Balance of Trade Definition
The balance of trade (BOT) is defined as the country’s exports minus its imports. For any economy current asset, BOT is one of the significant components as it measures a country’s net income earned on global assets. The current account also takes into account all payments across country borders. In general, the trade balance is an easy way to measure as all goods and services must pass through the customs office and are thus recorded.
Balance of Trade formula = Country’s Exports – Country’s Imports.
For the balance of trade examples, if the USA imported $1.8 trillion in 2016, but exported $1.2 trillion to other countries, then the USA had a trade balance of -$600 billion, or a $600 billion trade deficit.
$1.8 trillion in imports – $1.2 trillion in exports = $600 billion trade deficit
For any economy current asset, the balance of trade is one of the significant components as it measures a country’s net income earned on global assets. The current account also takes into account all payments across country borders. In general, the trade balance is an easy way to measure as all goods and services must pass through the customs office and are thus recorded.
- In effect, an economy with a trade surplus lends money to deficit countries whereas an economy with a large trade deficit borrows money to pay for its goods and services. In some cases, the trade balance may be correlated to a country’s political and economic stability as it reflects the amount of foreign investment in that country. Most nations view this as a favorable trade balance.
- When exports are less than imports, it is known as the trade deficit. Countries usually regard this as an unfavorable trade balance. However, there are instances, when a surplus or favorable trade balance is not in the country’s best interests. For a balance of trade examples, an emerging market, in general, should import to invest in its infrastructure
Some of the common debit items include foreign aid, imports, and domestic spending abroad and domestic investments abroad whereas credit items include foreign spending in the domestic economy, exports, and foreign investment in the domestic economy.
The US had a trade deficit since 1976, whereas, China has a trade surplus since 1995.
A trade surplus or deficit is not always a final indicator of an economy’s health and must be considered along with the business cycle and other economic indicatorsEconomic IndicatorsSome economic indicators are GDP, Exchange Rate Stability, Risk Premiums, Crude Oil Prices etc. . For the balance of trade examples in times of economic growth, countries prefer to import more to promote price competition, which limits inflation whereas, in a recession, countries prefer to export more to create jobs and demand in the economy.
When is Trade Balance Positive?
Most countries work to create policies that encourage a trade surplus in the long term. They consider a surplus as a favorable trade balance because it’s considered as making a profit for a country. Nations prefer to sell more products when compared to buy products which in turn receive more capital for their residents which translates into a higher standard of living. This is also beneficial for their companies as they gain a competitive advantage in expertise by producing all the exports. This results in more employment as companies hire more workers and generate more income.
But in certain conditions, a trade deficit is the more favorable balance of trade and it depends on the stage of the business cycleBusiness CycleThe business cycle represents the expansion and contraction of the economy that occurs due to ups and downs in the gross domestic product (GDP) of a country. It is experienced over the long term and goes parallel with the natural growth rate. the country is currently in.
- Let us take another balance of trade example – Hong Kong in general always has a trade deficit. But it is perceived as positive because many of its imports are raw materials which convert into finished goods and finally exports. This gives it a competitive advantage in manufacturing and finance and creates a higher standard of living for its people.
- Another balance of trade example is Canada’s whose slight trade deficit is a result of its economic growth and its residents enjoy a better lifestyle which is afforded only by diverse imports.
When is Trade Balance Negative?
In most situations, trade deficitsTrade DeficitsWhen the total sum of goods or services that a country imports from other countries is higher than the total sum of goods or services that a country exports to other countries, this is referred to as a trade deficit, which is the opposite of the balance of trade theory. are an unfavorable balance of trade for a country. As a rule of thumb, geographies with trade deficits export only raw materials and import a lot of consumer products. Domestic businesses of such countries don’t gain experience with time which is needed to make value-added products in the long run as they are mainly in the raw material exporter and thus economies of such countries become dependent on global commodity prices.
There are some countries that are so opposed to trading deficits that they adopt mercantilism to control it and this is considered as an extreme form of economic nationalism that works to remove the trade deficit in every situation.
It advocates protectionist measures such as import quotasImport QuotasImport quotas are a type of government-imposed restriction on the trading of a certain commodity. Such restrictions are either fixed in terms of the value or quantity of the product to be imported during a given time period (usually for one year). The government imposes such restrictions in order to benefit local producers. and tariffs. Although these measures may result in the reduction of the deficit in the short run, they raise consumer prices. Along with this, such measures trigger reactionary protectionism from other trade partners.
This has been a guide to what is Balance of Trade and its definition. Here we explain the formula of Balance of Trade along with practical examples. In addition, we discuss a trade surplus and trade deficit. You may learn more about macroeconomics from the following articles –