The cost and availability of raw materials, intermediate goods and other inputs;
  • Currency exchange rate movements;
  • Multilateral, bilateral and unilateral taxes or restrictions on trade;
  • Non-tariff barriers such as environmental, health or safety standards;
  • The availability of adequate foreign exchange with which to pay for imports; and
  • Prices of goods manufactured at home
In addition, the trade balance is likely to differ across the business cycle. In export-led growth, the balance of trade will shift towards exports during an economic expansion. However, with domestic demand-led growth the trade balance will shift towards imports at the same stage in the business cycle.
The monetary balance of trade is different from the physical balance of trade. Developed countries usually import a substantial amount of raw materials from developing countries. Typically, these imported materials are transformed into finished products and might be exported after adding value. Financial trade balance statistics conceal material flow. Most developed countries have a large physical trade deficit because they consume more raw materials than they produce.

Examples

Historical example

Many countries in early modern Europe adopted a policy of mercantilism, which theorized that a trade surplus was beneficial to a country. Mercantilist ideas also influenced how European nations regulated trade policies with their colonies, promoting the idea that natural resources and cash crops should be exported to Europe, with processed goods being exported back to the colonies in return. Ideas such as bullionism spurred the popularity of mercantilism in European governments.
An early statement concerning the balance of trade appeared in Discourse of the Common Wealth of this Realm of England, 1549: "We must always take heed that we buy no more from strangers than we sell them, for so should we impoverish ourselves and enrich them." Similarly, a systematic and coherent explanation of balance of trade was made public through Thomas Mun's 1630 "England's treasure by foreign trade, or, The balance of our foreign trade is the rule of our treasure".
Since the mid-1980s, the United States has had a growing deficit in tradeable goods, especially with Asian nations which now hold large sums of U.S. debt that has in part funded the consumption. The U.S. has a trade surplus with nations such as Australia. The issue of trade deficits can be complex. Trade deficits generated in tradeable goods such as manufactured goods or software may impact domestic employment to different degrees than do trade deficits in raw materials.
Economies that have savings surpluses, such as Japan and Germany, typically run trade surpluses. China, a high-growth economy, has tended to run trade surpluses. A higher savings rate generally corresponds to a trade surplus. Correspondingly, the U.S. with its lower savings rate has tended to run high trade deficits, especially with Asian nations.
Some have said that China pursues a mercantilist economic policy. Russia pursues a policy based on protectionism, according to which international trade is not a win–win game but a zero-sum game: surplus countries get richer at the expense of deficit countries.

Views on economic impact

The notion that bilateral trade deficits are bad in and of themselves is overwhelmingly rejected by trade experts and economists. According to the IMF trade deficits can cause a balance of payments problem, which can affect foreign exchange shortages and hurt countries. On the other hand, Joseph Stiglitz points out that countries running surpluses exert a "negative externality" on trading partners, and pose a threat to global prosperity, far more than those in deficit. Ben Bernanke argues that "persistent imbalances within the euro zone are... unhealthy, as they lead to financial imbalances as well as to unbalanced growth. The fact that Germany is selling so much more than it is buying redirects demand from its neighbors, reducing output and employment outside Germany." According to Carla Norrlöf, there are three main benefits to trade deficits for the United States:
  1. Greater consumption than production: the US enjoys the better side of the bargain by being able to consume more than it produces
  2. Usage of efficiently produced foreign-made intermediate goods is productivity-enhancing for US firms: the US makes the most effective use of the global division of labor
  3. A large market that other countries are reliant on for exports enhances American bargaining power in trade negotiations
A 2018 National Bureau of Economic Research paper by economists at the International Monetary Fund and University of California, Berkeley, found in a study of 151 countries over 1963–2014 that the imposition of tariffs had little effect on the trade balance.

Classical theory

Adam Smith on the balance of trade

Keynesian theory

In the last few years of his life, John Maynard Keynes was much preoccupied with the question of balance in international trade. He was the leader of the British delegation to the United Nations Monetary and Financial Conference in 1944 that established the Bretton Woods system of international currency management.
He was the principal author of a proposal – the so-called Keynes Plan – for an International Clearing Union. The two governing principles of the plan were that the problem of settling outstanding balances should be solved by "creating" additional "international money", and that debtor and creditor should be treated almost alike as disturbers of equilibrium. In the event, though, the plans were rejected, in part because "American opinion was naturally reluctant to accept the principle of equality of treatment so novel in debtor-creditor relationships".
The new system is not founded on free-trade but rather on the regulation of international trade, in order to eliminate trade imbalances: the nations with a surplus would have a powerful incentive to get rid of it, and in doing so they would automatically clear other nations' deficits. He proposed a global bank that would issue its own currency – the bancor – which was exchangeable with national currencies at fixed rates of exchange and would become the unit of account between nations, which means it would be used to measure a country's trade deficit or trade surplus. Every country would have an overdraft facility in its bancor account at the International Clearing Union. He pointed out that surpluses lead to weak global aggregate demand – countries running surpluses exert a "negative externality" on trading partners, and posed far more than those in deficit, a threat to global prosperity.
In "National Self-Sufficiency" The Yale Review, Vol. 22, no. 4 , he already highlighted the problems created by free trade.
His view, supported by many economists and commentators at the time, was that creditor nations may be just as responsible as debtor nations for disequilibrium in exchanges and that both should be under an obligation to bring trade back into a state of balance. Failure for them to do so could have serious consequences. In the words of Geoffrey Crowther, then editor of The Economist, "If the economic relationships between nations are not, by one means or another, brought fairly close to balance, then there is no set of financial arrangements that can rescue the world from the impoverishing results of chaos."
These ideas were informed by events prior to the Great Depression when – in the opinion of Keynes and others – international lending, primarily by the U.S., exceeded the capacity of sound investment and so got diverted into non-productive and speculative uses, which in turn invited default and a sudden stop to the process of lending.
Influenced by Keynes, economics texts in the immediate post-war period put a significant emphasis on balance in trade. For example, the second edition of the popular introductory textbook, An Outline of Money, devoted the last three of its ten chapters to questions of foreign exchange management and in particular the 'problem of balance'. However, in more recent years, since the end of the Bretton Woods system in 1971, with the increasing influence of monetarist schools of thought in the 1980s, and particularly in the face of large sustained trade imbalances, these concerns – and particularly concerns about the destabilising effects of large trade surpluses – have largely disappeared from mainstream economics discourse and Keynes' insights have slipped from view.