Balance of trade: Economic impact

Since the falling from favour of mercantilism, most economists do not believe that trade deficits are inherently good or bad, but must be judged based on the circumstances in which they arose. Large imbalances may sometimes be a sign of underlying economic problems or rigidities. An example includes a situation where exchange rates have been fixed or pegged for political reasons at levels impeding a correction of a trade imbalance.

In order to maintain a negative balance of trade, it must be financed either by income or transfers, or by running down the country's net international assets. This may be done for example by selling assets, through foreign direct investment or by international borrowing. An increase in net foreign liabilities tends to lead to an increase in the net outflow of income on international investments. Such payments to foreigners have intergenerational effects: by shifting consumption over time, some generations may gain at the expense of others.

However, a trade deficit may lead to higher consumption in the future if, for example, it is used to finance profitable domestic investment, which generates returns in excess of that paid on the net foreign liabilities (a situation that might arise if a country experiences an unexpected gain in productivity). Similarly, a surplus on the current account implies an increase in the net international investment position and the shifting of consumption to future rather than current generations.

However, trade imbalances are not always indicative of the smooth operation of the market given differences in international productivity and intertemporal consumption preferences. Trade deficits have often been associated with a loss of international competitiveness, or unsustainable 'booms' in domestic demand. Similarly, trade surpluses have been associated with policies that inefficiently bias a country's economic activity towards external demand, resulting in lower living standards. An example of an economy in which a positive balance of payments was regarded as a bad thing by some was Japan in the 1990s.

The positive balance was partly the result of protectionist measures that also caused the price of goods in Japan to be much higher than they would have been, had imports been freely allowed. The foreign currency Japanese companies earned overseas remained largely unconverted into yen in order to suppress the yen's value, further preventing Japanese consumers from benefiting from the trade surplus. In addition, the potential benefit from the trade surpluses were partly squandered by spending it on prestige real estate purchases in the United States that often proved unprofitable.