Explain why a government should avoid a large and persistent balance of trade surplus and deficit.
(a) Explain why a government should avoid a large and persistent balance of trade surplus and deficit. [10]
Introduction
Balance of trade refers to the difference between a country's export revenues and import expenditures. A trade surplus occurs when export revenues exceed import expenditures, while a trade deficit arises when import expenditures exceed export revenues. While having either a surplus or a deficit in the short term is not inherently problematic, a large and persistent balance of trade surplus or deficit can have significant implications for an economy.
Why governments should avoid large and persistent trade deficits
A persistent trade deficit can be symptomatic of underlying structural weaknesses in an economy. If a country consistently imports more than it exports, it may indicate that its exports are not competitive in global markets. This could be due to factors such as high production costs, high labour costs, or low levels of innovation. For example, if domestic industries are unable to compete with foreign producers due to inefficient production methods, the economy might rely too heavily on imports to meet consumer and business needs. Over time, this reflects greater issues such as declining industrial competitiveness, which could lead to further economic difficulties.
Furthermore, a large and persistent trade deficit can lead to the depletion of a country's foreign exchange reserves. In a trade deficit, a country must pay for its imports with foreign currency. If it runs a deficit for an extended period, it may eventually run down its foreign exchange reserves, which are crucial for stabilising the exchange rate and supporting international trade. Once these reserves are depleted, the country may need to borrow from foreign lenders, thereby incurring foreign debt.
Additionally, a large and persistent trade deficit may lead to the depreciation of the currency. When a country imports more than it exports, the demand for foreign currencies increases, while the demand for its domestic currency decreases, leading to a fall in the value of the domestic currency relative to others. While depreciation can, in theory, make exports cheaper and more competitive, the short-term effects can be damaging. A weaker currency increases the cost of imports, particularly essential goods such as fuel and raw materials, leading to imported inflation. Higher inflation further erodes purchasing power, affecting consumers and increasing production costs for businesses reliant on imported inputs, thereby deepening the economic challenges posed by the trade deficit.
Why governments should avoid large and persistent trade surpluses
While trade surpluses are generally more favourable than deficits because they allow a country to build foreign exchange reserves, large and persistent surpluses can also present problems. A persistent trade surplus may indicate low levels of import expenditure, which can suggest that domestic consumption is weak. If households and businesses are not spending enough on imported goods, it could be a sign of low domestic demand and low standards of living. For instance, if a country's consumers are spending less on imported luxury goods, advanced technology, or services, it could reflect a low consumption culture, which may keep the standard of living lower than it could be.
Moreover, if a country is running a large trade surplus for an extended period, it may face international trade tensions. Other countries may view the surplus as an indication of unfair trade practices, such as artificially devaluing the currency to make exports cheaper. This can lead to protectionist measures from other countries, such as tariffs or quotas, which could harm the economy in the long run. For example, China has often been accused of running large trade surpluses through such means, leading to trade conflicts with major trading partners like the U.S.
Conclusion
In conclusion, while short-term trade imbalances may not be a cause for concern, large and persistent trade deficits and surpluses can have serious negative consequences for an economy. A government should avoid persistent trade deficits to prevent a loss of competitiveness, depletion of foreign exchange reserves, and the accumulation of foreign debt. Similarly, while trade surpluses can help build foreign reserves and are generally preferred, large and persistent surpluses may indicate low domestic consumption and could lead to international trade conflicts.
🏁 J2 Last Lap — Your Final Push to A Level Economics Success
📘 Model answers are useful. But learning how to write distinction-ready essays — confidently, under pressure — is what gets you the A.
At Economics at Tuitiongenius (ETG) — Singapore’s leading economics tuition centre — we don’t just give students content. We provide structure, feedback, and real strategy. That’s what the JC2 Last Lap Programme is built for: your full-scope, final-phase prep for the A Levels.
🚀 One Programme. Every Tool You Need to Ace A Level Econs.
Led by Mr Eugene Toh, Singapore’s most trusted H2 economics tutor, this programme is designed for students who want to go all in — and finish strong.
✅ What’s Included in the Last Lap Bundle:
61 On-Demand JC2 Lessons — Revise anytime, binge or pace out
Weekly Live Classes — Zoom or onsite at 4 locations
11 Targeted Crashcourses — Drill content, essays, CSQs & evaluation techniques
Hardcopy Materials Delivered — Textbooks, summaries, model essays & diagrams
1-on-1 Consults with Mr Toh — Personalised answers to specific doubts
Weekly Homework + Feedback — Improve every week with targeted review
💬 “I scored an E for MYEs… and an A for the A Levels — because of ETG.”
– Wing Ter Tan, Class of 2023
💡 Best For:
JC2 students preparing for Prelims or A Levels
Students who need a structured game plan to jump grades
Anyone searching for economics tuition Singapore that consistently delivers results
🔗 Register now at tuitiongenius.com/lastlap
📲 Or WhatsApp 8168 3986 and we’ll help you join the next class
The clock is ticking. Let’s make these final months count — and get you the A you’ve worked for.