Trade Deficit: Definition, Causes, Effects, Role in BoP

China's 2014 Economic Growth Probable To Reach 7.5 Percent
Shipments from China headed to U.S. Photo: ChinaFotoPress/Getty Images

Definition: A trade deficit is when a country imports more than it exports. It is also called a negative balance of trade. It is one way of measuring international trade. To calculate the trade deficit, subtract the total value of exports from the total value of imports.

What Causes a Trade Deficit?

A trade deficit occurs when a country does not produce all it needs. Most nations must borrow from foreign states to pay for the imports.

Therefore, a country with a trade deficit will also have a current account deficit.

A trade deficit also results when domestic companies manufacture in foreign countries. When raw materials are shipped overseas to factories, they count as exports. When the finished goods are shipped back home, they count as imports. That's true even though they're made by domestic companies. The imports are subtracted from the country's gross domestic product. That's despite the fact the earnings benefit the company's stock price and the taxes increase the country's revenue stream.

Effects of a Trade Deficit

Initially, a trade deficit is not a bad thing. It raises a country's standard of living. Its residents have access to a wider variety of goods and services for a more competitive price. It reduces the threat of inflation, since it creates lower prices. A trade deficit indicates that the country's residents are feeling confident and wealthy enough to buy more than the country produces.

Over time, a trade deficit creates jobs outsourcing. As a country imports certain goods rather than buying domestically, the local companies start to go out of business. The domestic industry will lose the expertise needed to remain competitive. As a result, the home country creates fewer jobs in that industry.

Instead, the foreign companies hire new workers to keep up with the demand for their exports.

For this reason, many leaders propose reducing the trade deficit to increase jobs. They often blame trade agreements for causing deficits. A great example is the world's largest agreement, NAFTA. To reduce the negative effects of trade deficits, the government often raises import tariffs or use other forms of trade protectionism. These rarely work. That's because the domestic industry is has already become out-of-date by the time these policies are suggested. The skills are gone, so the industry won't recover. For more, see Pros and Cons of Trade Agreements.

Trade Deficit as Defined in the United States

In the United States, the Bureau of Economic Analysis measures and defines trade deficit. It defines U.S. imports as goods and services produced in a foreign country and bought by U.S. residents. It includes all goods shipped into the United States, even if produced by an American-owned company. If a product crosses U.S. Customs and is intended to be sold in America, it is an import.

Imports also include services. The BEA counts services purchased by U.S. residents while they are travelers in another country. A traveler is defined as anyone who is in the country for less than a year. This includes purchases of food, lodging, recreation and gifts while traveling overseas. It also counts travel, fares and other passenger transportation purchased while traveling.

Other imported services include payment of royalties or license fees and payment for services. These services could include (to name just a few) advertising, telecommunications or education. In short, if the consumer is a U.S. resident and the provider is a foreign resident, then it is an import.

An export is any good that passes through customs from the United States to be sold overseas. This includes merchandise shipped from an American-based company to its foreign affiliate or branch.

An export is also any service sold by a U.S. resident or U.S. business and bought by a foreign resident. It should be noted that the BEA estimates service imports and exports from benchmark surveys and other reports. The measurements of goods transactions come from the U.S. Census. See the most recent year's U.S. Trade Deficit. (Source: "Information Section," BEA. "A Guide to BEA Statistics on U.S. Multinational Companies," BEA.)

How the Trade Deficit Is Part of the Balance of Payments

What Is the Balance of Payments?

  1. Current Account
  2. Capital Account
  3. Financial Account

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