Trade Surplus – Its Importance, Calculation And How is It Related to Savings Rate
The balance of trade (BOT), commonly known as the trade balance, is the monetary value differential between a country’s imports and exports over a specific period. The trade balance is also the most critical component of the current account.
When exports are fewer than imports, the trade balance is negative and it indicates a trade deficit. On the other hand, when exports surpass imports, the trade balance is positive indicating a trade surplus.
Read on as we discuss trade surplus in detail.
What is a Trade Surplus?
A trade surplus refers to the net inflow of domestic currency from international markets due to exports. It is a financial index that indicates a favourable trade balance in which the country’s exports are more significant than its imports.
In simple terms, a trade surplus means a situation in which a country sells or exports more to other countries than it purchases or imports from them. It also signifies a country’s economic potential.
Importance of Trade Surplus
In a trade surplus country, revenue from exports surpasses the cost of importing items from other countries. As a result, the country’s manufacturing improves, the volume of goods sold to another country increases, and the employment rate rises as more people are employed in various businesses depending on their areas of expertise to meet the demands.
The growth in exports also has a direct impact on the currency exchange rates, and it could make it superior to other countries going through a trade deficit. However, this is determined by a country’s percentage of goods and services compared to other countries, as well as other market considerations.
Also Read: What Is Trade Credit And How Does Trade Credit Work?
How to Calculate the Trade Surplus?
The formula for computing a trade surplus is straightforward:
Total Value of Exports – Total Value of Imports = Trade Balance
A trade surplus occurs when the trade balance is positive in the above calculation. It is the inverse of a trade deficit, representing a net outflow, and happens when the above computation yields a negative result.
Example of Trade Surplus
Consider the following example of a trade surplus:
When a country exports more goods than it imports, it has a trade surplus. For example, if a country exports $1 trillion in products while importing only $200 billion in goods, it would have a trade surplus of $800 billion.
What are the Factors Affecting Trade Surplus?
A trade surplus is affected by several factors. A few of them are as follows:
1. Economic Expansion
The economy is more prosperous during periods of expansion. Prospects for income and employment improve with favourable demand for goods and services, allowing businesses to increase production and hire additional employees.
More robust global growth, particularly in trading partner countries, is expected to indicate a trade surplus depending on the steadiness of imports. Strong economic growth in partner countries raises demand for domestic goods and boosts exports.
2. The Exchange Rate
Foreign buyers are more responsive to price fluctuations. Depreciation enhances exports significantly if demand is elastic. Other countries benefit from currency depreciation by purchasing cheaper domestic goods. Exports rise as items become more competitive in the global market. Currency depreciation also raises the cost of imports, affecting the demand for imported goods. As a result, currency depreciation should result in a trade surplus.
On the other hand, when the domestic currency appreciates, the impact is the opposite of the abovementioned situation. Domestic goods become more expensive, reducing exports. As a result, foreign goods are less expensive for domestic purchasers, encouraging imports. As the exchange rate rises, the trade balance tends to fall into deficit.
3. Product Competitiveness
Domestic product competitiveness in foreign markets is determined by quality and pricing. Improved product quality helps boost demand and allows it to charge a higher amount. Even though the quantity is comparatively less than other products, the export value of such products stays high due to their high price.
The second factor influencing product competitiveness is price. Manufacturing costs and currency rates determine domestic product prices in global markets. Product costs are lower if the demand is elastic, and currency depreciation promotes exports.
The Economic Impact of a Trade Surplus
The real gross domestic product (GDP) of a country is affected by the trade surplus:
1. Impact on Real GDP
Real GDP is the most crucial indicator for measuring economic growth. The economy grows as real GDP rises. On the other hand, a natural GDP decline leads to the economy’s contraction. The monetary value of the domestic product produced by the economy is measured with the help of real GDP.
The country consumes part of the domestic products and exports the remaining products. If exports increase, it encourages domestic production and, in turn, real GDP rises. Imports lower real GDP and are a source of economic leakage.
Real GDP rises when the trade balance is in excess because exports outweigh imports, leading to increased economic growth. Higher demand for domestic goods encourages manufacturing, additional jobs, and revenue.
Pros and Cons of a Trade Surplus
1. Advantages of a trade surplus:
- A trade surplus suggests a favourable trade balance, which signals economic growth.
- It implies that the inflow of local currency and resources exceeds the outflow, indicating a strong economy.
- A trade surplus, as opposed to a trade deficit, is always desirable.
- More work opportunities are created in a trade surplus economy, increasing the employment rate.
- It contributes to a country’s economic progress.
- It improves an economy’s creditworthiness because the country has the resources to pay down its debt.
- Increased exports encourage manufacturing and economic growth. As a result, tax revenue increases.
- Foreign exchange reserves are increased because of the trade surplus. It strengthens the central bank’s credibility in intervening in the currency market and fighting speculative attacks.
2. Disadvantages of a trade surplus:
- Future growth may suffer as a result of the existing trade surplus. A trade surplus shows that the country is investing more money abroad.
- A trade surplus may result when imports are lower and exports are more robust. Low import demand suggests that domestic consumption is weak.
- When a country relies on exports, it becomes more sensitive to external demand shocks. For example, a global recession makes it harder for countries with trade surpluses to grow exports. And as domestic consumption is so low, it cannot make up for export shocks. This can have an impact on economic growth.
Relation between Savings Rates and Trade Surplus/Deficit
A country’s savings rate is the total amount of money a country’s corporations and government save. When national revenue is unspent, it is conserved, and the savings might be put to effective use in the economy. It is the amount of money left after a country’s net income has been spent on domestic consumption.
A high national savings rate encourages more investment in a country’s capital stock, which can boost productivity and economic growth. A low savings rate suggests consumers are spending more, increasing a country’s trade deficit.
Things to Know About Trade Surplus
A trade surplus means a favourable trade balance, which suggests economic growth. It is the gap between the money generated by exports and the expenditure incurred by imports. It implies that the inflow of local currency and resources exceeds the outflow, indicating a strong economy. A trade surplus can provide jobs and economic growth, and a country’s trade balance can impact the value of its currency in global markets.
This economic growth indicator can be harmful if governments begin interfering with trade through protectionism, an attempt to safeguard domestic industries. As a result, countries levy import duties and provide subsidies, making exports more difficult.
Tariffs also boost the cost of goods in such economies and negatively influence international relations. It can also raise prices and interest rates in an economy. When a large number of new jobs is introduced in the economy, inflation rates begin to grow rapidly. Because it is more expensive to do business, the benefits eventually balance out.
Also Read: Trade Finance: Accelerating International Trade Via a Risk-Free Mechanism
Final Word
Trade surpluses and trade deficits are essential in global marketplaces. This is especially true in emerging markets and countries with economies heavily reliant on exports. A trade surplus, also known as a positive trade balance, is calculated as the difference between the export and import numbers.
It is, however, important to note that trade surpluses and trade deficits are less critical in wealthy countries when imports and exports account for a modest proportion of GDP.
FAQs
Ans. When focused simply on trade effects, a trade surplus indicates that a country’s goods are in high demand in the global market, which raises the price of those items and leads to a direct strengthening of the home currency.
Ans. A country is said to have a favourable balance of trade or a trade surplus if its exports exceed its imports. If imports outweigh exports, there is an unfavourable trade balance or a trade deficit.
Ans. The trade surplus is beneficial since it promotes economic growth. The excess raises real GDP, stimulates production, and generates more employment and income for the domestic economy.
Ans. A country’s trade deficit or surplus is calculated by subtracting its imports from its exports. A positive outcome indicates a surplus, and an unfavourable outcome indicates a deficiency. The trade balance is expressed in the local currency of the country for which it is calculated.
Ans. Trade helps a country’s economy by increasing competition and lowering market prices.
Disclaimer
This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.
