Small trade deficits are generally not considered to be harmful to either the importing or exporting economy. However, when a national trade imbalance expands beyond prudence (generally thought to be several percent of GDP, for several years), adjustments tend to occur. While unsustainable imbalances may persist for long periods (cf, Singapore and New Zealand’s surpluses and deficits, respectively), the distortions likely to be caused by large flows of wealth out of one economy and into another tend to become intolerable.
In simple terms, trade deficits are paid for out of foreign exchange reserves, and may continue until such reserves are depleted. At such a point, the importer can no longer continue to purchase more than is sold abroad. This is likely to have exchange rate implications: a sharp loss of value in the deficit economy’s exchange rate with the surplus economy’s currency will change the relative price of tradable goods, and facilitate a return to balance or (more likely) an over-shooting into surplus the other direction.
More complexly, an economy may be unable to export enough goods to pay for its imports, but is able to find funds elsewhere. Service exports, for example, are more than sufficient to pay for Hong Kong’s domestic goods export shortfall. In poorer countries, foreign aid may fill the gap while in rapidly developing economies a capital account surplus often off-sets a current-account deficit. Finally, there are some economies where transfers from nationals working abroad contribute significantly to paying for imports. The Philippines, Bangladesh and Mexico are examples of transfer-rich economies.
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