10.1Measuring Trade Balances

10.1 Measuring Trade Balances

LEARNING OBJECTIVES By the end of this section, you will be able to:

• Explain merchandise trade balance, current account balance, and unilateral transfers
• Identify components of the U.S. current account balance
• Calculate the merchandise trade balance and current account balance using import and export data for a country

A few decades ago, it was common to track the solid or physical items that planes, trains, and trucks transported between countries as a way of measuring the balance of trade. Economists call this measurement the merchandise trade balance. In most high-income economies, including the United States, goods comprise less than half of a country’s total production, while services comprise more than half. The last two decades have seen a surge in international trade in services, powered by technological advances in telecommunications and computers that have made it possible to export or import customer services, finance, law, advertising, management consulting, software, construction engineering, and product design. Most global trade still takes the form of goods rather than services, and the government announces and the media prominently report the merchandise trade balance. Old habits are hard to break. Economists, however, typically rely on broader measures such as the balance of trade or the current account balance which includes other international flows of income and foreign aid.

Components of the U.S. Current Account Balance

Table 10.1 breaks down the four main components of the U.S. current account balance for the last quarter of 2015 (seasonally adjusted). The first line shows the merchandise trade balance; that is, exports and imports of goods. Because imports exceed exports, the trade balance in the final column is negative, showing a merchandise trade deficit. We can explain how the government collects this trade information in the following Clear It Up feature. Value of Exports (money flowing into Value of Imports (money flowing out of the United States) Balance the United States) Goods $1,428.8 $2,350.8 –$922.0 Services $705.6 $460.3 $245.3 Income receipts and payments $957.9 $769.4 $188.5 Unilateral transfers $166.3 $294.2 –$127.9 Current account balance $3,258.6 $3,874.7 –$616.1 TABLE 10.1Components of the U.S. Current Account Balance for 2020 (in billions of dollars). Source: https://apps.bea.gov/itable/index.cfm, ITA Table 1.1. CLEAR IT UP How does the U.S. government collect trade statistics? Do not confuse the balance of trade (which tracks imports and exports), with the current account balance, which includes not just exports and imports, but also income from investment and transfers. The Bureau of Economic Analysis (BEA) within the U.S. Department of Commerce compiles statistics on the balance of trade using a variety of different sources. Merchandise importers and exporters must file monthly documents with the Census Bureau, which provides the basic data for tracking trade. To measure international trade in services—which can happen over a telephone line or computer network without shipping any physical goods—the BEA carries out a set of surveys. Another set of BEA surveys tracks investment flows, and there are even specific surveys to collect travel information from U.S. residents visiting Canada and Mexico. For measuring unilateral transfers, the BEA has access to official U.S. government spending on aid, and then also carries out a survey of charitable organizations that make foreign donations. The BEA then cross-checks this information on international flows of goods and capital against other available data. For example, the Census Bureau also collects data from the shipping industry, which it can use to check the data on trade in goods. All companies involved in international flows of capital—including banks and companies making financial investments like stocks—must file reports, which the U.S. Department of the Treasury ultimately checks. The BEA also can cross check information on foreign trade by looking at data collected by other countries on their foreign trade with the United States, and also at the data collected by various international organizations. Take these data sources, stir carefully, and you have the U.S. balance of trade statistics. Much of the statistics that we cite in this chapter come from these sources. The second row of Table 10.1 provides data on trade in services. Here, the U.S. economy is running a surplus. Although the level of trade in services is still relatively small compared to trade in goods, the importance of services has expanded substantially over the last few decades. For example, U.S. exports of services were equal to about one-half of U.S. exports of goods in 2020, compared to one-fifth in 1980. The third component of the current account balance, labeled “income payments,” refers to money that U.S. financial investors received on their foreign investments (money flowing into the United States) and payments to foreign investors who had invested their funds here (money flowing out of the United States). The reason for including this money on foreign investment in the overall measure of trade, along with goods and services, is that, from an economic perspective, income is just as much an economic transaction as car, wheat, or oil shipments: it is just trade that is happening in the financial capital market. The final category of the current account balance is unilateral transfers, which are payments that government, private charities, or individuals make in which they send money abroad without receiving any direct good or service. Economic or military assistance from the U.S. government to other countries fits into this category, as does spending abroad by charities to address poverty or social inequalities. When an individual in the United States sends money overseas, as is the case with some immigrants, it is also counted in this category. The current account balance treats these unilateral payments like imports, because they also involve a stream of payments leaving the country. For the U.S. economy, unilateral transfers are almost always negative. This pattern, however, does not always hold. In 1991, for example, when the United States led an international coalition against Saddam Hussein’s Iraq in the Gulf War, many other nations agreed that they would make payments to the United States to offset the U.S. war expenses. These payments were large enough that, in 1991, the overall U.S. balance on unilateral transfers was a positive $10 billion. The following Work It Out feature steps you through the process of using the values for goods, services, and income payments to calculate the merchandise balance and the current account balance. WORK IT OUT Calculating the Merchandise Balance and the Current Account Balance Exports (in $ billions) Imports (in $ billions) Balance Goods Services Income payments Unilateral transfers Current account balance TABLE 10.2 Calculating Merchandise Balance and Current Account Balance Use the information given below to fill in Table 10.2, and then calculate:

• The merchandise balance
• The current account balance

Known information:

• Unilateral transfers: $130
• Exports in goods: $1,046
• Exports in services: $509
• Imports in goods: $1,562
• Imports in services: $371
• Income received by U.S. investors on foreign stocks and bonds: $561
• Income received by foreign investors on U.S. assets: $472

Step 1. Focus on goods and services first. Enter the dollar amount of exports of both goods and services under the Export column. Step 2. Enter imports of goods and services under the Import column. Step 3. Under the Export column and in the row for Income payments, enter the financial flows of money coming back to the United States. U.S. investors are earning this income from abroad. Step 4. Under the Import column and in the row for Income payments, enter the financial flows of money going out of the United States to foreign investors. Foreign investors are earning this money on U.S. assets, like stocks. Step 5. Unilateral transfers are money flowing out of the United States in the form of, for example, military aid, foreign aid, and global charities. Because the money leaves the country, enter it under Imports and in the final column as well, as a negative. Step 6. Calculate the trade balance by subtracting imports from exports in both goods and services. Enter this in the final Balance column. This can be positive or negative. Step 7. Subtract the income payments flowing out of the country (under Imports) from the money coming back to the United States (under Exports) and enter this amount under the Balance column. Step 8. Enter unilateral transfers as a negative amount under the Balance column. Step 9. The merchandise trade balance is the difference between exports of goods and imports of goods—the first number under Balance. Step 10. Now sum up your columns for Exports, Imports, and Balance. The final balance number is the current account balance. The merchandise balance of trade is the difference between exports and imports. In this case, it is equal to $1,046 – $1,562, a trade deficit of –$516 billion. The current account balance is –$419 billion. See the completed Table 10.3. Value of Exports (money flowing Value of Imports (money flowing out of the United States) Balance into the United States) Goods $1,046 $1,562 –$516 Services $509 $371 $138 Income receipts and payments $561 $472 $89 Unilateral transfers $0 $130 –$130 Current account balance $2,116 $2,535 –$419 TABLE 10.3 Completed Merchandise Balance and Current Account Balance

10.2 Trade Balances in Historical and International Context

LEARNING OBJECTIVES By the end of this section, you will be able to:

• Analyze graphs of the current account balance and the merchandise trade balance
• Identify patterns in U.S. trade surpluses and deficits
• Compare the U.S. trade surpluses and deficits to other countries' trade surpluses and deficits

We present the history of the U.S. current account balance in recent decades in several different ways. Figure 10.2 (a) shows the current account balance and the merchandise trade balance—the latter of which is simply the balance on goods exported versus imported—in dollar terms. Figure 10.2 (b) shows the current account balance and merchandise account balance yet again, this time as a share of the GDP for that year. By dividing the trade deficit in each year by GDP in that year, Figure 10.2 (b) factors out both inflation and growth in the real economy.