MISCONCEPTIONS ABOUT BALANCE OF PAYMENT DEFICITS

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.