Firstly a trade deficit refers to trade in goods (visible goods). A deficit implies the value of imports is greater than exports.
The trade deficit is an important component of the current account on the balance of payments. Sometimes people use ta rade deficit and a current account interchangeably, but in the UK this is not correct. The current account also includes trade on services (invisibles)
A trade deficit is often seen as a bad thing. It suggests we are ‘living beyond our means’ However, many economists argue a trade deficit isn’t necessarily a bad thing.
Summary – should we worry about a trade deficit?
- Suggests economy is relatively uncompetitive we cannot export as many goods as we import.
- Suggests economy is unbalanced – encouraging consumption at expense of saving, investment and exports
- Can lead to future devaluation in exchange rate to restore balance.
- Global credit crunch showed that capital flows, necessary to finance a current account deficit can suddenly dry up.
- A trade deficit is a much bigger problem for countries in the Euro, who can’t devalue to restore competitiveness. Their loss of competitiveness is leading to lower growth and higher unemployment.
- Trade deficit may be consequence of rapid growth, which causes higher consumer spending.
- Trade deficit financed by long term capital flows helps economy with financing inward investment (e.g. we run trade deficit with China, but China finances the deficit by investing in nuclear power stations in the UK.
- If the trade deficit is too large, it will cause a depreciation in the exchange rate to restore competitiveness and improve trade deficit.
- There are more pressing economic priorities than a trade deficit.
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