TRADE DEFICIT

Introduction

In economics, trade deficit or trade gap refers to an economic measuring of the negative or unfavorable balance of trade in which the imports of a country exceeds its exports (Pettis 29). This then means it typically symbolizes the outflow of a country’s domestic currency to the overseas markets. A deficit basically the amount by which a country’s resources falls short of a mark, mostly used for the purpose of describing the differences between inflow and outflow of cash. Since deficit is the opposite of surplus, it is equal to loss or shortfall (Kelly & Williams 44). Therefore, this is to say that in case a country does not have the capacity of producing all it needs, a trade deficit occurs. It should be noted that as a result of that, the majority of nations end up borrowing from other foreign states so as to pay for the imports (Frumkin 21). Consequently, a country with trade deficit will obviously have current account deficit.

On the other hand, trade deficit also occurs whenever domestic companies decide to carry out its day-to-day manufacturing in foreign countries. For instance, when there is the continuous shipment of shipment of raw materials to foreign factories, this is accounted as exports. And in the process of shipping finished goods back home, they are accounted as imports.  This remains to be the case in even if they were manufactured by domestic companies. These imports will ultimately be deducted from gross domestic product of the country in this context. Regardless of the fact that the earning obtained has the potential of benefiting the stock price of the company, taxes will increase (Frumkin 21).

In connection to that, net exports, or commercial balance, or balance of trade it termed as the difference between the monetary value of the exports and imports of a country over a specified period of time. At times, a clear distinction ought to be made between the balance of trade for services and goods. For example, in case a country ends up exporting greater volumes of its goods as compared to the amount it imports, it becomes a positive balance, trade surplus, or favorable balance of trade and vice versa (Pettis 30). Normally, trade deficit unlike trade surplus is perceived as negative economic indicator. Despite of that, in some exceptional circumstances, trade gap is as a result of government forex policy which is aimed at achieving other microeconomic goals

How the trade deficit is measured and obtained

As stated above, trade balance or balance of trade (BOT) is as a measure of the exports of a country minus its imports. Trade balance remains to be the main component of the balance of payment (BOP) of a country (Wu & Zeng 8). The reason for that is computed for a specified period of time, particularly quarterly or yearly.

On the other hand, imports and exports are the main components which are used to measure trade deficit. In the process of measuring or computing trade deficit, what is taken into consideration is the value of exports and imports that a country encountered during a stipulated period. Therefore, when imports are relatively more as compared to exports, the negative value obtained indicates the existence of trade deficit (Kelly & Williams 43)

                        Trade deficit = exports - imports

Significance of measuring trade deficit

In the modern business world, balance of trade (BOT) is normally used by economists and analysts for the purpose of assessing and understanding the economic strength of a country other foreign trading partners (Wu & Zeng 8). For instance, a country with large value of the trade deficit indicates it is fundamentally borrowing money to cater for the purchasing of goods and services, whereas the one with large trade surplus indicates that it is intensively lending finances to deficit nations (Mankiw 698). Conversely, calculating trade deficits assists in displaying the manner in which trade balance of a particular country correlates with its political stability. The reason for that is because it is a true indicator of the level of investment which is done by potential foreign investors in it.

Despite the fact that countries use different techniques to calculate balance of trade (BOT), the main objective of computing trade deficit is to evaluate the economy of a country is changing (Mankiw 418). Since trade deficit remains to be a reflection of a nation’s balance of trade (BOT) which is also part of the balance of payment, it means that that it assists potential investors in accessing the effectiveness of the financial account, capital account, and the current account of the country (Glantz & Robert 230). The reason for that is because it assists in evaluating the inflow and outflow of cash. Due to the fact that is comprises of those financial statements, it reflects the services, income receipts, and merchandise trade which is transferred for foreign aid.

Measuring trade deficit is essential in evaluating the value of a country’s gross domestic product (GDP). For example, mostly GDP increase whenever the total value of merchandise and services which are domestically produced and sold to foreign markets exceeds the total value of the overseas merchandise and services which is bought by domestic consumers (Wu & Zeng 8). Contrary to that, in case domestic consumers end up spending more on overseas goods and services as compared to what they spend on domestically produced goods and services, there a decrease in GDP. This indicates that;

            Gross domestic product (GDP) = government expenditure + private expenditure +                                                                               investments + (exports-imports)

In connection o that, the fact is that some economic subjects have ended up causing extensive confusion about the effectiveness of balance of trade with respect to the applicability of the trade deficit. The reason for that is the general explanation regarding the net trade of a country in its final goods if not services (Glantz & Robert 230). Despite that, as much as the rates of exchange are perceived as being free-floating, in the long-run trade balances never exist in the real sense. Even though it does, the truth is that there is little evidence which makes economics and analysts to believe that a country will ultimately have a negative impact (Mankiw 698). This means that even if the overall GDP falls by millions of dollars, the implication is that the economy of a country may not that worse i.e. it could have actually benefited from the net exchange. For instance, in case county A sold cars to country B, the gross domestic product (GDP) of country A will be measuring the dollar value of the finished goods or services in its economy. This will be measurable in terms of what was spent by the consumers (Wu & Zeng 8). The implication here is that, measuring the trade deficit of country A will effectively indicate how efficient country A manages its production activities for the sake of meeting the demands of international market. This in return will aid in evaluating whether the standard of living in that country is rising or effectiveness of investing the productive capital.

Nevertheless, it should be noted that trade deficit is not basically a sign of economic weakness as it is sometimes reported. This is to say that it is not a sign of economic retardation of a county. The significance of the increase in the trade deficit as well as imports is a clear indication of the retardation of a country’s GDP. This is depended on the manner in which that GDP was computed but not necessarily an economic drag or economic growth. Likewise, although economists and analyst may fail to acknowledge that, the truth is that trade deficit assists in reporting the financial investment surpluses or inflows which might have slipped-side of the report given regarding foreign exchange rates (Free 429).  This then means that the failure of recognizing some of the crucial or positive economic returns of a country’s economic benefits from the overseas capital inflows result to a poor enumeration of the value of imports and exports hence the need of measuring trade deficit (Mankiw 698).

In theory, trade deficits assist in indicating that the rising gap (deficit gap) between exports and imports has the potential of hindering economic growth, job creation, manufacturing output, and stock market appreciation. Contrary to that, the truth is that the existing evidence ends up pointing in the opposite direction. This then means that misguided efforts which entail supporting such ideas of restricting imports in order to cure the trade gap might cause extra harm rather than the good to the country’s economy (Kelly & Williams 44). Is should be acknowledged that ForEx rate or foreign exchange rate has been perceived as being the ultimate means of determining the relative level of a country’s economic health. The reason for that is because various researches have shown that foreign exchange rate offers the opportunity of enhancing economic stability of a country (Wankel 102). That is the reason as to why trade deficit also needs to be watched and analyzed if realistic result ought to be obtained. Other than depending on the foreign exchange rates, first there is the need of keeping track of the inflows and outflows of cash in the process of embarking in foreign trade. Since foreign exchange keeps on fluctuating as a result of the changing foreign market forces of demand and supply of currencies amongst countries, it is equally essential to have a clear picture of what mainly determines or result to trade deficit hence the need of computing trade deficit (Wankel 102).

Factors influence the value of the variables

As stated above, the main variables which are used for measuring trade deficit of a county or countries are exports and imports. Therefore, the main factors which influence the value of these variables include;

 Trade barriers _ the extent to which the government erects or removes trade barriers has a remarkable impact on both importation and exportation (James et al 8). For instance, the decision made the US to make its markets to be open to any foreign country after World War II greatly enabled Japan to extensively build up its economic base of exporting large volumes of its finished goods to the United States.

 Elasticity of demand and supply _ normally, the elasticity of demand for both imports or exports of any country have the capacity of influencing its terms of trade. For example, in case the demand for the exports of a country is less elastic unlike its imports, the end result is that its terms of trade will have the likelihood of becoming favorable (Mukherjee 883). This is due to the fact that such imports will end up commanding higher prices in the foreign markets, unlike imports. Conversely, in case the demand for its imports becomes less elastic unlike exports, the country will have unfavorable terms of trade (Prati 46)

On the other hand, the nature of the elasticity of supply considerably impacts the terms of trade of a country. For instance, in case the general supply of the exports of a country is perceived as being more elastic as compared to imports, the country will be having favorable terms of trade and vice versa.

Nature of the goods and the economic development of a country _ in case a country embark on the production and exportation of only primary goods, and in return imports finished goods, it will obviously have unfavorable terms of trade (Kennedy 59). Likewise, the economic growth of a country has two effects i.e. the demand effects and supply effects. The demand impact refers to the general increase in the demand for its imports due to the increase in consumers’ incomes as a result of economic development (Javier et al 127). Equally, supply effects illustrate the increase in the supply of import substitutes. In return, it means that the overall effect of the economic growth relies on the extent of these effects (Arestis et al 4).

 Exchange rates and tariff policy _ the terms of trade of a country is greatly affected by the country’s exchange rates. For example, in case the currency of a certain country appreciates, it’s obvious that there will be an improvement of its terms of trade (Jesper & David 19). This is due to the fact that a rise its currency value will have the ability of increasing the prices of its exports as well as decreasing that of the imports. Similarly, quotas and tariffs influences its terms of trade. It should be noted that if these measures are not retaliated by other trading partners, it will end up restricting imports from them (Mankiw 304)

The size of a country _ in case a country is overpopulated; it will be experiencing an increase in demand for imports. The effect of this is that it will make its terms of trade to be unfavorable as compared to optimally populated countries. Equally, a relatively populated country will have the opportunity of reaping the gains of the economies of scale which are enjoyed by bigger ones in the foreign trade (Goldstein 2). This is also in line with the idea that in case such a country enjoys monopoly power when it comes to exportation as well as the existence of several alternative sources of supplying its imports, it will continue to have favorable terms of trade (Branch 5).     

Terms of trade _ it should be noted that the terms of trade refers to the ration of export prices to that of import prices. The terms of trade of a country has the potential of improving in case the prices of its exports rise at a greater rate as compared to the prices of its imports (Branch 5). In return, the country will be reaping higher revenues which in will extensively cause a rise in demand for its currency as well as an increase in the value of its currency. The end result is the appreciation of the exchange rate (Kennedy 59).

 Balance of payments (BOP) _ the current accounts of a country are essential in that they assist in reflecting the balance of trade as well as earnings on international investment. This usually comprises of the total number of the transaction carried out including imports, exports, debts, and so on. An increase in deficit as a result of excessive expenditure on importations as compared to revenues gained through exportation causes depreciation (Kelly & Williams 4).  In return, this means that BOP will enhance the fluctuation of the exchange rate of the country’s domestic currency (Wankel 102).

 Inflation and interest rates ­_ the changes in the global market inflation results to the change in the currency exchange rates. Therefore, a country with lower rates of inflation as compared to others will definitely experience a rise in the value of its currency. In return, the prices of the goods and services of such a country will be increasing at a relatively slower rate. On the other hand, this is to imply that such a country with constantly lower inflation rates will typically make its currency to be traded at a higher value.

Equally, interest rates have the potential of affecting the currency value as well as the dollar exchange rate of a country. Thus, inflation, interest rates, and Forex rates are all correlated. As a result of that, a continuous increase in a country’s interest rates causes the appreciation of it currency because it offers relativelly higher rates to lenders. This, therefore, attracts more and more foreign capital hence increasing the exchange rates in return (Reinert et al 713)

Political performance and stability _ the political state and the economic performance of a country may impact the strength of its currency. For instance, a country which experiences less risks of political turmoil is perceived as being more attractive to foreign potential investors. This gives it the opportunity of drawing foreign investments from those countries which experiences more economic and political instability (Jahan & Mohammad 97). In turn, an increase in overseas capital results to the appreciation of the domestic currency.

 In other words, a country which has sound trade and financial policy does not allow uncertainties in the value of its domestic currency as compared to the one which is susceptible to political and economic confusion (Gerard 266). This illustrates that the one which experiences more political and economic instability will experience depreciation in its exchange rates hence inducing trade deficit it in its current accounts regarding imports and exports (Free 429).

Recession and speculation _ interest rates of a country sometimes have the likelihood of falling whenever it experiences recession and other forms of economic speculations. This has the effect of deteriorating its chances of acquiring foreign capital for investments (Howard 139). In return, this has the effect of weakening its currency as compared to that of the trading partners hence decreasing the rates of exchange (Tragakes 405). Moreover, in case the value of a country’s currency is expected to rise, potential investors will obviously demand more of such a currency so as to make more gains in future. This will result to an increase in its exchange rates as well (Reinert et al 713)

Government debt _ national debt is the debt which is owned by the central government (James et al 8). This then means that a country which has higher government debt has a lower opportunity of acquiring foreign capital for investing in various sectors of the economy hence leading to inflation. This will induce a decline in the value of the exchange rates (Yenko 8)

With respect to the above factors, in case the overall value of the exports is positive, the gross domestic product of a country increases. On the other, in case it is negative it makes the gross domestic product to decrease. Therefore any of the above factors which make a country to incur more importation costs than what it gains from its exports result makes such a country to have trade deficit. Moreover, all the international transactions carried out by a country are recorded in form of debits and credits in the BOT (Wu & Zeng 8).  Credits are international transactions which increases the inflow of money into a country while debits are those one which causes the outflow of money from the country.

Naturally, every individual nation desires its gross domestic product to rise hence the need of trying to ensure that the value of their net export is always positive. Contrary to that, the truth is that it is not easy for all countries to maintain a positive net of exports. The reason for that is because one or more countries should have the capacity of importing more as compared to what they export in case the others manage to export more than what they import (Wankel 102). Thus, the balance of foreign international payments, generally termed as the balance of payment (BOT) indicates the net accounting of a country’s foreign economic activities (Kelly & Williams 44) In order to arrive at the trade deficit, BOT must be prepared so as to assist in summarizing all the transactions that a country did between another one and the rest of the world, particularly quarterly or yearly.

 

Work cited

 

 

 

 

 

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