Trade Deficits: Causes, Effects and Remedies

This article is designed to explore the causes of trade deficits, the effects of trade deficits, policy options facing national governments in dealing with trade imbalances, and a comment on U.S. tariffs. Firstly, however, let us briefly consider what is referred to as the "balance of trade," which may be defined as the difference between the monetary value of a country’s exports of goods (X) and the monetary value of its imports of goods (M). The difference can ordinarily be said to be favorable (meaning that X – M > 0) or unfavorable (implying that X – M < 0). If a country’s trade with another country yields a favorable outcome (that is, X – M > 0), the trade culminates into what is referred to as a trade surplus for the country. If, on the other hand, the country’s involvement in trade yields an unfavorable outcome (that is, X – M < 0), the trade yields what is referred to as a trade deficit for the country. Therefore, a “trade deficit” essentially represents a greater outflow of a country’s currency reserves to any specific trading partner in exchange for goods from the trading partner relative to the inflow of currency reserves from the trading partner in exchange for goods from the trading partner, assuming that the country’s consumers and business entities have the wherewithal to pay for imports from the trading partner’s economic units. It is important to note here that the excess of a country’s outflow of its currency reserves over the inflow of currency reserves is essentially wiped out by earnings realized by local retailers of a portion of goods imported into the country. It is perhaps also important to make a distinction between any given country’s balance of trade (defined above) and its balance of international indebtedness, which portrays the difference between assets owned by a country’s nationals in foreign countries and those owned by foreigners in the country, and which is also referred to alternately as a country’s international investment position. A country can use data pertaining to its “international investment position” to project the inflow of income through investments made within its borders by foreign investors, and the flow of payments (in the form of dividends and/or interest) to be repatriated to foreign investors’ home countries (see Salvatore, 1990:438-439). The difference between income inflows and disbursements can, therefore, enable a country to determine whether it is a net “debtor nation” or a net “creditor nation” with respect to the concept of the “international investment position.” Private investments made in foreign countries by a country’s local investors can improve the country’s “international investment position” if they are greater than investments made by foreign private investors in the country. For countries which have an abundance of capital for investment in their domestic economies and are no longer in need of rapid economic growth (such as G-7 nations), it is perhaps desirable to seek to become net “creditor nations” by screening investments by foreign nationals. As Salvatore (1990:440) has advised, this can, among other things, forestall the potential for a financial crisis and high interest rates which can be caused by a sudden withdrawal of investments, for whatever reason, and the worsening of current account balances due to rising income payments to foreigners for their investments. Developing countries, however, do not have the luxury of screening foreign investors, mainly because they are, by and large, in dire need of foreign direct investments to prop up their fragile and poverty-gripped national economies.