Balance of trade and balance of payments Essay
Balance of trade and balance of payments
The balance of payments account indicates a systematic record of all export incomes and import payments of a country during any year. Any import from abroad has to be paid for. On the other hand, any export will bring money flow into the country. If we subtract the total value of the imported commodities from the total value of the exported commodities of a country, what we obtain is called the ‘Balance of Trade’ of the country. If the difference is positive, i.e. if the value of commodity exports exceeds the value of commodity imports, we say that the balance of trade is favourable.
If the difference is negative, we say that the balance of trade is unfavourable. Since commodities are visible but services are not, the difference between the values of exports and imports of commodities are referred to as the ‘Balance of Visible Trade’. On the other hand, the difference between the values of exports and imports of services is called the ‘Balance of Invisible Trade’. This balance of invisible trade is not included in the balance of trade. In other words, by Balance of Trade we mean the balance of visible trade only.
Foreign exchange can also be earned or spent in many other ways. If we subtract the total outflow or spending of foreign exchange by a country from the total inflow of foreign exchange, what we get is called the ‘Balance of Payments’. Therefore, the balance of trade of a country is an accounting of its exports and imports of goods only. On the other hand, the balance of payments is an accounting of its total exports and imports (including goods and services as well as other items). Items Entering Into Balance of Payments
We have already said that exports and imports of goods and services enter into the balance of payments. But foreign exchange can be earned and spent in other ways too. For instance, the country earns foreign exchange when a foreigner gives some money to a citizen of this country as a gift. Similarly, a citizen can give a gift to a foreigner. These are called unrequited or unilateral receipts and payments of foreign exchange. More important are ‘capital movements’ between countries. When foreigners invest in a country, the country gets foreign exchange.
These are called ‘capital receipts’ of the country. Capital receipts also arise if this country has lent money to another country in the past and that country now starts repaying the loan. On the other hand, a country faces ‘capital outflows’ if it invests money in other countries or repays foreign loans taken in the past. Thus, four types of income and expenditure of foreign exchange are included in the balance of payments:- 1. Exports and imports of visible commodities,
2. Exports and imports of invisible items (i.e. services),
3. Unrequited receipts and payments, and
4. Capital receipts and payments.
Adverse Balance of Payments
When we discuss the balance of payments in economic theory, we do not take into account the accommodating capital receipts and outlays. Thus, in economic theory the balance of payments may or may not be in equilibrium. If total autonomous earning of foreign exchange exceeds the total autonomous spending of foreign exchange in a given year, we say that the balance of payments is ‘favourable’, or that there is a balance of payments ‘surplus’. If autonomous earning falls short of spending, we say that balance of payments is ‘unfavourable’ or ‘adverse’ or that there is a balance of payments ‘deficit’. In both these cases the balance of payments is out of equilibrium, i.e. there is disequilibrium in the balance of payments. Causes of Adverse Balance of Payments
The main causes which can make the balance of payments of a country adverse are as follows:- 1. Lack of development of the production system- In a backward economy where the production system is not developed enough, all the necessities of life have to be imported. There are very few things that such a country can export. Naturally, such a country faces an adverse balance of payments. 2. Development efforts- When a backward economy tries to develop, it faces balance of payments difficulties again. Because the various development schemes often require the import of machines, raw
materials, etc. Naturally, these push up the import bill. This leads to an adverse balance of payments.
3. Population growth- A country with a high rate of population growth often faces an adverse balance of payments because the total demand for goods and services within the country cannot be met out of domestic production, again necessitating imports. 4. Natural calamities- Sometimes, natural calamities lead to a fall in production in the country. Under these circumstances the country has to import essential commodities to sustain its population. Exports also decline because of the damage to production, creating an adverse balance of payments.
5. Fall in exports due to change of tastes- The amount and the value of exports of a country depends on the foreign demand for the goods produced by the country. Sometimes, due to reasons beyond the control of this country, the foreign demand falls. This will reduce the country’s exports, creating adversity in the balance of payments. 6. Weak bargaining strength- In some cases the terms of trade as well as the volume of trade are determined by the relative bargaining powers of the exporting and the importing countries. If the exporting country is in a weak bargaining position, it fails to get remunerative prices for its products from the foreign countries. 7. Trade barriers- Finally, we should mention that every country wishes to limit imports and encourage exports. If the foreign countries raise trade barriers with a view to cutting down imports, this will limit the other country’s exports and will result in adverse balance of payments for them.
Adverse Balance of Payments
There are various steps that can be taken in order to remedy an adverse balance of payments. The basic task is to increase the inflow of foreign exchange and decrease its outflow. This can be done in several ways:- 1. Quotas- One obvious way of limiting the outflow of foreign exchange is to impose quotas. Quotas specify upper limits on imports of various goods. Imports in excess of these limits are not permitted. The importers are given licenses specifying how much they can import. The advantage of quotas is that they directly control the imports so that there is no uncertainty regarding their beneficial effects on the balance of payments.
2. Tariffs- The government can also impose tariffs, i.e. duties on imports. Import
duties, like sales taxes, are added to the price of the commodities. Thus, the prices of imported goods in the domestic market rise. The demand for such goods therefore falls. This reduces imports and is therefore, beneficial for the balance of payments. 3. Deflationary policies- If the government follows deflationary policies, this will reduce the level of effective demand in the economy. Demand for every commodity (domestic as well as imported) will decline, reducing the balance of payment deficit.
4. Devaluation- Another remedy is provided by devaluation of the domestic currency in relation to foreign currency. When the government of a country depreciates the value of domestic currency in terms of all foreign currencies irrespective of demand and supply conditions in the foreign exchange market, it is called devaluation of the domestic currency. 5. Export subsidy- Exports can be encouraged by giving subsidies to the exporters. Subsidies will enable the exporters to lower the prices of the exported goods. If the foreign demand for our exports is sufficiently elastic, this will increase the total value of exports and help in reducing the balance of payments deficit.
6. Other export incentives- the government can help the exporters in other ways also. For instance, income tax benefits can be given to the exporters. Various other types of concessions can also be given to the firms who export their products abroad. 7. Liberalization- In some cases the liberalization of imports (i.e. withdrawal of import restrictions) is beneficial for the balance of payments in the long run. This happens when the imported goods are used to increase the production of goods in general and exported goods in particular.
When we discuss the balance of payments in economic theory, we do not take into account the accommodating capital receipts and outlays. Thus, in economic theory the balance of payments may or may not be in equilibrium. If foreign exchange earning falls short of spending, we say that balance of payments is ‘adverse’ or that there is a balance of payments ‘deficit’. The several causes which can make the balance of payments of a country adverse are lack of development of the production system, development schemes, population growth, natural calamities, fall in exports due to change of tastes, weak bargaining strength and trade barriers.
There are various steps that can be taken in order to remedy an adverse balance of payments. The basic task is to increase the inflow of foreign exchange and decrease its outflow. This can be done in several ways, such as imposing quotas, tariffs, adopting deflationary policies, devaluation of domestic currency, giving export subsidies and liberalization of imports.