Balance of trade

The balance of trade (or net exports, sometimes symbolized as NX) is the difference between the monetary value of exports and imports of output in an economy over a certain period. It is the relationship between a nation's imports and exports.[1] A favourable balance of trade is known as a trade surplus and consists of exporting more than is imported; an unfavourable balance of trade is known as a trade deficit or, informally, a trade gap. The balance of trade is sometimes divided into a goods and a services balance.

Definition
The balance of trade forms part of the current account, which includes other transactions such as income from the international investment position as well as international aid. If the current account is in surplus, the country's net international asset position increases correspondingly. Equally, a deficit decreases the net international asset position.
The trade balance is identical to the difference between a country's output and its domestic demand (the difference between what goods a country produces and how many goods it buys from abroad; this does not include money re-spent on foreign stocks, nor does it factor the concept of importing goods to produce for the domestic market).
Measuring the balance of trade can be problematic because of problems with recording and collecting data. As an illustration of this problem, when official data for all the world's countries are added up, exports exceed imports by a few percent; it appears the world is running a positive balance of trade with itself. This cannot be true, because all transactions involve an equal credit or debit in the account of each nation. The discrepancy is widely believed to be explained by transactions intended to launder money or evade taxes, smuggling and other visibility problems. However, especially for developed countries, accuracy is likely.
Factors that can affect the balance of trade figures include:
Prices of goods manufactured at home (influenced by the responsiveness of supply)
Exchange rates regarded in 1933
Trade agreements or barriers
Offset agreements
Other tax, tariff and trade measures
Business cycle at home or abroad.
The balance of trade is likely to differ across the business cycle. In export led growth (such as oil and early industrial goods), the balance of trade will improve during an economic expansion. However, with domestic demand led growth (as in the United States and Australia) the trade balance will worsen at the same stage in the business cycle.
Since the mid 1980s, United States has had a growing deficit in tradeable goods, especially with Asian nations (China and Japan) which now hold large sums of U.S debt that has funded the consumption.[2][3] The U.S. has a trade surplus with nations such as Australia and Canada. The issue of trade deficits can be complex. Trade deficits generated in tradeable goods such as manufactured goods or software may impact domestic employment to different degrees than trade deficits in raw materials.
Economies such as Canada, Japan, and Germany which have savings surpluses, typically run trade surpluses. China, a high growth economy, has tended to run trade surpluses. A higher savings rate generally corresponds to a trade surplus. Correspondingly, the United States with its lower savings rate has tended to run high trade deficits, especially with Asian nations.

[edit] Views on economic impact
Economists are sometimes divided on the economic impact of the trade deficit.

[edit] Conditions where trade deficits may be considered harmful
Those who ignore the effects of long run trade deficits may be confusing David Ricardo's principle of comparative advantage with Adam Smith's principle of absolute advantage, specifically ignoring that latter. The economist Paul Craig Roberts notes that the comparative advantage principles developed by David Ricardo do not hold where the factors of production are internationally mobile.[4][5] Global labor arbitrage, a phenomenon described by economist Stephen S. Roach, where one country exploits the cheap labor of another, would be a case of absolute advantage that is not mutually beneficial.[6][7][8]

Detiorating U.S. net international investment position (NIIP) has caused concern among economists over the effects of outsourcing and high U.S. trade deficits over the long-run.[2]
Since the stagflation of the 1970s, the U.S. economy has been characterized by slower GDP growth. In 1985, the U.S. began its growing trade deficit with China. Over the long run, nations with trade surpluses tend also to have a savings surplus. The U.S. has been plagued by persistently lower savings rates than its trading partners which tend to have trade surpluses with the U.S. Germany, France, Japan, and Canada have maintained higher savings rates than the U.S. over the long run. [9] Some economists believe that GDP and employment can be dragged down by an over-large deficit over the long run. [10][11] Wealth-producing primary sector jobs in the U.S. such as those in manufacturing and computer software have often been replaced by much lower paying wealth-consuming jobs such those in retail and government in the service sector when the economy recovered from recessions.[12] [13] [5] Some economists contend that the U.S. is borrowing to fund consumption of imports while accumulating unsustainable amounts of debt.[2][14]
In 2006, the primary economic concerns centered around: high national debt ($9 trillion), high non-bank corporate debt ($9 trillion), high mortgage debt ($9 trillion), high financial institution debt ($12 trillion), high unfunded Medicare liability ($30 trillion), high unfunded Social Security liability ($12 trillion), high external debt (amount owed to foreign lenders) and a serious deterioration in the United States net international investment position (NIIP) (-24% of GDP),[2] high trade deficits, and a rise in illegal immigration.[15][14]
These issues have raised concerns among economists and unfunded liabilities were mentioned as a serious problem facing the United States in the President's 2006 State of the Union address.[16][15] On June 26 2009, Jeff Immelt, the CEO of General Electric, called for the United States to increase its manufacturing base employment to 20% of the workforce, commenting that the U.S. has outsourced too much in some areas and can no longer rely on the financial sector and consumer spending to drive demand.[17]

Conditions where trade deficits may not be harmful
When economists contend trade deficits are not harmful, they generally refer to explanations of comparative advantage. Buyers in the receiving country send the money back. A firm in America sends dollars for Brazilian sugarcane, and the Brazilian receivers use the money to buy stock in an American company. This may lead to profits leaving the U.S however as Americans may forfeit control. Although this is a form of capital account reinvestment, it may not be a liability on anyone in America.
Such payments to foreigners have intergenerational effects: by shifting the consumption schedule over time, some generations may gain and others lose [18]. However, a trade deficit may incur consumption in the future if it is financed by profitable domestic investment, in excess of that paid on the net foreign debts. Similarly, an excess on the current account shifts consumption to future generations, unless it raises the value of the currency, detering foreign investment.
However, trade inequalities are not natural given differences in productivity and consumption preferences. Trade deficits have often been associated with international competitiveness. Trade surpluses have been associated with policies that skew a country's activity towards externalities, resulting in lower standards. An example of an economy which has had a positive balance of trade was Japan in the 1990s.
Milton Friedman argued that trade deficits are not necessarily important as high exports raise the value of the currency, reducing aforementioned exports, and vise versa for imports, thus naturally removing trade deficits not due to investment. Milton Friedman's son, David D. Friedman, shares this view and cites the comparative advantage concepts of David Ricardo.[19]

Milton Friedman on trade deficits
In the 1980s, Milton Friedman, the Nobel Prize-winning economist and father of Monetarism, contended that some of the concerns of trade deficits are unfair criticisms in an attempt to push macroeconomic policies favorable to exporting industries. In the late 1970s and early 1980s, the U.S. had experienced high inflation and Friedman's policy positions tended to defend the stronger dollar at that time. He stated his belief that these trade deficits were not necessarily harmful to the economy at the time since the currency comes back to the country (country A sells to country B, country B sells to country C who buys from country A, but the trade deficit only includes A and B). However, it may be in one form or another including the possible tradeoff of foreign control of assets. In his view, the "worst case scenario" of the currency never returning to the country of origin was actually the best possible outcome: the country actually purchased its goods by exchanging them for pieces of cheaply-made paper. As Friedman put it, this would be the same result as if the exporting country burned the dollars it earned, never returning it to market circulation.[20] This position is a more refined version of the theorem first discovered by David Hume.[21] Hume argued that England could not permanently gain from exports, because hoarding gold (i.e., currency) would make gold more plentiful in England; therefore, the prices of English goods would rise, making them less attractive exports and making foreign goods more attractive imports. In this way, countries' trade balances would balance out.[22]
Friedman believed that deficits would be corrected by free markets as floating currency rates rise or fall with time to encourage or discourage imports in favor of the exports, reversing again in favor of imports as the currency gains strength. In the real world, a potential difficulty is that currency markets are far from a free market, with government and central banks being major players, and this is unlikely to change within the foreseeable future. Nevertheless, recent developments have shown that the global economy is undergoing a fundamental shift. For many years the U.S. has bore world has lent and sold. However, as Friedman predicted, this paradigm appears to be changing.
As of October 2007, the U.S. dollar weakened against the euro, British pound, and many other currencies. For instance, the euro hit $1.42 in October 2007[23], the strongest it has been since its birth in 1999. Against this backdrop, American exporters are finding quite favorable overseas markets for their products and U.S. consumers are responding to their general housing slowdown by slowing their spending. Furthermore, China, the Middle East, central Europe and Africa are absorbing more of the world's imports which in the end may result in a world economy that is more evenly balanced. All of this could well add up to a major readjustment of the U.S. trade deficit, which as a percentage of GDP, began in 1991.[24]
Friedman and other economists have pointed out that a large trade deficit (importation of goods) signals that the country's currency is strong and desirable. To Friedman, a trade deficit simply meant that consumers had opportunity to purchase and enjoy more goods at lower prices; conversely, a trade surplus implied that a country was exporting goods its own citizens did not get to consume or enjoy, while paying high prices for the goods they actually received.
Perhaps most significantly, Friedman contended strongly that the structure of the balance of payments was misleading. In an interview with Charlie Rose, he stated that "on the books" the US is a net borrower of funds, using those funds to pay for goods and services. He pointed to the income receipts and payments showing that the US pays almost the same amount as it receives: thus, U.S. citizens are paying lower prices than foreigners for capital assets to exchange roughly the same amount of income. The reasons why the U.S. (and UK) appear to earn a higher rate of return on their foreign assets than they pay on their foreign liabilities are not clearly understood. An important contributing factor is that the U.S. has investment primarily in stocks abroad, while foreigners have invested heavily in debt instruments, such as U.S. government bonds [25]. [26] Other reports contend that U.S. net foreign income has deteriorated, and appears set to stay in deficit in the future [27].
Friedman presented his analysis of the balance of trade in Free to Choose, widely considered his most significant popular work.

Warren Buffett on trade deficits
The successful American businessman and investor Warren Buffett was quoted in the Associated Press (January 20, 2006) as saying "The U.S trade deficit is a bigger threat to the domestic economy than either the federal budget deficit or consumer debt and could lead to political turmoil... Right now, the rest of the world owns $3 trillion more of us than we own of them."

John Maynard Keynes on the balance of trade
In the last few years of his life, John Maynard Keynes was much preoccupied with the question of balance in international trade. He was the leader of the British delegation to the United Nations Monetary and Financial Conference in 1944 that established the Bretton Woods system of international currency management.
He was the principal author of a proposal—the so-called Keynes Plan—for an International Clearing Union. The two governing principles of the plan were that the problem of settling outstanding balances should be solved by 'creating' additional 'international money', and that debtor and creditor should be treated almost alike as disturbers of equilibrium. In the event, though, the plans were rejected, in part because "American opinion was naturally reluctant to accept the principal of equality of treatment so novel in debtor-creditor relationships". [28]
His view, supported by many economists and commentators at the time, was that creditor nations may be just as responsible as debtor nations for disequilibrium in exchanges and that both should be under an obligation to bring trade back into a state of balance. Failure for them to do so could have serious consequences. In the words of Geoffrey Crowther, then editor of The Economist, "If the economic relationships between nations are not, by one means or another, brought fairly close to balance, then there is no set of financial arrangements that can rescue the world from the impoverishing results of chaos." [29]
These ideas were informed by events prior to the Great Depression when—in the opinion of Keynes and others—international lending, primarily by the United States, exceeded the capacity of sound investment and so got diverted into non-productive and speculative uses, which in turn invited default and a sudden stop to the process of lending. [30]
Influenced by Keynes, economics texts in the immediate post-war period put a significant emphasis on balance in trade. For example, the second edition of the popular introductory textbook, An Outline of Money, [31] devoted the last three of its ten chapters to questions of foreign exchange management and in particular the 'problem of balance'. However, in more recent years, since the end of the Bretton Woods system in 1971, with the increasing influence of Monetarist schools of thought in the 1980s, and particularly in the face of large sustained trade imbalances, these concerns—and particularly concerns about the destabilising affects of large trade surpluses—have largely disappeared from mainstream economics discourse [32] and Keynes' insights have slipped from view [33], they are receiving some attention again in the wake of the financial crisis of 2007–2009. [34]

Physical balance of trade
Monetary balance of trade is different from physical balance of trade (which is expressed in amount of raw materials). Developed countries usually import a lot of primary raw materials from developing countries at low prices. Often, these materials are then converted into finished products, and a significant amount of value is added. Although for instance the EU (as well as many other developed countries) has a balanced monetary balance of trade, its physical trade balance (especially with developing countries) is negative, meaning that a lot less material is exported rather than imported.

United States trade deficit

United States trade deficit (1991-2005).
The United States of America has held a trade deficit starting late in the 1960s. It was this very deficit that forced the United States in 1971 off the gold standard. Its trade deficit has been increasing at a large rate since 1997 [35] (See chart) and increased by 49.8 billion dollars between 2005 and 2006, setting a record high of 817.3 billion dollars, up from 767.5 billion dollars the previous year.[36]
It is worth noting on the graph that the deficit slackened during recessions and grew during periods of expansion. Also of note, many economists calculate trade deficits and/or current account deficits as a percentage of GDP. The US last had a trade surplus in 1991, a recession year. Every year there has been a major reduction in economic growth, it is followed by a reduction in the US trade deficit.[24] The investor Warren Buffett has proposed a tool called Import Certificates as a solution to the United States' problem.[37]

See also
List of the largest trading partners of the United States
Current account
Balance of payments
FRED (Federal Reserve Economic Data)
List of countries by current account balance

Notes
^ Sullivan, arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 462. ISBN 0-13-063085-3. http://www.pearsonschool.com/index.cfm?locator=PSZ3R9&PMDbSiteId=2781&PMDbSolutionId=6724&PMDbCategoryId=&PMDbProgramId=12881&level=4.
^ a b c d Bivens, L. Josh (December 14, 2004). Debt and the dollar Economic Policy Institute. Retrieved on July 8, 2007.
^ MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES. U.S. Treasury.gov
^ Roberts, Paul Craig (August 7, 2003). Jobless in the USA Newsmax. Retrieved on May 6, 2007.
^ a b Hira, Ron and Anil Hira with forward by Lou Dobbs, (May 2005). Outsourcing America: What's Behind Our National Crisis and How We Can Reclaim American Jobs. (AMACOM) American Management Association. Citing Paul Craig Roberts, Paul Samuelson, and Lou Dobbs, pp. 36-38.
^ See Roberts, Loc. cit.
^ Paul Craig Roberts (07/28/04)."Global Labor Arbitrage".VDARE. Retrieved on July 7, 2009.
^ Whitney, Mike (June 2006).Labor arbitrage. Entrepreneur. Retrieved on July 7, 2009.
^ The shift away form thrift.The Economist, April 7 2005.
^ Free Trade Bulletin no. 27: Are Trade Deficits a Drag on U.S. Economic Growth? Cato's Center for Trade Policy Studies
^ Causes and Consequences of the Trade Deficit: An Overview
^ David Friedman, New America Foundation (2002-06-15).No Light at the End of the Tunnel Los Angeles Times.
^ Sir Keith Joseph, Centre for Policy Studies (1976-04-05).Stockton Lecture, Monetarism Is Not Enough, with forward by Margaret Thatcher. (Barry Rose Pub.) Margaret Thatcher Foundation (2006).
^ a b Phillips, Kevin (2007). Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism. Penguin. ISBN 9780143143284.
^ a b Cauchon, Dennis and John Waggoner (October 3, 2004).The Looming National Benefit Crisis USA Today
^ George W. Bush (2006) State of the Union. Retrieved on April 17, 2009.
^ Bailey, David and Soyoung Kim (June 26, 2009).GE's Immelt says U.S. economy needs industrial renewal.UK Guardian.. Retrieved on June 28, 2009.
^ Debt and the dollar: The United States damages future living standards by borrowing itself into a deceptively deep hole
^ Price Theory, Chapter 6: Simple Trade
^ Free to Choose video series from PBS
^ Hume, David (1987). "Essays, Moral, Political, and Literary". Liberty Fund, Inc. http://www.econlib.org/library/LFBooks/Hume/hmMPL28.html.
^ ""David Hume: The Concise Encyclopedia of Economics"". 2008. http://www.econlib.org/library/Enc/bios/Hume.html. Retrieved 2009-03-20.
^ Dollar Hits a New Low, Oil Hits a New High - New York Times
^ a b Michael M. Phillips, World Economy in Flux As America Downshifts
^ http://www.bis.org/publ/work223.pdf
^ Economics Blog : Risk-Loving Americans Counter U.S.'s Foreign Debt
^ https://www.commerzbank.com/media/research/economic_research/pool/researchnotes/ResNote_us_niip_070627.pdf
^ Crowther, Geoffrey (1948). An Outline of Money. Thomas Nelson and Sons. p. 326-9.
^ Crowther, Geoffrey (1948). An Outline of Money. Thomas Nelson and Sons. p. 336.
^ Crowther, Geoffrey (1948). An Outline of Money. Thomas Nelson and Sons. p. 368-72.
^ Crowther, Geoffrey (1948). An Outline of Money. Thomas Nelson and Sons.
^ See for example, Krugman, P and Wells, R (2006). "Economics", Worth Publishers
^ although see Duncan, R (2005). "The Dollar Crisis: Causes, Consequences, Cures", Wiley
^ See for example, ""Clearing Up This Mess"". 2008-11-18. http://www.monbiot.com/archives/2008/11/18/clearing-up-this-mess/. Retrieved 2009-01-09.
^ http://www.census.gov/foreign-trade/statistics/historical/gands.txt
^ FTD - Statistics - Country Data - U.S. Trade Balance with World (Seasonally Adjusted)
^ http://www.berkshirehathaway.com/letters/growing.pdf