Balance of Trade: Favorable Versus Unfavorable
The Danger When Imports Exceed Imports
The balance of trade is the value of a country's exports minus its imports. It's the biggest component of the balance of payments that measures all international transactions. It's easy to measure since all goods and many services pass through the customs office.
The trade balance is also the biggest part of the current account. It measures a country's net income earned on international assets. It's the trade balance plus any other payments across borders.
- A positive trade balance (surplus) is when exports exceed imports.
- A negative trade balance (deficit) is when exports are less than imports.
- Use the balance of trade to compare a country’s economy to its trading partners.
- A trade surplus is harmful only when the government uses protectionism.
- A trade deficit is beneficial in the short-term for countries that must import heavily as an investment in economic development.
How to Calculate It
A country's trade balance equals the value of its exports minus its imports.
The formula is X - M = TB, where:
X = Exports
M = Imports
TB = Trade Balance
Exports are goods or services made domestically and sold to a foreigner. That includes a pair of jeans you mail to a friend overseas. It could also be signage a corporate headquarter transfers to its foreign office. If the foreigner pays for it, then it's an export.
Imports are goods and services bought by a country's residents but made in a foreign country. It includes souvenirs purchased by tourists traveling abroad. Services provided while traveling, such as transportation, hotels, and meals, are also imports. It doesn't matter whether the company that makes the good or service is a domestic or foreign company. If it was purchased or made in a foreign country, it's an import.
When a country's exports are greater than its imports, it has a trade surplus. Most nations prefer this favorable trade balance. When exports are less than imports, it creates a trade deficit. Most countries try to avoid such an unfavorable trade balance. Sometimes a favorable trade balance, or surplus, is not in the country's best interests. For example, an emerging market should import to invest in its infrastructure. It can run a deficit for a short period with this goal in mind.
Favorable Trade Balance
Most countries create trade policies that encourage a trade surplus. It's like making a profit as a country. Nations prefer to sell more products and receive more capital for their residents. That translates into a higher standard of living. Their companies also gain a competitive advantage in expertise by producing all the exports. They hire more workers, reduce unemployment, and generate more income.
To maintain this favorable trade balance, leaders often resort to trade protectionism. They protect domestic industries by levying tariffs, quotas, or subsidies on imports. That doesn’t work for long. Soon other countries retaliate with their protectionist measures. A trade war reduces international trade for all nations.
Unfavorable Trade Balance
Most of the time, trade deficits are an unfavorable balance of trade. As a rule, countries with trade deficits export raw materials. They import a lot of consumer products. Their domestic businesses don't gain the experience needed to make value-added products. Their economies become dependent on global commodity prices. Such a strategy also depletes their natural resources in the long run.
Some countries are so opposed to trade deficits that they adopt mercantilism. This is an extreme form of economic nationalism that says remove the trade deficit at all costs. It advocates protectionist measures such as tariffs and import quotas. Although these measures can reduce the deficit, they also raise consumer prices. Worst of all, they trigger reactionary protectionism from the nation's trade partners. It lowers international trade, and economic growth, for everyone involved.
Difference Between Trade Balance and Balance of Payments
The balance of trade is the most significant component of the balance of payments. The balance of payments adds international investments plus net income made on those investments to the trade balance.
A country can run a trade deficit, but still have a surplus in its balance of payments. A large surplus in investments could offset a trade deficit. That can only occur if the financial account runs a huge surplus. For example, foreigners could invest heavily in a country's assets. They could buy real estate, own oil drilling operations, or invest in local businesses.
The capital account records assets that produce future income, such as copyrights. As a result, it would rarely run a surplus large enough to offset a trade deficit.
How the Trade Balance Fits Into the Balance of Payments
Balance of Payments
- Current Account
- Capital Account
- Financial Account