Economic Basics

In times of growing economic uncertainty, trade wars and tariffs, everybody should have a basic idea about how the economy and economic accounting work [2, 3]. Within each country, we basically have four major economic actors (Fig. 1):

Private companies, i.e. entrepreneurs and their workforce, produce goods and services. In economic terms, they create value.
These goods and services are used by private households, which generate the required income by working for these companies (or for the public sector). In economic terms, they consume value.
Financial transactions are handled via the banking system.
The government (public sector) establishes the rules under which these actors operate. Additionally, it is responsible for maintaining internal and external security via the police, the justice system and the military and for providing public infrastructure such as roads, schools, and social security. The public sector generates the required income by taxing the private sector and collecting tariffs for imports. In economic terms, they consume and redistribute value. If income is not sufficient, it takes credit by issuing government bonds.

Each country must import goods and services, e.g. energy, which it does not produce domestically. To pay for these imports, the country needs to export a similar amount of other goods and services. If a country does not have enough goods and services to export, the country may force part of its population to work in other countries and send money home (foreign income). Economists [1] summarize these activities between a country and the rest of the world as:

Current Account (Leistungsbilanz) = Balance of Trade in Goods and Services + Balance of Foreign Income

If a country has a current account surplus, i.e. it earns more from exports than it has to pay for imports, the country may export capital, i.e. it invests in foreign companies either directly or via stocks or bonds (credit, debt). The technical term for this balance is Capital & Financial Account. If the country does not invest this surplus abroad, its central bank may keep the excess income as foreign exchange (FX) reserves (often in USD or gold). Countries with current account deficits will need capital imports and/or sell their FX reserves. Economists [1] describe this relation as:

Balance of Payments (Zahlungsbilanz) = Current Account (Leistungsbilanz) + Capital & Financial Account (Kapitalbilanz) incl. FX Reserve Balance (Devisenbilanz) = 0

As you can see this is an accounting identity, i.e. the sum of the the terms is zero, meaning a surplus in one account must be balanced by a deficit in another account.

To measure the economic power of a country, economists [1] use the annual

Gross Domestic Product GDP (Bruttoinlandsprodukt BIP) = Consumption of the private sector + Investments of the private sector + Government spending (not including transfer payments) + Balance of Trade in Goods and Services (Exports - Imports)

The GDP sums up the total value of all final goods and services created inside the country. Imports are subtracted as both the consumption and the investment term in the equation contain domestic and imported stuff. By definition only domestically created value shall be counted and thus imports must be subtracted.

Literature:

AIER (American Institute for Economic Research): Understanding Trade Balances, Jan. 2025
CFR (Council on Foreign Relations): The U.S. Trade Deficit, April 2025
Lyn Alden: A Trade Breakdown, May 2025
Lyn Alden: Why Trade Deficits matter, Oct. 2019
Stephen Miran: A User's Guide to Restructuring the Global Trade System, Nov. 2024

More Posts of the Economics series

Literature: