Trade Deficit and Surplus

Imagine this: you are a young kid given a $10 allowance each week. This week, you only use $5 of it on candy, leaving you with $5 leftover. However, next week you buy too much candy that you have to ask your parents for more money! This simple story is actually derivative of an economic concept known as surplus and deficits. This concept is prominent in many areas of economics, most commonly in trade. Continue reading to learn more about the trade deficit and surplus, the difference between them, and more!

Trade Surplus and Trade Deficit

Let's begin by defining a trade deficit and surplus. A trade surplus occurs when a country exports more goods than it imports while trade deficit occurs when a country imports more goods than it exports. Net exports can be calculated by taking a country's imports and subtracting them from the exports. Positive net exports mean that a country is in a trade surplus, whereas negative net exports mean that a country is in a trade deficit.

\(\text{Net Export}=\text{Export}-\text{Imports}\)

Is a trade deficit better than a trade surplus? Is a trade surplus better than a trade deficit?

Traditionally, a trade surplus is seen as more desirable for economic growth. However, there is no definitive answer to this question since every country is so different. For example, China and Japan are both net exporters with incredibly different growth rates. China's GDP is rapidly growing while Japan's GDP is stagnating.¹ It's not as simple as having a positive or negative trade balance to grow an economy, but it's still important to know the differences between a trade deficit and surplus and what their potential impacts are.

Difference between Trade Deficit and Surplus

The differences between a trade deficit and a surplus depend on whether a country exports or imports most of its goods. But what characteristics does a country have if they are constantly in a trade deficit or a surplus?

A country in a trade deficit may have a low savings rate and purchase goods abroad more often, whereas a country in a trade surplus may have a higher savings rate and produce more goods for other countries. The United States is an example of a country defying the notion that a trade surplus is the only way to grow an economy.

Fig. 1 - U.S. Trade Balance, StudySmarter Originals. Source: Federal Reserve Economic Data²

The chart above shows the United States' trade balance. The United States is currently in a trade deficit and has been for decades. The United States is also the world's largest economy, and barring any economic downturns, continues to grow at a steady rate.³

Current Account Trade Deficit and Surplus

To understand the current account trade deficit and surplus, let's first go over the current account in general.

The current account represents a country's exports and imports of goods, services, income, and capital transfers. Instead of just looking at the exports and imports of goods, the current account looks at the exports and imports of many things! The current account can also be represented as an equation:

\(\text{Current Account}=\text{Net Exports}+\text{Net Income from Abroad}+\text{Capital Transfers}\)

What does the equation above tell us? The current account trade deficit and surplus are simply a subset of the current account as a whole. Therefore, a current account trade deficit and surplus influence a country's overall current account. This is important since, generally, net exports are the greatest component of the current account, which makes them very influential for an economy's well being.

Fig. 2 - Cargo ship

Trade Deficit and Surplus Example

Let's go over an example of a trade deficit and surplus with the United States.

Trade Deficit and Surplus Example: U.S. Trade Surplus

We will be analyzing the United States and its exports and imports. Imagine the United States sells, on average, 100,000 goods and services every year to other countries and imports 80,000 goods and services from other countries — The United States has a trade surplus. We can expand upon this example with an equation:

Trade Deficit and Surplus Example: U.S. Trade Deficit

We will be analyzing the United States and its exports and imports. Imagine the United States sells, on average, 90,000 goods and services every year to other countries and imports 120,000 goods and services from other countries — The United States has a trade deficit. We can expand upon this example with an equation:

Effects of Trade Deficit

Let's go over the effects of a trade deficit. We will start with a country, the United States, going through a prolonged deficit. A prolonged deficit means that the United States has been importing goods more than it has been exporting goods for years, decades even. Since the United States is importing, then that means that there are more dollars going around in the international market.

What is the result of this?

When there are more dollars in the market (due to large amounts of imports), then those dollars will slowly lose value. The more of something there is, the less valuable it is. Since the value of the dollar will go down, imports will eventually go down and exports will go up.

Why will exports go up?

If the value of the dollar goes down, this will make the price of United States goods cheaper than if the value of the dollar went up. This will incentivize other countries to buy goods from the United States, resulting in exports increasing for the United States. This will either improve the United States trade balance or, even, the trade deficit eventually may become a trade surplus!

Fig. 3 Currencies