2.2.5: Net trade (X-M)

Net trade

• This is the value of the current account on the balance of payments

• A positive value indicates a surplus, whilst a negative value indicates a deficit

• The UK has a relatively large trade deficit, which reduces the value of AD

Influences on net trade balance: Real income

• During periods of economic growth, consumers have higher incomes and therefore can afford to consumer more due to their high PP

• As a result, they are more likely to Import due to their increased PP due to exchange rates (affects their marginal propensity to import)- this causes a larger deficit on the current account

• However, during periods of economic decline, real incomes fall and this historically leads to improvements in the UK’s current account due to fewer imports

• Incomes have little impact on exports

Influences on the net trade balance: Exchange rates

• A depreciation of the pound means imports are more expensive and exports are cheaper- the current account trade deficit narrows as people are less likely to buy imports and more likely to buy exports

• Depreciations make the currency relatively more competitive against other currencies

• However, it depends on which currency it depreciates against- e.g: a depreciation against the dollar or euro is likely toy to have a more significant effect than a currency which is not one of the UK’s major trading partners

• Moreover, the demand for Uk exports has to be price elastic to lead to an increase in exports

• If demand is price inelastic, exports will not increase significantly, and the value of exports will decrease

Influences on the net trade balance: State of the world economy

• A decline in economic growth in one of the UK’s export markets means there will be a fall in exports and therefore AD

• This is due to the fact that consumer spending in those economies will fall, due to falling real incomes

• E.g: If the EU (the UK’s largest export market) face an economic downturn, demand for UK goods and services will fall, since consumers in the EU are less able to afford imports

Influences on the net trade balance: Degree of protectionism

• Protectionism is the act of guarding a country’s industries from foreign competition

• It can take the form of tariffs, subsidies to domestic firms, quotas, regulation or embargoes (an official ban on trade with a particular country)

• If the UK subsidised domestic firms, it would lower their costs of production and increase competitiveness- this could increase exports and improve net trace- firms may also lower their prices due to being able to, and therefore encourage local consumers to spend more on domestic goods

• If the UK employed several protectionist measures, the trade deficit will reduce due to the fact that imports would decrease due to the quotas and tariffs imposed on imports

• However, since protectionism leads to retaliation, exports might decrease which would undo the effect of reduced imports

Influences on the net trade balance: Non-price factors

• These factors can be quality of goods/services, branding and reputation, innovation and technology, productivity, labour costs, political stability and infrastructure- these can increase exports

• The competitiveness of a country’s goods and services, which is influenced by by supply side policies which impacts how many exports a country has

• Moreover, trade deals and being part of trading blocs can influence how much a country exports- this either opens up a country to, or closes a country from significant export opportunities