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How international trade works-balance of trade-equality of

exports and imports


www.sanjayjohn.com /2016/08/on-balance-of-trade-its-surplus-and.html

Balance of trade is an often talked about subject by countries. The United States whines about a negative balance
of trade with China, China whines about a negative balance of trade with South Korea, etc. etc. This was covered
by Adam Smith in his Wealth of Nations [1]-but needs a new look in the present context.

Rule: Value of Annual Exports=Value of Annual Imports (E=I). The net balance of trade of a country with the
rest of the world, i.e. all other countries taken together, is always zero.

Money and currencies (dollars, euros, yuans, etc.) are just a way to facilitate the exchange of goods (and services)
between countries. The existence of currencies simplifies barter; but in the end, all trade is ultimately barter. What
Chile imports annually from the world, is necessarily equal in value to what it exports annually (the major exports of
Chile are copper, wines, fruits, and salmon. The major imports are construction materials, cars, electronic goods,
machinery). Everything which Chile sends out in the form of exports, comes back in the form of imports. The reason
to consider this over a year (annual) is because there may be a delay in the accounting of exports and imports and
there may be a month to month variation where a surplus or deficit might run in a month because of not receiving
the money in the same month, but over a longer period of time, say of one year (assuming payments in 30 to 90
days), the net exports should be equal to net imports. Chile is not sending its good anywhere for free; and neither is
any country giving away their stuff to it for free (ignoring the small amounts of goods countries send out as
charity/aid). The equality of exports and imports is a necessary condition for trade.

In practice, Chile first exports its goods to the outside world (more precisely, it is the companies in the Chilean
exports sector who do this), gets US dollars (or yuans or euros) for it, and uses those dollars to buy goods to be
imported to Chile (the companies who import goods into Chile do this part). Currencies serve as intermediaries to
facilitate this underlying exchange.

The only reason to export goods (or services) outside your country is to buy objects or services produced by other
countries, i.e. to import stuff (minor exceptions to this are covered later below).

It follows that if you export more, you import more. Similarly, if you export less, you have to import less.

Some allowance must be made for credit and foreign currency accumulation-for Chile might export stuff and instead
of exchanging them for other goods right away, maybe hold US dollar reserves, to buy something later in the US or
in other countries. This is a small correction to the rule E=I, because dollar or foreign currency reserves are a small

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part of the net value of goods exported or imported-they are like the liquid cash any businessman holds to facilitate
transactions.

Note that this is for a country with all the rest of the world taken together. However, Chile may run surpluses or
deficits with any one country for a long period of time or forever, without this rule being violated. That's because
countries are trading with each other, and surpluses with country A cancel out a deficit with country B.

Let us imagine a world with only three countries-Chile, USA and China. The numbers are just for example purposes,
and are not real.

Chile exports 10 million dollars worth of wine to USA.


Chile exports 5 million dollars worth of Salmon to China.
Chile receives 15 million dollars worth of machinery and automobiles from China.

Therefore, against USA, Chile is always running a surplus in trade balance, because it is only exporting, but
importing nothing from it.

But the surplus against USA must be exactly equal to the deficit against China, as you can see, to make sure that
the net exports are the same in value as net imports for Chile.

There must be some form of trade between USA and China, where USA must be exporting something to China and
running a surplus with China for exactly 10 million dollars.

An example might be

USA exports 500 million dollars of airplanes to China


USA imports 490 million dollars worth of computers from China

Taken all the data together, as shown in the figure above, makes every country's exports exactly equal to its imports.

Even if Chile is forever running a surplus against USA and a deficit against China, it all needs to add-up perfectly for
it, where all exports come back as imports, directly or indirectly.

Note that in this example, USA always runs a surplus against China.

This example can be extended to 4, 5 and hundreds of countries, with similar results.

Hopefully you can see with this explanation that there's no fuss to be made about a country running a deficit with a
particular country. It is just the nature of trade. For every surplus, there must be a deficit with a different country
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somewhere.

You can extend this concept to smaller divisions within a country (to States), to counties and ultimately to even to
the individual level.

Therefore, Texas has a net trade balance of zero with the rest of the USA+other countries. What goes out of Texas,
must come back into it, either from other States in the US or from other countries directly to Texas.

For an individual-what you produce, you must eventually exchange for what others produce. You eventually
exchange what you produce with the what others produce.

My trade balance with Walmart is always negative-I only buy stuff from Walmart, but don't sell anything to it. Does
that make me worse off? Not at all. If I was to profess equality of trade surplus and deficit with Walmart and each
company separately, I would have to sell something to Apple, Walmart, Home Depot, and thousands of other
companies I buy stuff from, individually making sure that I don't buy anything from these companies if I don't sell
anything to them. What I do normally is sell my labor to some company, get dollars for it, and with these dollars, buy
a load of stuff from Walmart, Apple, Home Depot, etc.

A couple of corrections need to be done to the rule for countries 1) when a country is loaned a large amount of
money by foreign countries e.g Greece or Puerto Rico, whose governments were loaned large sums of money by
foreign entities and 2) when a country has a good fraction of earnings coming from tourism e.g. Costa Rica. For
these countries the annual exports will not be equal to the annual imports (exports will be smaller than imports),
because a loan from a foreign entity or a tourist bringing in money are effectively an assignment to bring in
additional imports. When an American tourist goes to Costa Rica and spends a few thousand dollars there, those
dollars are in reality used by Costa Rica to buy imported goods. Same with loans to Greece by the German banks-
the loans are in Euros, and Greeks will buy stuff using their Euros for their country, without having to export any
goods. When the rule is skewed by foreign loans, as in the case of Greece and Puerto Rico, it is temporary, until the
loan is paid off or the country defaults, as has happened with Greece and Puerto Rico. When it is by tourism, as for
Costa Rica, Bahamas, Thailand, etc. the deviation from the rule, or the imbalance of exports and imports, is stable
and can continue on forever.

Let's examine the case of a tourist country like Costa Rica in detail. The net imports of Costa Rica will be
considerably more than the exports for Costa Rica.
The tourists who come to Costa Rica will sort of bring in their own consumption rights to the country-in the form of
foreign currency bills, normally US dollars. It as as if these tourists saved up loads of things to be consumed in their
home countries, but instead of consuming them there, they came to consume them in Costa Rica. This increases
the importation of goods for Costa Rica, because these foreign tourists in Costa Rica have the right to bring goods
from foreign countries, which they normally express by carrying US dollar bills.

If you have to troops to foreign lands-major countries like Russia, USA and France have a large number of troops
outside their borders, they are indirectly fed and supplied by exports from the home country. What the French troops
consume in Algeria needs to be exported out of France in some way.

Physics fans will realize that the Rule E=I is like the conservation of energy principle-energy can never be created or
destroyed (except the corrections due to Einstein).

But the US always runs a deficit, and China always a surplus with all countries!

If you see recent data it seems that the US is running a constant trade deficit with the rest of the world for many
years. On the other hand, China seems to be running a constant trade surplus with the rest of the world. This is a
problem with incomplete or bad data- not everything which goes out of or comes into a country shows in the exports
and imports numbers at customs. For example, Chinese have bought a lot of real estate in Canada, and that

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purchase must have been financed by something exported out of China (the goods exported from China have been
exchanged with a house in Vancouver, BC, Canada). Chinese tourists are the biggest tourist group to Thailand-and
are known to purchase massive quantities of goods in that country. That purchasing power also comes from what
China has exported from its shores in some way. As explained above, these activities of Chinese citizens will not
show in the customs declarations or the standard export and import numbers.

Trying to encourage domestic industries by restricting imports has the opposite effect, it actually
discourages domestic industry overall

If you agree that this basic equality of exports and imports holds, it is easy to show that if you restrict imports in
industry A to improve domestic industry in A, you must at some other place restrict the domestic industry B, which
was producing B domestically, which was being exchanged for the imported product in industry A.

Before the restriction, imported industry A products must have been exchanged for something which went out of the
country, products of industry B, for the trade equality to hold at that time. The moment you restrict imported industry
A products, ostensibly to increase the production of industry A in the country, because you have restricted the total
amount of A now coming into the country from foreign sources, you must be exporting less of some domestic
products of industry B.

A reduction in importation, by encouraging a domestic producer, automatically results in a reduction in exportation,


and the industries which were exporting will be hurt domestically.

A government must never restrict importation of industry A, and let the market take care of itself, because the skilled
part of the country is the industry B, who by their great products and skillful exports were getting the imported
products of industry A into the country. The country has built a comparative advantage in B, that's why it is able to
sell those products outside the country, and you don't want to handicap your strongest player to support your weaker
players, which is what happens when you restrict imports in a particular industry.

This article is very closely related to the article here about anti-dumping duties, restriction on imports because of bad
trade balance numbers with a country, supporting domestic producers, etc.

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