Other than depreciation in exchange rate discuss which solution to a balance of trade is best.

Governments often use expenditure dampening as a method to improve the balance of trade. This involves raising taxes and or interest rates, in order to apply a deflationary effect on the economy. By increasing taxes people’s income will be reduced and they will have less money to spend on goods and services, as a result aggregate demand will fall and demand for imports will decline, improving the balance of trade. Increasing interest rates will encourage consumers to save and discourage them to borrow money by increasing the price of borrowing, therefore there is less spending and demand for imported elastic goods falls. An overall decline in consumer spending will lead to the general price level to drop, this will increase a country’s international competitiveness as their goods become relatively cheaper compared to other countries and therefore more desirable leading to demand for exports rising. As consumer demand drops domestically, firms will be left with a surplus of output, this can alternatively be exported to other countries and as a result improve the balance of trade. However, if a country heavily imports goods such as oil, coal and gas, which are largely inelastic, meaning demand for them remains relatively unchanged regardless of a change in people’s incomes or price, then increased taxation and interest rates will have little affect on the demand for imports and consequently little affect on the balance of trade.                                                                                Expenditure dampening however can have harmful effects on the economy and can cause unemployment. By reducing aggregate demand through high taxation and interest rates, firms will face a decline in demand for their goods and services, as a result they will sell less, and profits will decline. In order to be sustainable, firms may look to reduce production costs by making workers redundant. As there is increased unemployment and a reduction in people’s net incomes, overall standard of living will decrease across a country.

If a deficit has arisen due to a lack of competitiveness it might be more appropriate to improve the demand for a country’s goods by improving competitiveness in terms of price and quality. This is done mainly through supply side polices. Governments may invest in research and development in the hope of providing technological advancements that can improve efficiency in firms and businesses. If a company is able to improve its efficiency, by either producing more output in a given time or enabling them to reduce production costs, firms will be able to offer lower prices to consumers. Similarly, if the quality of a good or service is improved, then demand will rise. Governments may also offer subsidies to firms in order to reduce their costs of production, enabling them to sell their goods at lower prices. Subsequently, domestic firms will become more internationally competitive as their prices will be relatively cheaper or their products will be more desirable and so demand for exports will rise, resulting in a reduced trade deficit. However if industries do not expand quickly enough or provide sufficient advancements, so as to see a return on investment then such policies may be unsustainable. Similarly, if the government is subsidising an industry that is being out competed international and as a result there is structural decline, then this is merely a short-term solution, which does not solve the underlying issues.

The most effective solution to a balance of trade is to introduce long-term supply-side improvements that improve a country’s productive potential. Protectionism is a short-term solution that will most likely bring around retaliation from other countries. Expenditure dampening reduces standard of living and can cause negative economic growth and unemployment. Although, supply-side polices can be costly to the government, by increasing the ability of a country to manufacture and produce goods, which in turn it can export at competitive prices, is the most effective solution to a trade deficit.