Balance of Payments

This article focuses on balance of payments. It provides an overview of the main categories of balance of payments accounts including current accounts, capital accounts, and financial accounts. The double-entry bookkeeping method used for balance of payments accounting is described. The article provides a close look at the United States' balance of payments accounts and practices. The connections between trade liberalization, economic globalization, and balance of payments are addressed.

Keywords Balance of Payments; Capital Account; Current Account; Deficit; Developing Countries; Double-Entry Bookkeeping; Economic Globalization; Exchange Rate; Financial Account; Globalization; Markets; Nations; Trade Liberalization; World Bank

International Business > Balance of Payments

Overview

Balance of payments (BOP) is a method used by countries to monitor and record international financial activities and transactions. The Federal Reserve Bank of New York defines balance of payments as “an accounting of a country's international transactions for a particular time period.” The balance of payments records all private and public sector trade activity and records the total of all money moving into and out of a country during a particular time period. The balance of payments may be recorded on a quarterly or annual basis. The balance of payments includes credits and debits.

• Credit refers to the money or payments a country has received during the balance of payments time period. Balance of payments credits include any transaction that causes money to flow into a country.
• Debit refers to the payments a country has made during a balance of payments time period. Balance of payments debits include any transaction that causes money to flow out.

A nation's balance of payments includes three separate accounts: The current account, the capital account, and the financial account, related to different types of international financial activity or transactions. The balance of payments should ideally or theoretically stand at zero. In practice, the balance of payments of most countries usually includes a trade surplus or deficit (Fieleke, 1996).

The following sections provide an overview of the three main categories in the balance of payments accounts and balance of payments record keeping practices. These sections serve as the foundation for later discussion of the United States' balance of payments accounts and practices. The issues associated with international governance of balance of payments practices are addressed.

Balance of Payment Accounts

Balance of payments includes three categories of accounts. These three accounts: Current accounts, capital accounts, and financial accounts, are described and analyzed below.

The Current Account

The current account reflects a country's inflow and outflow of goods, services, income, and current transfers. The current account includes a summary of a country's balance of trade. Revenue produced from investments and income-generating assets are included in the current account. The current account is considered to be a measure of a country's economic health and strength. Countries tend to have either a balance of trade surplus or deficit depending on the health and scale of their import and export programs. The current account includes four sub-categories: Merchandise trade, services, income receipts, and unilateral transfers.

• Merchandise trade refers to all raw materials and manufactured goods bought, sold, or given away.
• Services refer to activities such as tourism, transportation, engineering, and business services, such as law, management consulting, accounting, and fees from patents and copyrights.
• Income receipts refer to income derived from ownership of assets including dividends on holdings of stock and interest on securities.
• Unilateral transfers refer to one-way transfers of assets including worker remittances from abroad and direct foreign aid (Federal Reserve Bank of New York, 2004).

The Capital Account

The capital account reflects all of a country's international transfers. Examples of international capital transfers include the acquisition or disposal of non-financial assets. Capital transfers include debt forgiveness, migrants' transfers, the transfer of title to fixed assets, the transfer of funds connected to the sale or purchase of fixed assets, gift and inheritance taxes, death duties, and uninsured damage to fixed assets. In addition, capital accounts include transfers of non-produced, non-financial assets. Non-produced, non-financial assets refer to the sales and purchases of the rights to natural resources, leases, patents, copyrights, and trademarks (Federal Reserve Bank of New York, 2004).

The Financial Account

The financial account reflects all international monetary flows related to investment, business, real estate, bonds, stocks, foreign reserves, and direct foreign investments and assets. Foreign-owned assets include official reserve assets, government assets, and private assets. Examples of these assets include gold, foreign currencies, foreign securities, foreign credits, direct foreign investment, corporate securities, and direct investments (Federal Reserve Bank of New York, 2004).

Countries work to balance their capital and financial accounts. In practice, the goal of balanced accounts is not possible due to factors such as record keeping practices and exchange rate fluctuations, described in the next section.

Balance of Payments Record Keeping

Balance of payments record keeping follows double-entry bookkeeping accounting practices. For example, the amounts and figures involved are recorded on each of the two sides of the balance-of-payments accounts. While the two sides of the account would ideally be equal, this is rarely the case. The imbalances reflect surpluses or deficits in the national economy.

Balance of payments accounting practices and records include three main categories:

• Accounts dealing with goods, services, and income.
• Accounts recording gifts or unilateral transfers.
• Accounts on financial claims including bank deposits and stocks and bonds (Fieleke, 1996).

Common transactions recorded in the balance of payments record include the following:

• Commercial exports.
• Payment for commercial exports.
• Receipt of income from investment abroad.
• Commercial imports.
• Expenditures on travel abroad.
• Gifts to foreign residents.
• Loans to borrowers abroad.

Challenges to Balance of Payments Data Collection

Challenges, errors, and omissions are common in balance of payments data collection. For example, some international financial transactions go unreported. Purchases and sales of short-term financial claims are often underreported. Some transactions are consistently estimated rather than measured. There is often a difference in the value stated in accounting records and the value actually paid for a good or service. This difference in valuation can lead to disparity between debits and credits. In response to this problem, a residual account for statistical discrepancies has become standard practice in balance of payment accounting practices. This residual account gives strategy for satisfying the rule of double entry bookkeeping so that total debits must equal total credits (Fieleke, 1996).

In addition to statistical discrepancies, fluctuating exchange rates and the change in the value of money, can add to balance of payments discrepancies by changing the recorded value of transactions. An exchange rate is a comparison between a national currency and a foreign currency. Exchange rates and the global or macroeconomy are closely related. A country's exchange rate influences exports, imports, job rates, working conditions, external purchasing power of residents abroad, and trade balances. For example, a rising exchange rate depresses exports, boosts imports, and depresses the trade balance (Piana, 2001). International capital markets respond to exchange rate fluctuations and exchange rate volatility. Exchange rate variability and volatility depress trade and the economy in general. In an effort to limit exchange rate variability, international governance organizations, such as Group of Seven (G-7) industrialized countries and the European Union (EU), have explored the possibility of establishing informal target ranges for exchange rates. Currently, there is no international consensus on how currency relations among major regions should be approached or governed (Obstfeld, 1995). Ultimately, statistical discrepancies, accounting conventions, and exchange rate movements may combine to create significant discrepancies in balance of payments accounts. International governance organizations promote shared or standardized balance of payments record keeping in an effort to facilitate comparable accounting records and balanced trade relations.

Applications

The United States' Balance of Payments

The United States government and economic analysts track and monitor three measures of the balance of payment: The balance on goods and services, the balance on current account, and transactions in U.S. official reserve assets and in foreign official assets in the United States.

• The balance of payments on goods and services is measured by figuring the net excess of debits or credits in those accounts.
• The balance of payments on the current account is the net excess of debits or credits in the accounts for goods, services, income, and unilateral transfers.
• Transactions in U.S. official reserve assets and in foreign official assets in the United States measure the difference between the change in U.S. official reserves and the change in foreign official claims on the United States (Fieleke, 1996).

Federal Reserve Bank of New York

The Federal Reserve Bank of New York publishes information about United States' balance of payments terms and issues. General information about the process and purpose of balance of payments is included in the government document entitled "International Affairs Fedpoints." "Fedpoints" is a reference series explaining the structure and functions of the Federal Reserve System and the economic concepts relevant to its work. The Federal Reserve Bank of New York, as part of the Federal Reserve System, sets monetary policy to help promote national economic goals; promotes financial stability and banking stability in the United States and abroad; operates and oversees the United States' electronic wire transfer system commonly known as Fedwire; and provides banking and financial services to international institutions (Federal Reserve Bank of New York, 2004).

Bureau of Economic Analysis

The Bureau of Economic Analysis (BEA) is a sub-agency of the Department of Commerce. The Bureau of Economic Analysis produces economic accounts statistics that enable government and business decision-makers, researchers, and the American public to follow and understand the performance of the Nation's economy. The Bureau of Economic Analysis prepares national, regional, industry, and international account information on such key issues as economic growth, regional economic development, interindustry relationships, and the nation's position in the world economy (Bureau of Economic Analysis, 2007).

The Bureau of Economic Analysis includes balance of payments information as part of the data it prepares on international economic accounts. The Bureau of Economic Analysis refers to balance of payments as international transactions. It prepares quarterly and annual estimates of transactions with foreigners, including trade in goods and services, receipts and payments of income, transfers, and transactions in financial assets (Bureau of Economic Analysis, 2007). The Bureau of Economic Analysis publishes current and historical data about U.S. International transactions with the following geographical areas: Europe (1960-present), Canada (1960-present), Latin America and other western hemisphere (1960-present), Asia and the Pacific (1999-present), Middle East (1999-present), Africa (1999-present), and International organizations and unallocated areas (1960-present).

The United States includes the following categories within their current accounts, capital accounts, and financial accounts.

Current Account

The current account is comprised of:

• Exports of goods and services such as transfers under U.S. military agency sales contracts, passenger fares, and U.S. Government miscellaneous services.
• Income receipts.
• Compensation of employees.
• Imports of goods and services such as direct defense expenditures, royalties, and license fees.
• Income payments on foreign-owned assets in the United States.
• U.S. Government grants.
• U.S. Government pensions.
• Private remittances.

Capital Account:

The capital account is comprised of net capital account transactions.

Financial Account:

The financial account is comprised of U.S.-owned assets abroad such as:

• U.S. official reserve assets of gold, special drawing rights, and foreign currencies.
• Foreign-owned assets in the United States such as U.S. Government securities, U.S. Treasury securities, and U.S. liabilities reported by U.S. banks.
• Net financial derivatives.
• Statistical discrepancy amounts.

In the second quarter of 2007, the U.S. International Transactions News Release reported the following balance-of-payments data:

• Current account: The U.S. current-account deficit decreased to $190.8 billion in the second quarter of 2007 from $197.1 billion in the first quarter. A decrease in net unilateral current transfers to foreigners and increases in the surpluses on services and on income more than accounted for the decrease.
• Capital Account: Net capital account payments were virtually unchanged at $0.6 billion in the second quarter.
• Financial Account: Net financial inflows were $150.9 billion in the second quarter, down from $181.9 billion in the first. Net U.S. acquisitions of assets abroad picked up more than net foreign acquisitions of assets in the United States (Bureau of Economic Analysis, 2007).

The example of the United States' balance of payments data demonstrates the tendency of current accounts, capital accounts, and financial accounts to be out of balance (Weinberg, 2007).

Issues

Balance of Payments & International Governance Organizations

Trade liberalization and balance of payments policies are closely connected in the new global economy. With the increase in capital flows during the 1980s and 1990s, countries lifted trade restrictions to promote and facilitate economic liberalization. The global economy is characterized by growth (in populations and in output and consumption per capita), interdependence of nations, and international management efforts. Indicators of global growth and interdependence include the huge increases in communication links, world output, international trade, and international investment since the 1970s. The global economy is built on global interdependence of economic flows linking the economies of the world. The global economy is characterized by economic sensitivity. National economic events in one region often have profound results for other regions and national economies (Thurow, 1995). Business opportunities, including international investments and joint ventures, in the global economy are increasingly tied to trade pacts such as the North American Free Trade Agreement (NAFTA) between the United States, Canada, and Mexico, the Mercosur trade pact among South American countries, and the Asia Pacific Economic Cooperation (APEC) trade zone.

Global Financial Governance

Global financial governance, including the development and management of international financial architecture, is an increasingly important practice in the global arena. National economies exist not in isolation but in relationship and tension with other economies worldwide. The global economy includes numerous economic phenomena and financial tools shared between all countries. Examples include the price of gold, the price of oil, and the related worldwide movement of interest rates. The new global economy is characterized and controlled through global management or governance efforts. International organizations, both public and private, work to establish norms, standards, and requirements for international financial governance. These international organizations, including the International monetary Fund (IMF), the World Trade Organization (WTO), the Financial Stability Forum, the International Organization of Securities Commissions Organization for Economic Co-operation and Development (OECD), and the Basle Committee on Banking Supervision, develop and encourage implementation of standards, principles, best practices, and economic architecture (Preston, 1996).

The relationship between capital markets and international standards for financial governance is evolving as established and emerging markets and nations grow into one another. International economic organizations began forming in the twentieth century to manage and promote strong national economies. Economic development has been in existence, in some form, since the end of WWII. The modern era of aid to developing countries began in the 1940s as World War II ended. Developing countries, found primarily in Africa, Asia, and Latin America, are characterized by low per capita income, widespread poverty, and low capital formation. After WWII, world leaders and governing bodies put structures into place, such as the World Bank, United Nations, World Trade Organization, and International Monetary Fund, to prevent the economic depressions and instability that characterized the years following World War I. The efforts of the International Monetary Fund and the World Trade Organization to promote trade, in part through efforts to publish balance of payments data and promote standardized balance of payments practices, are described below.

The International Monetary Fund

The International Monetary Fund, founded in 1945, is an international organization of 185 member countries established to promote international monetary cooperation, exchange stability, and orderly exchange arrangements; to foster economic growth and high levels of employment; and to provide temporary financial assistance to countries to help ease balance of payments adjustment. The International Monetary Fund develops standards and codes of good practice and economic responsibility. The International Monetary Fund's Statistics Department publishes information about balance of payments of countries worldwide. Examples of International Monetary Fund materials include data, statistical publications, metadata, research, methodology, and coding systems (International Monetary Fund, 2007).

International Monetary Fund data about balance of payments includes the following types:

• Data on the international reserves and foreign currency liquidity of selected countries.
• Data on external debt.
• Data on portfolio investment from the Coordinated Portfolio Investment Survey (CPIS).

International Monetary Fund metadata about balance of payments include the following types: Metadata describing the practices of 56 countries for compiling their data on foreign direct investment (FDI) and metadata describing the practices of 63 economies for compiling their data on the coordinated portfolio investment survey (CPIS). International Monetary Fund research on balance of payment issues includes the following:

• Revision of the fifth edition of the Balance of Payments Manual.
• Manuals on balance of payments, external debt, financial derivatives, and statistics on international trade in services.
• Guidelines for the dissemination of data on international reserves and foreign currency liquidity, and for foreign exchange reserve management; information on the Coordinated Portfolio Investment Surveys (CPIS) and the Surveys on the Implementation of Methodological Standards for Direct Investment (SIMSDI).
• Information on remittances statistics; the annual reports of the International Monetary Fund Committee on Balance of Payments Statistics, and the statistical papers presented to that Committee.
• Country experiences in estimating data on travel services(International Monetary Fund, 2013).

In addition, the International Monetary Fund publicizes the coding system it uses for the balance of payments statistics.

The World Trade Organization

The World Trade Organization, established in 1995, is one of the main international governance organizations promoting rules of trade between nations. In 2013, the World Trade Organization had 159 member nations. The World Trade Organization actively works to help member nations understand the provisions of Articles XII and XVIII of the General Agreement on Tariffs and Trade (GATT) passed in 1994 and of the Declaration on Trade Measures Taken for Balance-of-Payments Purposes adopted in 1979. These international agreements govern and direct international trade activity, reporting, and accounting. The World Trade Organization asks member nations to confirm and agree to four main principles about balance of payments:

• Members confirm their commitment to announce publicly time-schedules for the removal of restrictive import measures taken for balance-of-payments purposes.
• Members confirm their commitment to give preference to those measures which have the least disruptive effect on trade such as import surcharges and import deposit requirements.
• Members should avoid the imposition of new quantitative restrictions for balance-of-payments purposes unless price-based measures cannot stop a decline in the external payments position.
• Members confirm that restrictive import measures taken for balance-of-payments purposes will only be applied to control the general level of imports and will not exceed what is necessary to address the balance-of-payments situation.

Current international economic organizations, such as the International Monetary Fund and World Trade Organization, are not responding to a particular war or political crisis, as they did post WWII, so much as responding to the economic and political forces of globalization. International economic organizations have far-reaching influence on the economies of nations worldwide. International lending institutions, both corporate and non-profit, use the policy recommendations and standards created and promoted by international economic institutions as a guide for investment decisions.

Conclusion

In the final analysis, balance of payments, which is a method used by countries to monitor and record international financial activities and transactions, is a crucial measure of a country's economic heath. The balance of payments, informed by current accounts, capital accounts, and financial accounts, provides information about nations' trade deficits and surpluses. Nations make trade and economic policy based on quarterly and annual balance of payments reports.

Terms & Concepts

Balance of Payments: An accounting of a country's international transactions for a particular time period (Federal Reserve Bank of New York, 2004).

Capital Account: A balance of payments account which reflects all a country's international transfers.

Current Account: A balance of payments account which reflects a country's inflow and outflow of goods, services, income, and current transfers.

Deficit: The amount of money which a government, company, or individual spends which exceeds its income.

Developing Countries: Countries characterized by an underdeveloped industrial base, low per capita income, and widespread poverty.

Double-Entry Bookkeeping: An accounting practices in which the amounts and figures involved are recorded on two separate sides or columns of a ledger.

Exchange Rate: A comparison between a national currency and a foreign currency.

Financial Account: A balance of payment account in which all international monetary flows related to investment, business, real estate, bonds, stocks, foreign reserves, and direct foreign investments and assets are included.

Globalization: A process of economic and cultural integration around the world caused by changes in technology, commerce, and politics.

Markets: Social or economic arrangements that allow buyers and sellers to discover information and carry out voluntary exchanges of goods and services.

Nations: Large aggregations of people sharing rules of law and an identity based on common racial, linguistic, historical, or cultural heritage; rarely act unilaterally.

World Bank: An international economic development assistance organization that was founded in 1944.

Bibliography

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Preston, L. (1996). Global economy/global environment: Relationships and regimes. EarthWorks. Retrieved October 11, 2007, from http://www.utexas.edu/depts/grg/eworks/proceedings/engeo/preston/preston.html

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Suggested Reading

Graeser, P. (1968). Money, growth, and the balance of payments. Journal of Finance, 23, 542. Retrieved October 11, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=4657284&site=ehost-live

Hopkin, B. (1970). Aid and the balance of payments. Economic Journal, 80, 1-23. Retrieved October 11, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=4539637&site=ehost-live

Scammell, W. (1976). The monetary approach to the balance of payments. Journal of Economic Studies, 3, 186. Retrieved October 11, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=5212821&site=ehost-live