Question

3. It is sometimes said that a balance of trade deficit between the United States and other nations can be harmful to the economic wellbeing of America. Explain what is the “balance of trade.” What does a “trade deficit” or a “trade surplus” mean? Why do some people say a trade deficit is “bad” and a trade surplus is “good”?

Many economists reply to these arguments that, at the end of the day, it does no “harm” for a country to run a trade deficit, certainly it does not matter with any particular country, and nor does it matter when looking at the U.S. and all of its trading partners as a whole. Explain in detail the logic of their argument. After explaining these two point-of-view which do you think in more correct? Why?

Answer 1

*Balance of trade or trade balance refers to the difference between the value of Exports and the Value of imports.

BOT= X-M

BOT = Balance of trade

X= value of exports

M = Value of imports

*A country has a trade surplus if balance of trade is positive which implies that value of Exports is greater than the value of imports.

X> M ( trade surplus).

* A country has trade deficit if balance of trade is negative which implies that the value of Exports is less than the Value of Imports.

X< M ( trade deficit)

* Many economists have an opinion that, trade deficit is bad. Following are the reasons.

> Since exports are greater than imports it results in the outflow of financial Capital.

> Leads to a decline in National income since exports are subtracted from the national income.

> Since payments made to the Foreign countries for imports are greater than the payments recieved from foreign countries, result is a fall in foreign exchange.

> Balance of payments are adversely effected.

* On the other hand, Other Economists have rejected above mentioned beliefs and they opine that trade deficit isn't bad Following are the reasons .

> Imports may be increasing due to increased in the ability to pay for them.

>The underlying factor behind high Imports is an increase in income.

> It leads to an increase in the variety of goods available to the consumer which symbolises an increase in consumer confidence.

> Trade deficit may occur due to the fact that, the country is an attractive destination for investment.ln other words, money flowing out to pay for imports comes back in to help pay for productive investment in new capital.

In short, even prolonged trade deficits won't create serious issues for a country like USA since dollar is a stronger currency which attracts capital inflows to the nation . Same can't be said about all the countries.

However, in the short run, trade deficits won't create any harm to even smaller developing countries. In fact trade deficit itself will be corrected via the depreciation of the currency making Imports expensive and Imports inexpensive.

However persistent and continuous trade deficit ( trade deficit in the long run) will be considered as a sign of imbalance in the economy . Trading partners may also consider the economy as uncompetitive.