Trade Balance Essay

The balance on the goods trade in a nation’s current account is known as the balance of trade, or trade balance. The current account includes all international economic transactions with income or payment within the year; the goods trade records all transactions involving merchandise or goods. The exports of goods by a country are merchandise credits; its import of foreign goods are merchandise debits. When exports (or credits) exceed imports (or debits), the goods trade shows a surplus. When imports exceed exports, the account shows a deficit.

The export and import of goods is known as merchandise trade. It is the oldest and most traditional form of international economic activity. Although many countries depend on imports of many goods (as they should, according to the theory of comparative advantage), they also normally work to preserve either a balance of goods trade or a surplus. Because the current account is typically dominated by the export and import of merchandise, the balance of trade, or trade balance, which is so widely quoted in the business press in most countries, refers specifically to the balance of exports and imports of goods trade only. For a larger industrialized country, the trade balance is somewhat misleading because service trade is not included. It may be opposite in sign on net (in surplus, for example, when goods are in deficit) and it may actually be fairly large as well. For example, the U.S. goods trade balance has consistently been negative, but has been partially offset by the continuing surplus in the services trade.

What does it mean if a country’s trade balance runs a persistent deficit? It means that country is borrowing from the rest of the world so that it can spend in excess of its own consumption. Underdeveloped countries limited to a single export experience trade deficits, but developed countries that have lost their manufacturing base experience them as well.

Merchandise trade, the original core of international trade, has three components: manufactured goods, agriculture, and fuels. The manufacturing of goods was the basis of the Industrial Revolution. The decline in manufacturing by industrialized countries has caused massive economic and social disruptions. Weaker domestic currency, rapid economic growth in Asia and Latin America, and a substantial increase in agricultural exports raise the overall export of goods.

Merchandise Import And Export

Understanding merchandise import and export performance is much like understanding the market for any single product. The demand factors that drive both imports and exports are income, the economic growth rate of the buyer, and price (the price of the product in the eyes of the consumer after passing through an exchange rate). As income rises, so does the demand for imports. Exports follow the same principle but in reverse. When buyer economies are growing, demand for supplier economies’ products will also rise.

While managers understand that expanding into international markets can have a positive impact on their firms’ bottom line, and use foreign direct investment (FDI) to participate in the emerging global marketplace, they may not understand the impact of their FDI on the trade balance of the host country. Edward Graham and Paul Krugman have shown that affiliates of foreign firms in the United States show an apparent tendency to export somewhat less and to import significantly more—2.25 times as much as U.S. firms.

Raw material–seeking investment and low-cost production–seeking investment are two common types of factor-seeking FDI that have an impact on host and home country trade balance. Raw material– seeking investment increases exports from the host nation to the home country and other countries; lowcost production–seeking investment takes advantage of low-cost factors as part of a global sourcing strategy, leading to an ability to export products from emerging nations. Here, the host country is able to increase exports and improve its trade balance; the home country, on the other hand, raises the level of its service imports.

Negative And Positive Trade Balances

What does a negative trade balance mean for the foreign investor and its relationship with the host government? What does a negative trade balance mean for the host government and public policy? Lance Brouthers et al. found that higher levels of FDI inflows appear to confer positive trade balances to developing countries, at least in the short run, because investing firms tend to use FDI to gain factor-seeking advantages that can be exploited in export markets, leading to exports, and hence trade surpluses. However, for advanced nations, higher levels of FDI inflows appear, at least in the short term, to help generate trade deficits, because FDI here tends to be market seeking.

  1. Orr and others have argued that FDI can contribute to positive trade balances in the long term if foreign-owned firms use only local suppliers of parts and components in producing their goods; replace imports with these goods; and/or export their products. In the absence of all three conditions being met, Orr suggests that trade deficits are the likely result. As K. Kojima suggested, by using FDI, the global firm can ignore or oppose the pattern of comparative advantages inherent in international trade and by doing so undermine what the economists call global welfare. Further theoretical development in this area may be of great value to countries in helping them determine their FDI policies, as well as to firms contemplating the use of FDI as part of a “socially responsible and economically rational” global business strategy.

Trade Balance And Economic Health

 Government policies that directly target the trade deficit can easily develop into protectionism. “Export or die,” a popular campaign poster in post–World War II Britain, became a sentiment embraced seriously by the Japanese. Island nations, both Britain and Japan perceived their ability to sell abroad as vital to maintaining their standard of living. While the British believed in free trade and the Japanese were strongly protectionist, each country considered exports vital, as did the Koreans and Taiwanese, taking Japan as a model. Continental European nations, in direct proximity to each other, often saw exports as a natural extension of domestic economic activity. Although China’s history includes a long, disastrous period of isolation, the Chinese have learned from their mistakes and their neighbors’ successes and have turned exporting into a national obsession.

The effect of the trade balance on national economic health depends on three factors: (1) the price of one country’s products relative to the world price; (2) the value of exchange of the national currency relative to other foreign currencies; and (3) the relative incomes of the national and other foreign economies. The first two factors can be called the price effect or competitiveness; they, along with the relative income level, determine the trade balance of the nation. If the nation’s (export) price level rises faster than that of foreign nations, the trade balance will deteriorate and competitiveness will worsen.

If the nation’s (export) price level declines faster than that of foreign nations, the trade balance will improve as will competitiveness. The exchange rate reinforces the price effect: if the nation’s currency revalues (upward), the trade balance will decline. If the nation’s currency devalues, the trade balance will improve. If the income of our focus nation goes up, absorption does the same and the trade balance worsens. However, if the world expands more rapidly than the focus economy, the trade balance will improve and the foreign income level will relate positively to the trade balance.

While many economists predict dire consequences for a persistent trade imbalance, a contrarian viewpoint has emerged. According to Miranda Zafa who surveyed these viewpoints, some economists, including Ben Bernanke, chairman of the U.S. Federal Reserve, explain the increase in Asian savings as a consequence of the export-led growth strategy pursued by Asian governments. The result is persistent current account surpluses and reserve accumulation by Asian central banks, thus generating a global savings glut and keeping interest rates low. This strategy has permitted emerging markets that are net lenders to grow rapidly by ensuring efficient intermediation of their savings. Another contrarian view that Zafa calls the “portfolio balance view” attributes global imbalances to portfolio optimization. In effect, the United States, Asia, and much of the Middle East are part of the dollar zone, and therefore, the imbalances between them are as irrelevant as those between Germany and Greece or Spain.

Bibliography:

  1. Augustine C. Arize et al., Balance of Payments Adjustment: Macro Facets of International Finance Revisited (Greenwood, 2000);
  2. Ben Bernanke, “The Global Saving Glut and the U.S. Current Account Deficit,” The Sandridge Lecture, Virginia Association of Economics, Richmond, VA (March 10, 2005);
  3. Lance Elliot Brouthers et al., “The Aggregate Impact of Firms’ FDI Strategies on the Trade Balances of Host Countries,” Journal of International Business Studies (v.27, 1996);
  4. Dooley, An Essay on the Revived Bretton Woods System, NBER Working Paper No. 9971 (National Bureau of Economic Research, 2003);
  5. John H. Dunning, Governments, Globalization and International Business (Oxford University Press, 1999);
  6. Jose Maria Fanelli and Rohinton Medhora, Finance and Competitiveness in Developing Countries (Routledge, 2002);
  7. Pavlos V. Karadeloglou, Enlarging the EU: The Trade Balance Effects (Palgrave Macmillan, 2002);
  8. Enzio Pfeil, Trade Myths: Globalization and the Trade Balance Fallacy (Inkstone Books, 2008);
  9. Yi Wu and Li Zeng, The Impact of Trade Liberalization on the Trade Balance in Developing Countries (International Monetary Fund, 2008);
  10. Miranda Zafa, “Global Imbalances: Do They Matter?” Cato Journal (v.27, 2007).

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