Should we worry about a trade deficit?

A trade deficit implies the value of imports of goods is greater than exports. (M>X)

The trade deficit is an important component of the current account on the balance of payments. Sometimes people use a trade 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.

UK current account deficit since 1980. (current account includes both trade in goods and services.)

Summary – should we worry about a trade deficit?


  1. A trade deficit suggests the economy is relatively uncompetitive and we cannot export as many goods as we import.
  2. A trade deficit suggests the economy is unbalanced – encouraging consumption at the expense of saving, investment and exports
  3. A trade deficit can lead to future devaluation in the exchange rate to restore balance.
  4. The global credit crunch of 2008/09 showed that capital flows, necessary to finance a current account deficit can suddenly dry up and this can cause a rapid depreciation in the exchange rate.
  5. 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.


  1. Trade deficit may be a consequence of rapid growth, which causes higher consumer spending on imports.
  2. Trade deficit financed by long term capital flows helps the economy with financing inward investment (e.g. we run a trade deficit with China, but China finances the deficit by investing in nuclear power stations in the UK.)
  3. If the trade deficit is too large, it will cause a depreciation in the exchange rate to restore competitiveness and improve the trade deficit.
  4. There are more pressing economic priorities than a trade deficit, such as economic growth, unemployment and inflation.

Trade deficit and surplus on financial account

A deficit on the trade deficit / current account means it has to be matched by a surplus on the financial and/or capital account. The financial account comprises of two main features:

  • Short Term Capital flows e.g. hot money flows and purchase of securities
  • Long Term Capital flows e.g. investment in building new factories

Therefore a trade deficit can lead to inward capital flows.

This means that we shouldn’t just look at the trade deficit but what else is happening in the economy.


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