What Is the Balance of Trade (BOT)?
Balance of trade (BOT) is the difference between the value of a country's exports and the value of a country's imports for a given period. Balance of trade is the largest component of a country's balance of payments (BOP). Sometimes the balance of trade between a country's goods and the balance of trade between its services are distinguished as two separate figures.
The balance of trade is also referred to as the trade balance, the international trade balance, the commercial balance, or the net exports.
- Balance of trade (BOT) is the difference between the value of a country's imports and exports for a given period and is the largest component of a country's balance of payments (BOP).
- A country that imports more goods and services than it exports in terms of value has a trade deficit while a country that exports more goods and services than it imports has a trade surplus.
- Viewed alone, a favorable balance of trade is not sufficient to gauge the health of an economy. It is important to consider the balance of trade with respect to other economic indicators, business cycles, and other indicators.
- The United States regularly runs a trade deficit, while China usually runs a large trade surplus.
What's the Balance of Trade?
Understanding the Balance of Trade (BOT)
The formula for calculating the BOT can be simplified as the total value of exports minus the total value of its imports. Economists use the BOT to measure the relative strength of a country's economy.
A country that imports more goods and services than it exports in terms of value has a trade deficit or a negative trade balance. Conversely, a country that exports more goods and services than it imports has a trade surplus or a positive trade balance.
A positive balance of trade indicates that a country's producers have an active foreign market. After producing enough goods to satisfy local demand, there is enough demand from customers abroad to keep local producers busy. A negative balance of trade means that currency flows outwards to pay for exports, indicating that the country may be overly reliant on foreign goods.
Calculating the Balance of Trade
A country's balance of trade is calculated by the following formula:
Where exports represents the currency value of all goods sold to foreign countries, as well as other outflows due to remittances, foreign aid, donations or loan repayments. Imports represents the dollar value of all foreign goods imported from abroad, as well as incoming remittances, donations, and aid.
Debit items include imports, foreign aid, domestic spending abroad, and domestic investments abroad. Credit items include exports, foreign spending in the domestic economy, and foreign investments in the domestic economy. By subtracting the credit items from the debit items, economists arrive at a trade deficit or trade surplus for a given country over the period of a month, a quarter, or a year.
Examples of Balance of Trade
The United States imported $239 billion in goods and services in August 2020 but exported only $171.9 billion in goods and services to other countries. So, in August, the United States had a trade balance of -$67.1 billion, or a $67.1 billion trade deficit.
A trade deficit is not a recent occurrence in the United States. In fact, the country has had a persistent trade deficit since the 1970s. Throughout most of the 19th century, the country also had a trade deficit (between 1800 and 1870, the United States ran a trade deficit for all but three years).
Conversely, China's trade surplus has increased even as the pandemic has reduced global trade. In Aug. 2022, China exported goods worth $314.9 billion and imported goods worth $231.7 billion. This generated a trade surplus of $79.4 billion for that month, a drop from $101 billion the preceding month.
A country with a large trade deficit borrows money to pay for its goods and services, while a country with a large trade surplus lends money to deficit countries. In some cases, the trade balance may correlate to a country's political and economic stability because it reflects the amount of foreign investment in that country.
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.
What Is a Favorable Balance of Trade?
A favorable balance of trade occurs when a country's exports exceed the value of its imports. This indicates a positive inflow of money to stimulate local economic activity.
How Do Changes in a Country's Exchange Rate Affect the Balance of Trade?
When the price of one country's currency increases, the cost of its goods and services also increases in the foreign market. For residents of that country, it will become cheaper to import goods, but domestic producers might have trouble selling their goods abroad because of the higher prices. Ultimately, this may result in lower exports and higher imports, causing a trade deficit.
How Can a Country Gain a Favorable Balance of Trade?
Many seek to improve their balance of trade by investing heavily in export-oriented manufacturing or extracting industries. It is also possible to improve the balance of trade by placing tariffs on imported goods, or by devaluing the country's currency.
The Bottom Line
The balance of trade refers to the net flows of currency in international markets. A positive balance of trade means that a country is a net exporter, and sells more goods on the foreign market than it imports. A negative balance of trade means that the country is a net importer.