Countries like India and the US have huge trade deficits with China and there is an ongoing trade war between the world's two most powerful economies.
I want to know if bilateral trade deficits are necessarily bad and if there is any positive side of this picture too?
It seems to me that trade deficits give us an idea of our competitiveness, globally, which can subsequently lead to improvement and betterment in various factors of production and supply chain management.

  • I remember John Oliver did a Last Week Tonight segment on international trade which addressed the question in passing. You should be able to find it on the Last Week Tonight Youtube site, but note that it may be popularised, simplified and more as the show is comedic in nature rather than scientific.
    – Jan
    Oct 3 '19 at 8:52
  • Related enough: economics.stackexchange.com/questions/27699/…
    – Fizz
    Oct 3 '19 at 14:52

First, I see your question interchangeably refers to bilateral deficits and just "trade deficit", which normally means the overall one of a given country, with all its trading partners. The overall trade balance of a country, being part of the larger current account balance, is the important macroeconomic factor for a given country's economy.

China, for example, has a large surplus with the US, but its overall current account for 2018 (with all its external partners) came down to a level that the IMF considers non-problematic, given the country's economy. And this is what it looks like in Bloomberg's summary, compared to other countries:

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(If this sound baffling with respect to China, it is because of China's "triangular" trade structure it has, importing massively from other Asian countries and commodity exporters.)

The IMF divides current account imbalances in "excessive" and not so. Their reasoning in non-technical terms is the following

To start, [current account] surpluses and deficits in and of themselves need not be problematic and may well be appropriate and beneficial. For example, young, fast-growing economies need to invest to grow—so they often tap external resources by importing more than they export and borrowing to cover the implied deficit. In contrast, rich, aging countries may need to save to prepare for when workers retire—so they run surpluses and lend to deficit countries.

Current account balances can, however, become excessive, that is, larger than warranted by the economy’s fundamentals and appropriate economic policies. Excessive external imbalances—both deficits and surpluses—pose risks for individual countries, and for the global economy.

Just as over-indebted households can lose access to credit, economies that borrow too much from abroad by running current account deficits that are too large may become vulnerable to sudden stops in capital flows that can be destabilizing not only at country level, but also globally, as proven by the long history of financial crises. Countries with excessive surpluses face different challenges—for example, the risk of investing their saving abroad when domestic investments could offer higher social returns. In addition—and importantly—they may become targets for protectionist measures by trading partners.

The analysis of external imbalances is inherently complex [...]

The nuts and bolts for how the IMF draws that line between excessive and "normal" imbalances is intricate, and you're better off asking on economics SE about it.

This a rebuttal of Relaxed's claim that no level of trade deficit is bad. (Or at least of claim that "economists agree" on that.) Here's what happened in the Eurozone crisis:

To study Greece’s trade performance, we compare developments in Greece with those in Ireland, Portugal and Spain. The comparison is informative because of these countries’ shared predicament – following the introduction of the euro, all four peripheral countries of the Eurozone experienced large net capital inflows and ever expanding current account deficits which were abruptly reversed in the aftermath of the Global Crisis (Figure 1). Furthermore, the adjustment to lower capital inflows was so disruptive that all four countries experienced severe economic crises leading to bailouts regardless of their pre-Crisis fiscal position (see Galenianos 2015 for a detailed account of the Crisis that emphasises the importance of the balance-of-payments dimension)

enter image description here

In other words, it worked exactly like the generic situation that the IMF is describing in the first quote. There is such a thing as excessive trade deficit.

And this was hardly the first crisis of this (balance of payments) kind. The ASEAN crisis of two decades ago was also of this kind

enter image description here

The World Bank also has a paper titled "When Is a Current Account Deficit Bad?" The answer is not "never", but

A bad current account deficit is characterized by underlying consumption and investment drivers, including policies, that raise doubts about a country’s long-term external solvency or are symptomatic of problems elsewhere in the economy. A good deficit supports smooth transitions — for instance, from building productive capacity while accumulating external debt to subsequently accumulating assets, and then drawing them down as the population ages.

To address one final misconception here, the Eurozone (crisis) current account adjustment is not some mere accounting trick of capital flow with no relationship to actual trade. It was mainly due to actual changes in imports and exports. Here's the ECB saying it:

A current account deficit can be reduced through a reduction in imports and/or an expansion of exports. During the ongoing adjustment of external imbalances in the stressed euro area countries both channels have played a role, albeit to varying degrees (see Chart B). In Spain and Portugal, the larger part of the improvement in current account balances is attributable to an increase in exports relative to GDP, while in Greece the improvement is mostly attributable to a compression of imports. In Ireland, exports have increased strongly since 2008, with imports contracting only in the initial stages of the adjustment phase and exceeding their pre-crisis level in 2012.

enter image description here

Yes, it's also true that for such sudden-stop crisis to actually happen, (external) money needs to stop flowing for whatever reason; this proximate trigger has varied between crises, despite the underlying condition [substantial current account deficit] being the same. (A lot of Relaxed's later comments below address this latter issue of the proximate trigger.)

As I said in an early comment, it's also true that the US is believed to be virtually immune to such a sudden stop crisis, owing to the special position that the US dollar has in international finance. Economist opinions vary however as to the impact of the (overall) US current account deficit: from nothing to worry about to implicating it in the 2008 crisis as Bernanke did.

U.S. officials did not see the fact that their country was the destination of choice for world lenders as being a big problem. Bernanke said he now knew otherwise. The flood of cheap foreign capital fueled a housing boom that belatedly and painfully was later found to have been a bubble.

For a more nuanced view on this see the (highly cited) paper of Obstfeld and Rogoff. One point I'll draw from there is that a widespread view before the 2008 crisis was that

global imbalances were essentially a “win-win” phenomenon, with developing countries’ residents (including governments) enjoying safety and liquidity for their savings, while rich countries (especially the dollar-issuing United States) benefited from easier borrowing terms. The fundamental flaw in these analyses, of course, was the assumption that advanced-country capital markets, especially those of the United States, were fundamentally perfect, and so able to take on ever-increasing leverage without risk.

And an empirical paper of Jordà et al. that expands this question worldwide found that

Our overall result is that credit growth emerges as the single best predictor of financial instability, but the correlation between lending booms and current account imbalances has grown much tighter in recent decades.

I think this issue of the US (overall) trade deficit is too much of a special topic to get into further here. (The OP's question didn't focus on it.)

A lot less attention is given (by economists) to bilateral trade [im]balances. But there has been some recently (obviously due to the oversized political importance they acquired in Trump's presidency). It's hard however to find much commentary from mainstream economists beyond something like

making it easier or harder to trade with specific countries tends to simply shift the trade deficit to other trading partners. Thus, economists warn against conflating bilateral deficits, which reflect the particular circumstances of trading relationships with specific countries, with the overall deficit, which reflects underlying forces in the economy.

As Trump's tariffs have provided the "natural experiment" to test these trade-shifting hypotheses, there will probably be some empirical papers in the future. Insofar we have to contend with news pointing to US trade shiting to Vietnam etc.

The people in the Trump administration who have some academic economics credentials, e.g. Navarro, have been summarized along these lines:

Peter Navarro, a senior advisor to the president on trade and industry, believes that the deficit threatens national security in that the United States depends on foreign debt and foreign investment to finance it.

These are (obviously) not purely economic arguments. If you put it in these terms, having trade deficit with some partners is worse than with others, from a certain national security perspective (which seemingly decides beforehand the acceptable list of countries to have trade deficit with). Wikipedia covers Navarro's views at some length.

As a final point here, the cost-effectiveness of moving production (or rather final assembly) elsewhere is actually more sensitive to tariffs than their nominal value suggest:

Whenever there is foreign value added or imported inputs, the nominal tariff has to be adjusted by a factor equal to the reciprocal of the domestic content share. To illustrate using an oft-cited example, the Fung Global Institute (2014) estimated that only about 10% of a $425 "Made in China" jacket sold in the US actually accrues to the Chinese. Therefore, unless the cost of moving production out of China was 250% ((1/0.1) x 25%) more than paying the 25% tariff, the shift would make economic sense. That’s ten times the margin implied by the nominal tariff rate. The same principle applies to the location of production by US firms exporting to the Chinese market, where they face retaliatory tariffs.


Déjà vu?

If any of this sounds familiar, it may be because a similar dispute took place just over 30 years ago, also triggered by a large bilateral trade imbalance, but between the US and Japan. The punishment then came in the form of a forced appreciation of the yen through the Plaza Accord. Japan responded by moving labour-intensive segments of manufacturing production to lower wage destinations in Southeast Asia, giving birth to ‘Factory Asia’ (Baldwin 2006). In the process, Japan was able to retain its export competitiveness through efficiency gains and by circumventing some of the currency revaluation effects (Athukorala and Menon 1994). It was also able to shift a part of its export surplus to the balance of payments accounts of the countries it had invested in, thereby appearing to shrink its bilateral surplus with the US.

  • It's the other side of the same coin but note that the concern is mostly on the effects of excessive trade surpluses, not deficits.
    – Relaxed
    Oct 3 '19 at 21:28
  • @Relaxed: No, if that were the case, you wouldn't see any BoP-crises affecting the countries running bad current account deficits.
    – Fizz
    Oct 3 '19 at 22:51
  • No, that's not what I am saying. And sure, ultimately both are a problem and I never said no level of deficit is bad. But I am emphasizing the surplus side of the equation because the intuition is often that countries with a deficit are doing something wrong and if they would only save and export more, everything would be right. It doesn't work that way.
    – Relaxed
    Oct 4 '19 at 6:33
  • The quotes you added largely buttress my claims: It's not about the level of deficit or trade deficits being bad in themselves, it's the fact that they are “symptomatic of problems elsewhere in the economy”. And it's not about trade in a narrow sense but about “large capital inflows” (which as a matter of accounting result in a trade deficit), i.e. excess savings and anti-cooperative policies elsewhere in the eurozone.
    – Relaxed
    Oct 4 '19 at 6:35
  • @Relaxed: Again no. See added quote from ECB.
    – Fizz
    Oct 4 '19 at 7:49

As trade balance is a complex topic that is discussed at length over entire sections of textbooks about economics, I will only address your question as to whether bilateral trade deficits are necessarily bad.

The answer is a clear no.

When the domestic economy of a country is strong, trade deficits are likely (among other things because the domestic demand can be so strong that the domestic supply can’t keep up). This is why the US has experienced trade deficits in the past decades. China and Germany have experienced trade surpluses, in part because their domestic economy is not as strong. To put it simply, Chinese and German consumers tend to save, those in the US tend to spend.

While it sounds like a good idea to save (for an individual), spending is a major economic driver. So, the fact that the US has experienced large trade deficits is, at least to some extent, good news.


Trade deficits are only loosely related to trade proper or competitiveness. They also depend on currency exchanges rates and capital flows. Economists do not consider a trade deficit to be a major issue but a trade surplus can be the sign of excessive savings, which creates bubbles and hampers recovery after demand shocks like the 2008 crisis.

  • [citation needed] What you're saying basically is like "taking a loan/credit is good, giving a loan/credit is bad".
    – Fizz
    Oct 3 '19 at 21:43
  • Maybe you had only the US in mind when you wrote that first part of your claim. But the US is in a special position. Nevertheless, the IMF considers that the US current account deficit is currently excessive. Milton Friedman would probably disagree with that, but that's another matter. When you say "economists agree", you claim a consensus that isn't there.
    – Fizz
    Oct 3 '19 at 22:12
  • If that's not convincing, go over your statement again and see how it reads if you put Greece as the example, instead of the US.
    – Fizz
    Oct 3 '19 at 22:22
  • @Fizz No, I didn't specifically have the US in mind. And I think the way you put it (taking/giving a loan) is exactly the wrong way to think about this.
    – Relaxed
    Oct 3 '19 at 22:22
  • @Fizz Greece's main problem is that it is locked in a currency union, hence the mechanisms I refer to are not fully in play. Another problem is that Greece is in a currency union with Germany, which has a massively destructive trade surplus and savings that fueled bubbles elsewhere in the eurozone that is exactly the kind of imbalance I refer to at the end. But Greece, Spain, etc. are mostly on the receiving end of all this, the trade deficit is not causal or to be understood in isolation.
    – Relaxed
    Oct 3 '19 at 22:28

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