This is an article about balance of payments including the current account and capital/investment account
Balance of payments
Made up of the current, financial and capital account.
Is where payments for the purchase and sale of goods and services are recorded. It has numerous properties affecting it including trade in goods balance, trade in service balance, investment income and current transfers (which is the least important as it makes a marginal proportion of the current account).
Trade in goods balance:
Often known as the ‘trade in visibles’ as they are tangible.
It is measured by the value of goods exported minus the value of goods imported. In an export, the tangible good is going to another country but there is an inflow of money into the host country. And it’s a common mistake to think that the export is the money going out of the economy. An import is just the opposite. So a tangible good comes into the host country and an outflow of money goes to another country. It is the value (money inflows and outflows) measured and not the volume of the goods.
There is said to be a surplus when the value of goods exported is greater than the value of goods imported.
There is said to be a deficit when the value of goods imported is greater than the value of goods exported.
Trade in services balance:
Funnily enough it is known as the ‘trade in invisibles’ as they are intangible.
(It is similar to the trade in goods just with services)
It is measured by the value of services exported minus the value of services imported. In an export, the intangible service is going to another country but there is an inflow of money into the host country. An import is once again just the opposite. So a intangible service comes into the host country and an outflow of money goes to another country. It is the value (money inflows and outflows) measured and not the volume of the services.
There is said to be a surplus when the value of services exported is greater than the value of services imported.
There is said to be a deficit when the value of services imported is greater than the value of services exported.
It is measured by the income flows into country from non-residents minus the income flows out of the country by residents. A major influence on the value of investment income is the number of assets owned abroad, such as houses or plots of land. Another major influence is repatriation of earnings from national workers in foreign counties.
There is said to be a surplus when the income flows into a country are greater than the income flows out of the country.
There is said to be a deficit when the income flows out of a country are greater than the income flows into a country.
Consist mainly of government transfers to organisations such as the EU with it’s common agricultural policy (CAP), but it also includes aid from government and Non-Government Organisations (NGO’s).
Comprises of transactions associated with changes of ownership of the UK’s foreign financial assets and liabilities.
It is measured by a change in foreign ownership of domestic assets minus a change in domestic ownership of foreign assets. The main influencing factors include:
- Foreign Direct Investment (FDI) – which refers to the long term capital investment on machinery or buildings. If foreigners choose to invest in a country, that is considered an inbound flow and creates a surplus on the capital account for the host country. If domestic investors reallocate investment to another country that creates a deficit on the capital account.
- Portfolio investment – refers to the purchase of stocks and shares. If you chose to invest into the S&P 500 (American share system) from a different country, there is a flow of income to the American economy, reflecting on there capital account.
- Changes in foreign exchange reserves – These include numerous currencies (US$ being the main currency) and reserves in gold. For example the Federal Reserve Bank of New York contains 7,700 tonnes of gold, roughly 5% of all the gold ever refined throughout human history.
- Short-term capital flows – These are referred to as ‘hot money’ flows as they are associated with speculative buying. Seen mainly in exchanges like Wall Street.
As you can see there are a lot of aspects which make up the balance of payments, therefore meaning that there are a lot of factors that alter it. But generally if there is more money/income flowing into the economy it is known as a trade surplus. And if there is more money/income flowing out of an economy it is known as a trade deficit.
Main contributing factors influencing balance of payments:
- Exchange rate – A rise in exchange rate will tend to increase imports and reduce exports (creating a deficit). A fall in exchange rate will tend to reduce imports and increase exports (creating a surplus).
- International competitiveness – If a country has lower labour costs, skilled workers, good infrastructure, key geographical locations or specialisies in certain industries it will be attractive for FDI which may possibly create an export market as they are providing a good or a service. A great example is the UK who in the last 20 years could be seen to have lost international competitiveness in the manufacturing sector seen by the closing down of northern steel factories due to the competitive nature of South-East Asian countries such as China.
- Trade cycle – If imports are high and exports are low, this creates a trade deficit (known as a bust in the trade cycle). This causes Aggregate Demand (AD) to fall which means that people are willing to spend less money on imported products. This means that the trade deficit is neutralised and even a possible surplus is created (known as a boom in the trade cycle). This then causes AD to rise and more money spent on imported products, which negates the surplus. This is a cyclical cycle and over the long-term changes vastly.
- Economic situation in different markets – In a world recession, this will effect exports of countries as there is less trade and therefore meaning there is a rise in trade deficit, however this may be counteracted by a fall in in imports due to a loss of trade.
- External shocks – A shock that is beyond the country’s power to control such as a disruption in oil areas will cause a large price rise, this is further emphasised by the good being highly inelastic due to the lack of substitutes.
- Government intervention – Use of fiscal policy, monetary policy and supply side policies to manipulate imports and exports. Also tariffs, quotas, subsidies to local industry directly effect imports and exports.
The balance of payments are a major factor in any economy especially with the large increase in world trade and globalisation. You can also see it has a lot of factors affecting it, too many.