Why do economies have such a huge trade deficit?

In economic studies a point of contention has been whether or not a trade deficit, also known as a current account deficit, is beneficial or harmful to a country's economy. More often than not the observed data and the underlying economic theory don't line up.

A trade deficit occurs when a country’s outlays for imports is bigger than what it receives from its exports. Because of its economic size the United States owns the largest trade deficit worldwide, with a trade imbalance of over $7.3 trillion accumulated over the past few decades. However other countries also have trade deficits among them: Spain, the United Kingdom, Australia, Mexico, Turkey, and Brazil, are all experiencing trade deficits. In the meantime, other countries have trade surpluses among them are: China, Russia and Japan with large current account surpluses.

Economic theory not consistent with data collected

Employment theory: If a country persistently experiences a trade deficit there are predictable negative consequences that can affect economic growth and stability. If demand for imports is higher than exports, domestic jobs may be lost to foreign manufacturers.

Data collection: It suggests that unemployment levels can actually persist at very low levels even with a trade deficit, and high unemployment may occur in countries with surpluses.

Currency Value: Demand for a country's exports impacts the value of its currency. Manufacturers of American goods that sell abroad must convert foreign currencies back into dollars in order to pay their workers and suppliers, bidding up the price of the dollar. In theory, as demand for lower cost imports increases the value of a currency should decline as in a market of floating exchange rates, where trade deficits should correct automatically. Nonetheless, data shows that a trade deficit is just an indication that a nation's currency is desired in the world’s currency exchange market, specially, when said currency qualifies a reserve currency as the dollar happens to be.

As a result, demand for U.S. dollars has remained quite strong despite persistent deficits. Surplus countries like China who do not utilize a floating currency regime, but rather keep a fixed pegged exchange rate versus the dollar and thus, benefiting its trade by keeping their currency artificially high.

In economics the balance of payments must always net out to zero. As a result, a trade deficit must be offset by a surplus in the country's capital account and financial account. This means that a trade deficient nation can experience a greater degree of foreign direct investment and foreign ownership of government debt like the ongoing ownership of US debt by China. However, fiscal and monetary policy tells us that the GDP to debt ratio must not be greater than one because debt holders will demand higher interest rates as result of the higher risk. For a small country this could be detrimental, if a large proportion of the country's assets and resources is owned by foreigners who can then control and influence how those assets and resources are used.

In conclusion

The United States, as the world's largest deficit nation, has consistently proven that trade deficits theories are not consistent with the data collected. This results in a special status for the United States as the world's largest economy and the dollar as the world’s largest reserve currency. Notwithstanding, growing budget deficits such as the large tax cut the Trump administration just passed into law indicates that fiscal and monetary policy are by far a more risky and concerning issue to the US economy for law makers if the current budget deficit trend is not corrected.

On the other hand, smaller countries have experienced the negative effects that trade deficits can bring over the short run. Nonetheless, the consensus among proponents of free markets, is however, that any negative effects of trade deficit will correct itself over time through exchange rate adjustments and through competitive advantage leading to an adjustment in what a country produces more effectively. A large trade deficits is simply a reflection of consumer preferences and may not really matter much at all in the long run.