Trade Deficit: Advantages and Disadvantages
Economists disagree on the simple question of whether sustained trade deficits are good, bad, or don't matter that much for a country and its economy. Broadly speaking, trade deficits have both advantages and disadvantages.
That's because there are so many variables involved—so many ways to generate a trade deficit and so many ways that it might help or hurt an economy. Or reflect good or bad aspects of that economy.
Key Takeaways
- A trade deficit occurs when a country imports more than it exports.
- Trade deficits are neither inherently good nor bad.
- Very large deficits can negatively impact the economy.
- A trade deficit can be a sign of a strong economy and, under certain conditions, can lead to stronger economic growth for the deficit-running country in the future.
What Is a Trade Deficit?
A trade deficit occurs when the value of a country's imports exceeds the value of its exports—with imports and exports referring to both physical goods and services.1
Put simply, a trade deficit occurs when a country buys more goods and services than it sells. An overly simplistic view sometimes encountered is that this generally hurts job creation and economic growth in the deficit-running country.
This view of trade deficits is behind many of the complaints among United States politicians about bilateral U.S. trade deficits. This is especially true for China, the country with which the U.S. runs its largest trade deficit.2
That deficit was a prominent campaign theme for the first administration of President Donald Trump, in 2016, and a primary reason he launched a trade war against China after taking office. Trump argued that cutting the trade deficit would create jobs in the U.S. and strengthen the economy.3
Advantages and Disadvantages of a Trade Deficit
Imported goods ensure that a country's people obtain the products they want but can't get at home.
An inflow of foreign capital, invested wisely, can increase productivity and economic growth.
A resulting drop in value of the domestic currency can lower the cost of exports and stimulate buying from abroad.
Job growth may occur in certain sectors.
An inflow of foreign capital, invested unwisely or reversed too quickly, can lead to financial problems and, potentially, recession.
Taxes on imports could be levied.
The heavy flow of foreign capital may result in foreign investors buying up too many important assets of the deficit-running country.
Job loss may occur in certain sectors.
An Imbalance of Savings and Investments
To many in the world of economics, a trade deficit is about an imbalance between a country's savings and investment rates.
This means that a country is spending more money on imports than it makes on its exports. Under the rules of economic accounting, it must make up for that shortfall. The U.S. can do just that by either borrowing money from foreign lenders or permitting foreign investment in U.S. assets.
This foreign lending and investment can be seen as a vote of confidence in the U.S. economy and a source of long-term economic growth, if the borrowed money or foreign investment is used wisely (such as in productivity growth).
This was the case with the U.S. for several decades in the 1800s.4 The foreign money went into railroads and other public infrastructure, which helped the U.S. develop economically.
The Risk of Foreign Capital Inflows
For a smaller country with a trade deficit, this greater degree of foreign direct investment and foreign ownership of government debt can be risky.
Many countries in East Asia ran large trade deficits throughout the 1990s and saw foreign capital pour into their nations. Some of these countries included Thailand, Indonesia, and Malaysia.5
Not all of that investment was efficiently or wisely allocated. When the Asian financial crisis erupted in 1997 and 1998, foreign investors were quick to flee. This left these East Asian countries at the mercy of global financial markets. The results were painful.6
A trade deficit can be an indicator of strong demand for products and spending by consumers, a healthy sign for an economy.
Trade Deficits and Economic Growth
In the U.S., some periods of strong economic growth have come at times of a surging trade deficit, as consumers and businesses buy more products and services from abroad, and foreign investors seek to put their money to work in the U.S.
The opposite of a trade deficit is a trade surplus. A strong trade surplus doesn't necessarily mean strong economic growth.
Japan, for example, has run significant trade surpluses during various periods of time. Yet its economy has often been stuck in low gear.7 Germany, too, generally runs a strong trade surplus but can register mediocre economic growth.89
Trade Deficits and Employment
Economists also disagree on the broad impact of trade deficits on employment. Some argue that imports necessarily reduce employment at home, while others point to offsetting job growth in other sectors through the same trade ties.
Often any job loss is limited to specific sectors. Research by the Economic Policy Institute found that the surge in Chinese imports cost the U.S. 3.7 million jobs between 2001 and 2018—and about 75% of those jobs were in manufacturing.10
This may partly explain why U.S. politicians are often focused on the bilateral trade deficit with China.
Why Does the U.S. Have a Large Trade Deficit?
The U.S. has a large and persistent trade deficit because it imports a greater value of goods than it exports abroad, especially from energy and technology imports. Economists argue that the deficit is due to an imbalance between domestic savings and total investment in the economy (i.e., the low U.S. savings rate). Borrowing enables Americans to enjoy a higher rate of economic growth than would be obtained if the U.S. had to rely solely on domestic savings.11
Has the U.S. Always Had a Trade Deficit?
The U.S. has been running consistent trade deficits since 1976. Before that, the country was generally a net exporter.12
How Is the Trade Deficit Different From the Budget Deficit?
A deficit refers to some gap or negative amount that occurs in the balance of payments. A trade deficit occurs when a country spends more on imports than it receives in revenue for its exports. A budget deficit, in the context of the government, occurs when there is more federal spending than revenue taken in from taxes, duties, fines, and other fees.
The Bottom Line
A trade deficit occurs when a country buys more goods than it sells. It can have certain advantages and disadvantages. That is, trade deficits can affect various parts of a country's economy—e.g., productivity, economic growth, employment, industry, and interest rates—in potentially positive or negative ways.
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