International business 7e czinkota moffett ch06

Chapter 6
The Balance of
Payments
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Learning Objectives
To understand the fundamental principles of how
countries measure international business
activity,
the balance of payments
To examine the similarities of the current and
capital accounts of the balance of payments
To understand the critical differences between
trade in merchandise and services and why
international investment activity has recently
been controversial in the United States
To review the mechanical steps of how exchange
rates are transmitted into altered trade prices
and eventually trade volumes
To understand how countries with different
government policies toward international trade
and investments, or different levels of economic
development, differ in their balance of payments

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Introduction
The measurement of all
international economic transactions

between the residents of a country
and foreign residents is called the
balance of payments (BOP)
The two major sub accounts of the
balance of payments are:
Current account
Capital account

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Fundamentals of Balance
of Payments Accounting
The balance of payments must balance
Subaccounts may be imbalanced

Three main elements to the process of
measuring international economic
activity include:
Identifying what is and is not an
international economic transaction
Understanding how the flow of goods,
services, assets, and money creates debits
and credits to the overall BOP
Understanding the bookkeeping
procedures for BOP accounting

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Defining International Transactions
Identifying many
international
transactions is
ordinarily not difficult
However, some
international
transactions are not
obvious
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The BOP as a Flow
Statement

The BOP is often
believed to be a
balance sheet rather
than a cash flow
statement
There are two types of
business transactions
that dominate the BOP:
Real assets
Financial assets

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BOP Accounting: DoubleEntry Bookkeeping

BOP employs an
accounting
technique called
double-entry
bookkeeping
In this age-old
method every
transaction
produces a debit
and a credit of the
same amount

A debit is created
whenever:
An asset is increased
A liability is
decreased
An expense is
increased

A credit is created
whenever:
An asset is decreased
A liability is increased
An expense is
decreased

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BOP Accounting: DoubleEntry Bookkeeping
The measurement of all international
transactions in and out of a country
over a year is a difficult task
Mistakes, errors, and statistical
discrepancies will and do occur
Current and capital account entries
are recorded independent of one
another, not together as this
accounting method would prescribe
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The Accounts of the
Balance of Payments
The BOP is comprised of two primary subaccounts:

Current Account
Financial/Capital Account
Two additional and important subaccounts of the BOP include:

Net Errors and Omissions Account
Official Reserves Account

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The Current Account
This account includes all
international economic

transactions with income or
payment flows occurring within
the year, the current period
It consists of four subcategories:
Goods trade
Services trade
Income
Current transfers

This account is typically
dominated by Goods Trade

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The Current Account
The Balance on Trade (BOT) refers
specifically to the balance of exports and
imports of goods trade only
The deficits in the BOT of the past decade
have been an area of concern for the U.S.
Merchandise trade is the core of
international trade and has three major
components:
Manufactured goods
Agriculture
Fuels

The most encouraging news for U.S.
manufacturing trade is the growth of

exports in recent years

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The Capital and Financial
Account
This account of the BOP measures all international economic transactions of financial assets
It is divided into two major components:

Capital Account
Financial Account

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The Capital Account
The Capital Account is made up of transfers of:

Financial assets
The acquisition and disposal of
nonproduced/nonfinancial assets

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The Financial Account
The Financial Account
consists of three
components:

Direct investment
Portfolio investment
Other asset investments

The contents of this account
are for all intents and
purposes the same as those
of the Capital Account under
IMFs BOP accounting
framework used prior to 1996
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Net Direct Investment
This is the net balance of capital
dispersed out of and into the U.S.
for the purpose of exerting control
over assets
Follows the 10% ownership
threshold rule
The source of concern over foreign
investments in any country focuses
on two topics:
Control
Profit

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Portfolio Investment

This is the net balance of capital that
flows in and out of the U.S., but does
not reach the 10% ownership
threshold of direct investment
It is capital invested in activities that
are purely profit-motivated rather
than ones made in the prospect of
controlling or managing the
investment
These have shown much more volatile
behavior than net direct investments
over the past decade
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Other Investment
Assets/Liabilities
This category consists of:
Short-term trade credits
Long-term trade credits
Cross-border loans from all types of
financial institutions
Currency deposits
Bank deposits
Other accounts receivable
Accounts payable
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Official Reserves

Account

This is the total currency
and metallic reserves
held by official monetary
authorities within the
country
Its significance depends
on whether the country
is operating under:
A fixed exchange rate
regime
A floating exchange rate
system

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The Balance of Payments-Total
The International Monetary Fund (IMF) is the
multinational organization that collects the
BOP statistics for over 160 different
countries around the globe
The current, capital, and financial accounts
combine to form the basic balance and is one
of the most frequently used summary
measures of the BOP
The current, capital, financial, and net errors
and omissions accounts combine to form the
summary measure known as the overall

balance or official settlements balance

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The Balance of Payments
and Economic Crises
The sum of cross-border
international economic activity can
be used by international managers
to forecast economic conditions
and in some cases, the likelihood of
economic crises
The mechanics of international
economic crises often follow a
similar path of development
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The Asian Crisis
The roots of this currency crisis
extended from a fundamental change in
the economics of the region
It started as early as 1990 in Thailand
The most visible roots were the excesses
in capital flows into Thailand in 1996 and
early 1997
Corporate socialism, corporate
governance, banking liquidity and
management are underlying causes that

apply to every nation facing economic
crisis
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Capital Mobility
The degree to which capital moves
freely cross-border is critical to a
country’s balance of payments
The ability of capital to move
involves economic and political
factors
Obstfeld and Taylor (2001) studied
the globalization of capital markets
and argued the post-1860 era can be
subdivided into four distinct periods
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Capital Flight
Capital flight is the sudden
and shocking outflow of
capital from a nation’s
economy in which it is
perceived there is political,
economic, or currency
crises forthcoming
Five primary mechanisms
exist by which capital may
be moved from one country

to another
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The Cases of China and
Turkey
The Chinese
balance of
payments serves
as an interesting
example of one
country’s ongoing
efforts to manage
its current and
financial accounts

Turkey’s economic
and financial crisis
of 2000-2001
serves as a prime
example of how a
country’s balance
of payments can
deteriorate or
essentially collapse
in a very short
period of time

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