Updated Feb 09, 2022

What is Trade Surplus in Countries?

Introduction

Having a positive trade balance is what constitutes a trade surplus. As a measure of a country's capacity to sell more than it consumes, trade surpluses are used. The entire worth of imports is deducted from the absolute value of exports to reach a trade balance. A trade surplus replicates the net incursion of internal capital into the foreign market. When there is a trade surplus, the net outflow of goods and services is greater than the net inflow.

TB = EX – IM

In other words, when exports surpass imports, the trade balance is positive.

Role of GDP

Gross domestic product (GDP) includes trade balances, which reflect the total market cost of all final products and services generated in the country. There are two components that make up GDP: domestic residents' absorption (A) and net exports (TB), which are the sum of domestic residents' absorption and the sum of domestic residents' absorption. Because of this, it is possible to view the trade balance in terms of a country's GDP-to-domestic absorption ratio:

TB = GDP – A

As a result, when a country's gross domestic output surpasses its domestic absorption, it is running a trade surplus.

Role of Exporting Goods

When the world's demand for exports exceeds the country's need for imports, a trade surplus is created economically. Let's look at trade flows from the perspective of a traditional partial equilibrium model. Export demand depends on two factors: positively the economy's price competitiveness, which is roughly reflected in its real exchange rate, and entirely aggregate demand conditions, roughly reflected in its foreign income. Because export items are pretty inexpensive, the claim is expected to rise.

Moreover, as the purchasing power of foreign customers grows, so does the demand for the export products of the home economy. It is also thought that the need for imports from one nation is adversely related to its price competitiveness and favorably related to its income. To put it another way, when a country's currency rate depreciates, inflation falls, or the country's domestic revenue grows more slowly than it is expected to in comparison, the trade balance gets better. Trade excesses may be generated, of course, if these changes are severe enough to impact export and import demand and the initial circumstances are favorable.

The MF Model

The Mundell-Fleming (MF) model is the workhorse model in textbooks for analyzing the consequences of such shocks. Prices are assumed to be stable over short periods. Therefore, the short-term output is dictated by demand. Aggregate demand affects total income, the real exchange rate, and the trade balance by affecting demand for export and import products. To what extent macroeconomic shocks influence the trade balance in a given MF model depends on the present exchange rate regime; there is no universal solution.

New Open Economies

Short-term price stickiness is also assumed in recent "New Open Economy Macroeconomics" (NOEM) models for studying macroeconomic shocks on exchange rates, trade balances, and other macroeconomic variables. Using a micro-founded intertemporal optimizing model framework, the NOEM models are constructed. Consumption smoothing creates trade balance surpluses (deficits) in this scenario. One of the essential functions of the trade balance is to protect a country's consumption from variations in short-term revenue.

A nation can generate a trade surplus by producing more than it takes and then selling the excess to the rest of the world. This condition is known as being a net exporter. By borrowing from the rest of the world, the nation increases its global net worth by acquiring foreign assets or reimbursing existing loans obtained from the rest of the world in previous periods. This is how the transaction is financed.

Conclusion

A country's international solvency may be gauged by its trade balance. As seen in the preceding equation, a country's current account balance is the sum of its trade surplus and its net foreign income receipts. According to this theory, countries with persistent current account deficits have a negative net foreign asset position and are thus net debtors to the rest of the global economy. As a result, to pay back its foreign debt, the government will have to continue maintaining trade balance surpluses. To put it another way, a country's international solvency and creditworthiness are based on its ability to meet its debt obligations in the future through generating trade balance surpluses.