Trade Deficit

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A Trade Deficit occurs when the value of a country’s imports exceed its exports for a specific period of time, usually a year. The relationship between imports and exports are called the trade balance. When exports exceed imports it is called a trade surplus. Trade deficits can occur in both developing and advanced countries. The United States, for example, has been running a trade deficit for many years. While a trade surplus contributes to the GDP of a nation, a trade deficit will reduce GDP. While economists state that a controlled short term trade deficit is manageable and in some cases necessary for growth and development, they consider a long-term trade deficit to be an wealth destroyer that can trigger job losses, increase debts and lead to possible speculative attacks on currency.

Understanding Trade Deficit

The layman normally thinks of a trade deficit as being bad, but if that deficit means that goods can be bought at a lower price, and therefore corporate can increase their profit margins and consumers have greater spending power, then a trade deficit can have beneficial effects.

However, this is not true, as a certain level of trade deficit is required in a flourishing economy. A growth-oriented economy focuses on imports to provide price competition, which in turn limits inflation. In contrast, a trade deficit triggers repercussion during a recession. For instance, the US trade deficit pertaining to goods and services rose to $27.6 billion in March 2009. Japan is also combating high trade deficit. In January 2009, Japan’s deficit of ¥952.6 billion indicated that the global recession had weakened the country’s exports.

A recessive economy endeavors to generate more employment and raise the demand for domestic products by propelling exports. Hence, a trade deficit has numerous implications for a country’s domestic business cycle and economic situation.

Reasons and Implications of a Trade Deficit

A long-term trade deficit leads to an unstable economy, where unemployment, foreign debt and currency crises become concerns.

Agriculture-based economies may face a trade deficit due to:

  • the seasonal nature of trade
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  • financial soundness of the domestic business, which significantly impacts the trade balance
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  • low domestic production or substandard quality goods downgrade the monetary value of imports
The overvaluation of the domestic currency may also lead to a long-term trade deficit. Static exchange rates and high inflation rates lead to the overvaluation of a currency. During the 1980s-1990s, Chile, Malaysia, Argentina and Turkey faced severe economic depression due to an overvalued currency.
Understanding and quantifying the reasons for a trade deficit is important. The poor performance of a specific industry may help to bridge the gaps through the implementation of reforms to boost production. A target-oriented industrial policy can level the trade balance.