Readers Questions on Trade Deficit and Debt

Readers Question: I keep reading about our country’s trade deficit which was £3bn in April. How does that work, if a country is spending more than it’s earning? Are we getting ourselves into more debt? I read that Germany has a trade surplus, which is not surprising but why can’t we do the same?

There is an important distinction between a trade deficit and government debt (national debt / public sector debt).

  • Government debt occurs when they spend more than they receive in tax.
  • A trade deficit means we are importing more than exporting. It is not a debt as such, but an outflow of money from the UK overseas in order to buy goods.

See: Difference between Government debt and trade deficit

A trade deficit requires funding from the other component of the Balance of Payments – the financial account / capital account. Therefore whilst we run a trade deficit, we have a surplus on the financial account (which is capital flows e.g. foreign direct investment or purchase of UK securities)

Should We worry about a Trade deficit?

  • It may suggest the economy lacks competitiveness (therefore we prefer imports to domestic goods)
  • It may suggest the economy is unbalanced (relying too much on consumer spending)
  • However, it is not necessarily a bad thing. Capital flows into the UK can have benefits e.g. Japanese firms building factories. A trade deficit may also indicate an economy growing strongly (though that is not case for UK at moment). Japan has a large trade surplus but a long period of stagnant growth.

More details see: Should we worry about Trade deficit?

However, most economists feel that the persistent large current account (trade) deficits in the US and UK are unhelpful for balanced global growth. These deficits are matched by large current account surplus in Germany / China and Japan.

Are we getting ourselves into more debt?

A trade deficit implies capital inflows. It means foreigners are owning an increasing amount of UK assets (which is not necessarily good or bad)

I read that Germany has a trade surplus, which is not surprising but why can’t we do the same?

To gain a trade surplus, the UK would need to

  • Become more competitive internationally e.g. increase labour productivity e.t.c
  • Devote a higher % of National income to investment and lower % to consumption (lower consumption means less imports)
  • Allow Pound to fall even further. (though interestingly the recent decline in value of pound has not significantly improved the current account deficit. See: Terms of Trade effect for why devaluation in Pound has not improved current account deficit

2 thoughts on “Readers Questions on Trade Deficit and Debt”

  1. The above recommendations are good for the UK to increase exports, but what it comes down to is a country has to produce something. If it can not be a low cost producer like Asian countries it has to develop a niche, usually connected being once step ahead in technology.
    I do not know if the UK or the US can do this?

  2. The United States has not had a current account surplus since 1975. We have not had a trade surplus with Japan since April, 1976. We have been in deficit with the EU since 1983. We have run trade deficits with both Russia and China for more than 20 years. How did America go from being the largest creditor nation in 1975 to the largest debtor nation by the end of the 1980’s? To understand what has happened one must go back in time. Prior to 1860 much of the Western World practiced Mercantilism. After 1860, led by Great Britain, Mercantilism was abandoned in favor of the teachings of John Locke and the free trade principles of Adam Smith. Trade barriers throughout Europe came down. A great debate on economic policy took place in America. Lincoln for instance was a Mercantilist. For the next 110 years the Western World basically traded with itself. Good flowed across the Atlantic and trade disputes if they arose were generally settled quickly. By 1970 the world was changing. The post world war II era produced the eventual rise of Japan as an economic machine. Goods started to flow from Japan to the United States and to Europe. The problem was that goods were only flowing one way. America for instance was banned by Japan from selling rice or apples to Japanese consumers. While disputes like this in many industries were festering, Japan was quietly becoming a world power in automobile and electronics manufacturing. Auto’s and electronics were exported out of Japan at an ever faster clip. By 1977 Japan was running steady trade surpluses with the United States and American politicians were raising alarms that Japan was simply practicing protectionism. What Japan was really doing is practicing a new form of Mercantilism which I have pegged, “Asian Mercantilism.” Japan was more concerned with full employment in Japan than the loud voices of western politicians. By the late 1980’s the United States and Europe were both running huge trade deficits with Japan. After 15 years of trade deficits America had found herself in the position of having gone from being the world’s biggest creditor nation to being a debtor nation. The rise of China over the past 20 years has given the world another Japan but this time on steroids. If Japan practices Mercantilism then China practices Supra Mercantilism: Goods are exported, imports are controlled. The currency is massively controlled, not free floating. Production is favored over consumption. With a population of 1.5 billion China has been able to give Mercantilism a whole new dynamic. What we have in the world today are two competing economic models for prosperity. We have the Western model with relies on the system of Free Trade and we have the Asian system with relies on a super sized form of Mercantilism. We have the West running trade deficits and the Asians running trade surpluses. China, Japan, and South Korea are the producers of goods while Europe and America are the consumers. Who is winning the battle between Western Free Trade and Asian Mercantilism? Asia is clearly the winner. The question going forward needs to be how we reverse a trend that is leaving America and much of the western World indebted and economically broken. What the West now calls protectionism, the Asians call Mercantilism.

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