Definitions and Statistics in the context of the Balance of Payment (BoP)

(1) Please list the different sub-balances of the BoP. What type of transactions are
recorded there?
The Balance of Payments or BoP is a statement or record of all monetary and economic
transactions made between a country and the rest of the world within a defined period
(every quarter or year). These records include transactions made by
individuals, companies and the government.
Operations Credit, Debit,
plus (+) minus (-)

I. Current account Export Import

A. Products and services Receipts Payouts
B. Income (wages and investment income)
Receiving Transferring
C. Current transfers

II. Capital and financial account Disposal of Acquisition of

A. Capital account: assets assets
1. Capital transfers Receiving Transferring
2. Purchase / sale of non-produced non-
financial assets
B. Financial account
1. Direct Investment
2. Portfolio Investment
3. Financial Derivatives
4. Other Investment
BoP should be zero. The current account must balance with the combined capital and
financial accounts.
The balance of payments consists of:
• the current account - Current accounts measure international trade, net income on
investments, and direct payments.
• the capital account - It records acquisitions and disposals of nonproduced nonfinancial
assets (land sold to embassies and sales of leases and licenses), as well as capital transfers,
(provision of resources for capital purposes by one party without anything of economic
value as a direct return – donations, heritage, debt-forgiveness, transfer of goods and
financial assets by migrants, transfer of ownership on fixed assets and of funds, patents,
copyrights, royalties).
• the financial account – includes Direct Investment, Portfolio Investment, Financial
Derivatives, Other Investment (General government, Reserve Asset)

The euro area balance of payments summarises all the transactions between euro area
residents and nonresidents, on a monthly and quarterly basis. Transactions between euro
area residents are excluded.
(2) With reference to the BoP’s “Current Account”, analyse the different forms of
international trade in goods and services; in particular, find out which types of
transactions are recorded in the different sub-balances of the “Current Account”.
 “Goods” are raw materials (agricultural & mining: fruit and vegetables, fish, oil and gas)
and manufactured products exported (credit) and imported (debit)
 Services include – transportation, consultancy, tourism, royalties, or licensing.
If money is being paid for a service, it is recorded as an import (a debit). If money is
received, it is recorded as an export (credit).
 Primary income refers to wages, dividends, and interest rates paid by persons or
institutions to persons/institutions in another country.
Examples:
 A person living in Germany works in Switzerland. The Swiss company transfers the wage
to the employee’s bank account in Germany.
 IBM Germany pays dividends to the capital owner IBM Corp (USA).
 Secondary income refers to unilateral transfers providing or receiving goods, services,
income, or financial items.
Examples:
 Public contributions to international organisations such as UN, WHO, OECD, World Bank
etc.
 Payments sent from migrants living abroad to their family or friends back in their home
country.
(3) In addition, discuss how income generated by foreign-invested property and royalties
are exhibited in the BoP’s “Current Account”.
Income generated by foreign-invested property and royalties are exhibited in Service
transactions.
(4) With reference to the BoP’s “Financial Account”, analyze the different forms of
international financial flows. In particular, explain the difference between FDI and
portfolio flows.
- Direct Investment, Portfolio Investment, Financial Derivatives, Other Investment
(Eurosystem, Other MFIs, General government, Other sectors), changes in Reserve Assets
(or currency reserves)
Foreign Direct Investment (FDI) Portfolio Investment
 … is an investment in the form of a  … comprises all other forms of
controlling ownership in a business in investment.
one country by an entity based in  … implies no long‐term commitment
another country.  … invested capital may be withdrawn
 Statistically: “controlling”: minimum within the second of a mouse click.
10% ownership
 … implies investor’s long‐term
commitment
 Brownfield investment
 Greenfield investment
*When a company or government entity purchases or leases existing production facilities to
launch a new production activity, it is called a brownfield investment. Greenfield
investments, unlike brownfields, undertake new construction of property, plant, and
equipment.
- Financial Derivatives - Options, Forwards, etc. A call option gives the buyer the right (not
the obligation) to buy an asset at a set price on or before a set date. A forward contract is an
obligation to buy or sell an asset.

*In BoP statistics, the expression investment is used for flows.

- In many other international statistics, the expression investment is also used for the
foreign invested assets; means: All accumulated foreign investments MINUS all accumulated
depreciations
- So, in order to clarify the contents of FDI, we often use the expressions FDI flows, Inward
FDI (when an external or foreign entity either investing in or purchasing the goods of a local
economy. It is foreign money that comes from abroad.)
(5) Critically discuss the short-term and long-term effects of inward FDI on
economic growth.
An inward investment consists of foreign entities investing in local economies bringing in
foreign capital.
Foreign direct investment is a specific type of inward investment, consisting of mergers and
acquisitions or establishing new operations for existing businesses.

Empirical results from the study can be summarized as follows. Firstly, FDI capital flows can
hinder a country’s economic growth in the short run, but also have a positive effect in the
long run.

Long-term effects: FDI triggers technology spillovers, assists human capital formation, contributes
to international trade integration, helps create a more competitive business environment and
enhances enterprise development. All of these contribute to higher economic growth, which is the
most potent tool for alleviating poverty in developing countries. Moreover, beyond the strictly
economic benefits, FDI may help improve environmental and social conditions in the host country
by, for example, transferring “cleaner” technologies and leading to more socially responsible
corporate policies.

Short-term effects: deterioration of the balance of payments, repatriation of profit, lack of positive
linkages with local communities, social disruptions of accelerated commercialization, low of
competition in national markets (monopolies), lack of highly skilled labor for know-how transferred
through FDI

Short-term effects: Potential drawbacks include a deterioration of the balance of payments as

profits are repatriated (albeit often offset by incoming FDI), a lack of positive linkages with local
communities, the potentially harmful environmental impact of FDI, especially in the extractive and
heavy industries, social disruptions of accelerated commercialisation in less developed countries,
and the effects on competition in national markets (monopolies). Moreover, some host country
authorities perceive an increasing dependence on internationally operating enterprises as
representing a loss of political sovereignty. Even some expected benefits may prove elusive if, for
example, the host economy, in its current state of economic development, is not able to take
advantage of the technologies or know-how transferred through FDI (lack of highly skilled labor).

As a result, it can be asserted that FDI is an important factor for economic growth in a long
run, especially for emerging and developing economies. Efforts to attract FDI to supplement
domestic investment in lower-middle-income developing economies should be encouraged.
However, it should be considered that policies to attract FDI need to be constructed with a
long-term view to maximize the positive effects of FDI on a country’s economy. Policies that
aim to attract FDI at all cost in the short run will not bring fundamental benefits to the
economy. Lower-middle-income developing countries have been trying to attract FDI to
seek its positive benefits. The impact of FDI on economic growth is not always positive, as it
depends on characteristics of the investment resulting from FDI, such as type, sector, scope,
duration, proportion of domestic businesses in the sector, and so on. Governments should
put in place policies to improve the quality of human resources and labor skills. Since FDI
always comes with technology, there needs to be highly skilled labor in order to utilize the
new technology and to create a positive technological diffusion effect.

Neoclassical growth theory,

The neoclassical growth theory states that economic growth is the result of three factors—
labor, capital, and technology. F is a “neoclassical” production function
difference between physical capital and financial capital
Physical capital is a tangible asset that can be touched in a real sense, while financial
capital refers to the legal ownership of assets such as physical capital, as well as the
monetary value of any asset that could be liquidated for cash.
their different importance for economic growth.
In order to enhance economic growth and absorb the maximum FDI benefits,
governments should look into policies on human capital. Since FDI always comes with
technology, there needs to be highly skilled labor in order to utilize the new technology and
to create a positive technological diffusion effect.

(6) With reference to the BoP, discuss how imbalances in the current account
may be aggravated or compensated by imbalances in the financial account.
Discuss how the currency reserves of a country change as a result of such
imbalances.
Scenario 1

Scenario 2
If “net outward investment” mainly consists of portfolio investment, you may replace the
expression with lending.
Thus, countries with a long‐term surplus in the current account (“export champions”)
- either become other countries’ creditors
- or increase their currency reserves (which also is a type of creditor position)
The two main representatives of this
scenario: • China • Germany
Scenario 3

The country’s risk is to run out of currency reserves (=being internationally

insolvent/illiquid)
Scenario 4

If “net inward investment” mainly consists of portfolio investment, you may replace the
expression with borrowing. The country’s risk is to become internationally indebted.
Thus, countries with a long‐term deficit in the current account
- either become other countries’ debtor
- or run out of currency reserves (are internationally illiquid)
The main representatives of this scenario: • USA • UK • many LDCs (less-developed
countries / “emerging markets”)
The crisis Scenario

This scenario seems to be quite typical for emerging markets during financial crises.
Ideal scenario
current account: balanced net flows = 0
capital & financial account balanced net flows = 0
reserve assets (currency reserves) stay unchanged
So, one of the world’s main economic problem are the large imbalances in trade (current
account). It is necessary that the USA and the UK lower their current account deficit and
simultaneously China and Germany lower their current account surplus.

(7) Research the Internet for the last ten years’ BoP of different countries:
- U.S.A. – UK - PR China - euro area – Germany – Brazil - South Africa - your home country
and find out to which extent their current and financial accounts are
balanced. Discuss the implications for economic growth, production, and
employment.
Hint: A country’s Central Bank (the ECB for the euro area) publishes the
country’s BOP data. For international comparisons, OECD and IMF data
may be used.

https://data.worldbank.org/indicator/BN.CAB.XOKA.GD.ZS?
end=2019&locations=US&start=2009

USA.
Current account balance balance (% of GDP) = -2.2% deficit
Last 10 years between -2.9% and -1.8%.

Net financial account $-395 bln

Last 10 years between $-526 bln and $-297bln

UK.
Current account balance balance (% of GDP) = -4.0% deficit
Last 10 years between -5.3% and -1.8%

Net financial account $-141 bln

Last 10 years between $-161 bln and $-42bln

China.
Current account balance balance (% of GDP) = +1.0% surplus
Last 10 years between +0.184% and +4.7%

Euro area. 2019 year. Current account balance balance (% of GDP) = +3.5% surplus
Last 10 years between -0.5% and +3.5%

Germany.
Current account balance balance (% of GDP) = +7.1% surplus
Last 10 years between +5.8% and +8.6%

Net financial account +$229 bln

Last 10 years between +$123 bln and +$319 bln

Brazil. 2019 year. Current account balance balance (% of GDP) = -2.8% deficit
Last 10 years between -4.13% and -0.7%

South Africa.
Current account balance balance (% of GDP) = -3.0% deficit
Last 10 years between -5.8% and -1.46%

Net financial account $-0.008 bln

Last 10 years between $-22 bln and $-0.008 bln
Uzbekistan. 2019 year. Current account balance balance (% of GDP) = -5.8% deficit
Last 10 years not available.

Interpretation.

economic growth, production, and employment

It would be useful to examine a country’s BOP for at least two reasons. First, BOP provides detailed
information about the supply and demand of the country’s currency. Second, BOP data can be used
to evaluate the performance of the country in international economic competition. For example, if a
country is experiencing perennial BOP deficits, it may signal that the country’s industries lack
competitiveness.

Balance of payment deficit:

- The country imports more goods and services and capital than it exports
- it must borrow from others countrie to pay for its imports
- in the short-term, this fuels economic growth
- in the long-term, it will have to go into debt to pay for consumption

In the long-term, the country becomes a net consumer, not a producer, of the world's economic
output. It will have to go into debt to pay for consumption instead of investing in future growth. If
the deficit continues long enough, the country may have to sell its assets to pay its creditors. These
assets include natural resources, land, and commodities.

Balance payment surplus:

- the country exports more than imports
- country provide enough capital to pay for all domestic products
- a surplus boosts economic growth in the short-term
- in the long-run, it becones to dependant on the export-driven growth

A surplus boosts economic growth in the short term. There are enough excess savings to lend to
countries that buy its products. The increased exports boost production in its factories, allowing
them to hire more people. In the long run, the country becomes too dependent on export-driven
growth. It must encourage its residents to spend more. A larger domestic market will protect the
country from exchange rate fluctuations. It also allows its companies to develop goods and services
by using its own people as a test market.

Example:
Current account deficit. The U.S. economy’s reliance on consumption and low prices has created a
large deficit in the balance of payments. Americans should cut back on credit card spending and
increase their savings rate. That will help to fund domestic business growth. Second, the government
must reduce its health care spending. The best way to do that is to lower the cost of health care. If
these solutions don't work, it could lead to inflation, higher interest rates, and a lower standard of
living.
Current account Import and Export. First, USA is the third-largest exporter but the top importer.
With its size and wealth, it should be exporting more. One of the major challenges to increasing U.S.
exports is that other countries have lower costs of living. They can make things more cheaply
because they pay their workers less. Domestic manufacturing would cost a lot more. Most people
aren't willing to pay more to save U.S. jobs.  U.S. imports cost less than domestically-made
products. America imports more than half of its goods from just five countries.
Current account Trade deficit. A trade deficit is a result of a country's importing more than it
exports. America's reliance on foreign oil causes a large part of the U.S. trade deficit. When oil prices
rise, so does the trade deficit. America also imports a lot of automobiles and consumer products.
U.S. exports include many of the same things, but not enough to outweigh the deficit. 

(8) If you are not familiar with relevant international organisations, please find out about
the role of the following organisations in setting rules for
international trade and investment
- IMF
- OECD
- UNCTAD
- World Bank (IBRD)
- WTO
- IMF
The IMF promotes international monetary cooperation and provides policy advice and capacity
development support to help countries build and maintain strong economies. The IMF also provides
medium-term loans and helps countries design policy programs to solve balance of payments
problems when sufficient financing cannot be obtained to meet net international payments. IMF
loans are short and medium term and funded mainly by the pool of quota contributions that its
members provide. IMF staff are primarily economists with wide experience in macroeconomic and
financial policies.

- OECD
The mission of the Organisation for Economic Co-operation and Development (OECD) is to promote
policies that will improve the economic and social well-being of people around the world.
The OECD provides a forum in which governments can work together to share experiences and seek
solutions to common problems. We work with governments to understand what drives economic,
social and environmental change. We measure productivity and global flows of trade and
investment. We analyse and compare data to predict future trends. We set international standards
on a wide range of things, from agriculture and tax to the safety of chemicals. We also look at issues
that directly affect everyone’s daily life, like how much people pay in taxes and social security, and
how much leisure time they can take. We compare how different countries’ school systems are
readying their young people for modern life, and how different countries’ pension systems will look
after their citizens in old age.

- UNCTAD
UNCTAD is the part of the United Nations Secretariat dealing with trade, investment, and
development issues. The organization's goals are to: "maximize the trade, investment and
development opportunities of developing countries and assist them in their efforts to integrate into
the world economy on an equitable basis".

- World Bank (IBRD)

The International Bank for Reconstruction and Development (IBRD) is a global development
cooperative owned by 189 member countries. As the largest development bank in the world, it
supports the World Bank Group’s mission by providing loans, guarantees, risk management
products, and advisory services to middle-income and creditworthy low-income countries, as well as
by coordinating responses to regional and global challenges. 
Created in 1944 to help Europe rebuild after World War II, IBRD joins with IDA, our fund for the
poorest countries, to form the World Bank.  They work closely with all institutions of the World Bank
Group and the public and private sectors in developing countries to reduce poverty and build shared
prosperity.

- WTO
In brief, the World Trade Organization (WTO) is the only international organization dealing with the
global rules of trade. Its main function is to ensure that trade flows as smoothly, predictably and
freely as possible. The WTO has six key objectives: (1) to set and enforce rules for international
trade, (2) to provide a forum for negotiating and monitoring further trade liberalization, (3) to
resolve trade disputes, (4) to increase the transparency of decision-making processes, (5) to
cooperate with other major international economic institutions involved in global economic
management, and (6) to help developing countries benefit fully from the global trading system.