Balance of Trade (BOT) Explained for Dummies

 

What is the balance of trade?

  Balance of trade (BOT) refers to the difference in monetary value between a country’s imports and exports of goods, also called visibles, and services, also called invinsibles, over a given period of time.     The difference in value is typically expressed in the unit of currency of a particular country (for example US dollars (USD) for the USA, South African rands (R) for South Africa, and Australian dollars (AUD) for Australia), or an economic union (for instance euros (EUR) for the European Union, consisting of 27 countries in Europe).     The BOT represents the largest component of a nation’s balance of payments (BOP).  The balance of trade is also called the commercial balance, the trade balance, the international trade balance, or the net exports of goods and services (NX).   

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Explaining key aspects of the balance of trade 

  As mentioned, the balance of trade (BOT) is also referred to as the net exports of goods and services (NX), measuring all goods and services that pass through (in and out) the customs authorities of a country.  Trade (imports and exports) between countries is the foundation of the global economy. It provides consumers and industries of a country with a variety of goods, products, and services that may not otherwise be available to them.   

Two types of balance of trade

Simply put, there are two types of balance of trade, namely: positive trade balance and negative trade balance.     Positive trade balance A positive trade balance, also called a positive balance, a favourable trade balance, or trade surplus, occurs when a country’s exports of goods and services exceed its imports of goods and services.    There are various reasons why governments of countries strive to generate a trade surplus by enacting policies that encourage a trade surplus in the long term. Reasons like: 

• Sales of products and services that exceed the purchases of services and products generate more capital for a country’s residents, resulting in a higher standard of living.  
• A favourable trade balance is an indication that a country is generating a profit. 
• A trade surplus usually increases the gross domestic product (GDP) of a country. 
• A positive trade balance may reflect a country’s economic and political stability, convincing foreign investors to invest in projects, infrastructure, and companies. 
• Companies in the country may gain a competitive advantage in technical expertise by manufacturing goods that comply with international standards and requirements. This can create more employment opportunities, reduce unemployment and allow workers to earn higher wages or salaries. 
• A country with a trade surplus can lend money to countries that have a current account deficit, earning income through interest payments received. 

  Negative trade balance A negative trade balance, also known as a trade deficit, trade gap, or unfavourable trade balance, occurs when the imports of goods and services of a country exceed its exports of goods and services.    There are various reasons why it is considered that a trade deficit may have a negative impact on a nation’s economy. For instance: 

• An economy experiencing a large trade deficit borrows money from other countries or from global organisations such as the International Monetary Fund (IMF) and the World Bank. These loans enable them to buy products and services from other countries. However, loans involve interest payments, which can be quite expensive.  
• Trade deficits may lead to job losses, implying that excess imports are diminishing jobs in the local manufacturing sector.  
• A negative trade balance puts downward pressure on the currency of a country which follows a floating exchange rate policy. A country with a cheaper domestic currency has to pay more for imports. In response, consumers reduce their consumption of imported goods, shifting toward locally produced goods.  
• Trade deficits can be bad because countries consume more than they produce. 

 

Misconceptions about a positive or negative trade balance 

  A positive trade balance is not necessarily an indication of a healthy (strong) economy. Likewise, a trade deficit does not necessarily represent a weak or declining economy.  According to the Global Future Council of Trade (GFCT) of the World Economic Forum, ‘there is no straightforward relationship between the state of a nation’s trade balance and the state of its economy.’ Also, the GFCT believes that ‘trade deficits are not necessarily bad and are not a measure of whether trade policies or agreements are fair or unfair.’    Likewise, economists generally agree that neither positive nor negative trade balances are by definition ‘good’ or ‘bad’ for a nation’s economy.    Considered in isolation, a trade surplus or trade deficit is not sufficient to evaluate the health of a country’s economy. It is necessary to consider the BOT of a nation regarding other economic indicators, business cycles, the duration of the positive or negative BOT, and the amount of the trade imbalance, among other indicators.     There are instances where a favourable trade balance is not in a nation’s best interests. For example, certain countries in Asia, Africa, and Latin America with emerging market economies should import as much as possible to invest in their infrastructure.    Most economists are of the opinion that the impacts of unfavourable trade balances are over-simplified, concluding that trade deficits are not exclusively bad, citing the following examples to substantiate their conviction: 

• Trade deficits enable countries to consume more than they produce. This can help increase a nation’s economic activity and improve the living conditions and standards of the citizens. 
• A trade deficit can be considered favourable in certain conditions, depending on the business cycle the particular country is currently in. 
• Generally, Hong Kong always has a negative balance of trade. However, it is viewed as a positive situation because the region imports considerable quantities of raw materials, which are converted into manufactured goods and finished goods, which are finally exported. This enables the region to have a competitive advantage in manufacturing, allowing a higher standard of living for its residents. 
• When a significant trade deficit exists between countries, it is often argued that excess imports are reducing jobs in the local manufacturing industry. However, this claim is frequently unsubstantiated, according to analysts. 

  In this regard, the World Economic Forum (WEF) refers to the USA as an example, explaining that the United States ‘has a significant trade deficit with China, and attempts to reduce the deficit have largely failed to increase to increase US manufacturing jobs.’    The WEF also quotes the Congressional Research Service (CRS) of the USA: ‘Most economists argue that equating a trade deficit, whether on a bilateral basis or overall, with unemployment or job losses is questionable given the macroeconomic origin of the trade deficit and the relatively limited role that trade plays in the overall U.S. economy.’ (Accentuation in the quotation is by the article writer.)   

• The USA is also used as an example of a country with a long-lasting trade deficit, but which has experienced significantly long periods of economic growth. 

   

Calculating the balance of trade 

  The balance of trade of a country is typically calculated on a monthly basis. It is also calculated at the end of a country’s fiscal year.    The formula to calculate the balance of trade is:  Balance of trade = Exports - Imports    Example:  Let us say that country A exports goods and services to the value of R500 million and imports products and services worth R420 million in a given month.  Country A’s BOT will be calculated as follows:  BOT = Exports - Imports          = R500 million - R420 million          = R80 million, meaning the country has a trade surplus of +R80 million.  If the figures were R500 million for imports and R420 million for exports, the calculation would look as follows:  BOT = Exports - Imports          = R420 million - R500 million          = -R80 million, meaning the country has a trade deficit of -R80 million.   

Balance of trade versus balance of payments 

  The balance of trade (BOT) is a sub-division in the balance of payments (BOP), which is the sum of all international economic transactions between one country and its global trading partners.    The BOP consists of three main categories: the current account, the capital account, and the financial account.    The current account The current account includes the balance of trade (exports minus imports) as well as earnings on investments, both public and private, and transfers like foreign aid and gifts.    The capital account The capital account includes, inter alia, the following international capital transfers: 

• The acquisition or disposal of non-financial assets (for instance, a physical asset such as property). 
• Monetary flows originating from debt forgiveness. 
• The transfer of goods and financial assets by migrants leaving or entering a country. 
• The transfer of funds received for the acquisition or sale of fixed assets. 
• Gift and inheritance taxes. 

  The financial account The financial account records transactions related to investments in business, real estate, bonds, and stocks, to name a few.  A country can have a positive BOP and a negative BOP when its exports exceed its imports, but also lose financial capital or make financial transfers. The opposite is also true. 

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