2.2.5: Influences on Net Trade (X-M)

This Edexcel economics study note covers influences on the net trade balance.

Key Influences on the (Net) Trade Balance

Real Income

• Definition: Real income refers to the income of individuals or nations adjusted for inflation.
• Impact:
  • Domestic Income Increases: Higher real incomes typically lead to increased consumption, including imported goods, potentially worsening the trade balance. Example: In the U.S., rising real incomes often correlate with increased imports from China and other countries.
  • Foreign Income Increases: Higher real incomes abroad can boost demand for exports from other countries, improving the trade balance. Example: Economic growth in China has increased its imports from countries like Germany and Australia.

Exchange Rates

• Definition: Exchange rates are the value of one currency for the purpose of conversion to another.
• Impact:
  • Depreciation: A weaker domestic currency makes exports cheaper and imports more expensive, potentially improving the trade balance. Example: The depreciation of the British pound post-Brexit referendum initially boosted UK exports.
  • Appreciation: A stronger domestic currency makes exports more expensive and imports cheaper, potentially worsening the trade balance. Example: The appreciation of the Swiss franc has made Swiss goods more expensive abroad, impacting their trade balance.

State of the World Economy

• Definition: The overall health and trends of the global economy.
• Impact:
  • Global Economic Growth: When the global economy is strong, demand for goods and services increases, benefiting exporting countries. Example: The global economic boom in the early 2000s increased demand for exports from emerging markets.
  • Global Recessions: During economic downturns, global demand drops, negatively affecting export-dependent countries. Example: The 2008 financial crisis reduced global demand for exports from countries like Germany and Japan.

Degree of Protectionism

• Definition: Protectionism refers to government actions and policies that restrict international trade to protect local businesses and jobs.
• Impact:
  • High Protectionism: Tariffs, quotas, and other trade barriers can reduce imports, potentially improving the trade balance but also risking retaliatory measures. Example: The U.S.-China trade war saw increased tariffs leading to reduced trade volumes.
  • Low Protectionism: More open trade policies can increase imports, potentially worsening the trade balance but promoting competition and efficiency. Example: The European Union's single market facilitates free trade among member countries, increasing trade volumes.

Non-Price Factors

• Definition: These include aspects other than price that affect trade, such as quality, innovation, branding, and trade agreements.
• Impact:
  • Quality and Innovation: High-quality, innovative products can maintain strong export performance despite price changes. Example: Germany’s reputation for high-quality engineering supports strong export performance in automotive and machinery sectors.
  • Branding: Strong brand recognition can sustain demand for exports. Example: Global demand for American technology brands like Apple.
  • Trade Agreements: Agreements can reduce barriers and enhance trade flows. Example: The North American Free Trade Agreement (NAFTA) boosted trade between the U.S., Canada, and Mexico.

Glossary

• Net Trade Balance: The difference between the value of a country's exports and imports.
• Real Income: Income adjusted for inflation, reflecting the purchasing power of income.
• Exchange Rates: The value at which one currency can be exchanged for another.
• Protectionism: Government policies that restrict international trade to protect domestic industries.
• Tariffs: Taxes imposed on imported goods to make them more expensive and less attractive to consumers.
• Trade Agreements: Treaties between two or more countries to facilitate trade by reducing trade barriers.

Key Economists and Their Contributions

• David Ricardo: Developed the theory of comparative advantage, emphasizing the benefits of free trade and specialization.
• Paul Krugman: Contributed to new trade theory, explaining the role of economies of scale and network effects in international trade.
• Bertil Ohlin: Co-developed the Heckscher-Ohlin model, which explains trade patterns based on factor endowments (land, labor, and capital).

Essay-Style Questions

1. Analyze how changes in real income levels in both domestic and foreign markets can affect a country's net trade balance. Use specific examples to illustrate your points.
2. Discuss the impact of exchange rate fluctuations on the trade balance, providing real-world examples of how countries have been affected by these changes.
3. Evaluate the influence of the global economic environment on a country’s trade balance, considering both periods of economic growth and recession.
4. Explain the role of protectionism in shaping the trade balance. How can protectionist policies both positively and negatively impact an economy?
5. Assess the importance of non-price factors, such as product quality and trade agreements, in determining a country’s trade balance. Provide examples to support your arguments.

These notes provide a detailed overview of the main influences on the net trade balance, supported by theoretical insights and real-world applications.