International Finance Theory and Policy
by Steven M. Suranovic

Finance 6-3

Are Trade Imbalances Good or Bad?: Summary Results

These stories suggest that trade imbalances, when evaluated in terms of their momentary effects and their long-term economic consequences, can be either good, bad or immaterial, depending on the circumstances.

Trade deficits may signal excessive borrowing which could in the future lead to possible default, or even worse, an excessive reduction in living standards needed to repay the accumulated debt. In this case the trade deficit is clearly bad for the nation. Alternatively, trade deficits may represent a country that is merely drawing down previously accumulated foreign savings or selling other productive assets, in which case, there is no potential for default or reduced living standards in the future. Here the trade deficit is either immaterial or even beneficial in that the nation is able to achieve a higher current living standard because of the deficit. Trade deficits might also make possible an expansion of domestic investment which could spur future economic growth sufficiently to make repayment consistent with growing living standards. In this case, trade deficits are clearly good as they stimulate future economic prosperity. Finally, in a free market economy, trade deficits may simply reflect the aggregated choices of numerous individuals to forgo future consumption in order to achieve more current consumption. In this case the trade deficit should be viewed as immaterial since it merely reflects the free choices of the nation's people.

On the other hand, a trade surplus may correspond to prudent foreign saving and purchases of foreign productive assets which may be used to support a growing retired population in the future. In this case the trade surplus is a good thing for the nation. The trade surplus might also represent a period of repayment of past debt. This outcome may be acceptable if achieved together with growing living standards. However, if the surplus arises in a period of slow growth or falling GDP, then the surplus would correspond to painful reductions in living standards, which is clearly a bad outcome for the country. Finally, the trade surplus may occur as a result of the aggregated choices of numerous individuals who have acquired greater past consumption by forgoing current consumption. In this case, the surplus should be viewed as immaterial to the nation as a whole.

International Finance Theory and Policy - Chapter 6-3: Last Updated on 9/13/98