BALANCE OF TRADE

Even though the United States is well endowed with both human and natural resources, as well as the ways and means to use them in the production and distribution of goods and services, it cannot provide its people with all that they want or need. For this reason, the United States engages in international trade, which is the exchange of goods and services with other nations. Without international trade, goods would either cost more, not be available, or, if available, be of unreliable supply.

On a broader level, the world's endowment of natural resources is both uneven and capricious. For example, Canada, with its huge forests, is a major producer of lumber and paper products; the Middle East has rich oil reserves; and the coastal regions of the world are leaders in the fishing industry. Ironically, however, each of these nations (or regions) may lack resources (or goods) that are abundant elsewhere.

Without international trade, each country would have to be totally self-sufficient. Each would have to make do only with what it could produce on its own. This would be the same as an individual being totally self-sufficient, providing all goods and services, such as clothing and food, that would fulfill all wants and needs. International trade allows each nation to specialize in the production of those goods it can produce most efficiently. Specialization, in turn, allows total production to be

greater than would be true if each nation attempted to be completely autonomous.

EXPORTS AND IMPORTS

Goods and services sold to other countries are called exports; goods and services bought from other countries are called imports. The Foreign Trade Division of the U.S. Bureau of the Census states that U.S. exports include such goods as corn, wheat, soybeans, plastics, iron and steel products, chemicals, and machinery, while imports include such goods as chemicals, crude oil, machinery, diamonds, and coffee.

The balance of trade, also known as net exports, is the difference between the dollar amount of merchandise exports and the dollar amount of merchandise imports. The United States has many trade partners. Table 1 shows the U.S. balance of trade with its four largest trading partners.

In order to have a trade surplus, a country must export (sell) more tangible goods than it imports (buys). If the opposite were true, a trade deficit would exist. On an individual nation-to-nation basis, a country can have a trade surplus with one country, yet a trade deficit with another. The Bureau of the Census records indicated that in 2004, the United States had a trade deficit with each of its four largest trading partners. Table 1 also reveals the total percentage of trade accounted for by the four largest trading partners of the United States (this percentage is derived by adding total exports to, and total imports from, a particular country and expressing this sum over the sum of aggregate exports and imports with all nations in a particular year).

The Bureau of the Census also reported that the United States experienced its first trade deficit (total of all exports minus total of all imports) of the twentieth century in 1971, with a trade deficit of approximately $1.5 billion. For the most part, this condition continued throughout the 1980s, 1990s, and into the twenty-first century when, by 2004, the United States realized a record trade deficit of nearly $651 billion. Table 2 shows the U.S. balance of trade for 1960 through 2004. As may be noted, while the volume of total exports and imports increased in dollar terms over the period, the disparity between merchandise imports and exports widened in the later years.

ABSOLUTE ADVANTAGES

As stated earlier, total production increases when a nation specializes in the production of those goods it can produce most efficiently instead of attempting to be totally self-sufficient. Allen Smith stated that "a country that can produce a product more efficiently than another country is said to have an absolute advantage in the production of

that product" (1986, p. 315). When a nation can use fewer resources to produce the same amount of a product, it has an absolute advantage in the production of that product. For example, Brazil has an absolute advantage over the United States in the production of coffee; the nations of the Middle East have an absolute advantage over the United States in the production of crude oil.

Because of its ideal climate, Ecuador can produce bananas more efficiently than can the United States; therefore, Ecuador has an absolute advantage over the United States in the production of bananas. In contrast, however, the United States has an absolute advantage over Ecuador in the production of most other products. Given these absolute production possibilities, both the United States and Ecuador stand to benefit by engaging in the production (and subsequent trade) of those products which each can produce most efficiently. Since exchange is voluntary, nations will (most typically) not trade with one another unless the outcome is mutually beneficial. Nevertheless, the gains realized by each of the trading partners may not necessarily be equal.

Smith also stated that "any time a nation has an absolute advantage in the production of two goods or services, the nation has a comparative advantage in the production of that good or service where the absolute advantage is greater" (p. 315). In other words, if a nation has a two-to-one absolute advantage in the production of one product and a three-to-one absolute advantage in the production of another product, the comparative advantage lies with the product with the larger (three-to-one) ratio. Smith went on to add that "even though a nation has an absolute disadvantage in the production of two products, it has a comparative advantage in the production of that product in which the absolute disadvantage is less" (p. 316). For example, even though a nation has a disadvantage in the production of a certain product, if that disadvantage is small compared to its disadvantage in the production of other products, it still has a comparative advantage with the former product.

MONETARY TRANSACTIONS

When the United States buys goods from another country, it will usually pay for those goods in the currency of the exporting country. Many international transactions involve the exchange of money between nations. The balance of payments is an accounting record of the difference between the amount of money that a country receives (known as inpayments) and the amount of money that it pays out (known as outpayments). A positive overall balance of payments means that a country has realized more aggregate inpayments than outpayments over a period (typically one year). In contrast, a negative balance of payments exists when a country pays out more money than it takes in.

Any transaction that involves a flow of funds between countries is recorded in one of several accounts within a nation's balance of payments. The largest single account in the overall balance of payments is, for most countries, the current account. The balance of trade, as noted above, records the flow of merchandise exports and imports and is a component of the current account. When adding the net flow of funds arising from services to a nation's balance of trade, one obtains the balance on goods and services (also recorded in the current account). Finally, net unilateral transfers (one-way flows by individuals, governments, and businesses) are included in a nation's current account as well.

Across global markets, it is not uncommon to observe the buying and selling of both real assets (plant and equipment, land) and financial assets (stocks, bonds). Such transactions are recorded in the capital account of a nation's balance of payments. One last category of international transactions involves those arising among governments and central banks. These transactions are recorded in the official reserve account of a nation's balance of payments.

While unimpeded free trade tends to promote the greatest benefits arising from international specialization, the importing and exporting of some goods and services is controlled by the U.S. government (and the governments of other nations as well). Three of the most common impediments to trade are tariffs, quotas, and embargoes. A tariff is a tax levied by the government on the importation of goods. An import quota sets a physical limit on the amount of goods that may be imported during a given period. An export quota does the same for a nation's exports. Finally, an embargo (import or export) is employed when a government wishes to completely halt all imports or exports of a specific product.

see also International Trade

bibliography

Gottheil, Fred M. (2005). Principles of economics (4th ed). Mason, OH: Thomson Pub.

Smith, Allen W. (1986). Understanding economics. New York: Random House.

U.S. Bureau of the Census. Foreign Trade Division. http://www.census.gov/foreign-trade/statistics

Gary P. Tripp

Balance of Trade

BIBLIOGRAPHY

A nation’s balance of trade, also called “net exports,” is a measure of the net flow of goods and services between that country and the rest of the world. Given domestic output (or income) (Y ), domestic spending on domestic output (D ), exports (X ), and imports (M ), the balance of trade is B = Y – D = X – M. The balance of trade is in surplus if B > 0, and it is in deficit if B < 0. This formulation suggests that fluctuations in domestic output can be absorbed by fluctuations in the trade balance, keeping domestic spending relatively stable. In 2005, the balances of trade relative to GDP (gross domestic product) for the United States, South Korea and Brazil was –5.7 percent, 2.6 percent, and 4.6 percent, respectively.

A nation’s income, the income of its trading partners, and the relative price of domestic goods (compared to foreign goods) determine its balance of trade. As domestic income (Y ) rises, expenditure on all goods—including foreign-produced goods—increases. Thus, imports increase and the balance of trade decreases. Similarly, when the income of a nation’s trading partners increases, so do its exports, thus increasing the balance of trade. The relative price (R ) of domestic to foreign goods is R = SP/P*, where S is the spot exchange rate (the foreign currency price of the domestic currency) and P and P* denote the native currency prices of domestic and foreign goods, respectively. With short-run price inflexibility, a change in the exchange rate (S ) is fully reflected in a change in the relative price.

Since domestic and foreign outputs have a degree of substitutability, the nominal exchange rate affects both exports and imports. Generally, an exchange-rate depreciation (a decrease in S ) switches spending away from foreign goods toward domestic goods and increases the balance of trade.

Reflecting an excess of domestic spending over domestic income, a balance-of-trade deficit may be offset by a net inflow of labor and asset incomes from abroad. Otherwise, overspending must be funded through a depletion of national wealth, possibly in the form of increased indebtedness to foreign entities through the sale of domestic bonds or of outright sales of equity or other assets. This net inflow of foreign capital requires that foreign savers be willing to lend against, or buy, domestic assets. If they are unwilling to do so or if they are not allowed to do so because of domestic capital controls, the domestic currency will depreciate and eliminate the deficit. If this does not occur and if the exchange rate is fixed, the central monetary authority must sell its gold or foreign currency reserves, causing the domestic money supply and, over time, the domestic price level to decrease and reverse the deficit.

A nation may sustain a balance-of-trade deficit for short periods but not persistently. Rising indebtedness would cause foreign lenders to fear that their claims would not be honored, leading to a reduction of further investment in domestic assets. Moreover, the government’s corpus of gold and foreign currency reserves is finite. The existence of a long-term trade imbalance that is not offset by factor-income inflows is of concern because it reflects a fundamental divergence between domestic income and domestic spending. Many countries have learned, sometimes from bitter experience, that persistent failure to harmonize income and spending can lead to corrective forces, sometimes resulting in economic crises in the form of large increases in interest rates, unemployment, or a sharp depreciation of domestic currency.

Policymakers must balance short-run conflicts in maintaining the trade balance at a targeted level B* (possibly zero), while also maintaining domestic output at a level Y* consistent with full employment and constant inflation. In a fixed-exchange-rate regime, these goals can be met by judiciously mixing domestic demand and exchange-rate levels. Assuming stability, the relationships Y* = D + B (Y*, S ) and B* = B (Y*, S ) together yield unique values of domestic demand and exchange rate, D ₀ and S ₀, consistent with the goals. The level D ₀ is achieved by adjusting fiscal policy; monetary policy cannot be used independently under a fixed exchange rate regime.

It may be inferred that if fiscal policy is set at D ₀ but the exchange rate is overvalued (S > S ₀), a trade deficit will result, accompanied by unemployment. It may also be inferred that if the exchange rate is undervalued (S < S ₀), a trade surplus will accrue, along with inflationary pressure. Similarly, if the exchange rate is set at S ₀ but fiscal policy is too restrictive (D < D ₀), a trade surplus will coexist with unemployment, while an expansive fiscal policy (D > D ₀) results in a trade deficit and inflationary pressure.

If the exchange rate is flexible, both fiscal and monetary policies will quite likely affect the balance of trade. Both affect the interest rate (r ) and, thereby, the exchange rate, which moves to equilibrate international asset markets by equating the expected returns on domestic and foreign assets. If the foreign interest rate exceeds the domestic interest rate, the difference is offset by an expected appreciation of the domestic currency; otherwise, the foreign asset yields excess returns. Given an unchanged expected future exchange rate, a decrease in r causes the domestic currency to depreciate (it decreases S ) immediately, thus generating expectations of a forthcoming appreciation. The depreciation increases the balance of trade.

Fiscal and monetary expansions, by increasing Y, cause an incipient worsening of the trade balance, which works to depreciate the domestic currency. Additionally, a monetary expansion decreases r and causes capital outflows, compounding this depreciation and causing the balance of trade to improve. However, a fiscal expansion increases r, stimulates capital inflows, and appreciates domestic currency. The appreciation caused by sufficiently high capital mobility can overwhelm the depreciation effect of output expansion and worsen the balance of trade. Thus, a budget deficit can give rise to a trade deficit, invoking the label “twin deficits.”

SEE ALSO Mundell-Fleming Model; Trade Deficit; Trade Surplus

BIBLIOGRAPHY

Appleyard, Dennis R., Alfred J. Field Jr., and Steven Cobb. 2006. International Economics. 5th ed. Boston: McGraw-Hill.

Krugman, Paul R., and Maurice Obstfeld. 2006. International Economics: Theory and Policy. 7th ed. Boston: Addison-Wesley.

Mundell, Robert. 1963. Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates. Canadian Journal of Economics and Political Science 29 (4): 475-485.

Swan, Trevor W. 1963. Longer-Run Problems of the Balance of Payments. In The Australian Economy: A Volume of Readings, eds. H. W. Arndt and W. M. Corden, 384-395. Melbourne, Australia: F. W. Cheshire Press.

Vikram Kumar

BALANCE OF TRADE

BALANCE OF TRADE. Trade balances are the financial flows that arise from trade in goods and services and unilateral transfers between countries. These financial flows constitute a portion of a country's current account. The balance of trade is measured by the dollar value of payments and receipts for goods and services.

Overview

From 1815 to 1934, U.S. governments generally enacted policies that limited imports of manufactured goods, in the interest of protecting domestic producers. Trade balances were generally negative until the United States emerged as an industrial power in the 1870s. Notwithstanding the improving competitive position of U.S. manufacturers, reflected in surging trade surpluses, high tariffs remained in place until the Smoot-Hawley tariff of 1930 brought protectionism into disrepute.

The administration of President Franklin D. Roosevelt adopted a freer trade position with the passage of the Reciprocal Trade Agreements Act in 1934. In the context of growing surpluses in the trade of merchandise goods, the United States played a leading role in liberalizing trade after World War II (1939–1945). Persistent and growing trade deficits from the 1970s on prompted successive administrations in Washington to pursue "strategic" trade policies that retreated selectively from the free trade position of the early postwar period. Despite the concessions to so-called fair trade, U.S. governments remained biased toward freer trade, despite the large and growing trade deficits of the 1980s and 1990s.

Economists generally frown on the idea that trade surpluses are better than deficits and believe that policies that suppress imports invariably reduce exports in the long run. With the growth of the trade deficit, concern over jobs and the means to service trade balances have prompted calls for policy changes that redress the imbalance among exports and imports. At the end of the twentieth century, however, public policy expressed little concern regarding the trade deficit.

From Colonialism to World War I

The thirteen American colonies ran persistent trade deficits with Great Britain from 1721 to 1772. Surpluses with other countries reduced the overall deficit somewhat. Yet from 1768 to 1772, colonial exports totaled £2.8 million, while imports equaled £3.9 million. There were significant regional differences. As of 1770, for instance, Georgia, Maryland, Virginia, and the Carolinas maintained a roughly even trade balance with Britain on the strength of staple crop exports. At the same time, the Mid-Atlantic and New England colonies ran significant deficits. They serviced them with earnings from shipping and other mercantile services, in which New York and Philadelphia excelled, and exports of primary and semi-processed products.

The new American nation maintained imports of British manufactured goods. American producers benefited from the Napoleonic Wars (1803–1815); in 1807, they were exporting three times more goods than they had exported in 1793. From 1807 to 1830, British protectionism and a growing U.S. economy produced growing trade deficits, as manufacturing imports soared, while Britain kept its markets closed to U.S. finished goods. However, British demand for cotton soared during the mid-nineteenth century, and exports of the staple crop constituted half of America's total exports in the two decades prior to the Civil War (1861–1865). From 1791 to 1850, America's merchandise trade balance was in a deficit for all but eight years. At the same time, the volume of U.S. exports increased more than sevenfold, from $19 million in 1791 to $152 million in 1850. When services are included, the trade balance was in surplus for nineteen of the sixty years between 1791 and 1850.

From 1850 through the end of World War I (1914–1918), America's trade balance moved from slightly unfavorable to enormously favorable, reflecting the nation's emergence as a world economic power and the continuation of trade protectionism. Thus, from 1850 to 1873, the merchandise trade deficit totaled $400 million, as exports grew from $152 million to $524 million. From 1874 to 1895, the trade balance turned favorable on the strength of agricultural exports and increases in shipments of manufactured goods. Volume increased steadily as well, with exports of goods and services reaching $1 billion for the first time in 1891. From 1896 to 1914, the trade balance was markedly favorable, as U.S. manufacturers competed globally for markets. Indeed, the merchandise trade balance was some $9 billion in surplus for this period. Purchases of services reduced the overall trade surplus to $6.8 billion. Spurred by the European demand for U.S. goods and services during World War I, the U.S. trade surplus soared from 1915 to 1919. Net goods and services totaled $14.3 billion for the five-year period, with exports topping $10.7 billion in 1919—an amount that was not exceeded until World War II (1939–1945). Not incidentally, America also became a creditor on its current account for the first time, on the strength of lending to wartime allies Britain and France.

From World War II to the Twenty-First Century

During the interwar period, the U.S. trade balance was consistently in surplus on greatly reduced volumes of trade, even as the merchandise trade balance turned negative from 1934 to 1940. As was the case during World War I, U.S. exports soared during World War II, peaking at $21.4 billion in 1944. Much of this volume was owed to the lend-lease program. As a result, America enjoyed an enormously favorable balance of trade, which it sustained during the early postwar period, from 1945 to 1960.

The favorable trade position of the United States at the end of World War II, underpinned by the relative strength of its manufacturing sector, contributed to the willingness of U.S. administrations to liberalize the global trading regime through the General Agreement on Tariffs and Trade and its successor, the World Trade Organization. Both Democratic and Republican administrations remained committed to a freer trade policy stance—de-spite many exceptions, most notably steel, autos, and semiconductor chips—even as the U.S. merchandise trade balance disappeared in the late 1960s and then turned negative in the context of growing competitiveness on the part of European and Japanese manufacturers and sharply increased prices for crude oil.

From 1984 to 2000, the merchandise trade balance topped $100 billion in all but the recession years of 1991 and 1992, even as trade volumes increased absolutely and relative to GNP. In 1997, it exceeded $200 billion, as exports nearly reached $900 billion and GNP hit $8 trillion for the first time. For the twelve months ending 31 December 2001, the merchandise trade deficit stood at $425 billion. A surplus in services, which grew from $6.1 billion in 1980 to $85.3 billion in 1997, has offset 30 to 40 percent of the deficit on goods. America has funded its trade deficit largely by attracting foreign investment, so that it runs large surpluses on its capital account. As a result, the United States became the world's largest debtor on its current account during the 1980s and remained so at the beginning of the twenty-first century.

BIBLIOGRAPHY

Balaam, David N., and Michael Veseth. Introduction to International Political Economy. Upper Saddle River, N.J.: Prentice Hall, 1996. See chapter 8.

Lovett, William A., Alfred E. Eckes Jr., and Richard L. Brink-man. U.S. Trade Policy: History, Theory, and the WTO. Armonk, N.Y.: M. E. Sharpe, 1999.

Thompson, Margaret C., ed. Trade: U.S. Policy Since 1945. Washington, D.C.: Congressional Quarterly, 1984.

U.S. Department of Commerce. Historical Statistics of the United States: Colonial Times to 1970. Washington, D.C.: General Printing Office, 1975.

Walton, Gary M., and Hugh Rockoff. History of the American Economy. 8th ed. New York: Harcourt, Brace, 1998.

Michael R.Adamson

See alsoDebt and Investment, Foreign ; Trade, Foreign .

BALANCE OF TRADE

As individuals, private businesses, and government agencies buy and sell goods and services around the world, they create a balance of trade. International trade is composed of exports and imports. (Exports are the goods and services produced within a country and sold to foreign countries. Imports are the goods and services that a country buys from other countries.) A country's balance of trade represents the difference between the value of its exports and imports. If a country has a trade surplus, or a favorable balance, then it is exporting more goods than it is importing. On the other hand, a nation may experience a trade deficit or unfavorable balance when its imports are greater than its exports. Because the balance of trade is a result of foreign trade, a surplus is called the foreign trade surplus and a deficit is called the foreign trade deficit. The balance of trade is considered a key component of a country's economic health. Soaring trade deficits slow economic growth because as more goods are imported, demand for domestic products falls.

During the 1980s and 1990s the balance of trade became a major issue in the United States. In 1975 the United States had a foreign trade surplus of $10.4 billion, but afterwards it experienced foreign trade deficits. Although deficits are rarely good, it was not until 1983 that they became a serious problem. In that year, the U.S. foreign trade deficit started rising, going from $38 billion in 1982 to $170 billion in 1987. While the deficit decreased over the next five years it remained more than $100 billion each year. The U.S. foreign-trade deficit rose in 1993 to $115.8 billion. The top two trading partners for the United States were Canada and Japan; they, accounted for $70 billion of the trading deficit that year. The United States had a $10.7 billion trading deficit with Canada and a $59.3 billion trading deficit with Japan. In 1993 the United States had trading surpluses with the United Kingdom and the Netherlands—$4.7 billion and $7.4 billion, respectively.