In the analysis of
comparative costs in Unit Eleven, we confined ourselves to trade by barter,
deliberately
excluding any idea of
money of currency. In practice, it is the use of different (token) currencies
that causes
most of the problems
associated with International Trade. This unit shows the need for careful
recording of
international
transactions, the nature of these transactions, recent changes in their
structure as far as the
Nigerian economy is
concerned, and the methods available for dealing with short-term Balance of
Payments
difficulties.
Balance of Trade – Meaning/Definitions
Foreign Trade is made up of Exports and Imports.
Exports are the goods
and services which a country sends to other countries (abroad) in return for
some
payment made in
foreign exchange.
We have “visible
exports” and “invisible exports”. Exports of goods refer to visible exports
while exports
of services refer to
invisible exports.
Imports are goods and
services which are brought into a country from foreign nations for which the
receiving country
pays for in foreign exchange. There are also “visible and invisible” imports.
Imports of
goods are visible
imports while imports of services are invisible imports.
Nigeria’s major
imports include manufactured goods, machinery, transport, equipment, chemicals,
foods
and live animals,
etc.
Balance of Trade
shows a country’s receipts and payments for goods and services, such as crude
oil,
cocoa, machines,
equipment, baking, etc. That is, it deals with exports and imports of goods and
services
which may be visible
or invisible. Visible trade is that concerned with buying and selling of goods.
Invisible trade
consists of services provided to or by other nations, e. g. Insurance, Banking,
etc. It can
also be called
Balance of Current Accounts.
Terms of Trade and Measurement
Terms of Trade means
the rate at which one country’s products exchange with those of another and this
depends on the
countries’ prices of exports and imports. That is, it is the rate at which a
nation’s exports
exchange for its
imports.
To say that the terms
of trade of a country is favorable means that the prices of its exports are
higher
relative to the
prices of its imports. Otherwise, it is unfavorable if the prices of imports
are higher relative to
the prices of
exports.
The measurement of
TOT is given as follows:
TOT = Index of Export
Prices x 100
Price Index of Import Duties 1
- Bilateral Trade –
This means trade between two countries
- Multilateral Trade
– This occurs when there are more than two (2) countries involved in trade.
Nigeria exports
barrels of crude oil, Cocoa, tin and some other commodities to the rest of the
world. At the
same time, Nigeria
imports machinery, milk, ink, writing paper, services of exports and so on from
other
countries. With the
income earned from exports, Nigeria is able to buy a certain amount of imports.
It follows
that a certain amount
of exports has to be exported to the rest of the world before Nigeria can
import a
certain quantity of
import. This rate of exchange between Nigeria’s exports and imports it gets
from the rest
of the world is
Nigeria’s terms of “Trade”. In other words, the term of Trade of any country is
the rate at
which its exports
equates its imports at any given time.
The terms Trade
change from time to time, following the prices of traded commodities. If the
price of
motor cars rise in
Japan, Nigeria will have to sell more barrel of crude oil assuming that there
is no change in
the price of crude
oil in order to buy the number of motor cars. In this case, the terms of trade
are unfavorable
to Nigeria. If the
price of oil rises in favor of Nigeria, Japan will have to sell more cars to
buy the same
quantity of crude oil
from Nigeria. In this case, we say that the terms of Trade are favorable to
Nigeria as
its exports if it
exports the same amount of crude oil but get more cars from Japan.
Briefly, if a country
gets more imports for a given amount of exports, the term of trade are favorable
to
the country. If on
the other hand, the same country gets less imports for the same amount of
exports the
terms of Trade are unfavorable
to the country. The terms of Trade are
important determinants of the
balance of payments.
The concepts of the
terms of Trade is of great importance in the theory of International Trade
since it
measures the terms on
which a country’s exports are exchanged for its imports. It thus determines how
much
a country gains from
foreign trade. Because money is so important in foreign trade, the terms of
Trade are
measured as a ratio
of changes in exports and import prices.
The Concept of the Balance of Payments
A country’s balance
of payments refers to a systematic record of all economic transactions between
the
residents of the
reporting country and residents of foreign countries during a given period of
time, usually a
year. An economic
transaction, as used here, is an exchange of value, typically an act in which
there is
transfer of title to
an economic good, the rendering of services or the transfer of title to assets
from one
country’s residents
to another.
Thus, the balance of
payments is a statistical record which summarizes all transactions which take
place
between the residents
of a country and the rest of the world. It is a statement of a country’s
economic
transaction with
other countries and it shows, for that accounting period usually a year, total
income (receipts)
and total expenditure
(payments) and the balance of income over expenditure. The transactions include
buying, selling,
borrowing and lending, investment and disinvestment, income from investment and
repatriation
of profits and
dividends, in addition to gifts and grants, etc. All transactions which entail
inflow of
payments are taken as
credit plus entries while debit or minus entries are those transactions which
generate
an outflow of
payments.
Thus, a balance of
payments account refers to a classified summary of the money value of all
international
transactions of an
economy, in some form of aggregation, pertaining to a given period of time,
usually a year.
Both in the
accounting and economic sense, a country’s balance of payments must always
balance since
every purchase of
goods and services by a country is recorded both as a credit item (the goods
received and
as a debt item) (the
debt owed by the purchasing country to the supplier). This is an accounting
procedure
based on common sense
rather than on mere fancy.
The Reasons for Measuring the Balance of Payments
(a) To measure
performance
A country’s Balance
of Payment may be likened to the annual income and expenditure of a household,
although the
comparison must not be carried too far. The household receives income by
supplying the
services of factors
of production and spends that income on the purchase of goods and services it
requires. If the
household spends all its income, no more and no less, it is in the same
position as a
country whose Balance
of Payments just balances, if it spends more than its income either by
borrowing
or drawing on past
savings, the household has a balance of payments deficit for the year, if its
expenditure falls
short of income, it may regard itself as having a balance of payments surplus.
This illustrates one
reason for assessing the Balance of Payments. It shows whether or not the
country
as a whole is paying
its way in the world. The Government needs an assessment of the Balance of
payment in order to
check that the community is living within its means.
(b) To protect the
foreign currency reserves
Goods imported from
abroad have to be paid for in currency acceptable to the supplier. Individual
importers do not keep
stocks of foreign currencies needed to buy goods overseas but they can acquire
them from the Central
Bank of Nigeria (CBN). A second important reason for keeping track of the
Balance of Payments
is that a deficit leads to the reduction in these reserves and prolonged
deficits
force the Government
(CBN) to take restrictive actions in order to preserve the currency for
essential
purposes.
(c) To inform
governmental authorities of the international position of the country.
(d) To aid
governmental authorities in reaching decisions on monetary and fiscal policy on
the one hand and
trade and payment
questions on the other.
(e) They are used to
measure the resource flows between one country and another.
(f) Information on
payments and receipts in foreign exchange constituting a foreign exchange
budget,
helps to assure
monetary authorities that the country could go on buying foreign goods and
meeting
payments in foreign
currency when they become due.
(g) To measure the
influence of foreign transactions on national income.
The Components/Structure of the Balance of Payments
Lipsey (1983), said
that a more analytically convenient way to present a nation’s balance of
payment is to
divide it into three
components, viz Current Account, Capital Account, and Official Financing.
The Capital Account
These records
transactions related to movement of long and short-time capital i. e. it shows
the volume of
private foreign
investment and public grants and loans from individual nations and multilateral
donor agencies
such as UNDP and the
World Bank. It includes direct investment, portfolio investment, long-term
capital and
short-term capital.
The capital account will be a deficit if payment exceed receipts but a surplus
if receipts
exceed payments.
The capital account
section records all capital movements. They do not consist of goods and
services but
debts and paper
claims such as long term and short term loans that government and private
citizens make or
receive from foreign
government and private citizens.
The capital account
is very crucial because it is used to finance any deficit on the balance of
trade (i. e.
current account
deficit) and also used to finance a net flow of goods to the recipients
country. This explains
why the balance of
payments must always balance.
The Current Accounts
The account of import
and export goods and services is known as the current account. This is the
basic
component of the
balance of payments. It equally has the largest entries. The current account is
further
divided into two
sections: merchandise trade items and service transaction items.
The merchandise items
refer to the import and export of goods (merchandise). This is also known as
visible items or
visible trade items. The service items are known as invisible items.
The difference
between the debit and credit entries in the current account is known as balance
of Trade.
The balance of Trade
is said to b e “favorable” or surplus if exports (sources of foreign exchange)
exceeds
imports (use of
foreign exchange). It is also said to be “unfavorable ” or “deficit” if the
imports exceed
exports.
In most cases, when
the balance of payment is said to be in deficit or in surplus, reference is
being made
to the current
account or one account heading not to the total of all balance of payment
entries. This is
because, in totals
the balance on the Capital Account normally offsets the balance on current
account. An
excess of imports
over exports (a debit balance on current account), creates an international
debt obligation
which is an
equivalent credit balance in the capital account.
Official Financing
After summation of
the investment and capital flows, a balancing item is added in the Capital
Account. This
has noting to do with
the size of the Balance of Payments deficit or surplus but merely indicates the
errors
and omissions which
have occurred. That part of the accounts which we have so far overlooked is
called
“Official Financing”.
This records the changes that have occurred, in government holdings of foreign
currency
of liquid claims to
currency over the year.
Official financing
items or official settlements represent transactions involving the Central Bank
of the
country whose balance
of payment is being recorded and there are three ways in which credit items may
occur on the official
financing account.
(a) The Central Bank
may borrow, say from the IMF and this represents a capital inflow and is hence
a
credit item on the
balance of payment. Repayment of old IMF is a debit item.
(b) The Central Bank
may run down its official reserves of gold and foreign exchange and this is a
credit
item since it gives
rise to a sale of foreign exchange and a purchase of naira.
(c) The Central Bank
might borrow from other Central Banks though a network of arrangement and these
will be on the credit
side of the BOPs account.
There is also a Cash
Account showing how cash balances (foreign reserves) and short term claims have
changed in response
to current and capital account transactions. Such a cash account is, thus, the
balancing
items which is
lowered (i. e. a net outflow of foreign exchange) whenever total disbursements
on the current
and capital account
exceed total receipts (Todaro, 1977).
Finally, actual
recording of BOPs can rarely be quite complete and accurate, hence there are
bound to be
certain omissions and
error in some other entries in terms of their values. Some of the errors and
omissions
on credit side might
be compensated by errors and omissions on credit side. This, a balancing item
of “errors
and omissions” is
provided to equate the two sides of the account, and it could be positive or
negative, and
hence might appear on
the credit or the debit side of the balance. This entry does not violate the
principle that
debits and credits
will equal each other, but only reflects the reality that actual recording is
bound to be
incomplete in more
than one ways.
Balance of Payments Disequilibrium
A state of disequilibrium
occurs in the balance of payments when an adverse or unfavorable balance results
in movements in
short-term capital and or adjustments to reserves. Disequilibrium has two
aspects: surpluses
and deficits. A
country is said to have a surplus in the balance of payments if its income flow
exceeds its
expenditure flow. On
the other hand, a deficit or debit in balance is of two kinds: temporary and
fundamental. A
deficit is temporary, if it can be corrected or adjusted within a short-time.
It is persistent,
if it is of long
duration. If it is not corrected, reserves will run out and other countries
will lose confidence in
the country. As a
result, such a country will find it difficult in raising external loans for the
development of
its economy.
The following are the
causes of disequilibrium in the balance of payments.
(i) excessive
importation of goods and services
(ii) deficiency in
domestic output
(iii) inadequately
patronage of home made goods which are regarded as inferior goods and
(iv) high-level of
importation of technical know-how in developing countries,.
In an accounting
sense, credit and debit side totals of the BOPs must balance. Therefore, an
inherent
tendency for the
balance of payments to balance refers to equilibrium in the balance of payments
since when
there are variations
in the balance, the surpluses tend to cancel out the deficits. However, the
absence of an
inherent tendency for
the balance of payments to balance refers to disequilibrium in the balance of
payments
since when there are
variations in the balance, the surpluses do not tend to cancel out the
deficits. Then
disequilibrium or gap
in the balance of payments generally refers to an inherent tendency of an
absence of
balance the balance
of payments “unfavorable or deficit balance
is considered more undesirable than an
“active”, “positive”,
favoruable or surplus one.
Such as
disequilibrium may be due to factors which cause an imbalance in trade account
and/or in capital
account. The factors
include:
(a) Persistent
inflationary pressures at home hence the nation’s cost-price structure makes it
unprofitable
for foreigners to
import from this country, but making imports to rise.
(b) Inflationary
pressures in trading partners’ economies hence the country in question is
forced to import
at higher prices and
hence bear the burden of high wages and other types of exploitation by the
richer
economies.
(c) Servicing of
existing debts through fresh loans without generating an adequate export
surplus.
(d) Political
disturbance such as war of threat of war which result in large imports of arms,
ammunitions,
food and strategic
raw materials for stockpiling. This sudden spurt in imports and possibly a
planned
reduction in exports
result in a deficit in the trade and payments.
(e) Economic calamities
such as drought, flood, earthquake or general crop failure which increase
imports
reduce exports.
(f) Lacks of capacity
to meet changing requirements of importers due to lack of resourcefulness,
diversification
and resiliency. This
exports lag behind imports more so when the latter is influenced by
demonstration
effect, (Bhatia,
1984).
Ways of Correcting Balance of Payments Disequilibrium/Deficits
Thus, while a
temporary balance of payments can be financed (official financing) by running
down foreign
currency reserves and
by foreign borrowing, these cannot go on indefinitely since such financing
cannot
carry a persistent
balance of payments deficit. This calls for corrective action/policy on the
part of the
government.
Government corrective action can be grouped into two broad categories:
Expenditure Reducing
Policies and
Expenditure Switching Policies.
(a) Expenditure
Reducing Policies
These are meant to
achieve a deflation of aggregate demand in the economy such that the demand for
imports will reduce.
Also, it is expected that domestic industry, faced with a contraction of demand
in the
domestic market, will
attempt to export more aggressively.
Specific expenditure
reducing policies include:
(i) Fiscal Policy: This involves
increase in taxes and decrease in government expenditure. This is
expected to lower
purchasing power in the domestic economy and hence lower imports of goods
and services, and
therefore correct the persistent deficits in the BOPs.
(ii) Monetary Policy:
This
involves measures which include contraction for restrictions on money
supply, raising
interest rates and restriction of credit. Again, this lower people’s purchasing
power
and hence lower
demand for imports.
The Balance of
Payment 91
(b) Expenditure
Switching Policies
These are meant to
switch expenditure away from imported goods toward domestically produced
substitutes, as well
as to stimulate the level of exports and hence export earnings. These policies
can also be
categorised into two
– Trade Policy and Exchange Rate Policy.
Trade Policy includes
(i) Control of
imports or direct controls –Attempts to directly control imports of goods
and services
can take the form of
tariffs or import duties, quantitative restrictions (quotas) exchange control
and
export schemes.
- Tariffs or
import duties: The deficit nation can impose a tax on imports to increase
their price
and reduce demand for
them. The government might also change licence fees for the imports.
- Quantitative
Restrictions or quatos or ban: These involves physical controls on the
amount of
a good which are
imported from a particular source in a given time period. At the extreme, it
may
involve outright ban
on the importation of certain items.
- Exchange
Control: A country which has a balance of payments problem may restrict the
supply
of foreign exchange.
This is meant to regulate both the inflow and the outflow of foreign exchange
hence all transaction
in foreign exchange pass through the hands of the authorities.
- Export Schemes: These
involves scheme meant to increase exports to subsidise export industries
and for which might
make exporting simpler to finance and less risky. For example, in Nigeria,
there is the export
promotion strategy meant to encourage exports and generate foreign exchange
and enhance the
nation’s BOPs position. It involves such measures as duty-free export of some
goods and services,
tax holidays or elimination of export subsidy, retention of a percentage of the
foreign exchange
earnings by the exporter, assistance on export costing and pricing, liberalised
export and the
establishment of an Export Credit Guarantee and Insurance Scheme to provide
insurance risk of
default by foreign buyers and cheap finance for exports.
- Exchange Rate
Policy: In addition, to foreign exchange restriction, a country can
intervene in the
foreign exchange
market by fixing its own rate. This also essentially involves devaluation i. e.
reduction in the
value of the home country in terms of one or more currencies or gold. This is a
deliberate measure of
shifting the exchange rate against the home country. Devaluation means a
fall in the exchange
value of a country’s currency in relation to the currencies of other countries.
Devaluation cheapens
exports and makes imports clearer, thus improving the balance of payments.
For devaluation to be
effective, the demand for the devalued exports should be elastic.
Apart from
elasticities, the success of devaluation also depends on other factors
including Retaliation
by Trading Partners.
If the devaluating country’s trade partners retaliate by devaluing their
currencies then
devaluation will have disruptive effects without improving the balance of
Trade.
Conclusion
International Trade
gives rise to indebtedness between countries. The BOPs shows the relation
between a
country’s payments to
other countries and its receipts from them, and thus a statement of income and
expenditure on
international account. In other words, it is the country’s monetary and
economic transactions
with the rest of the
world over a period of time usually one calendar year.
Like the Balance
Sheet of Income and Expenditure of a company or a person, the balance of
international
payments or accounts
shows credit (+) for payment received by the country and debit (-) for payment
made
to other countries.
The overall balance enables the government of a country to see its position in
international
economic order and to
take measures to improve correct or adjust its position.
There are three main
accounts of the balance of payments into which all economic transactions between
a nation and the rest
of the world are classified. They are
(i) the current
account, (ii) the capital account and
(iii) the official
settlement account or financing.
When a country has an
adverse or debit balance in its balance of payments, it regards it with serious
concern, when it has
a favorable or credit balance there is satisfaction.
A variety of
instruments are available for correcting balance of payment deficits.
Summary
In this unit, we have
succeeded in stating that all transactions between one country and the rest of
the world
involving the
exchange of currency are brought together annually under the heading of the
Balance of
Payments. This
effectually summarizes the country’s economic relationships with the rest of
the world during
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