Balance of Trade (bot)

Cheah Sin Yee, 15WBR08857 [1472 words]

Balance of trade (BOT) is defined as the difference between a country’s export and its import in value of goods and services. When the value of imports is greater than the value of exports, it has an unfavorable balance of trade, called a trade deficit. It represents an excess of domestic investment over savings. The trade deficit shows that the domestic economy has a net outflow of payments to the foreign country. Therefore, fewer payments are coming in than going out lead to less income and low living standards in the domestic country. There are several measures available to correct the balance of trade deficit in Malaysia which is to increase its exports and decrease its imports.

First and foremost, an explicit measure available that can be used to correct a trade deficit is currency devaluation. It is to devalue the domestic currency against the foreign currency. It depends on the Marshall Learner condition and the J-Curve effect. The devaluation makes domestic exports become cheaper and the quantity demanded of exports will increase. It causes the domestic products become more competitive and attractive to foreign investors in international markets. It discourages imports by making the foreign products become more expensive in domestic so the quantity demanded of imports will decrease. A devaluation could cause higher economic growth so it will increase the aggregate demand. Therefore, devaluation can reduce trade deficit in domestic as it has higher exports and lower imports.

Besides that, the exchange depreciation is an explicit measure available that can be used to correct a trade deficit. It is a decline in the exchange rate of domestic currency in term of foreign currency. When there is an exchange depreciation, the domestic exports will become cheaper and import products will become more expensive. It leads to the domestic exports be more competitive in global market. Therefore, there will be an increase in exports and decrease in imports. The increase in net export will help to increase aggregate demand and lead to higher economic growth. The domestic industries will benefit from increased sales. This may lead to job creation and lower unemployment, especially for the exporting industries. As a result, exchange depreciation can reduce deficit in domestic as the exports are more than its imports.

Additionally, the explicit measure available that can be used by the governments to correct a trade deficit is deflationary fiscal policy. It is a government policy that involves higher taxes and lower government spending in a country. When the government increases the taxes, the disposable income of residents will reduced. This causes the residents have a decline in spending and less spending on imports. Also, it helps to reduce inflation so the price of domestic products will decrease. The residents will choose domestic products because they are cheaper than the imported products. Thus, it can improve the competitiveness of exports as it would make the domestic products cheaper in foreign market. So, there is a rise in export’s aggregate demand.  Therefore, deflationary fiscal policy can reduce trade deficit in domestic as the increase in its exports and decrease in its imports.