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Definition of a Trade Deficit:
A trade deficit
occurs when a country’s balance of trade is negative. In other words, countries with a trade deficit import more than they export.
The balance of trade measures the relationship between a country’s exports and imports. Mathematically, the balance of trade can be calculated by subtracting the value of imports from the value of exports. A country has a trade deficit when its balance is negative. Imports exceed exports. A country has a trade surplus when its trade balance is positive. Exports exceed imports. The United States has had a trade deficit since 1975, when its reliance on foreign oil and rising oil prices contributed to the increased value of imports. The US has had a trade surplus for services in every year since 1971, but the trade deficit for goods far exceeds the surplus for services.
Source: US Census Bureau Foreign Trade Statistics
What causes trade deficits?
When one economy expands faster than its trading partners, the demand for goods and services provided by the trading partners will increase more than the demand for the economy. The graph provides the United States balance of trade deficit between 1960 and 2017. The deficit ballooned between 2004 and 2008 because the US economy was growing faster than most other global countries. Income and economic growth in the US increased the demand for imported goods relative to other countries, explaining the larger trade imbalance during this period.
The Chinese government has manipulated the exchange rate for the yuan to encourage exports. If the yuan had appreciated relative to the dollar, Chinese goods would have been more expensive for Americans to purchase. Furthermore, US goods would have been less expensive for Chinese consumers and producers. A severe recession in Asian countries (most notably Japan) sent their currencies tumbling, which caused the price of their goods to fall relative to the price of US goods. This helped increase the trade deficit as US imports from Asian countries increased and US exports fell. In extreme cases, countries devalue their currencies during steep recessions to encourage exports and discourage imports.
During business expansions, a trade deficit can be beneficial by reducing inflationary pressures because the imports add competition. Recessionary periods benefit from surpluses because the added exports create jobs and boost GDP.
Some of the factors that influence the trade balance include currency exchange rates, differing comparative advantages, and trade barriers imposed by governments. As mentioned above, when a currency loses its value, its goods and services become less expensive in other countries, so exports should increase. Differing comparative advantages also influence trade. A country has a comparative advantage when the opportunity cost to produce a good or service is lower than another country. Perhaps one country has easy access to a vital raw material, or another country has a very highly educated work force. Comparative advantages make trading beneficial for both parties by enabling countries to produce the goods and services where they are the most efficient. Finally, government-imposed trade barriers, like tariffs and quotas can influence the balance of trade. Negotiated trade agreements also influence a country's balance of trade.
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