What Is a Trade Deficit?
Trade Deficit Definition
A trade deficit describes an economy that imports more goods, products, or services into the country than it exports to other countries over a given time. If a country is in a trade deficit, it is more heavily reliant upon buying goods and services from other economies.
As global trade continues to grow, understanding whether countries are in a trade deficit or surplus and calculating this is invaluable for investors.
Table of contents
Trade Deficit Explained with Examples
Countries that find themselves purchasing more goods (like cars) and services (like software licenses) from abroad relative to their exports are considered to have a trade deficit. [1] To discover whether a country has a trade deficit, investors must assess a countries balance of trade (the trade balance) which reflects the difference between the value of a nation’s imports and exports.
For example, the United States has one of the most significant trade deficits globally as it imports significantly more than it exports. Over the past 5 years, the United States has had a mean trade deficit of around $50,000 million US dollars (USD). [2]
In contrast, China’s economy is built upon a substantial trade surplus as it manufactures many products and exports them globally. China’s mean trade surplus over the past 5 years has been just under USD 400,000 million. [3]
The United States’ trade in goods with China in 2021 demonstrates their reliance on the importation of Chinese goods. The United States’ overall trade balance sits at -USD 130,704.6 million. [4]
U.S. Trade In Goods with China, 2021. Source: United States Sensus Bureau
As countries’ economies develop, so do their trade deficits and surpluses, depending on the number of goods and services they’re importing and exporting.
Alternative names: Trade Gap, Trade Balance, Negative Balance of Trade (BOT).
How Trade Deficit Works
Government and central bank policies, business health and trade agreements are significant factors determining whether a country has a trade deficit or surplus. As of 2016, according to the Central Intelligence Agency (CIA), around 139 countries, out of 206 globally, we’re in a trade deficit. [5]
Trade Deficit Formula
To calculate the trade deficit or a surplus of any given country, one must minus the imports from exports. The trade deficit formula is:
TB = X - M, where
X = Exports
M = Imports
TB = Trade Balance
This formula can determine the trade balance of any country. For example, in 2020, the value of Australia’s exports equalled $50 million, and the value of their imports equalled $120 million; their total trade balance would be -$70 million. A negative number would mean that they were in a trade deficit. However, if Australia’s exports equalled $50 million and their imports equalled $30 million, their total trade balance would be $20 million meaning the nation had a trade surplus.
Trade Deficit vs. Trade Surplus
A trade deficit describes a country that imports more than it exports (as a negative trade balance), whereas a trade surplus is a term for a country that exports more than it imports (positive trade balance). Depending on countries’ policy objectives and economic performance, they can change from a surplus to a deficit and vice versa over time.
What It Means for Retail Investors
A countries trade balance acts as an essential macroeconomic indicator for national governments, institutions and investors.
Understanding how to calculate, analyse, and observe macroeconomic indicators, such as differentiating between the trade deficits and surpluses of a given country, is valuable for investing. As a Credit Suisse report on the economic outlook of 2021 noted, the European Unions (EU) ‘large external surplus and excessive dependence on exports’ made the economy ‘vulnerable to geopolitical shocks and trade wars.’ A country or regions balance of trade can act as a critical determinant in making informed investment decisions. [6]
For investors interested in learning more about macroeconomics and the impact of indicators such as trade deficits on global markets, global macro trading is a great starting point to become a more informed investor.
Article Sources
Inter-Secretariat Working Group on National Accounts. "System of National Accounts 1993, https://unstats.un.org/unsd/nationalaccount/docs/1993sna.pdf." Table 2.3, Page 50. Accessed July 23, 2021
Trading Economics, “United States Balance of Trade, https://tradingeconomics.com/united-states/balance-of-trade.” Accessed July 22, 2021.
Trading Economics, “China Balance of Trade, https://tradingeconomics.com/china/balance-of-trade.” Accessed July 22, 2021.
United States Census Bureau, “Trade in Goods with China,https://www.census.gov/foreign-trade/balance/c5700.html” Accessed July 22, 2021
CIA, “Country Comparisons– Current account balance, https://www.cia.gov/the-world-factbook/field/current-account-balance/country-comparison.” Accessed July 22, 2021.
Credit Suisse, “2021 Economic Outlook: Sunrise in a Fractured World.” Page 21. Accessed July 22, 2021.
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