Balance of trade

The balance of trade represents the difference between the monetary value of a nation’s exports and imports of goods over a specified period. Although services are sometimes included in broader discussions of trade performance, the official definition used by the International Monetary Fund considers only tangible goods. As a flow variable, the balance of trade records movements of exports and imports over time, rather than at a single point. A positive balance, or trade surplus, occurs when exports exceed imports, while a negative balance, or trade deficit, arises when imports are greater than exports. Contemporary economic analysis often challenges the assumption that trade deficits are inherently harmful, noting that their effects depend on a country’s broader economic conditions.

The Balance of Trade and the Current Account

The balance of trade forms a major component of the current account within a nation’s balance of payments framework. The current account also includes cross-border income flows, such as investment income, remittances and international aid. A current account surplus reflects an increase in a nation’s net foreign assets, whereas a deficit reduces this position.
From an economic standpoint, the trade balance is equivalent to the difference between a country’s output and its domestic demand. This identity highlights that a trade deficit does not necessarily imply weakness; it may simply indicate that domestic consumption exceeds production. However, this measure excludes financial flows such as portfolio investments and ignores the fact that imported goods may be used to produce domestic exports.
Accurate measurement remains difficult due to data-collection challenges. A well-known anomaly is that aggregated global figures appear to show that worldwide exports exceed imports by a small margin, an impossibility in accounting terms. This discrepancy is attributed to tax evasion, smuggling, under-invoicing and errors in recording transactions, surprising economists as many inconsistencies occur among countries with strong statistical systems.

Determinants Influencing the Balance of Trade

A wide range of structural and cyclical factors influences the balance of trade:

• Cost of production in exporting and importing countries, including labour, land, capital, taxation and subsidies.
• Availability and cost of raw materials and intermediate goods.
• Exchange rate movements, which affect the relative price competitiveness of exported and imported goods.
• Trade policies, including tariffs, quotas and non-tariff barriers such as environmental or health regulations.
• Foreign exchange availability, affecting a country’s ability to pay for imports.
• Price levels and supply responsiveness within the domestic manufacturing sector.

The balance of trade typically varies over the business cycle. Export-led economies, such as those reliant on commodities, tend to record rising surpluses during expansions. Conversely, domestic-demand-driven economies, including the United States and Australia, experience increased imports and thus more pronounced trade deficits during periods of strong economic activity.
A distinction also exists between monetary and physical balances of trade. The physical balance measures the net flow of raw materials, known as Total Material Consumption. Developed economies often record physical deficits because they import significant volumes of raw materials for processing and re-export, even when their monetary trade balances appear more favourable.

Historical Perspectives

Early modern European states widely embraced mercantilism, a doctrine asserting that national wealth depended on accumulating precious metals and maintaining trade surpluses. Policies encouraged the export of raw materials from colonies and the import of manufactured goods to the colonies, thereby channelling economic benefits to the European metropoles. Concepts such as bullionism strengthened mercantilist thinking, with governments seeking to maximise inflows of gold and silver.
The intellectual foundations of trade-balance analysis can be traced to texts such as Discourse of the Common Wealth of this Realm of England (1549), attributed to Thomas Smith, which argued against buying more from foreign countries than one sells to them. Thomas Mun’s England’s Treasure by Foreign Trade (1630) provided a systematic exposition of mercantilist principles and remained influential in debates about national wealth.
Since the mid-1980s, the United States has experienced persistent trade deficits, particularly with East Asian economies such as China and Japan. These surpluses contributed to accumulating foreign holdings of US government debt. At the same time, the United States has maintained trade surpluses with countries such as Australia. The economic effects of such imbalances vary depending on whether deficits arise in manufactured goods, services, or raw materials.
High-savings economies, including Japan and Germany, typically run surpluses. Fast-growing economies such as China also tend to exhibit surplus positions. By contrast, countries with lower savings ratios often record deficits, reflecting an excess of consumption over production.

Economic Impact and Interpretations

Modern trade economists largely reject the belief that bilateral trade deficits are inherently harmful. They argue that deficits may reflect underlying economic strengths, such as high consumer demand or investment opportunities attracting foreign capital. Nevertheless, trade deficits can create pressures on the balance of payments and foreign exchange reserves, particularly in developing economies.
Some economists, including Joseph Stiglitz, point out that persistent trade surpluses can generate negative externalities by reducing global demand and contributing to economic imbalances. A similar view is echoed by Ben Bernanke regarding the eurozone, where wide disparities between surplus and deficit countries have contributed to financial instability.
Other analyses emphasise benefits from trade deficits. According to Carla Norrlöf, the United States gains from:

• Higher consumption than domestic production allows.
• Use of efficient foreign-produced intermediate goods, enhancing productivity.
• Global bargaining power derived from its role as a major consumer market.

A National Bureau of Economic Research study of 151 countries over several decades found that imposing tariffs had little long-term effect on the trade balance, challenging arguments that protectionism can correct structural deficits.

Classical and Keynesian Perspectives

Adam Smith criticised the mercantilist obsession with maintaining trade surpluses. In The Wealth of Nations (1776) he argued that the doctrine of the balance of trade was conceptually flawed, as it assumed that gains and losses in trade resembled a zero-sum game. Smith emphasised that trade could be mutually beneficial regardless of imbalances.
John Maynard Keynes, concerned with global economic stability during the 1940s, argued that both deficit and surplus countries contribute to disequilibrium. As the chief architect of the Keynes Plan at the Bretton Woods Conference in 1944, he proposed an International Clearing Union that would create international money and impose obligations on both creditors and debtors. Although his proposal was not adopted, it influenced later thinking on balanced global growth and the responsibilities of surplus economies.