Causes of a Balance-of-Trade Deficit

Idea

A balance-of-trade deficit ($X < M$) arises in one of two ways: export revenue (X) falls, or import expenditure (M) rises. This note catalogues the drivers of each; it reaches no verdict.

Considerations

Falling export revenue (X).

• Higher relative inflation. Inflation above that of trading partners makes exports relatively more expensive abroad. Because exports typically have price-elastic demand — substitutes are available from other economies — quantity demanded falls more than proportionately, and export revenue falls sharply.

• Unfair trade practices abroad. Trading partners may deliberately depreciate their currencies to cheapen their own exports, or impose protectionist measures such as tariffs that price the domestic economy’s exports out of their markets.

• Loss of comparative advantage. An economy holds a comparative advantage in the goods it produces at lowest opportunity cost, but advantages shift: many developed economies lost their advantage in low-end manufacturing as low-cost producers such as China emerged, with cheaper labour, land and resources lowering China’s opportunity cost in those goods.

Rising import expenditure (M).

• Higher domestic growth. As national income rises, so does disposable income. Imports tend to be income-elastic — they take a higher share of income, have domestic substitutes and are often non-essential — so import demand rises more than proportionately and import expenditure climbs sharply.

• Changing tastes and preferences. Cultural shifts can raise demand for foreign goods quickly; the spread of K-pop culture across Southeast Asia, for instance, lifted demand for imported Korean beauty products, food and services.

• Higher relative inflation. Domestic inflation above trading partners’ makes imports relatively cheaper than domestic goods, so consumers switch to imports and import expenditure rises — the mirror image of the export effect above.