In a nutshell, the balance of trade, a key component of a nation’s current account, is a measurement of a country’s net exports. If the exports exceed imports, then it is known a trade surplus. On the other hand, if imports exceed exports, it is known as the trade deficit. The trade surplus is usually looked upon as a favorable trade balance and a trade deficit in an unfavorable balance of trade.
Conventional wisdom puts a lot of weight on a favorable trade balance. Economists used to explain it in terms of a country making profits as a whole. The thought is that by selling more than buying, there is more capital present among a nation’s residents. In terms of the exports, the domestic companies will get a competitive advantage in the global market in terms of expertise, which would make these domestic firms hire more, thus reducing the unemployment rate, as well as increasing the standard of living.
In the past, we have seen many countries seeking a favorable balance of trade as a one-stop solution towards prosperity, via such ill-advised policies as trade protectionism. This was usually implemented with some combination of import duties as well as putting a quota on the number of units of various products that can be imported. However, these tactics are nullified when the international community responds in kind.
Even if a trade surplus is achieved, it does not automatically mean that a country is prosperous. For example, under Nicolae Ceausescu, Romania followed a policy of severe protectionism and forced Romanian citizens to save, which resulted in a trade surplus. However, the standard of living in Romania was probably one of the lowest in all of Europe. Romanians were so upset by the situation that finally Ceausescu and his wife were executed by a firing squad with one of the charges being that they had sabotaged the Romanian economy.
Japan and China are two countries that have bet heavily on trying to achieve a trade surplus. Although their economy has grown by leaps and bounds in recent years, it is to be noted that both China and Japan artificially keep the value of their currency low with respect to the US Dollar by purchasing an obscene amount of US Treasury Bills. So one can easily make an argument that the demand for Chinese and Japanese goods is achieved by macroeconomic manipulation, and the current policy of continued purchase of US T-Bills will be unsustainable in the long term.
On the other end of the spectrum, Canada and Hong Kong are two countries that have a trade deficit but are extremely prosperous. Hong Kong’s deficit is mainly fueled by the raw materials that it imports. However, it is to be noted that they do convert the raw materials into finished products and export the same. On the other hand, Canada has been enjoying a growth spurt. Thus, an increase in their trade deficit is caused by a demand for imports by its citizens who enjoy a very hard standard of living.
In short, the balance of trade is a useful measurement; however it is not a sole factor by which a country’s prosperity and standard of living can be measured!