What is a Trade Surplus?

It is an economic measure of a positive trade balance. In simple words when a country's export, exceeds its import, it is a trade surplus.

The net sum of a country's exports and imports without considering all financial transfers, investments, and other financial components are called trade balance.
If the value of exports exceeds the value of imports, the country's trade balance is said to be positive.

Importance of Trade Surplus

A country with a trade surplus, through trade, exports most of its currency. This has an effect on the value of the said currency in the global market. Exporting goods and services boost the country's currency with respect to other country's currency, affecting the exchange rate of the currency. This mostly depends on the goods and services of the country concerning the other countries, keeping in account other market factors.

This surplus also creates new employment opportunities and enables economic growth.
Amidst the COVID-19 pandemic, even though almost all economic superpowers suffered huge losses, China's economy has not only recovered from the initial impact of the virus but has started to thrive again.

The biggest reason for this was its exports. China's exports grew more than the projections. The disruption created in the global market by the coronavirus increased the demand for goods made in China.

The surplus created in the trade balance account of China has not only paved the way for economic growth but improved the exchange rate of the country. This means, the Coronavirus pandemic helped in the economic growth of China. 

How to Calculate Trade Surplus? 

A nation's international trading activity is made up of 

1. Imports (a commodity bought by the home country from some other country)
2. Exports (a commodity sold by the home country to other countries)

We can determine whether a country is primarily a buyer, or a seller based on the value of its exports relative to the value of its imports. This is done by calculating net export.

Net exports = (Value of goods and services a nation exports) - (Value of goods and services a nation imports). This is also known as a country's trade balance.

Trade surplus happens when a country has made more money through exports than it spent on imports. In this case, the net exports will be positive. 

What is a Trade Deficit?

A trade deficit is the opposite of trade surplus.

A trade deficit occurs when a country spends more on imports than it makes through exports. The net exports will be negative in this case.

A trade deficit can be calculated by using the following formula:

Trade Deficit = (Country's Imports) - (Country's Exports).

What is Balance of Payment?

Balance of trade or trade balance is a part of a wider concept - balance of payment. The balance of payment (BOP) account of a country refers to a systematic record of all the monetary transactions country did with the rest of the world.

The BOP record is prepared in a standard double-entry book-keeping method. The payments received from foreign countries are entered in the credit side of BOP and payments made to other countries on the debit side of the BOP. It includes transactions like exports and imports of goods (visible items), services (invisible items), and assets (flow of capital). 

Components of Balance of Payment

BOP contains two types of accounts.

Current Account

The transactions recorded under the current account are as follows.

• Export and imports of goods (visible items)
• Export and imports of services (invisible items)
• Unilateral transfers

The transactions that cause an inflow of money in the country are recorded on the credit side of the current account and treated as positive items. The transactions which cause an outflow of money from the country are recorded on the debit side and are treated as negative items.

When the debit side is more than the credit side, the current account surplus will take place. On the other hand, when the credit side is more than the debit side the current account deficit will take place. The balance of the current account can be calculated using the following formula:

Balance of Current Account = Balance of Trade + Services + Unilateral Transfers.

Capital Account

It includes those economic transactions of the country with the rest of the world which affect the liabilities or assets of the country. The main transactions included in the capital account of BOP are:

• Investment
• Loans
• Banking Capital

How Does Current Account Deficit Affect Economy?

A deficit in the current account shows that the country has imported goods and services significantly more than it has exported. It may show that the country has not been able to do well in the global markets. But this deficit also implies excess investment over savings which highlights an expanding economy with increasing GDP and high productivity. 

If the economy's fiscal policy is poor or there is a consumption binge, the current account deficit means low savings instead of high investment. Without being certain if there is a high investment or low savings, it is difficult to label the deficit as good or bad. 

Current account deficits bring forward underlying trends of the economy, these trends may be considered favorable or unfavorable for a country. Their effectiveness depends on the global trends. 

More About Trade Surplus and Trade Deficit

A nation that exports more than it imports is a net exporter. Similarly, a nation that imports more than it exports is a net importer. When the same amount of money is made on exports as is spend on imports, it is called balanced trade.

Deficits and surpluses are typically expressed in terms of a nation's respective currency. For instance, in the United States, in 1975, there was a trade surplus of 12.4 billion dollars. This means that the United States sold more through exports than spend on imports.

Trade deficits and trade surpluses are important indicators of a country's economic health and are components of vital measures such as GDP. Whether a trade surplus or trade deficit is viewed positively or negatively, depends greatly on the general situation of the country concerned. For example, the United States is a major exporter on the world market, but imports outweigh American exports. The US runs a trade deficit. However, the extent to which this impacts the GDP of the United States is limited because most goods produced in the US are consumed domestically.

Other countries, especially those that produce and export valuable natural resources such as oil and minerals may run large trade surpluses and use their exports as the engine of their economic growth.

For example, in 2012, the trade surplus of the United Arab Emirates, fueled by oil sales, reached 520 billion Dirham, which is about 140 billion US dollars. This can be a risky strategy because it renders the nation's wider economy vulnerable to price fluctuations in the main commodity traded. In simple words, the UAE's economy is so dependent on their natural gas and petroleum exports that a significant change in their prices can crumble the economy.

Context and Applications

The subject “Trade Surplus and Deficit Analysis” is important for the professionals associated with international business exclusively in trading. The topic is significant for students enrolled in

• MBA (International Business)
• Master in Commerce and Economics
• Bachelor in Commerce and Economics
• Bachelor in Business Administration

The topic ‘Trade Surplus and Deficit Analysis’ would help fellows planning to do research work on foreign trade and principles that govern the trade policy of nations. Concepts like trade balance and current account surplus and current account deficits are part of macroeconomics.

Related Concepts

• Surplus and Deficit of Trade Balance
• Tariff and Non-Tariff Barriers
• WTO and Global Trade
• Bilateral Trade between Countries
• Government Spending and its Effects on Economy.
• Calculation of National Income

Practice Problem

Problem: Why a country's currency is weakened by the trade deficit?

Solution: When a country’s import of goods and services is more than its export, it is called a trade deficit. This means it is importing more than it is exporting. Every trader needs a line of credit (LOC) to continue trading without any hiccups. Similarly, a country needs credit so that it can spend more than its income. This is what causes a trade deficit and it requires financing from foreign institutions and individuals. 

Problem: How can foreign individuals and institutions finance these countries? 

Solution: They can either lend money to them or invest there. Needless to say, these foreign investors expect to get paid back and for that to happen, the country needs to turn its trade deficit into a surplus.

To turn the trade deficit into a surplus, they will have to increase exports and reduce imports. This can be done by depreciating the country's currency, making imports more expensive for foreigners and exports cheaper. A large amount of trade deficits is generally associated with a weak exchange rate at some point in the future.

To conclude, the relationship between deficit in trade balance and the currency is weak in the short run. Whereas, in the long run, trade deficits generally weaken the exchange rate as the economy tries to adjust to create surpluses needed to repay foreign investors.