Balance of trade
Encyclopedia
The balance of trade is the difference between the monetary value of export
Export
The term export is derived from the conceptual meaning as to ship the goods and services out of the port of a country. The seller of such goods and services is referred to as an "exporter" who is based in the country of export whereas the overseas based buyer is referred to as an "importer"...

s and import
International trade
International trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product...

s of output in an economy over a certain period. It is the relationship between a nation's imports and exports. A positive balance is known as a trade surplus if it consists of exporting more than is imported; a negative balance is referred to as a trade deficit or, informally, a trade gap. The balance of trade is sometimes divided into a goods and a services balance.

Early understanding of the functioning of balance of trade informed the economic policies of Early Modern Europe that are grouped under the heading mercantilism
Mercantilism
Mercantilism is the economic doctrine in which government control of foreign trade is of paramount importance for ensuring the prosperity and security of the state. In particular, it demands a positive balance of trade. Mercantilism dominated Western European economic policy and discourse from...

. An early statement appeared in Discourse of the Common Weal of this Realm of England, 1549: "We must always take heed that we buy no more from strangers than we sell them, for so should we impoverish ourselves and enrich them." Similarly a systematic and coherent explanation of balance of trade was made public through Thomas Mun
Thomas Mun
Thomas Mun was an English writer on economics who has been called the last of the early mercantilists. He was among the first to recognize the exportation of service, or invisible items, as valuable trade, and made early statements strongly in support of capitalism.Mun began his career by engaging...

's c1630 "England's treasure by forraign trade, or, The balance of our forraign trade is the rule of our treasure"

Definition

The balance of trade forms part of the current account
Current account
In economics, the current account is one of the two primary components of the balance of payments, the other being the capital account. The current account is the sum of the balance of trade , net factor income and net transfer payments .The current account balance is one of two major...

, 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 stock, nor does it factor in 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 almost 1%; it appears the world is running a positive balance of trade with itself. This cannot be true, because all transactions involve an equal credit
Credit (finance)
Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...

 or debit
Debit
Debit and credit are the two aspects of every financial transaction. Their use and implication is the fundamental concept in the double-entry bookkeeping system, in which every debit transaction must have a corresponding credit transaction and vice versa.Debits and credits are a system of notation...

 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 include:
  • The cost of production (land, labor, capital, taxes, incentives, etc.) in the exporting economy vis-à-vis those in the importing economy;
  • The cost and availability of raw materials, intermediate goods and other inputs;
  • Exchange rate movements;
  • Multilateral, bilateral and unilateral taxes or restrictions on trade;
  • Non-tariff barriers such as environmental, health or safety standards;
  • The availability of adequate foreign exchange with which to pay for imports; and
  • Prices of goods manufactured at home (influenced by the responsiveness of supply)


In addition, the trade balance is likely to differ across the business cycle
Business cycle
The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...

. 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, the 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. The U.S. has a trade surplus with nations such as Australia
Australia
Australia , officially the Commonwealth of Australia, is a country in the Southern Hemisphere comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands in the Indian and Pacific Oceans. It is the world's sixth-largest country by total area...

. 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
Canada
Canada is a North American country consisting of ten provinces and three territories. Located in the northern part of the continent, it extends from the Atlantic Ocean in the east to the Pacific Ocean in the west, and northward into the Arctic Ocean...

, Japan
Japan
Japan is an island nation in East Asia. Located in the Pacific Ocean, it lies to the east of the Sea of Japan, China, North Korea, South Korea and Russia, stretching from the Sea of Okhotsk in the north to the East China Sea and Taiwan in the south...

, and Germany
Germany
Germany , officially the Federal Republic of Germany , is a federal parliamentary republic in Europe. The country consists of 16 states while the capital and largest city is Berlin. Germany covers an area of 357,021 km2 and has a largely temperate seasonal climate...

 which have savings surpluses, typically run trade surpluses. China
China
Chinese civilization may refer to:* China for more general discussion of the country.* Chinese culture* Greater China, the transnational community of ethnic Chinese.* History of China* Sinosphere, the area historically affected by Chinese culture...

, a high growth economy, has tended to run trade surpluses. A higher savings rate generally corresponds to a trade surplus. Correspondingly, the U.S. with its lower savings rate has tended to run high trade deficits, especially with Asian nations.

Conditions where trade imbalances may be problematic

Those who ignore the effects of long run trade deficits may be confusing David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...

's principle of comparative advantage
Comparative advantage
In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...

 with Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...

's principle of absolute advantage
Absolute advantage
In economics, principle of absolute advantage refers to the ability of a party to produce more of a good or service than competitors, using the same amount of resources...

, specifically ignoring the latter. The economist Paul Craig Roberts
Paul Craig Roberts
Paul Craig Roberts is an American economist and a columnist for Creators Syndicate. He served as an Assistant Secretary of the Treasury in the Reagan Administration earning fame as a co-founder of Reaganomics. He is a former editor and columnist for the Wall Street Journal, Business Week, and...

 notes that the comparative advantage
Comparative advantage
In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...

 principles developed by David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...

 do not hold where the factors of production are internationally mobile. Global labor arbitrage
Global labor arbitrage
Global labor arbitrage is an economic phenomenon where, as a result of the removal of or disintegration of barriers to international trade, jobs move to nations where labor and the cost of doing business is inexpensive and/or impoverished labor moves to nations with higher paying jobs...

, a phenomenon described by economist Stephen S. Roach
Stephen S. Roach
Stephen S. Roach is a senior executive with Morgan Stanley, the New York-based investment bank. In addition to his position at Morgan Stanley, Roach is a lecturer at Yale University's School of Management and Jackson Institute for Global Affairs.-Career:...

, where one country exploits the cheap labor of another, would be a case of absolute advantage
Absolute advantage
In economics, principle of absolute advantage refers to the ability of a party to produce more of a good or service than competitors, using the same amount of resources...

 that is not mutually beneficial.
Since the stagflation
Stagflation
In economics, stagflation is a situation in which the inflation rate is high and the economic growth rate slows down and unemployment remains steadily high...

 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. generally has lower savings rates than its trading partners, which tend to have trade surpluses. Germany, France, Japan, and Canada have maintained higher savings rates than the U.S. over the long run.

Few economists believe that GDP and employment can be dragged down by an over-large deficit over the long run. Others believe that trade deficits are good for the economy. The opportunity cost
Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...

 of a forgone tax base may outweigh perceived gains, especially where artificial currency pegs and manipulations are present to distort trade.

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. Some economists contend that the U.S. is borrowing to fund consumption of imports while accumulating unsustainable amounts of debt.

In 2006, the primary economic concerns focused on: high national debt
United States public debt
The United States public debt is the money borrowed by the federal government of the United States at any one time through the issue of securities by the Treasury and other federal government agencies...

 ($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
External debt
External debt is that part of the total debt in a country that is owed to creditors outside the country. The debtors can be the government, corporations or private households. The debt includes money owed to private commercial banks, other governments, or international financial institutions such...

 (amount owed to foreign lenders) and a serious deterioration in the United States net international investment position
Net international investment position
The difference between a country's external financial assets and its liabilities is the net international investment position . Both public and private held external assets and liabilities by legal residents of the respective country are hereby taken into account...

 (NIIP) (-24% of GDP), high trade deficits, and a rise in illegal immigration
Illegal immigration
Illegal immigration is the migration into a nation in violation of the immigration laws of that jurisdiction. Illegal immigration raises many political, economical and social issues and has become a source of major controversy in developed countries and the more successful developing countries.In...

.

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
2006 State of the Union address
The 2006 State of the Union Address was delivered by United States President George W. Bush at 9 p.m. EST on Tuesday, January 31, 2006 to a joint session of the U.S. Congress...

. On June 26, 2009, Jeff Immelt, the CEO of General Electric, called for the U.S. 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.

Conditions where trade imbalances may not be problematic

Small trade deficits are generally not considered to be harmful to either the importing or exporting economy. However, when a national trade imbalance expands beyond prudence (generally thought to be several percent of GDP, for several years), adjustments tend to occur. While unsustainable imbalances may persist for long periods (cf, Singapore
Singapore
Singapore , officially the Republic of Singapore, is a Southeast Asian city-state off the southern tip of the Malay Peninsula, north of the equator. An island country made up of 63 islands, it is separated from Malaysia by the Straits of Johor to its north and from Indonesia's Riau Islands by the...

 and New Zealand
New Zealand
New Zealand is an island country in the south-western Pacific Ocean comprising two main landmasses and numerous smaller islands. The country is situated some east of Australia across the Tasman Sea, and roughly south of the Pacific island nations of New Caledonia, Fiji, and Tonga...

’s surpluses and deficits, respectively), the distortions likely to be caused by large flows of wealth out of one economy and into another tend to become intolerable.

In simple terms, trade deficits are paid for out of foreign exchange reserves
Foreign exchange reserves
Foreign-exchange reserves in a strict sense are 'only' the foreign currency deposits and bonds held by central banks and monetary authorities. However, the term in popular usage commonly includes foreign exchange and gold, Special Drawing Rights and International Monetary Fund reserve positions...

, and may continue until such reserves are depleted. At such a point, the importer can no longer continue to purchase more than is sold abroad. This is likely to have exchange rate
Exchange rate
In finance, an exchange rate between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in terms of another currency...

 implications: a sharp loss of value in the deficit economy’s exchange rate with the surplus economy’s currency will change the relative price of tradable goods, and facilitate a return to balance or (more likely) an over-shooting into surplus the other direction.

More complexly, an economy may be unable to export enough goods to pay for its imports, but is able to find funds elsewhere. Service exports, for example, are more than sufficient to pay for Hong Kong
Hong Kong
Hong Kong is one of two Special Administrative Regions of the People's Republic of China , the other being Macau. A city-state situated on China's south coast and enclosed by the Pearl River Delta and South China Sea, it is renowned for its expansive skyline and deep natural harbour...

’s domestic goods export shortfall. In poorer countries, foreign aid may fill the gap while in rapidly developing economies a capital account
Capital account
The current and capital accounts make up a country's balance of payment . Together these three accounts tell a story about the state of an economy, its economic outlook and its strategies for achieving its desired goals...

 surplus often off-sets a current-account deficit. Finally, there are some economies where transfers from nationals working abroad contribute significantly to paying for imports. The Philippines, Bangladesh
Bangladesh
Bangladesh , officially the People's Republic of Bangladesh is a sovereign state located in South Asia. It is bordered by India on all sides except for a small border with Burma to the far southeast and by the Bay of Bengal to the south...

 and Mexico
Mexico
The United Mexican States , commonly known as Mexico , is a federal constitutional republic in North America. It is bordered on the north by the United States; on the south and west by the Pacific Ocean; on the southeast by Guatemala, Belize, and the Caribbean Sea; and on the east by the Gulf of...

 are examples of transfer-rich economies.

Adam Smith on trade deficits

"In the foregoing part of this chapter I have endeavoured to show, even upon the principles of the commercial system, how unnecessary it is to lay extraordinary restraints upon the importation of goods from those countries with which the balance of trade is supposed to be disadvantageous.
Nothing, however, can be more absurd than this whole doctrine of the balance of trade, upon which, not only these restraints, but almost all the other regulations of commerce are founded. When two places trade with one another, this [absurd] doctrine supposes that, if the balance be even, neither of them either loses or gains; but if it leans in any degree to one side, that one of them loses and the other gains in proportion to its declension from the exact equilibrium." (Smith, 1776, book IV, ch. iii, part ii)

Frédéric Bastiat on the fallacy of trade deficits

The 19th century economist and philosopher Frédéric Bastiat
Frédéric Bastiat
Claude Frédéric Bastiat was a French classical liberal theorist, political economist, and member of the French assembly. He was notable for developing the important economic concept of opportunity cost.-Biography:...

 expressed the idea that trade deficits actually were a manifestation of profit, rather than a loss. He proposed as an example to suppose that he, a Frenchman, exported French wine and imported British coal, turning a profit. He supposed he was in France, and sent a cask of wine which was worth 50 francs to England. The customhouse would record an export of 50 francs. If, in England, the wine sold for 70 francs (or the pound equivalent), which he then used to buy coal, which he imported into France, and was found to be worth 90 francs in France, he would have made a profit of 40 francs. But the customhouse would say that the value of imports exceeded that of exports and was trade deficit against the ledger of France.

Note that Bastiat only comes to this conclusion thanks to the customhouse's accounting error. The customhouse is valuing imports and exports based on the good's value in their home country, not the price paid when the actual international trade occurs as is conventionally done when calculating the trade balance. Correcting for the accounting error a neutral conclusion is reached: France sells wine for 70 and buys coal for 70, and Bastiat's profit does not come from England but simply from trading goods within France.

By reductio ad absurdum
Reductio ad absurdum
In logic, proof by contradiction is a form of proof that establishes the truth or validity of a proposition by showing that the proposition's being false would imply a contradiction...

, Bastiat argued that the national trade deficit was an indicator of a successful economy, rather than a failing one. Bastiat predicted that a successful, growing economy would result in greater trade deficits, and an unsuccessful, shrinking economy would result in lower trade deficits. This was later, in the 20th century, affirmed by economist Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...

.

John Maynard Keynes on the balance of trade

In the last few years of his life, John Maynard Keynes
John Maynard Keynes
John Maynard Keynes, Baron Keynes of Tilton, CB FBA , was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments...

 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
United Nations Monetary and Financial Conference
The United Nations Monetary and Financial Conference, commonly known as the Bretton Woods conference, was a gathering of 730 delegates from all 44 Allied nations at the Mount Washington Hotel, situated in Bretton Woods, New Hampshire, to regulate the international monetary and financial order after...

 in 1944 that established the Bretton Woods system
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...

 of international currency management.

He was the principal author of a proposal — the so-called Keynes Plan —— for an International Clearing Union
International Clearing Union
The International Clearing Union was one of the institutions proposed to be set up at the 1944 United Nations Monetary and Financial Conference at Bretton Woods, New Hampshire by British economist John Maynard Keynes...

. 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 principle of equality of treatment so novel in debtor-creditor relationships".

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
Geoffrey Crowther, Baron Crowther
Geoffrey Crowther, Baron Crowther was a British economist, journalist, educationalist and businessman. He was editor of The Economist from 1938 to 1956.-Early life and education:...

, then editor of The Economist
The Economist
The Economist is an English-language weekly news and international affairs publication owned by The Economist Newspaper Ltd. and edited in offices in the City of Westminster, London, England. Continuous publication began under founder James Wilson in September 1843...

, "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."

These ideas were informed by events prior to the Great Depression
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...

 when — in the opinion of Keynes and others — international lending, primarily by the U.S., 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.

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, 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
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...

 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 effects of large trade surpluses — have largely disappeared from mainstream economics
Mainstream economics
Mainstream economics is a loose term used to refer to widely-accepted economics as taught in prominent universities and in contrast to heterodox economics...

 discourse and Keynes' insights have slipped from view. They are receiving some attention again in the wake of the Financial crisis of 2007–2010.

Milton Friedman on trade deficits

In the 1980s, Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...

, the Nobel Prize
Nobel Prize
The Nobel Prizes are annual international awards bestowed by Scandinavian committees in recognition of cultural and scientific advances. The will of the Swedish chemist Alfred Nobel, the inventor of dynamite, established the prizes in 1895...

-winning economist and father of Monetarism
Monetarism
Monetarism is a tendency in economic thought that emphasizes the role of governments in controlling the amount of money in circulation. It is the view within monetary economics that variation in the money supply has major influences on national output in the short run and the price level over...

, contended that some of the concerns of trade deficits are unfair criticisms in an attempt to push macroeconomic policies favorable to exporting industries.

Prof. Friedman argued that trade deficits are not necessarily important as high exports raise the value of the currency, reducing aforementioned exports, and vice versa for imports, thus naturally removing trade deficits not due to investment. Since 1971, when the Nixon administration decided to abolish fixed exchange rates, America's Current Account accumulated trade deficits have totaled $7.75 Trillion as of 2010. This deficit exists as it is matched by investment coming in to the United States- purely by the definition of the balance of payments, any current account deficit that exists is matched by an inflow of foreign investment.

Milton Friedman's son, David D. Friedman
David D. Friedman
David Director Friedman is an American economist, author, and Right-libertarian theorist. He is known as a leader in anarcho-capitalist political theory, which is the subject of his most popular book, The Machinery of Freedom...

, shares his father's view and cites the comparative advantage concepts of David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...

.

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. This position is a more refined version of the theorem first discovered by David Hume
David Hume
David Hume was a Scottish philosopher, historian, economist, and essayist, known especially for his philosophical empiricism and skepticism. He was one of the most important figures in the history of Western philosophy and the Scottish Enlightenment...

. 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.

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 borrowed and bought while in general, the rest of the 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, 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.

Friedman contended 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 essentially claimed that the foreign assets were not carried on the books at their higher, truer value.

Friedman presented his analysis of the balance of trade in Free to Choose
Free to Choose
Free to Choose is a book and a ten-part television series broadcast on public television by economists Milton and Rose D...

, widely considered his most significant popular work.

Warren Buffett on trade deficits

The successful American businessman and investor Warren Buffett
Warren Buffett
Warren Edward Buffett is an American business magnate, investor, and philanthropist. He is widely regarded as one of the most successful investors in the world. Often introduced as "legendary investor, Warren Buffett", he is the primary shareholder, chairman and CEO of Berkshire Hathaway. He is...

 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." Buffett has proposed a tool called Import Certificates
Import Certificates
Import Certificates are a proposed mechanism to implement balanced trade, and eliminate a country's trade deficit. The idea was proposed by Warren Buffett in 2003 to address the U.S. trade deficit. In the United States, the idea was first introduced legislatively in the Balanced Trade Restoration...

 as a solution to the United States' problem and ensure balanced trade
Balanced trade
Balanced trade is an alternative economic model to free trade. Under balanced trade nations are required to provide a fairly even reciprocal trade pattern; they cannot run large trade deficits....

.

Physical balance of trade

Monetary balance of trade is different from physical balance of trade (which is expressed in amount of raw materials, known also as Total Material Consumption). 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 than imported. For this reason, activists talk about the issue of ecological debt
Ecological debt
Ecological debt is a term used since 1992 by some environmental organizations from the South. The first one to use this term was the Instituto de Ecologia Politica from Chile . J.M. Borrero, from Colombia, a lawyer, wrote a book on the ecological debt in 1994...

 which implies a sort of predatory economic system. The nature of the trade balance statistics is such that it conceals distorted material flow.

United States Trade Deficit

The U.S. has held a trade deficit starting late in the 1960s. Its trade deficit has been increasing at a large rate since 1997 (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.

The graph indicates that, as Frédéric Bastiat
Frédéric Bastiat
Claude Frédéric Bastiat was a French classical liberal theorist, political economist, and member of the French assembly. He was notable for developing the important economic concept of opportunity cost.-Biography:...

 predicted, 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 1975. Every year there has been a major reduction in economic growth, it is followed by a reduction in the US trade deficit.

See also

  • Current account
    Current account
    In economics, the current account is one of the two primary components of the balance of payments, the other being the capital account. The current account is the sum of the balance of trade , net factor income and net transfer payments .The current account balance is one of two major...

  • Balance of payments
    Balance of payments
    Balance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers...

  • FRED (Federal Reserve Economic Data)
  • Marshall–Lerner condition


Lists:

External links

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