Trade Deficit

A trade deficit occurs when a country's imports exceed its exports during a given time period. It is also referred to as a negative balance of trade (BOT).

The balance can be calculated on different categories of transactions: goods (a.k.a., “merchandise”), services, goods and services. Balances are also calculated for international transactions—current account, capital account, and financial account.

A trade deficit occurs when there is a negative net amount or negative balance in an international transaction account. The balance of payments (international transaction accounts) records all economic transactions between residents and non-residents where a change in ownership occurs.

A trade deficit or net amount can be calculated on different categories within an international transaction account. These include goods, services, goods and services, current account, and the sum of balances on the current and capital accounts.

The sum of the balances on the current and capital accounts equals net lending/borrowing.

This also equals the balance on the financial account plus a statistical discrepancy. The financial account measures financial assets and liabilities, in contrast to purchases and payments in the current and capital accounts.

The most relevant balance depends on the question being asked and the country about which it is being asked. In the U.S., the International Transaction Accounts are published by the Bureau of

Economic Analysis. The current account includes goods and services, plus primary and secondary income payments.

Primary income includes payments (financial investment returns) from direct investment (greater than 10% ownership of a business), portfolio investment (financial markets), and other.

Secondary income payments include government grants (foreign aid) and pension payments, and private remittances to households in other countries (e.g., sending money to friends and relatives).

The capital account includes exchanges of assets such as insured disaster-related losses, debt cancellation, and transactions involving rights, like mineral, trademark, or franchise.

The balance of the current account and capital account determines the exposure of an economy to the rest of the world, whereas the financial account (tracking financial assets, rather than products or income flows) explains how it is financed. In principle, the sum of the balances of the three accounts should be zero, but there is a statistical discrepancy because of source data used for the current and capital accounts is different from the source data used for the financial account.

Trade deficits occur when a country lacks efficient capacity to produce its own products – whether due to lack of skill and resources to create that capacity or due to preference to acquire from another country (such as to specialize in its own goods, for lower cost or to acquire luxuries).

The most obvious benefit of a trade deficit is that it allows a country to consume more than it produces. In the short run, trade deficits can help nations to avoid shortages of goods and other economic problems.

In some countries, trade deficits correct themselves over time. A trade deficit creates downward pressure on a country's currency under a floating exchange rate regime. With a cheaper domestic currency, imports become more expensive in the country with the trade deficit. Consumers react by reducing their consumption of imports and shifting toward domestically produced alternatives. Domestic currency depreciation also makes the country's exports less expensive and more competitive in foreign markets.

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