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Trade Deficit

Causes, Effects and How It Differs from a Trade Surplus

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trade deficit

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Definition: A trade deficit occurs when the value of a country's imports is greater than the value of its exports. This means that the country's balance of trade is negative.

What Causes a Trade Deficit?

Obviously, a trade deficit is caused when a country cannot produce all it needs. However, the true causes run a little deeper than that. A country cannot have a trade deficit unless other countries are willing to loan it the funds needed to finance the purchases of imports. Therefore, a country with a trade deficit will most likely have a current account deficit.

A trade deficit can also result if a domestic company manufactures a lot of its products in other countries. If the raw materials are shipped overseas to its plant, that's counted as an export. When the finished good is shipped back home, that's counted as an import -- even though it's made by a domestic company. It's subtracted from the country's Gross Domestic Product, even though the earnings will benefit the company's stock price, and the taxes will benefit the country's revenue stream.

Effects of a Trade Deficit

Initially, a trade deficit is not a bad thing. It raises the standard of living of a country's residents, since they now have access to a wider variety of goods and services for a more competitive price. It can reduce the threat of inflation, since the products are priced lower. A trade deficit can also indicate that the country's residents are feeling confident, and wealthy, enough to buy more than the country produces.

Over time, however, a trade deficit can cause jobs outsourcing. That's because, as a country imports certain goods rather than buying domestically, the local companies start to go out of business. The domestic business itself will lose the expertise needed to produce that good competitively. As a result, fewer jobs in that industry are created in the home country. Instead, the foreign companies hire new workers to keep up with the demand for their exports.

For this reason, many leaders propose reducing the trade deficit to increase jobs. They often blame trade agreements for causing deficits. A great example is the world's largest trade agreement, the North American Free Trade Agreement, or NAFTA. A response to trade deficits is often to raise import tariffs, or other forms of trade protectionism. However, these rarely work. That's because the industry is usually already moribund, and the skills lost, by the time these policies are suggested.

Trade Deficit as Defined in the U.S.

In the United States, the trade deficit is measured and defined by the Bureau of Economic Analysis. It defines U.S. imports as goods and services produced in a foreign country and bought by U.S. residents. It includes all goods that are shipped into the U.S., even if produced by a American-owned company. If a product crosses Customs and is intended to be sold in the U.S., it is an import.

Imports are also services that are produced in a foreign country and sold to a U.S. resident. Under this definition, imports include the services purchased by U.S. residents while they are travelers in another country. A traveler is defined as anyone who is in the country for less than a year. This includes purchases of food, lodging, recreation and gifts while traveling overseas. It also counts travel, fares and other passenger transportation purchased while traveling.

Other services that are considered imports include payment of royalties or license fees, and payment for services such as (to name just a few) advertising, telecommunications, or education. In short, if the consumer is a U.S. resident, and the provider is a foreign resident, then it is an import.

An export is any good that passes through customs from the U.S. to be sold overseas. This includes merchandise shipped from an American-based company to its foreign affiliate or branch.

An export is also any service that is paid for by a foreign resident to a U.S. resident or U.S.-based business. It should be noted that the BEA estimates service imports and exports from benchmark surveys and other reports. The goods transactions are from the U.S. Census. See the most recent year's U.S. Trade Deficit. (Source: BEA, Information Section; Source: BEA, A Guide to BEA Statistics on U.S. Multinational Companies)

Understand the Balance of Payments, Its Components and Why It Matters

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