ECON 5335 — International Economics Chapter 3 The

ECON 5335 - International Economics Chapter 3 The Balance of Payments

Preview The purpose of a national balance of payments accounts Accounting principles Sub-accounts of the balance of payments Compare balance of payments accounts for different countries The macroeconomic role of the Balance of Payments The role of Savings and Investment International investment position 2

Concept map – Ch. 3 3. 1 The Concept of the Balance of Payments 3. 2 Accounting Principles in the Balance of Payments Chapter 3 – The Balance of Payments 3. 3. 1 Current account 3. 3 Main Categories and Subcategories in the Balance of Payments 3. 3. 2 The Financial Account 3. 3. 3 The Capital Account 3. 3. 4 Putting it all together 3. 4 How the Balance of Payments Affects Economic Growth

The Concept of the Balance of Payments 14 th century – British “mercantilists”: encourage exports and discourage imports 17 th century: “balance of trade” 18 th century – David Hume: “price-specie flow” 1944 Bretton Woods: empower International Monetary Fund (IMF) to gather and organize international trade data Balance of Payments: it encompasses and accounts for all the international transactions (whether monetary or not) that happen between one country and the rest of the world. 4

Accounting Principles “Double-entry” book-keeping: in every transaction there actually two flows: the physical good or delivery of the service money is used to pay for the physical good or service The Balance of Payments must (in theory) balance - the Balance of Payments must add up to zero. Special cases: Foreign aid; Mis-measurement of flows 5

Main categories of the Balance of Payments Current Account – this contains items relating to trade and income flows from investments and other factors of production; Financial Account: this contains flows of assets between countries, and incorporates changes of ownership of assets as well Capital Account: this contains flows of assets that are specifically earmarked for investment – for example official debt forgiveness and the money migrants bring into the country 6

Sub-categories of the Balance of Payments – Current account Line Item US (in US$m) Italy (in euro millions) China (in 100 m US$) Nigeria (in naira m) i) Exports of Goods 1, 561, 239 390, 150 20, 569 14, 234, 176. 05 ii) Imports of Goods 2, 302, 714 370, 150 17, 353 9, 484, 431. 97 -741, 475 20, 000 3, 216 4, 749, 744. 09 iv) Exports of Services 649, 346 82, 762 1, 914 520, 914. 39 v) Imports of Services 442, 527 82, 983 2, 812 3, 782, 982. 23 vi) Services Trade Balance 206, 819 -221 -897 -3, 262, 067. 84 -534, 656 19, 779 2, 318 1, 487, 676. 25 viii) Income Receipts 776, 364 51, 081 1, 604 138, 088. 24 ix) Income Payments 552, 437 62, 271 2, 026 3, 643, 780. 02 x) Income Balance 223, 928 -11, 190 -421 -3, 505, 691. 78 xi) Unilateral Transfers -129, 688 -18, 087 34 3, 356, 003. 01 xii) Current Account -440, 416 -9, 498 7 1, 931 1, 337, 987. 48 iii) Merchandise Trade Balance vii) Balance on Goods and Services

Sub-categories of the Balance of Payments – Current account cont. 8

Sub-categories of the Balance of Payments – Current account cont. 9

Sub-categories of the Balance of Payments – Current account cont. 10

Sub-categories of the Balance of Payments – Current account cont. 11

Sub-categories of the Balance of Payments – Current account cont. Cumulative Current Accounts in US$m: 1980 -2008 12

Sub-categories of the Balance of Payments – Financial account Line i) ii) Item Direct investment abroad Inward direct investment Portfolio investment abroad – iii) equities iv) Portfolio investment - debt Domestic portfolio investment – v) equities Domestic portfolio investment – vi) debt vii) Other investments abroad viii) Other investments by foreigners ix) Reserve assets flowing abroad Reserve assets flowing into x) country xi) Net financial derivatives xii) Financial Account US (in US$m) -388, 293 166, 411 Italy China (in euro (in 100 m US$) millions) -23, 836 -624 6, 832 2535 Nigeria (in naira m) -126, 202. 88 1, 360, 237. 43 -144, 823 -17, 145 20 -227, 071. 01 * 76, 846 -84 -20, 642. 82 196, 908 16, 124 299 395, 514. 28 156, 385 -39, 288 243 397, 506. 93 440, 106 -369, 742 -4, 460 -43, 269 38, 572 -1, 461 -2316 -284 -1101 -2, 685, 958. 56 111, 929. 77 -46, 604. 41 393, 922 * 136 * -7, 064 439, 350 1, 727 15, 102 0 13 * -841, 291. 27 -211

Sub-categories of the Balance of Payments – The Capital Account Introduced by IMF Included two components: 1. Transactions in non-financial assets (such as patents, copyrights and leases) and 2. Transactions in factors of production (such as land labor) Can be listed separately or combined with other accounts. 14

Sum of the Balance of Payments Accounts Line -440, 416 Italy (in euro millions) -9, 498 439, 351 15, 102 -211 -841, 291 Capital Account 6, 956 783 43+-966 0 Sum of i) to iii) Statistical Discrepancy -[iv)] 5, 891 6, 387 1763 496, 696 -5, 891 -6, 387 -798 -496, 696 0 0 0. 7 25. 2 26. 0 22. 8 Item i) Current Account ii) Financial Account iii) iv) v) vi) Balance of Payments [iv) + v)] vii) Statistical Discrepancy as % US (in US$m) China Nigeria (in 100 m (in naira m) US$) 1, 931 1, 337, 987 15

How the Balance of Payments Affects Economic Growth National Income: Current Account (CA): Y = income derived from production C = total amount spent on consumption goods I = investment G = government spending CA surplus: increase Y, stimulate growth CA deficit: drag on economic growth 16

How the Balance of Payments Affects Economic Growth A lot depends on why CA is negative CA could turn negative because domestic consumers suddenly prefer foreign products – this would be a problem and clearly would detract from domestic growth If CA is negative it could reflect good internal growth in the economy that is faster than other countries – that would not be a problem

How the Balance of Payments Affects Economic Growth cont. Current Account (CA): Amount of income that we earn from producing goods and services Amount of what we spend domestically on both goods produced at home and abroad. CA surplus: our income is greater than what we spend – so the difference must be accounted for by the exporting that we do compared to how much we import CA deficit: our income is smaller than the amount that we spend on goods and services, so this implies that we must be importing goods 18 and services

How the Balance of Payments Affects Economic Growth cont. National Saving Current Account ‘truism”: the way we set up the national accounts means that given our definition of national saving it has to be true 19

Chapter summary The Concept of the Balance of Payments Accounting Principles Main categories of the Balance of Payments Sub-categories of the Balance of Payments: Current account, Profile of world economy, Financial Account, Capital Account How the Balance of Payments Affects Economic Growth

MBA Annex Saving, Investment and the Current Account International Investment Position

Saving, Investment and the Current Account Introducing the variable T (taxes) Government Budget Balance = T - G 22

Saving, Investment and the Current Account cont. Interpreting equation: Current account is the difference between the total level of savings in a country and the actual level of investment that a country does. Financial and Capital accounts combined So if I > S, this means that investment is being financed by foreigners, so that FA > 0 23

Balance of Payments and International Investment Position Balance of payments is a measure of flows But flows become stocks over a period of time So what is the stock variable equivalent of the flow of tangibles, intangibles, assets or money flows? This is accounted for by the International Investment position Measures domestic assets owned by foreigners and domestic ownership of foreign assets

International Investment Position Private assets owned abroad US (2011) Italy (2012) China (2012) Nigeria (2010) 15, 712. 8 1, 648, 259 1, 788 51, 329 Government assets owned abroad 178. 9 102, 460 Reserve assets owned abroad 536. 0 213, 788 3, 388 32, 339 21, 132. 4 1, 964, 467 5, 176 83, 668 Foreign owned official assets 5, 250. 8 984, 182 11, 696 Foreign owned other assets 15, 333. 4 1, 368, 037 82, 982 Total foreign owned assets 25, 162. 6 2, 352, 219 3, 439 94, 678 Net international investment position -4, 030. 3 -370, 966 1, 737 -11, 009 Total assets owned abroad US: $bn; I: €mn; China: US$bn; Nigeria: US$mn 25