What is a Trade Deficit?
When the value of a country's imports exceeds the value of its exports, the resulting negative number is called a trade deficit.
How Does a Trade Deficit Work?
Balance of trade (BOT; also called the 'trade balance') is a measure of a country's exports minus its imports. BOT is a component of a country's balance of payments (BOP) as is calculated for a particular period (usually a quarter or a year). In the United States, the Bureau of Economic Analysis calculates the BOT.
For example, if the value of imported items to the United States equaled $1 trillion last year, but the value of exported items from the United States equaled $750 billion, then the United States would have a negative $250 billion BOP, or a $250 billion trade deficit.
Why Does a Trade Deficit Matter?
Countries have various methods for calculating BOT, but the objective is to help economists and analysts understand the strength of a country's economy in relation to other countries. For example, a country with a large trade deficit is essentially borrowing money to purchase goods and services, but a country with a large trade surplus is essentially doing the opposite. In some cases, the BOT correlates with the country's political stability because it is indicative of the level of foreign investment occurring there.
As mentioned, the BOT is part of the BOP, which is actually composed of three subaccounts in the United States: the current account, the capital account, and the financial account, each of which have their own types of inflows and outflows. The BOT is part of the current account, which is composed of merchandise trade, services, income receipts, and one-way transfers such as foreign aid.