The trade balance is also the biggest part of the current account. It measures a country’s net income earned on international assets. It’s the trade balance plus any other payments across borders.
How to Calculate It
A country’s trade balance equals the value of its exports minus its imports. The formula is X - M = TB, where: X = Exports M = Imports TB = Trade Balance Exports are goods or services made domestically and sold to a foreigner. That includes a pair of jeans you mail to a friend overseas. It could also be signage a corporate headquarter transfers to its foreign office. If the foreigner pays for it, then it’s an export. Imports are goods and services bought by a country’s residents but made in a foreign country. It includes souvenirs purchased by tourists traveling abroad. Services provided while traveling, such as transportation, hotels, and meals, are also imports. It doesn’t matter whether the company that makes the good or service is a domestic or foreign company. If it was purchased or made in a foreign country, it’s an import. When a country’s exports are greater than its imports, it has a trade surplus. When exports are less than imports, it has a trade deficit. On the surface, a surplus is preferable to a deficit. However, this is an overly simplistic assumption. A trade deficit is not inherently bad, as it can be indicative of a strong economy. Moreover, when coupled with prudent investment decisions, a deficit can lead to stronger economic growth in the future.
Favorable Trade Balance
Many countries implement trade policies that encourage a trade surplus. These nations prefer to sell more products and receive more capital for their residents, believing this translates into a higher standard of living and a competitive advantage for domestic companies. For some, this holds true, especially over the short term. Unfortunately, to maintain a trade surplus, some nations resort to trade protectionism. They defend domestic industries by levying tariffs, quotas, or subsidies on imports. Soon, other countries react with retaliatory, protectionist measures, and a trade war ensues. Inevitably, this results in higher costs for consumers, reduced international commerce, and diminished economic conditions for all nations.
Unfavorable Trade Balance
Sometimes, a trade deficit can be unfavorable for a nation, especially one whose economy relies heavily on the export of raw materials. Generally, this type of nation imports a lot of consumer products. As a result, its domestic businesses don’t gain the experience needed to make value-added products. Rather, its economy becomes increasingly dependent on global commodity prices, which can be highly volatile. Mercantilism advocates protectionist measures, such as tariffs and import quotas. While these measures can prove effective in increasing the balance of trade, they typically lead to retaliatory acts of protectionism, which result in higher costs for consumers, reduced international trade, and diminished economic growth.
Difference Between Trade Balance and Balance of Payments
The balance of trade is the most significant component of the balance of payments. The balance of payments adds international investments plus net income made on those investments to the trade balance. A country can run a trade deficit but still have a surplus in its balance of payments. A large surplus in investments could offset a trade deficit. That can only occur if the financial account runs a huge surplus. For example, foreigners could invest heavily in a country’s assets. They could buy real estate, own oil drilling operations, or invest in local businesses. The capital account records assets that produce future income, such as copyrights. As a result, it would rarely run a surplus large enough to offset a trade deficit.
How the Trade Balance Fits Into the Balance of Payments
Balance of Payments
