Net trade
Definition
Net trade (X − M): the value of exports (X) minus the value of imports (M).
Trade surplus: exports exceed imports, so net trade adds to AD.
Trade deficit: imports exceed exports, so net trade subtracts from AD.
- Exports are an injection into AD and imports a leakage from it, which is why a surplus raises AD and a deficit lowers it.
- The UK usually runs a trade deficit, so net trade tends to reduce UK AD rather than raise it.
Income and the world
Definition
Real income: income adjusted for inflation, measuring true purchasing power.
State of the world economy: the strength of demand in the UK's trading partners.
- Higher UK real income worsens net trade because households spend more on imports as their purchasing power rises.
- Higher real income abroad improves net trade because foreign buyers demand more UK exports.
- A stronger world economy raises global demand and so demand for UK exports, improving net trade, while a global downturn does the reverse.
Example
- When major economies such as the US and EU grow strongly, UK exporters typically see rising orders; in a global downturn those orders fall, worsening net trade.
Competitiveness factors
Definition
Appreciation: a rise in the external value of the pound against other currencies.
Protectionism: barriers to trade such as tariffs and quotas.
Non-price factors: aspects of competitiveness other than price, such as quality, design, reliability and branding.
- A stronger pound makes UK exports dearer abroad and imports cheaper at home, so net trade tends to worsen, while a weaker pound has the opposite effect, as the fall in the pound after the 2016 referendum made Scotch whisky and UK-built cars cheaper abroad and lifted export orders.
- Greater protectionism abroad, such as tariffs and quotas, reduces UK exports and worsens net trade.
- Non-price factors affect how competitive UK goods are regardless of price, so strong quality, design and branding can support exports even when the pound is strong.
Does a weaker pound always improve net trade?
- It holds because a depreciation makes exports cheaper abroad and imports dearer at home, so over time export volumes rise and import volumes fall, improving net trade.
- But it depends on elasticities: if demand for exports and imports is price-inelastic in the short run, the higher import bill can worsen net trade first (the J-curve effect) and improvement follows only once volumes adjust.
- On balance the effect depends on the price elasticity of demand for exports and imports and on non-price competitiveness: a weaker pound helps most when demand is elastic and UK goods are close substitutes for foreign ones.
Exam technique
- Always state whether an influence raises exports or imports before concluding its effect on net trade.
- Consider both price and non-price competitiveness when judging UK trade performance.
Common Mistake
- Remember that higher domestic income worsens net trade by pulling in more imports.
- A stronger pound worsens net trade, so do not assume a strong currency is always good for exporters.
Self review
- How is net trade calculated?
- Why does higher UK real income tend to worsen net trade?
- How does an appreciation of the pound affect net trade?
- Give two non-price factors that affect trade competitiveness.
