Question

When is a trade deficit likely to work out well for

an economy? When is it likely to work out poorly?

Short answer

When the trade deficit is caused by the budget deficit, it might work out poorly.

Step-by-step solution

Step 1. Introduction

As per the Savings-Investment identity,

S + (M – X) = I + (G – T),

or, (M-X)= (I-S) + (G-T)

where,

S- Savings,

M- Imports,

X-Exports,

M-X - Trade Deficit,

I- Investments,

G- Government Expenditure,

T- Taxes

Step 2. Explanation

It totally depends upon the savings and investment relationship. whether the trade deficit if is beneficial for an economy or not,

If domestic investments exceed domestic savings, then the country shall undergo a situation of trade deficit, and to finance this there shall be an inflow of financial capital into the economy. This is not necessarily bad. It is so because with more and more investment, the incomes in the future shall rise too.

But, when trade deficit is caused primarily due to the budget deficit, it might not be good for the economy as the government shall borrow and there won't be any income to finance investments.