What is Balance of Trade (BOT)?
Balance of Trade (BOT) is the difference in the value of all exports and imports of a particular nation over a period of time. A positive or favorable trade balance occurs when exports exceed imports. A negative or unfavorable balance occurs when the opposite happens. Simply put, if a country exports more than what it imports, for a given period of time, it has a positive BOT.
Understanding Balance of Trade (BOT)
Economists use the BOT to measure the relative strength of a country’s economy. The balance of trade is also referred to as the trade balance or the international trade balance. A country that imports more goods and services than it exports in terms of value has a trade deficit. Conversely, a country that exports more goods and services than it imports has a trade surplus. The formula for calculating the BOT can be simplified as the total value of imports minus the total value of exports.
There are countries where it is almost certain that a trade deficit will occur. For example, the United States has had a trade deficit since 1976 because of its dependency on oil imports and consumer products. Conversely, China, a country that produces and exports many of the world’s consumable goods, has recorded a trade surplus since 1995.
A trade surplus or deficit is not always a viable indicator of an economy’s health, and it must be considered in the context of the business cycle and other economic indicators. For example, in a recession, countries prefer to export more to create jobs and demand in the economy. In times of economic expansion, countries prefer to import more to promote price competition, which limits inflation.
Components of the Balance of Trade
Economic products included in the Balance of Trade calculation are categorised into goods or services, and their prices have direct influence on the export and import values.
Goods are tangible merchandise produced locally, ranging anywhere from food and medicine to automotive and energy.
Services are based on human interactions and involve offering support for or assuming the responsibility of performing a task. The scope of services can range anywhere from entertainment and education to sales and health care.
The prices of goods and services depend initially on the production costs like raw materials, storage, transportation, and personal expenses. For example, price fluctuations in crude oil can lead the manufacturers of oil-based products to adjust their prices to reflect the changes.
Profit margin of the producer is then added according to local supply/demand ratio. Supply and demand volumes can change seasonally and are affected heavily by economic and fiscal conditions like inflation and taxes.
Foreign demand is the final determinant of the prices. Especially if the foreign currency is more valuable than the local currency, companies would naturally prefer to export their products and earn higher profits. As a result, the export prices would continuously rise, so long as they remain feasible for foreign buyers.
On the other hand, an industry with demand surplus would encourage companies to import products, preferably from low-cost countries, and increase the total value of imports. Eventually, the nominal prices in the domestic markets would be driven down and reduce the value of exports.
How to Calculate the Balance of Trade?
As the comparison of imports and exports, the Balance of Trade highlights the efficacy of a country’s international trade activities. The BoT formula is as follows:
TB (trade balance) = X (total export value) – M (total import value)
The computation may differ between countries. For example, the primary Balance of Trade report in the Euro Zone and France include only goods and do not account for the services. French trade balance of services is calculated separately, and two categories are combined in a different report.
Balance of trade, the difference in value over a period of time between a country’s imports and exports of goods and services, usually expressed in the unit of currency of a particular country or economic union (e.g., dollars for the United States, pounds sterling for the United Kingdom, or euros for the European Union). The balance of trade is part of a larger economic unit, the balance of payments (the sum total of all economic transactions between one country and its trading partners around the world), which includes capital movements (money flowing to a country paying high interest rates of return), loan repayment, expenditures by tourists, freight and insurance charges, and other payments.
Exports are goods or services made domestically and sold to a foreigner. That includes a pair of jeans you mail to a friend overseas. It could also be signage a corporate headquarter transfers to its foreign office. If the foreigner pays for it, then it’s an export.
Imports are goods and services bought by a country’s residents but made in a foreign country. It includes souvenirs purchased by tourists traveling abroad. Services provided while traveling, such as transportation, hotels, and meals, are also imports. It doesn’t matter whether the company that makes the good or service is a domestic or foreign company. If it was purchased or made in a foreign country, it’s an import.
When a country’s exports are greater than its imports, it has a trade surplus. Most nations prefer this favorable trade balance. When exports are less than imports, it creates a trade deficit. Most countries try to avoid such an unfavorable trade balance. Sometimes a favorable trade balance, or surplus, is not in the country’s best interests. For example, an emerging market should import to invest in its infrastructure. It can run a deficit for a short period with this goal in mind.
Interpretation of BOT for an Economy
To the misconception of many, a positive or negative trade balance does not necessarily indicate a healthy or weak economy. Whether a positive or negative BOT is beneficial for an economy depends on the countries involved, the trade policy decisions, the duration of the positive or negative BOT, and the size of the trade imbalance, among other things.
In short, the BOT figure alone does not provide much of an indication regarding how well an economy is doing. Economists generally agree that neither trade surpluses or trade deficits are inherently “bad” or “good” for the economy.
- A positive balance occurs when exports > imports and is referred to as a trade surplus.
- A negative trade balance occurs when exports < imports and is referred to as a trade deficit.
Favorable Trade Balance
Most countries create trade policies that encourage a trade surplus. It’s like making a profit as a country. Nations prefer to sell more products and receive more capital for their residents. That translates into a higher standard of living. Their companies also gain a competitive advantage in expertise by producing all the exports. They hire more workers, reduce unemployment, and generate more income.
To maintain this favorable trade balance, leaders often resort to trade protectionism. They protect domestic industries by levying tariffs, quotas, or subsidies on imports. That doesn’t work for long. Soon other countries retaliate with their protectionist measures. A trade war reduces international trade for all nations.
Unfavorable Trade Balance
Most of the time, trade deficits are an unfavorable balance of trade. As a rule, countries with trade deficits export raw materials. They import a lot of consumer products. Their domestic businesses don’t gain the experience needed to make value-added products. Their economies become dependent on global commodity prices. Such a strategy also depletes their natural resources in the long run.
Some countries are so opposed to trade deficits that they adopt mercantilism. This is an extreme form of economic nationalism that says remove the trade deficit at all costs. It advocates protectionist measures such as tariffs and import quotas. Although these measures can reduce the deficit, they also raise consumer prices. Worst of all, they trigger reactionary protectionism from the nation’s trade partners. It lowers international trade, and economic growth, for everyone involved.
Difference Between Trade Balance and Balance of Payments
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. As a result, it would rarely run a surplus large enough to offset a trade deficit.
How the Balance of Trade Affects the Economy?
The Balance of Trade reveals whether the country is generating extra resources beyond its local capacity to create value. As a major indicator of economic growth potential and an important part of the , the BoT figures are carefully monitored by governments and central banks to adjust their policies. A trade surplus usually increases the GDP, while a trade deficit weakens it.
Although most countries aim for a positive trade balance, surplus or deficit does not necessarily indicate economic strength or weakness. The BoT figures should be interpreted in the context of the country’s current economic conditions, economic policies and business cycles.
The Balance of Trade as an Economic Indicator
The Balance of Trade is a lagging economic indicator and monitors the trading activities only in retrospect. A positive BoT figure indicates that the total value of exports increased more than imports in the focused period, while a negative trade balance report suggests the opposite. There are a few factors which can influence the trade balance:
- Major domestic industries and their internal conditions like local supply/demand
- Costs of raw materials and intermediate goods
- The fluctuations in exchange rates
- Trade policies, taxes, regulations, and restrictions
- International relations with major trading partners
- Custom controls
In the financial markets, BoT is used as an economic indicator of a country’s economic health and proximity to economic policy goals. Traders follow the BoT releases to gauge the international trade performance of the country and infer whether the growth potential is being fulfilled and expanded. It is considered as a strong predictor of GDP and the government’s future fiscal policies.