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International Economics: the Balance of Payments

The balance of payments reveals the records of receipts and payments of a country in her transaction with other countries. If all transactions that take place between two or more countries are included, the receipts and payment of each country must be alike. For instance, if the US procure cars from Japan (assuming that the two countries do not engage in any other transaction), the Japanese will be paid dollars for the automobiles which they may decide to invest the money in the US or keep it as bank deposits in the country (Stein, n.d., para. 2). Even though the totals receipts and payments are essentially identical, there will be surpluses and deficits in certain types of transactions. Therefore, surpluses and deficits can be manifested in a number of areas such as: merchant trade balances, balances on services, balances on investment income, balances on goods, services and income; balances on current account; and balances on capital account (Stein, n.d., para. 3). This paper will thus discuss the impact of surplus/deficit in the abovementioned areas.

According to the monthly report released by the Ministry of Finance, Custom Office (Japan), merchant trade balance measures visible trade (i.e. trade in goods such as automobiles and electronics). In other words, merchant trade balance measures the differences between Japan’s exports and imports of goods (services are excluded). A trade surplus occurs when aggregate exports exceed aggregate imports while a trade deficit (indicated by a negative value) occurs when aggregate imports exceed aggregate exports. Movements in the merchant trade balances reveal changes in demand for the domestic currency which can also alter the currency’s value. For example, a surplus in merchant trade balances may cause the domestic currency to appreciate. On the other hand, a deficit in the merchant trade balance is likely to depreciate the value of the local currency in light of the declining demand for the currency in the forex market (Ministry of Finance, n.d., para. 1).

Trade balance is a critical component of a country’s gross domestic product (GDP). It is important to mention that trade balance comprises of both goods and services. Anything that impact inequitably on exports and imports can as well impact trade balance. Price and non-price competitiveness is of particular interest in this regard. Consequently, a trade balance will occur especially if external pressure reduces the prices of goods [and services] exported by a country. In addition, there will be a deficit on balance on goods and services if the country’s GDP growth rate is higher than those of trade partners in view of the fact that imports are elastic to GDP. Another critical aspect with respect to balance on services is the currency exchange rate of a country. For example, an undervaluation of the local currency can result in trade surplus on balance on goods and services while the opposite effect (overvaluation) can cause a trade deficit on balance on goods and services (Piana, 2006, para. 3).

Ever since 1973, the current account has been used in many discourses to refer to either surplus or deficit in the balance of payments. The current account consists of investment income earned in foreign countries; trade in goods and services; as well as unilateral transfers. However, it does not include the capital account which comprises the sale or procurement of securities and other assets. Since the capital account and the current account sum up to the total account (which is automatically balanced), a deficit in the capital account is necessarily followed by an identical surplus in the current account and vice versa. Consequently, a surplus or deficit in the capital account cannot be assessed or explained devoid of a concurrent assessment and explanation of an identical surplus/deficit in the current account ((Stein, n.d., para. 6).

A deficit in a country’s current account is caused by several factors such as: higher gross national product (GNP); higher price level; lower barriers to imports; higher interest rates; and better incentives to investment opportunities in comparison to the conditions in other trade partners. The impact of a change in the abovementioned aspects on the current account cannot be envisaged without taking into account the impact on other causal aspects. For instance, if the US raises tariffs, Americans, will procure a smaller number of imports thereby decreasing the deficit in the current account. Nonetheless, this reduction will take place only if one of the other aspects alters to reduce surplus in the capital account. If none of the abovementioned aspects alters, the decline in imports (as a result of high tariffs) will bring about a decrease in the demand for foreign currency. As a result, the value of the US dollar will rise making imports cheaper and export expensive. The net outcome is that an increase in the tariff will not alter the current account in any way (Stein, n.d., para. 7).

The presence of a deficit in the current account does not reflect bad economic situations. For instance, if a country has a deficit in her current account, this implies that the country is importing capital. The current account deficit is merely a reaction to the country’s economic conditions. For example, it may be due to low productivity, excessive inflation or insufficient saving. What’s more, the deficit could also be due to the profitability of investments in the country. For example, in 1980s, the US current account balance shifted from a surplus of $5 billion to a deficit of $160 billion. During this period, the deficit in the US goods and services increased by the same amount. Nonetheless, the number of people employed during this period increased by over 12 million. This implies that a deficit in the current account increases income balances as well as investment income balances in a country and vice versa (Stein, n.d., para. 8).

References

Ministry of Finance. (n.d.). Merchandise Trade Balance Monthly: Japan. Web.

Piana, V. (2006). Trade Balance: Bilateral import promotion as a key to trade balance improvementWeb.

Stein, H. (n.d.). The Concise Encyclopedia of Economics: Balance of Payments. Web.