From time to time, some politicians (who care about their votes) bring up trade imbalances as a problem. You might even take some seriously, if they would take a balanced approach. Instead, they hail a trade surplus as a miracle cure to make a country rich. To give the mercantilists credit where it is due, but also to warn of its side effects, we dissect the benefits and risks of a great trade surplus.
Benefits of a Trade Surplus
A trade surplus, where a country exports more goods and services than it imports, can have several beneficial effects on the economy.
Job Creation and Economic Growth
A trade surplus often indicates strong demand for a country’s goods and services, leading to increased domestic production. Thereupon, this can result in higher employment rates and economic growth. As exports rise, more people are employed in various sectors to meet the demand, contributing to overall economic expansion.
Additional Resources for Investments
Countries with a trade surplus have additional resources available for investments. These surplus funds can be used to modernize various sectors, enhance productivity, and support infrastructure development projects such as transportation networks, communication systems, and energy facilities.
Reduction in Government Expenditure
With surplus funds from trade, businesses and industries may require less financial support from the government or can pay more taxes. Accordingly, this can lead to a reduction in government expenditure, allowing public money to be redirected towards other beneficial projects like infrastructure improvements.
Enhanced Foreign Reserves
A trade surplus contributes to an increase in foreign reserves, providing a buffer against external economic shocks. Accumulating foreign reserves enhances a nation’s ability to stabilize its currency and manage its balance of payments effectively.
Currency Strength
A trade surplus can strengthen a country’s currency relative to other currencies. As a benefit, increased demand for the country’s goods and services leads to higher demand for its currency, which can appreciate in value in global markets.
You will find more infographics at StatistaRisks and Disadvantages of a Trade Surplus
While a trade surplus offers several benefits, it also comes with some significant risks and disadvantages. You do not want to catch a Dutch disease.
Higher Inflation Levels
A trade surplus can lead to higher inflation levels within the country. The increased demand for domestic goods and services can outstrip supply, driving up prices and reducing the value of money.
Economic Challenges if Trade Surpluses Diminish
Economies heavily reliant on trade surpluses can face significant challenges if these surpluses diminish. Consequently, this reliance on exports for economic stability can make it difficult to implement adjustments in other economic sectors, potentially leading to financial crises.
Natural Resource Degradation
Countries that heavily rely on natural resources as their primary export commodities may face ecological damage and depletion of natural reserves. Over time, this can have long-term negative impacts on the environment and sustainable economic growth.
Trade Protectionism Risks
Persistent trade surpluses can invite protectionist measures from trading partners, such as tariffs, quotas, or trade barriers, aimed at reducing imports and rebalancing trade. This can even escalate into trade disputes and undermine international trade relations, potentially leading to retaliatory actions and trade wars.
Dependency on External Demand
A trade surplus can make an economy dependent on external demand. But if global demand for the country’s exports decreases, it can lead to economic instability. Furthermore, often exports are seldom diversified, and the structural deficits challenge the maintenance of economic growth.
Political Economy
Exporters tend to be well organized and capital intensive. As a consequence, only a smaller stratum of the population tends to hold wealth and political influence in an export-dependent economy. In turn, the strength of civil society and democratic institutions tends to suffer.
Real-World Examples
Japan’s Experience
Japan is a notable example where large trade surpluses have not necessarily translated into robust economic health. Despite significant trade surpluses since the 1990s, Japan’s economy has experienced slow growth, averaging only about 1% real GDP growth per year, and rising unemployment rates. This highlights that a large trade surplus is no guarantee of economic good health.
China’s Experience
China’s economy, which has become a dominant exporter in the global market, also illustrates the complexities of trade surpluses. While China’s trade balance has expanded significantly, economists note that this strength might be temporary and subject to global economic conditions. In effect, the reliance on exports and the potential for trade protectionism and retaliatory measures are significant concerns. Combine this with a strong reliance on imports to feed and fuel the economy, and China strongly depends on free international trade.
Conclusion
A trade surplus can be a double-edged sword for an economy. While it offers benefits such as job creation, economic growth, and increased foreign reserves, it also poses risks like higher inflation. Other risks include economic challenges if the surplus diminishes, natural resource degradation, and the risk of trade protectionism. With that in mind, understanding these dynamics is crucial for policymakers to manage trade balances effectively and ensure sustainable economic growth. In the end, to determine the health of an economy, its structure, and the goods traded within the global economic context are of higher importance.
