Balance of Trade
What is Balance of Trade?
The balance of trade is a country's exports minus its imports over a period, a surplus when exports are larger and a deficit when imports are larger.
The balance of trade is usually the largest single component of the current account, and it moves with relative prices, national income and the exchange rate. When domestic income rises, households and firms buy more of everything including foreign goods, so imports climb and the balance shifts toward deficit; when the currency depreciates, exports become cheaper to foreigners and imports dearer at home, so the balance tends to shift toward surplus. That second effect is not automatic: it improves the balance only if buyers respond enough to the price change, the Marshall-Lerner condition, and in the short run quantities are locked into contracts while import prices move immediately, so the balance often worsens first and improves later, the pattern known as the J-curve. A deficit also has an accounting counterpart: a country running one is absorbing more goods and services than it produces, and the gap is financed by a net inflow of foreign funds. That is why a deficit is not by itself evidence of a weak economy, since fast-growing countries with heavy investment routinely run one.
Balance of Trade: a worked example
A country exports $420 billion of goods and services in a year and imports $505 billion. Its balance of trade is $420 billion - $505 billion = -$85 billion, a deficit of $85 billion. With GDP of $1.7 trillion, the deficit is 85 / 1,700 = 0.05, or 5 percent of output. The next year exports rise to $460 billion and imports to $510 billion, giving a balance of -$50 billion. The country still runs a deficit, but it has narrowed by $35 billion, and that narrowing is what shows up as a positive contribution of net exports to GDP growth.
The mistake students make with balance of trade
Students read a trade deficit as money leaving the country or as national debt being run up. Neither is right: the dollars spent on imports come back as foreign purchases of domestic assets, so a current account deficit is matched by a net inflow on the financial account and the balance of payments sums to zero apart from measurement error. The second error is treating the balance of trade and the current account as the same number. The trade balance covers goods and services only, while the current account adds net income earned on foreign investments and net transfers such as remittances and aid.
Balance of Trade questions
What is the difference between the balance of trade and the current account?
The balance of trade counts only exports and imports of goods and services. The current account adds two more pieces: net primary income, meaning wages and investment income earned abroad minus what foreigners earn domestically, and net secondary income, meaning transfers such as remittances and foreign aid. The trade balance is normally the biggest part of the current account, so the two move together, but they are not equal and can even have opposite signs for countries with large overseas earnings.
Is a trade deficit bad for an economy?
Not by itself, because what matters is what the deficit finances. A deficit means the country is consuming and investing more than it produces, with the difference funded by foreign capital, and if that capital builds productive assets it can raise future income enough to service the foreign claims. Deficits also widen during booms simply because rising income pulls in imports. The concern is a persistent deficit that funds consumption, since the foreign claims still have to be paid and the currency may eventually have to fall.
How does a weaker currency change the balance of trade?
A depreciation makes domestic goods cheaper in foreign currency and foreign goods more expensive at home, so export volumes tend to rise and import volumes to fall, improving the balance. The improvement requires demand to be responsive enough to price, which is the Marshall-Lerner condition that the export and import demand elasticities sum to more than one. In the first months the balance usually gets worse instead, because contracted quantities cannot change yet while the higher price of each imported unit takes effect at once.
Formula / Example
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