Quite often I speak to people and they try
to relate a country’s balance of payment to its standard of living, or more
generally people try to think that a country with a balance of payment deficit is
having economic troubles. Balance of payments is always a hot topic in economic
and political discussions and many people seem to have the concept that
deficits are unambiguously bad.
Well firstly balance of payments are always
balanced because they are calculated based on double entry accounting, it is a
specific category of the balance of payment that can either be in a surplus or
a deficit e.g. the current account. In general people mean a current account
deficit when they talk about balance of payment deficit. The current account is
the part of balance of payments that records the value of trade in merchandise,
services, income (from investments) and unilateral transfers.
Given what is recorded in the current
account i.e. Exports, imports and investment incomes it is not surprising why
it is the most important or may be the most talked about account in the balance
of payment. Export and Imports are specifically very important because they
make up most of the current account value. Exports bring foreign exchange (money)
into the country and hence they are credits in the CA, Imports flow foreign
exchange out of a country and they are debit transactions in the CA. A current
account deficit occurs when debits are more than credits, which means that a
country owes the rest of the World than it is owed by the rest of the World, in
other words the country is a net debtor to the rest of the World.
Knowing what is recorded in the CA, we can
now easily tell what causes a balance of payments deficit. For instance, since
Exports bring money into a country and Imports move money out of a country, we
often hear argument for policies aimed at increasing Exports and reducing
Imports. The last sentence lead me to the title of this blog, we need to
know what caused a BOP deficit before we can make any conclusions about whether
it is bad or good.
Consider this; How about if a country is
running a current account deficit (Imports more than exports) because it is
importing capital and technology for developmental purposes? Of course this
country might need the capital and technology in order for it to increase its
future long-term exports and run BOP surpluses. From this we can see that short
term BOP deficits are not always bad & they are sometimes an intermediate
step towards future BOP surpluses. Sometimes nations also run short term BOP
deficits because of high imports of intermediate goods to be processed into
finished final goods for export.
Husted & Melvin
give a simple hypothetical example about BOP deficits; Consider country A and B, A is a wealthy creditor that has extended
loans to poor country B. For country B to repay these loans, B must run trade
surpluses with A to earn the income required for repayment. Would you rather
live in rich country A and experience trade deficits or in poor country B and
experience trade surpluses? Perhaps this is a simplistic example; there are
real World analogues of rich creditor countries with trade deficits and poor
debtor nations with trade surpluses. For Example the U.S has had a trade deficit
every year since 1971 (except 1973 & 1975). If you follow the last US
election you might have realised that the US trade deficit was a hot topic, the
US trade deficit is of a great concern because its causes are largely due to
high consumption, which is not good because this means people (and firms) are
spending more than they are earning. We see that if the cause of a BOP deficit
is rooted in consumption it is unambiguously bad.
“Sometimes
governments simply spend more than they earn simply due to ill-advised economic
planning. Money may be spent on expensive imports while domestic production
lags behind or it may be deemed a priority for a government to spend on the
military rather than domestic production.”
In a nutshell it is not generally obvious
if a country is better off or worse off running payment surpluses rather than
deficits.
When discussing the BOP or the current
account it is important for people to understand that it is practically
impossible for every country to run a surplus, since one country’s imports is
another country’s exports, therefore a
deficit in one country’s current account is surplus in another country’s
current account.
KEY:
CA: Current Account
BOP: Balance of Payment
The Student.
The Student.
