Impact of Trade Deficits and Surpluses on Investors

World trade has been credited as the source for a range of impacts and outcomes, from driving global economic growth to ensuring a high level of world peace. Economists at the World Trade Organization (WTO) estimate that cutting trade barriers in agriculture, manufacturing, and services by just one-third would boost the world economy by $613 billion. Also, as one of many other welcome side effects, integrating world markets more tightly has made it much more costly for countries to declare war on each other.

To learn more about the design and impacts of the global market, it will help to have insight into how economists measure world trade on a country-by-country basis, and how to compare a country’s exports to its imports.

Trade Deficits & Surpluses Defined

For the most part, the world’s countries can be divided into net exporting and net importing countries. This is based on their balance of payments or net exports.

Changes in any of these metrics will lead to what is known as trade deficits and surpluses:

• Trade Deficits: Trade deficits occur when a country imports more products than it exports. For example, if the U.S. were to import $800 billion worth of goods and export only $200 billion worth of goods, there would be a $600 billion trade deficit.
• Trade Surplus: Trade surpluses occur when a country exports more products than it imports. For example, if China were to export $1 trillion worth of goods and import only $200 billion worth of goods, it would have an $800 billion trade surplus.

Keep in mind that you can't judge trade deficits and surpluses on the surface. You may need to look deeper into how countries trade products, too, and whether there are any stopping points, or places where money is rerouted. For example, The Economist points out that the Apple iPad is imported from China, and when the U.S. imports it, the $275 production cost counts as a trade deficit for the U.S. However, most of the profits end up flowing into Apple Inc., which is a U.S. company. The value added from work in China amounts to just $10 of the $275 production cost.

How Do Trade Surpluses and Deficits Impact Economies?

Trade deficits and surpluses have an immediate impact on a number of major economic indicators. A country's gross domestic product (GDP), for example, will reflect its balance of account and other trade issues. However, these figures must be assessed within the context of a country’s overall size. For example, the U.S. may have a large trade deficit, but since most of its goods and services are produced and consumed domestically, this trade deficit doesn’t have a major impact on its overall GDP.

Often, investors should pay the closest attention to the current account as a percentage of GDP, since it shows the current account number relative to overall economic output. Trade balances should also be balanced by an equal dollar amount of foreign direct investment (FDI) to maintain global purchasing power. If the current account deficit rises as a percentage of GDP and FDI doesn’t balance out the difference, a country could be headed for trouble.

Trade surpluses can be extremely important to watch in countries that rely on exports to drive economic growth, too. For example, countries that export oil may rely on trade surpluses to fund public programs or sovereign wealth funds. If oil prices go down, these countries end up with more narrow trade surpluses, and in turn, more hardship finding money for public welfare.

The Bottom Line

Trade deficits and surpluses play a key role in global markets. This is particularly true in emerging markets, and in countries whose economies are highly driven by exports. As you invest, you should be mindful of the risks that come with both persistent trade deficits and narrowing trade surpluses. These can reduce global purchasing power and lead to higher political risks, respectively. It's also important to keep in mind that trade deficits and surpluses don't matter as much in developed countries where imports and exports only account for a small fraction of GDP.