The Pros and Cons of Trade Deficits and Surpluses

Self-Check Questions

For each of the following, indicate which type of government spending would justify a budget deficit and which would not.

  1. Increased federal spending on Medicare
  2. Increased spending on education
  3. Increased spending on the space program
  4. Increased spending on airports and air traffic control

Hint:

  1. Increased federal spending on Medicare may not increase productivity, so a budget deficit is not justified.
  2. Increased spending on education will increase productivity and foster greater economic growth, so a budget deficit is justified.
  3. Increased spending on the space program may not increase productivity, so a budget deficit is not justified.
  4. Increased spending on airports and air traffic control will increase productivity and foster greater economic growth, so a budget deficit is justified.

How did large trade deficits hurt the East Asian countries in the mid 1980s? (Recall that trade deficits are equivalent to inflows of financial capital from abroad.)

Hint:

Foreign investors worried about repayment so they began to pull money out of these countries. The money can be pulled out of stock and bond markets, real estate, and banks.

Describe a scenario in which a trade surplus benefits an economy and one in which a trade surplus is occurring in an economy that performs poorly. What key factor or factors are making the difference in the outcome that results from a trade surplus?

Hint:

A rapidly growing trade surplus could result from a number of factors, so you would not want to be too quick to assume a specific cause. However, if the choice is between whether the economy is in recession or growing rapidly, the answer would have to be recession. In a recession, demand for all goods, including imports, has declined; however, demand for exports from other countries has not necessarily altered much, so the result is a larger trade surplus.