Question

Suppose an economy has high unemployment with a large trade deficit. What kind of policy would best achieve the objective lower unemployment consistent with external balance?

Answer 1

An Economy with large trade deficit means that it is importing more goods than it is exporting. It indicates that industrial activity in the economy is low and the level of output produced is much below the the full employment level.

High imports indicate that prices of imported goods are much more Less than the goods being produced by the domestic industries.

In such scenario policy adopted should be such which is able to to boost employment i and decrease the trade deficit. Any such policy must include following two insruments.

1. DEVALUATION :The first step taken should be devaluation of domestic currency which means value of  domestic currency is decreased. This will make Exports of goods cheaper in the foreign market and as a result they will increase. As a result of increase in Exports, production in domestic territory will increase as a result level of employment will also increase and with the increased Exports trade deficit will also decrease.

On the other hand devaluation of currency will make imports of goods expensive as a result demand for imported goods in domestic market will decrease.consumers will now prefer to buy homemade goods which will increase production result leading to increase in employment. Demand for foreign goods will decrease leading to reduced trade deficit.

2. Secondly industrial competitiveness should be enhanced within the country so that firms are able to produce quality goods at reduced cost of production.

This will increase demand for domestic goods by the domestic consumers. Moreover domestic firms will be able to export cheaper goods easily in the international market. This will give boost to the production within the the economy which not only will increase employment but it will also reduce the trade deficit.