Globalisation and Trade Restrictions: Reducing a Current Account Deficit

This section explores one of the key reasons why countries impose trade restrictions: to address a deficit on their current account balance of payments. A current account deficit occurs when a country imports more goods and services than it exports.

Understanding the Current Account Balance

The current account balance is a component of the balance of payments, which is a record of all economic transactions between a country and the rest of the world. The current account primarily includes:

• Trade in goods and services
• Net income (interest, dividends, profits)
• Current transfers (e.g., foreign aid)

A current account deficit indicates that a country is spending more on imports than it is earning from exports.

Why Does a Current Account Deficit Occur?

Several factors can contribute to a current account deficit, including:

• High domestic demand
• Strong exchange rate (making imports cheaper and exports more expensive)
• Low productivity compared to trading partners
• Expensive domestic resources (e.g., energy)

Trade Restrictions as a Policy Response

Governments may implement trade restrictions to try and reduce a current account deficit. These restrictions aim to decrease imports and/or increase exports.

Types of Trade Restrictions

Type of Restriction	Description	Example
Tariffs	A tax imposed on imported goods.	A tariff on imported steel.
Quotas	A limit on the quantity of a specific good that can be imported.	A quota on imported cars.
Subsidies	Government payments to domestic producers, making their goods cheaper and more competitive in international markets.	Subsidies for the domestic airline industry.
Embargoes	A complete ban on trade with a particular country or for a specific good.	An embargo on trade with a country due to political reasons.

How Trade Restrictions Can Reduce a Current Account Deficit

The logic behind using trade restrictions to reduce a current account deficit is as follows:

• Tariffs: By increasing the price of imported goods, tariffs can make domestic goods relatively more attractive to consumers and businesses, potentially boosting domestic production and reducing the need for imports.
• Quotas: Limiting the quantity of imports directly reduces the amount of money flowing out of the country to pay for those imports, thereby narrowing the current account deficit.
• Subsidies: By making domestic goods cheaper, subsidies can increase exports. Increased exports mean more money flowing into the country, which can help to offset the outflow of money due to imports and reduce the current account deficit.
• Embargoes: Completely stopping trade with a country eliminates imports from that specific source, directly reducing the current account deficit.

Limitations of Using Trade Restrictions

While trade restrictions can potentially reduce a current account deficit, they also have potential drawbacks:

• Retaliation: Countries that are subject to trade restrictions may retaliate with their own restrictions, leading to trade wars and harming overall global trade.
• Higher Prices for Consumers: Tariffs and quotas can lead to higher prices for consumers as they face fewer cheaper import options.
• Reduced Choice: Restrictions limit the availability of goods and services for consumers.
• Inefficiency: Trade restrictions can protect inefficient domestic industries from competition, hindering innovation and productivity growth.

Conclusion

Governments may use trade restrictions as a tool to address a current account deficit. However, this approach is often controversial and can have significant economic consequences. The potential benefits of reducing the deficit must be weighed against the potential costs and drawbacks of these policies.