Drop the trade diffidence: Why we need not fear bilateral trade deficits when negotiating free trade agreements like RCEP
Abstract:
Deep down, perhaps the most important factor that concerned Indian negotiators of the Regional Comprehensive Economic Partnership (RCEP) was the threat of competition from China. India has a large existing bilateral trade deficit with China and it was feared that opening to it under RCEP would widen this deficit yet further. A related concern was that an avalanche of new Chinese goods would hit Indian markets, undermining its manufacturing sector and Make in India programme.
Examine first the issue of bilateral trade deficit. Setting politics aside for the moment, as long as a country’s trade in goods and services is balanced in aggregate, economic logic tells us that bilateral deficits and surpluses should not be a matter of concern. There are nearly 200 countries in the world and each of them strives to buy its imports from countries that charge it the lowest prices and sell its exports to countries that offer it the highest prices. It will be a wonder if these myriad transactions result in mutually balanced trade for each pair of countries.
To understand the benign nature of bilateral deficits, consider for a moment how households earn and spend their incomes. I sell (“export”) my services to Columbia University because it pays me the highest salary I can get. I then use that salary to buy (“import”) the goods and services I need from sellers who sell them to me at the lowest prices. In the process, I run a bilateral surplus with Columbia and bilateral deficits with all sellers from whom I buy the goods and services I need. But as long as the dollar value of all my purchases does not exceed my earnings from Columbia, I have no reason to worry. If my total purchases exceed my earnings, I incur debt and if this happens year after year, I have something to worry about, namely, the loss of my creditworthiness.