What Is a Trade Deficit? Why Importing More Than You Export Is Not Always Bad

The trade balance is the value of a country's exports of goods and services minus its imports over a period, and it is negative, a deficit, when imports are larger. Goods are easy to count as they cross a border; services, tourism, banking, software, consulting, are harder and are a growing share, and Britain runs a large surplus in services against a larger deficit in goods. The trade balance is one part of the current account, which also includes the income a country earns on its investments abroad minus what it pays foreigners on theirs, and the current account is what economists watch, since it is the whole of a country's earning and spending with the rest of the world.

A deficit must be financed, and the financing is the point that the headlines miss. A country that imports more than it exports is sending out more of its currency than comes back for goods, and foreigners who hold that currency use it to buy the deficit country's assets: its government bonds, its shares, its companies, its houses. The current account deficit is therefore matched, to the penny, by a capital account surplus, an inflow of investment, and the question of whether the deficit is good or bad is the question of what that investment is doing:

• •A country borrowing abroad to build factories, ports and skills is investing and will repay from the returns; the United States ran deficits through the nineteenth century financed by British capital that built its railways
• •A country borrowing to consume, importing cars and holidays on credit, is running down its future income
• •A country whose assets foreigners want to hold, because its bonds are safe and its currency is the world's reserve, can run deficits indefinitely at low cost, which is the American case
• •A country that must borrow in someone else's currency, at rising rates, can find the inflow stops suddenly, which is the emerging-market crisis of 1997 and Argentina's of every decade

The deficit is not mainly caused by trade policy. A country's trade balance equals the difference between what it saves and what it invests, since a nation that invests more than it saves must borrow the rest from abroad and the borrowing arrives as imports; the American deficit reflects a low saving rate and a government that borrows, and China's surplus reflects households that save half their income and a state that suppresses consumption. Exchange rates matter, and a country whose currency is held high by its status or its central bank will import more; tariffs shift the deficit between partners without much changing the total, as the American tariffs on China after 2018 did, moving the imports to Vietnam and Mexico. A recession shrinks a deficit, since people buy less of everything, and a boom widens it, which is why a rising deficit is as often a sign of strength as of weakness.

Deficits harm particular people even when they do not harm the country. The imports that a deficit represents displace domestic producers, and the towns that made furniture, textiles and steel do not become the towns that write the software the country exports; the political anger about trade in the American Midwest and the English North is about that distribution, and the economics of comparative advantage, which says the country as a whole gains, has no consolation for the losers except retraining that mostly did not happen. A persistent deficit also builds a stock of foreign claims, and a country that has sold a large share of its assets abroad pays a growing stream of dividends and interest out, which is the current account turning against it. And a deficit financed by short-term borrowing in a foreign currency is dangerous, since the lenders can leave in a week, which is why the countries that fear deficits most are the ones that have been through a sudden stop.

The instinct that exports are good and imports bad is mercantilism, the doctrine that a nation grows rich by selling more than it buys and hoarding the gold, which Adam Smith spent much of The Wealth of Nations refuting: the point of trade is the imports, the things a country gets that it could not make as well, and exports are what it gives up to pay for them. A country that exported everything and imported nothing would be working for foreigners for free. The doctrine has never died, because a surplus feels like winning and a deficit like losing, and every trade war since has been fought on the feeling. The accounting says something plainer: a deficit is a loan, and a loan is good or bad according to what it buys.

Trade figures record the full value of a product at the border it last crossed, and that can give a distorted picture of who earns what. Take a smartphone designed in the United States, built from a screen made in South Korea, memory chips from Japan and Taiwan and components from several other countries, then assembled in China and shipped to an American shop. The official statistics count the whole wholesale value as an import from China, even though the Chinese factory's share of the value is usually a small fraction, mostly the cost of assembly labour.

Economists have therefore built value-added trade statistics, which trace how much of each export's value was actually created in each country, using tables of what every industry buys from every other. Measured this way, a country's deficit with its final assembler tends to shrink and its deficits with the countries that make components tend to grow, while the overall balance with the world stays the same. That is the key point for you as a reader of headlines. A deficit with one partner mostly reflects where supply chains happen to finish, and cutting it with tariffs usually just moves the final assembly, and the deficit, to another country.

A common prescription for a deficit is a cheaper currency, which makes imports dearer and exports cheaper. The effect is real but arrives in an odd order. Suppose a country's currency loses a fifth of its value. In the following months, firms and households are still buying under contracts and habits fixed earlier, so the quantity of imports barely changes, but each import priced in foreign currency now costs a quarter more at home. Export volumes also take time to grow, since foreign buyers must notice the lower prices and switch suppliers. For a while the deficit, measured in the home currency, gets larger rather than smaller.

Over the following year or two, volumes catch up: buyers at home switch to local products, foreign customers buy more of the newly cheap exports, and the balance improves, often beyond where it started. Plotted against time, the balance dips and then rises in a shape economists call the J-curve. Whether the recovery comes at all depends on how strongly buyers respond to prices, a requirement known as the Marshall-Lerner condition: the combined responsiveness of export and import demand must be large enough to outweigh the higher price of each import. In practice the response is often slower and weaker than the textbook diagram suggests.

Headlines about a trade deficit often refer only to goods, the physical things that cross borders in containers and lorries. Trade also includes services, such as banking, insurance, consulting, tourism and education, and a country can run a deficit in one and a surplus in the other. The United Kingdom is a clear example: it has long imported more goods than it exports, but it sells far more services abroad than it buys.

Overseas students paying tuition fees at British universities count as service exports, as do foreign companies paying London firms for legal or financial advice. Looking only at goods therefore gives a misleading picture of how a country earns its living. Economists usually look at the overall current account, which brings goods, services and income together, before drawing conclusions.

A trade deficit is the amount by which a country's imports of goods and services exceed its exports, and it is always matched by an inflow of foreign investment that pays for it, so its meaning depends on whether the borrowing funds investment or consumption and whether the lenders can withdraw. It is driven by the gap between national saving and investment more than by tariffs, it rises in booms and falls in slumps, and it harms the industries and towns that imports displace even where the country as a whole gains.