Assess whether measures aimed at correcting a trade deficit could lead to difficulties for a country’s economy.
b. Assess whether measures aimed at correcting a trade deficit could lead to difficulties for a country’s economy. [15]
Introduction
A trade deficit arises when a country's import expenditure exceeds its export revenue, resulting in a negative balance of trade. While a short-term trade deficit may not pose significant problems, a persistent and widening trade deficit may indicate underlying structural weaknesses in the economy and could lead to currency depreciation, debt accumulation, and weakened investor confidence. Governments often adopt policy measures to address this imbalance—but while such measures can improve the Balance of Trade (BOT), they are not without potential macroeconomic trade-offs.
Contractionary Monetary and Fiscal Policy
One approach to reduce a trade deficit is through contractionary demand management policies, including contractionary fiscal or monetary policy. These policies aim to reduce aggregate demand (AD) in the domestic economy, thereby lowering the demand for imports.
For instance, the government may implement contractionary fiscal policy by increasing personal or corporate income taxes, or cutting government expenditure. This leads to a fall in consumption (C) and investment (I), causing AD to shift leftward from AD₀ to AD₁. A fall in real national income (NY) reduces households' disposable income, and therefore their purchasing power, which in turn leads to a reduction in import expenditure. With lower spending on imports, the (X - M) component of AD improves, leading to a narrowing of the trade deficit.
However, this strategy can cause significant short-term difficulties. A fall in AD also results in lower real output and economic growth, as shown by a contraction in NY from Y₀ to Y₁. As firms produce less, they require fewer factor inputs, including labour, resulting in higher cyclical unemployment. The broader economy may enter or deepen a recession. Hence, while contractionary policies may reduce import spending, they can also undermine growth.
Devaluation of the Exchange Rate
Another tool to address a persistent trade deficit is currency devaluation, particularly in countries operating under a managed exchange rate regime. The central bank can intervene in the foreign exchange market by selling domestic currency and buying foreign currencies, leading to an increase in the supply and a depreciation of the domestic currency.
A weaker currency makes exports cheaper for foreign buyers and imports more expensive for domestic consumers. Provided the Marshall-Lerner condition holds—i.e., the sum of the price elasticities of demand for exports and imports is greater than one—the country will experience an increase in net exports (X - M), thereby improving the trade balance.
However, depreciation carries significant economic costs, especially for countries heavily dependent on imports. More expensive imports lead to imported inflation, raising the general price level (P), particularly for essential goods such as food, energy, and raw materials. For firms that rely on imported inputs, the cost of production rises, shifting short-run aggregate supply (SRAS) leftward, which leads to cost-push inflation.
Consumers experience a decline in purchasing power, and the overall standard of living deteriorates. Therefore, while exchange rate depreciation may correct trade imbalances, it may simultaneously worsen inflation and create macroeconomic instability—particularly for economies like Singapore with high import dependence.
Supply-Side Policies to Improve Export Competitiveness
A more long-term strategy to address a trade deficit is to improve export competitiveness through supply-side policies. The government may invest in training, technology adoption, and infrastructure to raise labour productivity and lower unit labour costs. Tax incentives and subsidies may also be granted to firms investing in automation or R&D. As production efficiency improves and costs fall, the prices of exports decrease, making them more competitive in global markets. The resulting increase in export demand boosts export revenue, leading to an improved BOT position.
This approach avoids many of the negative side effects associated with contractionary or exchange rate policies. However, supply-side measures are costly and time-consuming. Substantial government funding is required to subsidise training programmes, support research, or fund infrastructure development. This can result in a worsening budget position and opportunity costs, as funds are diverted away from other pressing areas like healthcare or welfare. Moreover, the effectiveness of supply-side policies is uncertain, particularly if industries do not respond to incentives or if the improvements in productivity take years to materialise. There is also the risk that certain sectors continue to underperform despite state support.
Conclusion
In conclusion, while policy measures aimed at correcting a trade deficit can help restore external balance, they often involve macroeconomic trade-offs. Contractionary policies may reduce import expenditure but risk dampening growth and raising unemployment. Exchange rate devaluation may improve competitiveness but cause inflation and hurt consumers. Supply-side measures, though less distortionary, are expensive and take time to implement. The most appropriate policy mix will depend on the structure of the economy, the elasticity of exports and imports, and the time horizon in which results are needed. In practice, governments may need to combine policies—such as short-term demand management with long-term structural reforms—to reduce trade deficits while minimising the negative side effects.
📘 June Holiday Crash Courses — Write Like a Top Scorer This A Level Season
💡 Reading model essays is a great start. But knowing how to write them — with precision, structure, and L3 evaluation — is how you score real marks.
At Economics at Tuitiongenius (ETG) — Singapore’s most trusted economics tuition centre — we train students to think like examiners, write like top scorers, and walk into the A Levels fully prepared.
This June, join our high-impact crash courses designed for serious JC1 and JC2 students who want clarity, confidence, and results.
🚀 ETG June Crash Course Lineup
Whether you’re catching up or aiming for the A, this H2 economics tuition programme covers the critical content and exam skills you need — fast.
🧠 What’s Included:
📘 Micro & Macro Content Crash Courses (2 & 4 June 2025)
✅ 8 Core A Level Topics
✅ Complete in just 12 hours
✅ Attend onsite or get lifetime online access
✍️ Essay & Case Study Bootcamp (9 & 10 June 2025)
✅ 10 Full Essays + 8 CSQs dissected live
✅ Learn exam technique, evaluation, structure & strategy
✅ Practise in real time with feedback from Mr Eugene Toh
💥 Bundle Deal — Save Over $1,000
✅ Lifetime access to recordings
✅ Printed materials delivered to your home
✅ Learn from the economics tutor trusted by 2,000+ JC students
💬 “This course taught me how to actually think and write like an A-grade student. Best decision I made all year.”
💡 Best For:
JC1 students preparing for Promos
JC2 students heading into Prelims or A Levels
Anyone searching for economics tuition Singapore that actually works
🔗 Secure your seat now at tuitiongenius.com/june
📲 Or WhatsApp us at 8168 3986 — our team will guide you in under 24 hours
The June holidays are limited. Let’s make them count — and get you exam-ready with ETG.