Do trade deficits matter?

Economists have long considered free trade as mutually beneficial for all countries involved. With this said, during the 2016 US Presidential Campaign, free trade received criticism from the Republican nominee Donald Trump, who touted the decline in manufacturing jobs in the midwestern states as a consequence of trade liberalisation. The US has had a trade deficit since the 1970s, with manufacturing jobs having declined by 50% since then. This raises the question of whether trade deficits are good or bad, with numerous ways to establish a trade imbalance, as well as numerous ways in which it might benefit or harm an economy. Thus, whether trade deficits are good or not depends entirely on the state and circumstances of the nation.

Introduction

A trade deficit occurs when the value of a nation’s imports exceeds that of their exports, with these imports and exports referring to goods and services. When exports rise and imports decline can a trade deficit change into a surplus. This usually occurs when a country isn’t capable of producing all of the required goods, leading to imports from foreign nations.

Both the UK and US have had trade deficits for a long time, with the former having the worst current account deficit in the G7 at -4.2% of GDP in 2018. Trade deficits lead to money flowing out of a nation, creating an imbalance between investment and savings. With this said, a trade imbalance does not always mean that money is leaving the country. A capital influx will bring money into a country with a current account deficit through investments.

G7 Balance of Trade

Downsides

Running a trade deficit isn’t without its costs. For developing nations, trade deficits can be harmful as they are inflationary. This is because a trade deficit causes reduced demand for that currency to decrease as individuals exchange their sovereign currency for another. This leads to this nation’s currency depreciating as a country’s currency flows to foreign markets. This is an issue for debtors, which comprise largely of developing nations as they are more susceptible to borrowing, with a devaluation leading to increased debt repayments. Civilians in Hungary have experienced this issue, as many had taken out a mortgage in Euros; following the depreciation of the Hungarian forint, repayment costs became more expensive to pay off. A devaluation of a currency on a large scale can trigger the mass outflow of capital as the value of investors’ holdings decreases.

The outsourcing of jobs is another common issue that a trade deficit induces. As consumers purchase more goods from overseas, the demand for goods in a home nation decreases. This is inherently deflationary, with the lower demand leading to businesses being forced to lay off workers. Following the introduction of China into the WTO in the early 2000s, the US trade deficit increased greatly from -$400 to -$750 billion in 5 years. This coincided with a sharp decrease in manufacturing jobs, falling from 17.5 to 13.75 million during the same period.

Greater foreign ownership in a nation arises following continuous years of running trade deficits. This is due to the greater foreign investment received, with other countries buying up capital in the nation with a negative current account balance. Foreign ownership becomes an issue when civilians can’t afford goods such as property, due to foreign investors driving up their prices.

Benefits

Trade deficits have huge benefits like the improvements in living standards that can follow, as imports allow nations to receive greater investment. This is because of the Balance of Payments, which states that for a given current account deficit, there is an equivalent financial account surplus and vice-versa. For example, if a nation has a $100 billion current account surplus, then it would have a $100 billion financial account deficit. A financial account encompasses investments, whereas a current account refers to that of trade. Thus, a trade deficit leads to the inflow of capital and investment.

Foreign investment in a nation can lead to greater prosperity if these funds are allocated efficiently. For example, South Korea ran large trade deficits for much of the 1970s, being an importer of capital. These funds were invested in mostly equipment and factories, resulting in long-term economic growth and improving living standards. South Korea ended up running large trade surpluses in the preceding decades, in effect repaying its previous borrowing through sending capital abroad. A similar story occurred in the US, running large trade deficits for 40 out of the 45 years between 1830 and 1875. What followed was investment in railroads that brought significant economic benefit in the long run, due to more efficient transportation that followed. This growth gave the US the highest GDP per capita in the world by the early 1900s.

Trade deficits lead to increased product diversity. When imports exceed exports, consumers experience a greater variety of products – especially that of which a country cannot produce. In this way, current account deficits enable consumers to access goods at more competitive prices, ensuring that a nation avoids shortages of products.

Overview

Trade deficits affect different countries in different ways, depending on their respective circumstances and thus their significance is circumstance dependent. Nations such as South Korea and the US have benefitted greatly from trade deficits, with the inflow of capital leading to long term investments that have paid off. However, this isn’t the case for all nations and thus the specific circumstances of a nation must be considered to determine whether trade deficits are positive or negative for an economy.