One of the more important measures in regard to international economics is the balance of payments. Think of it as a national accounting measure that looks at the flow of goods and services into and out of an economy in a given period of time. It also shows capital flows into and out of a country. Until 1980, the United States tended to run a positive-to-neutral balance of payments position and was a creditor nation. In the course of the past 30 years, the United States has moved to a negative balance of payments and to being a debtor nation.
Review and discuss the following:
- Discuss the importance of the balance of payments as an accounting measure.
- Discuss the current account and its components and the capital and financial accounts and their components.
- How important is the U.S. deficit in traded goods in regard to the balance of payments?
Discuss the importance of the balance of payments as an accounting measure.
Generally, Balance of Payment is understood as a sum / record of financial transactions (international). However, another understanding of the balance of payment is recorded as evidence of imports and exports of goods/services of a particular country.
From the study of this subject, we learn that the balance of payment (BoP) has three parts, which are 1) Capital Account, 2) Financial Account, and 3) Current Account. All these three components make it an accounting measure, as they provide evidence regarding trade and health. For instance, the current account provides evidence or information regarding international trade and return on investment (net income) and direct payments.
Also, the Balance of Payment provides information regarding the size of exports and imports. It is vital information, as it facilitates determining the health of an economy. For instance, if exports are greater than imports, we conclude that the economy is producing quality products at a competitive price. Therefore, Balance of payment is not only an accounting measure, but also it is an economic indicator that provides essential information regarding the size and health of the economy.
For economists, Balance of Payment is important, as an accounting measure, because it provides quite detailed data regarding the flow of money, in and out of the country. For instance, for instance, economists may learn about various kinds of international transactions by emphasizing on Balance of Payment and its various components. However, it must also be acknowledged that current economies are complex and only Balance of Payment cannot provide desired information that is required to understand an entire economy. For instance, increase in imports may also positively affect the economy (Blejer & Skreb, 2007).
Discuss the current account and its components and the capital and financial accounts and their components.
Current Account is constituted by 1) Net Income, 2) Trade Balance, and 3) Direct Payments. The trade balance is information or evidence regarding an economy’s imports and exports of services and goods. For instance, Current Account will reveal how much of the goods and services which are produced in the country have been sold in markets in other countries. If the current account is in deficit, it suggests that imports are more than exports, and if current account is surplus, it indicates that exports exceed imports (Amadeo, 2018).
There are four elements of the Current Account, which are 1) Trade, 2) Direct Transfers, 3) Net Income, and 4) Asset Income. Trade is considered a major part of the current account. For this exact reason, the current account would be in deficit, if there is a trade deficit. Currently, United States’ current account is in deficit as the United States is facing an immense trade deficit. As per statistics, United States’ trade deficit with China alone was around $385 billion in the year 2016.
The net-income is residents’ income minus income of the foreign workers, and direct transfers are the foreign remittances. Asset income is a return on financial investment, which is affected by some factors.
Capital Account, which constitutes the balance of Payment along with Current and Financial account, has sub-accounts. These sub-accounts are 1) Capital Transfer, and 2) Acquisition and Disposal of Non- financial and Non- produced Assets. Capital transfer measures the volume of capital transfer, such as insurance payments by foreign companies, whereas acquisition and Disposal of Non- financial and Non- produced Assets measures are selling and buying of intangible and tangible assets (Kimberly, 2018). (Note: Capital Account measures such transactions, which affect the economy and income in the long run.)
Financial Account, which components are Direct Investment, Portfolio Investment, and Reserve Assets, covers liabilities or claims of a financial type, which pertain to foreign residents. It is in fact mostly viewed as an instrument that provides evidence regarding the change of ownership about international ownership.
How important is the U.S. deficit in trade goods regarding the balance of payments?
The element of the balance of payment, which provides evidence regarding the surplus/neutral/deficit nature of trade, is a current account. As per information, the United States is facing current account deficit because of the extraordinary increase in imports. For instance, the United States is running a trade deficit against both its neighbors. The trade deficit against Mexico is around $64.1 billion, in the year 2016; whereas the trade deficit with Canada is $17.5 billion, in the year 2017. Against China, one of the largest manufacturing economies in the world, the trade deficit exceeds $380 billion (figure from 2016) (Office of United States Trade Representative, 2018).
We also learn that US capital has flown to developing countries. American companies are manufacturing goods that to be sold in lucrative markets around the world, including the United States. Most of the economists are of the view that a trade deficit, of small size, does not adversely affect the economy. In fact, smaller current account deficits positively affect inflation, consumer surplus, and innovation. However, in case of the United States, it is quite evident that the trade deficit is abnormal in size. With China alone, the trade deficit is around $385 billion (in the year 2016), which is enormous.
This huge trade deficit is causing deindustrialization, as American companies are shifting their manufacturing operations to those countries, in which cost of production is low. Several American companies are now manufacturing in labor-intensive economies and selling their products in the United States, because of trade agreements such as North Atlantic Free Trade Agreement.
One of the many consequences of de-industrialization (caused by trade deficit), is unemployment, which directly affects consumption (the engine of economic growth). Therefore, we can conclude that trade deficit and flight of capital are adversely affecting the American economy and making it difficult for the United States to realize primary economic objectives such as 1) Full employment and 2) Sustainable economic growth.
References
Amadeo, K. (2018, March 6). Balance of Payments, Its Components, and Deficit Versus Surplus. Retrieved from https://www.thebalance.com/what-is-balance-of-payments-components-and-deficit-3306278
Blejer, M. I., & Skreb, M. (2007). Balance of Payments, Exchange Rates, and Competitiveness in Transition Economies. Springer Science & Business Media.
Kimberly, A. (2018, April 8). Measured, and Examples. Retrieved from the balance: https://www.thebalance.com/what-is-the-capital-account-measurement-and-examples-3306266
Office of United States Trade Representative. (2018, January 1). U.S.-Mexico Trade Facts. Retrieved from https://ustr.gov/countries-regions/americas/mexico#
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