Balance of Payments Continued in Economics
For examining the factors that affect international trade and lending first requires an understanding of the basics of balance of payments accounting. The Balance of Payments accounts, which are a part of the national income accounts are the record of the country’s international transactions.
When we examine the accounts, we can see that the current account measures a country’s trade in currently produced goods and services, along with unilateral transfers between countries. We can divide the current account into three separate components, (1) net export of goods and services, (2) net income from abroad and (3) net unilateral transfers.
Net Exports of Goods and Services: Net exports, NX or exports minus imports, as part of the expenditure approach to measuring GDP. Net exports are often broken into two categories: merchandise (goods) and services.
Merchandise consists of currently produced goods, such as American soy-beans, French perfume, Brazilian coffee and Japanese cars. When an American buys a Japanese car for example, the transaction is recorded as a merchandise import for the United States (a debit item for the United States, because funds flow out of the United States to pay for the car) and a merchandise export for Japan (a credit item for Japan because funds flow into Japan to pay for the car). The difference is called “merchandise trade balance”, or simply the trade balance.
Net Income from abroad: Net Income from abroad equals income from abroad minus the income payments to residents of other countries. It is almost equal to net factor payments from abroad, NFP. The income receipts flowing into a country, which are credit items in the current account, consist of compensation, received from residents, working abroad, plus investment income from assets abroad. Investment income from assets abroad includes interest payments, dividends, royalties and other returns that they own in other countries. The income payments flowing out of a country, which are debit items in the current account, consist of compensation paid to foreign residents working in the country plus payments to foreign owners of assets in the country.
Net Unilateral Transfers: Unilateral transfers are payments from one country to another that do not correspond to the purchase of any good, service, or asset. Ex are official foreign aid, or a gift of money from a resident in one country to family members living in another country. When the United States makes a transfer to another country, the amount of transfer is debit item because funds flow out of the United States. A country’s net unilateral transfers equal unilateral transfers received by the country minus unilateral transfers flowing out of the country.
Current account balance: Adding all the credit items and subtracting all the debit items in the current account yields a number called the current account balance. If the current account balance is positive- with the value of credit items exceeding the value of debit items- the country has a current account surplus. If the current account balance is negative – with the value of debit items exceeding the value of credit items – the value of credit items – the country has a current account deficit.
The Capital and Financial Account
International transactions involving assets, either real, or financial are recorded in the Capital and Financial Account is a newly defined category that encompasses unilateral transfers of assets between countries, such as debt forgiveness or migrants’ transfers. The Capital Account Balance measures the net flow of assets unilaterally transferred into the country.
Most transactions involving the flow of assets into or out of a country are recorded in the Financial Account. This account was called the Capital Account. When the home country sells an asset to another country, the transaction is recorded as a financial inflow for the home country and as a credit item in the financial account of the home country. When a home country buys an asset from abroad, the transaction involves a financial outflow from the home country and is recorded as a debit item in the home country’s financial account because the funds are flowing out of the home country.
The Financial Account Balance equals the value of financial inflows (credit items) minus the value of the financial outflows (debit items). When residents of a country sell more assets to foreigners than they buy from foreigners, the financial account balance is positive, creating a financial account surplus. When residents of the home country purchase more assets from foreigners than they sell, the financial account balance is negative, creating a financial account deficit. The Capital and Financial Account Balance is the sum of the capital account balance and the financial account balance. Because the capital account balance of the United States is so small, the capital and financial account balance is almost equal to the financial account balance.
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This is in continuation with our previous article in Economics on Balance of Payments.