BALANCE OF TRADE and BALANCE OF PAYMENT

BALANCE OF TRADE and BALANCE OF PAYMENT

 

               Here, we would like to make a sharp distinction between balance of international trade and balance of international payments as they are often confused by the readers. By balance of international trade we mean, statement that takes into account the total value of exports and imports of visible commodities of a country during a year. By visible commodities is meant the commodities which when exported or imported are recorded to the trade accounts at the ports. Balance of imported are recorded to the trade accounts at the ports. Balance of payments, on the other hand, is a statistical statement of income and expenditure both of the visible and invisible items of trade on international account during a calendar year. Invisible items are those items which are not shown in the trade accounts at the time of their imports. Under this heading comes all the receipts and payment made for the international services such as banking, shipping, educational, insurance, travel, etc. when the total value of visible exports is in excess to total value to visible imports during a year, the country is said to have favourable or positive balance of trade. Conversely, when the total value of goo imported exceeds the total value of goods exported, the country is said to have unfavourable balance of trade. The mercantilists believed that a favourable balance of trade indicates that country is heading towards prosperity while unfavourable balance of trade is a sign of approaching national disaster. When exports are greater than imports, they say gold is brought into country and national wealth in increased. When imports exceed exports, gold is taken out of the country and this leads to reduction in national wealth. The importance of service transactions and other invisible item was under estimated by them.

       The modern economists, however, differ with this view. They are of the opinion that a country’s prosperity or adversity in not judged by its favourable or unfavourable balance of trade but by its favourable or unfavourable balance of payment in England, for instance with the exception of 1958 had an adverse balance of trade since 1890 but its national wealth during these long years was increasing at a very last rate. It was because of this fact that its debt balance visible trade was offset by its credit balance on invisible trade. We conclude therefore, that favourable balance of trade is not an index of the economic prosperity or poverty of the country. It is the balance of payment which serves as a better guide to its economic position. If a country has persistently unfavourable balance of payments, it can be safely taken as a sing of apporoaching national disaster. Temporarily, a country may have favourable or unfavourable balance payments but on the long run, it must balance its payment, otherwise, it will be inviting troubles.

PRESENTATION OF INTERNATIONAL BALANCE OF PAYMENTS

        The total balance of international payments is customarily divided into section;

(1) The balance of international payments on current account.

(2) The balance of international payments on capital account. The movement of gold coins and bullion is sometimes shown separately in the next section.

 (1)  THE BALANCE OF INTERNATIONAL PAYMENTS ON CURRENT ACCOUNT:

        The balance of payment, as we know, is built lip inn terms of credit and debit entries. On the side of credit account, the amount which a country has to receive from the other country is shown, while on the debt side of the account, the payment which has to be made to other countries is entered. In the balance of payment of current account only those item are entered which do not create a new item or cancel a previously existing capital claim.

   THE MAIN CREDIT ITEM IN THE BALANCE ON CURRENT ACCOUNT ARE AS FOLLOW:

(1) Value of merchandise exports

(2) Payments received from foreigners for rendering banking and shipping services.

(3) Travel expenditure of the foreign tourists in the country.

(4) Expenditure of foreign students.

(5) Remittances of money by the nationals of the country living in other country.

(6) Income on investment (interest and dividend, etc.) from abroad.

(7) Charity contributions made to the institutions by the foreigners.

(8) Miscellaneous government transactions such as sale as of diplomatic representative, repatriation, military and payments, etc.

    THE MAIN DEBIT ITEMS IN THE BALANCE OF PAYMENTS ON THE CURRENT ACCOUNT ARE:

1. Value on merchandise imports.

2. Payments made to the foreigners for rendering banking and insurance and shipping services for the country.

3. Travel expenditure of country’s tourists in other countries.

4. Payments made to country’s students studying abroad.

5. Remittance by immigrants to their home country.

6. Interest and dividend payment by the foreigners to their home countries.

7. Donations sent to other countries.

8. Miscellaneous government transaction such as salaries of diplomatic representatives, repatriation; military aid payments, ect, To other countries.

(2) THE BALANCE OF PAYMENT OF INTERNATIONAL PAYMENTS ON CAPITAL ACCOUNT:

            The balance of international payments on capital account is split up into two parts,

  (i) The balance of payment on long term capital account

  (ii) The balance of payment on short term capital account in the balance of international payment on long term capital account, we include the net private and government long term loans and net long term foreign investment. The short term capital account is composed of (1) private or government short term loans and (2) net investment in short term debts.

     The movement of capital from one country to another country takes place due to three reasons; firstly, when country has to make investment abroad, Secondly when it has to advance loans to another country, Thirdly when the capital has to shifted due to safety reasons, The movement of capital from one country to another has a serious repercussion on the international payment on current account when the capital is shifted to another country, a payment is to be made. Therefore, it is a debit entry and when we borrow from abroad, we receive payment, therefore it is credit entry. If we have a favourable balance on current account, it may be offset by a debit account balance on capital account.

GOLD MOVEMENTS:

          Gold is sometimes an important balancing item. If the deficit on international account exists, it is covered by shipping gold from one country to another. U.S.A received large quantity of gold from other countries in the 1930’s.

EQUILIBRIUM OF BALANCE OF PAYMENTS

     The balance of international payment is a statement that takes into account the debits and credits of a country on international account during a calendar year. When a country has unfavorable or adverse balance of payment, it is regarded as herald of disaster because the country by have deficit in her balance of payment either decreases her balances abroad or increases her foreign debit. When it has favourable credit balance, it is considered that country is heading towards prosperity because by having surpluses, it either increases her foreign credits or reduces her foreign debits.

     There is no doubt that a study of country’s balance of payment reveals much information about its economic position and development of the country. But when we are to see that a country is heading towards financial bankruptcy or higher standard of living, we are to examine the balance of payment of many years of that country. A persistent deficit in the balance of payments on current account certainly leads to economic and financial bankruptcy. A continued favourable balance on current account is also disadvantageous because it creates difficulties for other counties. The credit country may utilize her surplus in advancing short or long term loans to the debtor country. But if it gives no opportunity to the debtor country to repay the loan by exporting more, then how can the loans he realized? The hard earned surplus of the credit country will then one day be turned into gifts and this may create political difficulties for the creditor country. We have seen, thus that a country should neither have unfavourable nor favourable balance of payment on current account in perpetuity. It must obtain equilibrium in her balance of payments over a reasonable period of time. From this it may not be concluded that a country should balance her account every year with every country with which it has trade relations. A country may have favourable balance of payment with one country and unfavourable with another but in the long run it must balance her account. The total liabilities and total assets of all nations related to one currency block must balance over a reasonable period of time.

  CAUSES OF DISEQUILIBRIUM IN THE BALANCE OF PAYMENT:

            Balance of international payment is a summary account of total debits and credits of a country during a year. It includes both visible and invisible trading terms, i.e. merchandise imported and exported, interest on dividend receive and paid, payments and receipts of transport services, commission, insurance, brokerage, etc. received and paid money lent abroad or borrowed, movement of gold, etc. disequilibrium in the balance of payment can arise due to persistently one sided movement of one or more than one trading terms. If for instance, the total value of goods imported over a given period and this surplus is not offset by the debit balance on invisible item, the country will have favourable balance of payments. Disequilibrium in the balance arises when exports of a country fall short of imports because of decrease in production at home, due to stiffer competition abroad or of an appreciation in the currency or fall of purchasing power of the buyers in the foreign market when the imports remain unaffected or increase, then the country will have disequilibrium in her balance of payments. Disequilibrium in her balance of payments can also arise over a given period due to excessive imports not equalized by exports of invisible item and if it is not offset by credit balance on visible items, the country will face disequilibrium in her balance of payments.

CORRECTION OF DISEQUILIBRIUM IN THE BALANCE OF PAYMENTS

        We have state earlier that country must obtain equilibrium in her balance of payments with other country in the long run. When the balance of payments is favourable, it can looked at with satisfaction from her point of view because the surplus will be invested abroad in securities. But if a country has deficit balance in perpetuity, it must be certified by taking necessary steps. The days of the gold standard are gone when the balance was corrected automatically under gold standard an active or passive balance accompanied by an inflow or outflow of gold was normally supposed to result in an expansion or contraction of the domestic money supply, and this expansion or contraction was expected to bring about a rise or fall in the level of domestic costs and prices tending in the latter, to discourage imports and stimulate exports. Gold flow, changes in the quantity of money, and changes in relative price levels, thus appeared as the principal factor in the mechanism of adjustment. But, now-a-days when every country is on inconvertible standard, steps are to be taken to correct the adverse balance of payments. The main methods adopted to cover a deficit in balance of payment of a country are as follows:

(i)   Rectifying the balance of trade: one of the major items which can adversely affect the balance of payment of a country is the excess of imports over exports. Inn case of a deficit of the balance of payments, a country must try to stimulate exports or discourage imports or do both. The exporters can encouraged by bringing down the level of costs in the country or by granting bounties or by giving concessions to industrialists and exporters. Imports can be restricted either by adopting quota system or by imposing duties or by reducing people’s disposable income or by higher taxation or by a reduced government expenditure or by total prohibitions etc.

(ii) Deflation: Deflation is another important weapon which is used to correct the unfavourable balance of payment. The currency authority may try to lower the price by reducing the quantity of money in circulation. If the country succeeds in bringing down the prices , it then becomes a good market to sell in. Exports are encouraged, and imports fall and thus the deficit gap is greatly reduced. This method when adopted is full of dangers. If by contracting supply of money, the prices are lowered, the rigid costs may not be brought down. Labour may oppose the reduction in the wages. This can lead to depression and unemployment in the country which may prove very dangerous. By 30%

(iii) Devaluation: devaluation is a remedy which is applied only in times of extreme crisis to correct the adverse balance of payments. Devaluation means the lowering of the exchange rate. This method like devaluation is adopted to cheapen exports and make imports dearer, devaluation, thus, raises exports and lowering imports. England devalued the value of pound from 4.03 dollars to 2.80 dollars, i.e. By 30% in September, 1949 to correct disequilibrium in her balance of payments. Pakistan first devalued its currency in 1955. The advantage with this method is that there is no need to reduce the money wages and the object is achieved. The disadvantage is that it shakes the people’s confidence in home currency.

(iv) Exchange control:  Exchange control is a very effective and useful method for correcting adverse balance of payment. Under this system, the government enforces a complete monopoly of buying and selling of foreign exchange in the foreign exchange market. The exporters are required to surrender their foreign exchange at fixed rates to the central bank. The central bank then rations out this foreign exchange among the licensed importers of essential commodities only. When imports are restricted to the available foreign exchange, the problem of adverse balance of payments is then greatly solved.

(v) International monetary fund: Deficit in the balance of payment can also be covered by obtaining assistance from international monetary fund. The IMF, which began its operation in march, 1941, helps member countries in maintaining equilibrium in the balance of payment. The international monetary fund has proved very helpful in promoting exchange stability and facilitating the settlement of international transactions.