What is the Balance of Trade?
Definition: Balance of Trade is simply the difference between the number of a country’s exports and imports and exports over a given period. It is a measure of valuing a country’s balance of payments and often used to measure the strength of a country’s economy.
Countries engage in the exportation and importation of goods, leading to what is often referred to as international trade. By importing goods, a country can address shortages within its borders. Likewise, exportation allows countries to sell whatever they produce in surplus. The export and importation of goods often result in a financial measure referred to as Balance of Trade.
Balance of Trade Formula Computation
The balance of trade formula is calculated like this:
Balance of Trade = Exports – imports
Exports refer to goods and services produced domestically and sold to another country or foreigner. Likewise, imports refer to goods and services bought by a country and residents to address a shortage.
Balance of Trade Example
Consider country X exported goods worth $1 billion for the financial year 2016-2017 and imported goods worth $1.5 billion for the same period. In this case, Country X had an unfavorable trade balance as the imports exceeded exports leading to a trade deficit of $0.5 billion.
Understanding the Balance of Trade
Whenever a country exports more than it imports, a trade surplus occurs. A trade surplus, in this case, is viewed as a favorable balance of trade as it allows a country to benefit more. A favorable balance of trade provides necessary means for financing a country’s purchase of foreign goods crucial to maintaining export trade.
A country with a booming trade surplus would essentially be lending money to countries with a trade deficit, as they need the money to buy the goods and services they purchase. A trade surplus is also associated with political and economic stability that also underscores the amount of foreign investment in the country. For this reason, the trade surplus is often envisioned as a favorable balance of trade.
In contrast, whenever a country imports more than it exports, it results in a situation termed as a trade deficit. Trade deficits tend to be unfavorable, as a country tends to spend more compared to what it gains on international trade. Trade deficits are synonymous with countries that export raw materials and import a lot of finished consumer products in return.
A trade deficit could be as a result of a country’s falling comparative advantage when it comes to manufactured goods. Likewise, overvalued exchange rates could make a country’s exports to be expensive compared to what other countries are offering. If this were to happen, then a country’s exports would be costly and import cheaper, leading to a trade deficit.
Trade deficit tends to shrink during recessions as consumer spending drops, leading to a reduction in imports while exports increase.
Countries tend to create policies that allow them to enjoy a trade surplus when it comes to international trade. Likewise, a country could pass policies that would ensure domestic companies could sell more products to receive more capital in return. To protect local businesses and companies in a bid to fuel export trade and curb imports, a country may opt to impose tariffs and quotas to suppress imports.
However, a trade deficit can also come with its fair share of benefits. For instance, some countries import large amounts of raw materials that are, in return, converted into finished products for exports. Likewise, a trade deficit may occur because of economic growth.
Summary
Balance of Trade matters as it helps economists and analysts understand how an economy is doing. A country struggling with a large trade deficit could be as a result of immense borrowing for the purpose of importing more goods and services. Likewise, a country with a large trade surplus could indicate a booming economy as well as favorable economic policies and exchange rates that make exports to be favorable on the international scene.