Many countries implement trade policies that encourage a trade surplus. These nations prefer to sell more products and receive more capital for their residents, believing this translates into a higher standard of living and a competitive advantage for domestic companies. For some, this holds true, especially over the short term. Unfortunately, to maintain a trade surplus, some nations resort to trade protectionism.
They defend domestic industries by levying tariffs, quotas, or subsidies on imports. Soon, other countries react with retaliatory, protectionist measures, and a trade war ensues.
Inevitably, this results in higher costs for consumers, reduced international commerce, and diminished economic conditions for all nations. Sometimes, a trade deficit can be unfavorable for a nation, especially one whose economy relies heavily on the export of raw materials. Generally, this type of nation imports a lot of consumer products. As a result, its domestic businesses don't gain the experience needed to make value-added products.
Rather, its economy becomes increasingly dependent on global commodity prices, which can be highly volatile. Some countries are so opposed to trade deficits that they adopt mercantilism, an extreme form of nationalism that seeks to achieve and maintain a trade surplus at all costs. Mercantilism advocates protectionist measures, such as tariffs and import quotas. While these measures can prove effective in increasing the balance of trade, they typically lead to retaliatory acts of protectionism, which result in higher costs for consumers, reduced international trade, and diminished economic growth.
The balance of trade is the most significant component of the balance of payments. The balance of payments adds international investments plus net income made on those investments to the trade balance. A country can run a trade deficit , but still have a surplus in its balance of payments. A large surplus in investments could offset a trade deficit. That can only occur if the financial account runs a huge surplus.
For example, foreigners could invest heavily in a country's assets. They could buy real estate, own oil drilling operations, or invest in local businesses. The capital account records assets that produce future income, such as copyrights. Don't already have an Oxford Academic account? Oxford University Press is a department of the University of Oxford.
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Volume Haverford College. The tariff discouraged imports, whereas the export subsidy encouraged exports. The thrust of the classical attack on mercantilism--particularly by Adam Smith in his great work The Wealth of Nations --was that the mercantilists incorrectly specified the wealth of nations by identifying it with the government's stock of precious metals rather than with the consumption alternatives available to the nation's citizens--that is, the nation's standard of living.
Although tariffs and export subsidies could increase the government's stock of precious metals, they could also reduce the economy's consumption alternatives by comparison with a policy of free trade. The classical economists argued that free trade constituted a decrease in the real wealth of the nation, even though the government's gold stock would be increased by trade interventions.
Free trade is a better policy if the intent is to maximize a country's consumption opportunities. Notwithstanding this argument, the mercantilistic fallacy--that an export surplus is inherently a good thing for the nation--is so ingrained in the public's mind that even today it is routinely referred to as a favorable balance of trade.
Why should this be? Why should it be considered favorable to the nation if the value of the goods and services it sends to foreigners is greater than the value of the goods and services they send the nation in return? The reason modern mercantilists give is that the trade surplus generates funds that can be invested abroad in foreign stocks, bonds, real estate, companies, and so on.
This accumulation of foreign assets is alleged to expand the influence and power of the surplus country and decrease that of the deficit country, just as two hundred years ago the inflow of gold was considered to expand the influence and power of the prince at the expense of his foreign rivals.
The current fear of and hostility to Japan in the United States, for example, is based in part on the fact that Japan's export surplus has allowed that country to build up substantial holdings of U. The sight of Japanese investors buying Rockefeller Center and Columbia Pictures, coupled with a ballooning surplus in Japan's trade with the United States, has frightened and angered many Americans. The current best-selling novel, Rising Sun , panders to their fears and resentments.
But what does it matter who owns Rockefeller Center, Columbia Pictures, or whatever so long as these assets are properly managed? Do the hotel's guests really care if Japanese, Chinese, or Americans own the hotel so long as they are pleased with their rooms, service, and prices? And what reasonable objection could an American worker have to working for a Japanese boss so long as he or she paid decent wages for a decent day's work?
A country with a large trade deficit borrows money to pay for its goods and services, while a country with a large trade surplus lends money to deficit countries. In some cases, the trade balance may correlate to a country's political and economic stability because it reflects the amount of foreign investment in that country.
Debit items include imports, foreign aid, domestic spending abroad, and domestic investments abroad. Credit items include exports, foreign spending in the domestic economy, and foreign investments in the domestic economy. By subtracting the credit items from the debit items, economists arrive at a trade deficit or trade surplus for a given country over the period of a month, a quarter, or a year.
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