ECON5335 - International Economics

Chapter 3

The Balance of Payments

The purpose of a national balance of payments accountsAccounting principlesSub-accounts of the balance of payments Compare balance of payments accounts for different countriesThe macroeconomic role of the Balance of Payments The role of Savings and InvestmentInternational investment position

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Chapter 3 – The Balance of Payments

3.2 Accounting Principles in the Balance of Payments

3.1 The Concept of the Balance of Payments

3.3 Main Categories and Sub-categories in the Balance of

Payments

3.4 How the Balance of Payments Affects Economic

Growth

3.3.2 The Financial Account

3.3.3 The Capital Account

3.3.4 Putting it all together

3.3.1 Current account

14th century – British “mercantilists”: encourage exports and discourage imports

17th century: “balance of trade”

18th century – David Hume: “price-specie flow”

1944 Bretton Woods: empower International Monetary Fund (IMF) to gather and organize international trade data

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Balance of Payments: it encompasses and accounts for all the international transactions (whether monetary or not) that happen between one country and the rest of the world.

“Double-entry” book-keeping: in every transaction there are actually two flows:

the physical good or delivery of the service

money is used to pay for the physical good or service

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The Balance of Payments must (in theory) balance - the Balance of Payments must add up to zero.Special cases:

Foreign aid;Mis-measurement of flows

Current Account – this contains items relating to trade and income flows from investments and other factors of production;

Financial Account: this contains flows of assets between countries, and incorporates changes of ownership of assets as well

Capital Account: this contains flows of assets that are specifically earmarked for investment – for example official debt forgiveness and the money migrants bring into the country 6

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Line ItemUS

(in US$m)

Italy(in euro millions)

China (in 100m

US$)

Nigeria (in naira m)

i) Exports of Goods 1,561,239 390,150 20,569 14,234,176.05

ii) Imports of Goods 2,302,714 370,150 17,353 9,484,431.97

iii) Merchandise Trade Balance -741,475 20,000 3,216 4,749,744.09

iv) Exports of Services 649,346 82,762 1,914 520,914.39

v) Imports of Services 442,527 82,983 2,812 3,782,982.23

vi) Services Trade Balance 206,819 -221 -897 -3,262,067.84

vii) Balance on Goods and Services -534,656 19,779 2,318 1,487,676.25

viii) Income Receipts 776,364 51,081 1,604 138,088.24

ix) Income Payments 552,437 62,271 2,026 3,643,780.02

x) Income Balance 223,928 -11,190 -421 -3,505,691.78

xi) Unilateral Transfers -129,688 -18,087 34 3,356,003.01

xii) Current Account -440,416 -9,498 1,931 1,337,987.48

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12Cumulative Current Accounts in US$m: 1980-2008

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Line ItemUS

(in US$m)

Italy (in euro millions)

China (in 100m US$)

Nigeria (in naira m)

i) Direct investment abroad -388,293 -23,836 -624 -126,202.88ii) Inward direct investment 166,411 6,832 2535 1,360,237.43

iii)Portfolio investment abroad – equities

-144,823 -17,145 20 -227,071.01

iv) Portfolio investment - debt * 76,846 -84 -20,642.82

v)Domestic portfolio investment – equities

196,908 16,124 299 395,514.28

vi)Domestic portfolio investment – debt

156,385 -39,288 243 397,506.93

vii) Other investments abroad 440,106 -43,269 -2316 -2,685,958.56viii) Other investments by foreigners -369,742 38,572 -284 111,929.77ix) Reserve assets flowing abroad -4,460 -1,461 -1101 -46,604.41

x)Reserve assets flowing into country

393,922 * 136 *

xi) Net financial derivatives -7,064 1,727 0 *xii) Financial Account 439,350 15,102 -211 -841,291.27

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Introduced by IMF

Included two components:

1. Transactions in non-financial assets (such as patents, copyrights and leases) and

2. Transactions in factors of production (such as land and labor)

Can be listed separately or combined with other accounts.

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Line ItemUS (in

US$m)

Italy (in euro millions)

China (in 100m

US$)

Nigeria (in naira

m)i) Current Account -440,416 -9,498 1,931 1,337,987

ii)Financial Account

439,351 15,102 -211 -841,291

iii) Capital Account 6,956 783 43+-966 0iv) Sum of i) to iii) 5,891 6,387 1763 496,696

v)Statistical Discrepancy -[iv)]

-5,891 -6,387 -798 -496,696

vi)Balance of Payments [iv) + v)]

0 0 0 0

vii)Statistical Discrepancy as %

0.7 25.2 26.0 22.8

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National Income: Current Account (CA):

Y = income derived from production

C = total amount spent on

consumption goods

I = investment

G = government spending

CA surplus: increase Y, stimulate growth

CA deficit: drag on economic growth

A lot depends on why CA is negativeCA could turn negative because domestic consumers suddenly prefer foreign products – this would be a problem and clearly would detract from domestic growthIf CA is negative it could reflect good internal growth in the economy that is faster than other countries – that would not be a problem

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Current Account (CA):

Amount of income that we earn from producing goods and services

Amount of what we spend domestically on both goods produced at home and abroad.

CA surplus: our income is greater than what we spend – so the difference must be accounted for by the exporting that we do compared to how much we import

CA deficit: our income is smaller than the amount that we spend on goods and services, so this implies that we must be importing goods and services

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National Saving Current Account

‘truism”: the way we set up the national accounts means that given our definition of national saving it has to be true

The Concept of the Balance of PaymentsAccounting PrinciplesMain categories of the Balance of PaymentsSub-categories of the Balance of Payments: Current account, Profile of world economy, Financial Account, Capital Account How the Balance of Payments Affects Economic Growth

Saving, Investment and the Current AccountInternational Investment Position

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Introducing the variable T (taxes)

Government Budget Balance = T - G

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Current account is the difference between the total level of savings in a country and the actual level of investment that a country does.

Financial and Capital accounts combined

Interpreting equation:

So if I > S, this means that investment is being financed by foreigners, so that FA > 0

Balance of payments is a measure of flowsBut flows become stocks over a period of timeSo what is the stock variable equivalent of the flow of tangibles, intangibles, assets or money flows?This is accounted for by the International Investment positionMeasures domestic assets owned by foreigners and domestic ownership of foreign assets

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US (2011) Italy (2012) China (2012) Nigeria (2010)

Private assets owned abroad 15,712.8 1,648,259 1,788 51,329

Government assets owned abroad

178.9 102,460

Reserve assets owned abroad 536.0 213,788 3,388 32,339

Total assets owned abroad 21,132.4 1,964,467 5,176 83,668

Foreign owned official assets 5,250.8 984,182 11,696

Foreign owned other assets 15,333.4 1,368,037 82,982

Total foreign owned assets 25,162.6 2,352,219 3,439 94,678

Net international investment position

-4,030.3 -370,966 1,737 -11,009

US: $bn; I: €mn; China: US$bn; Nigeria: US$mn