What Is a Trade Deficit?

What Is a Trade Deficit?

With all the talk of globalization, trade imbalances, imports, exports and deficits, it's easy to become confused and misunderstand some of the terms used by politicians and economists. The trade deficit is one of the more important issues facing American society. Knowing what it is and what it means to you can help make sense of what people and politicians say about it.

Significance
1. Trade is the lifeblood of any country. In the United States, literally trillions of dollars are generated by the importation and exportation of goods to U.S. shores. Ideally, the United States should export more than it imports, particularly if the value of those goods is high. For instance, selling raw lumber nets a relatively low profit. Turning the lumber into furniture, however, adds value to the lumber. These "value-added" products are then sold at a much higher profit and though less of them may be send abroad, the trade-off is a "surplus" of revenue.

Geography
2. The United States trades either directly or indirectly with every country on the planet, with a few minor exceptions. Some countries import American value-added goods and send raw materials to the United States. Underdeveloped nations, usually in Latin America and Africa, export agricultural or mineral products in exchange for American products. For example, Jamaica produces a mineral called "bauxite," which is used to make aluminum. The United States exports cars, computers and telecommunications equipment. With developed or developing countries, the United States trades finished goods (toys, electronics, machines) in return for finished goods from those countries. Another example is when the United States trades with China; China purchases high-tech equipment and some raw materials such as lumber and in return, the United States imports everything from toothpaste to flatware to clothing.

Effects
3. When a trade deficit is in effect, the United States is purchasing more from another country than it is selling to that country. In the examples mentioned earlier, the United States may have a trade "surplus" with Jamaica but a trade "deficit" with China. This means more of America's money is going to China than Chinese money is coming to America. A trade deficit may mean that products made in America are becoming too costly for Americans to purchase, or it may mean that foreign products are made more cheaply and thus are more attractive to American consumers. Either way, American companies are forced to cut jobs, cut production or close altogether in the face of dwindling sales. This means less jobs domestically and less money in consumers' pockets, which may reinforce the cycle of purchasing cheaply made imported items.

Types
4. Though there may be a deficit with one or even several countries, the aggregate value of all products exported is compared to the value of all products imported. If the result is a positive number, the United States is said to have an "overall trade surplus." If that number is negative, the United States is said to have an "overall trade deficit." Trade deficits vary from year to year; certain years may favor products from certain countries. French wines, for example, may be in fashion for a few years, but then as the price becomes too high, consumers may choose to drink Australian, Chilean or even domestic wines instead.

Prevention/Solution
5. Trade deficits, if left running for several years, can adversely affect the United States. Businesses, particularly small businesses, may cease to function or may be harmed by falling profits. As consumers become aware of the deficit between the United States and another country, they may opt to purchase products from another country or domestic versions. For instance, the proliferation of Japanese electronics in the 1980s and 1990s led to a growing dissatisfaction with Japanese dominance in that area. The result was purchases of domestic electronics, as well as the purchasing of Korean, Taiwanese and European electronics. For example, in the personal music industry, Japanese electronics giant Sony's Walkman product was the best-selling personal music player throughout the 1980s and into the 1990s. With the advent of Apple's iPod, however, Sony found itself unable to make a product that appealed to American audiences and lost considerable market share.

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