What Are Trade Deficits: Good, Bad or Irrelevant?

The phrase “Trade Deficits” has been in the news a lot lately. But what exactly are trade deficits? Why do we have them and are they a good or a bad thing? Are trade deficits indicative of the absence of Free Trade?

Before we go any further, it’s probably worth noting that free trade is something we have not had for a very long time. If ever. Multilateral trade agreements like NAFTA, by their very definition, are not free trade. They are multi-party trade agreements.

A pure free trade agreement is politically hard to come by in the real world because it’s not as easy as just getting rid of tariffs. Issues of corporate tax rates, governmental regulations, and other non-tariff barriers to trade, such as subsidies, licensing requirements, product standards, etc., all need to be taken into account and intrude their way into practical application. Therefore, if we must enter into trade agreements, let’s do so directly with each country on a bi-lateral, directly negotiated basis.

Which is precisely what President Trump is looking to do.

It’s also worth noting that imports, of themselves, are not “bad” and can be highly additive to economic growth. At its most basic level an import is no more than a transaction. It just happens to occur between a buyer and seller who reside in different countries.

The transaction occurs for a reason. Consumers—companies, individuals & governments (theoretically)—look for the best value for their money. This doesn’t necessarily mean the cheapest price. Quality can be a huge factor as well.

Free trade can be beneficial for all parties. And trade deficits are not inherently bad. But long-term, persistent trade deficits are a problem.

A Trade Balance is simply the value of Exports minus the value of Imports:

Trade Balance = Price of Exports * Quantity of Exports – Price of Imports * Quantity of Imports

A Trade Surplus means the Value of Exports exceeds the Value of Imports. A Trade Deficit means the Value of Imports exceeds the Value of Exports.

Let’s look at a simplistic example (intentionally leaving aside currency rates):