International Finance and the Balance of Payments

1
International Finance and the Balance of Payments

• Lecture 1
• International Economy, Globalization, and the
  Balance of Payments

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Elements of interdependence
Economic interdependence

• Trade goods, services, raw materials, energy
• Finance foreign debt, foreign investment,
  exchange rates
• Business multinational corporations, global
  production

3
Globalization
Economic interdependence

• The process of greater interdependence between
  countries and their citizens
• Involves increased integration of product and
  resource markets
• Trade
• Labor (immigration)
• Investment
• Globalization is political, economic
  technological and cultural

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Forces driving globalization
Economic interdependence

• Technological change
• Production
• Communication information
• Transport
• Liberalization of trade investment
• Tariff, non-tariff barrier reductions
• Liberalized financial transactions
• International financial markets

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Waves of Globalization
Economic interdependence

• 1st wave 1870-1914
• Falling tariff barriers
• Improved transportation
• 2nd wave 1945-1980
• Agreements to lower barriers again
• Rich country trade specialization growth of
  agglomeration economies
• Poor nations left behind
• 3rd wave 1980-present
• Growth of emerging markets
• International capital movements regain importance
• Less immigration, more foreign outsourcing

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Globalization goes white collar
Economic interdependence
U.S. Company No. of Workers Country Type of
Work Moving Accenture 5,000 in the Philippines
Accounting, software, office work Conseco 1,700
in India Insurance claim processing Delta Air
Lines 6,000 in India, Philippines Airline
reservations, customer service Fluor 700 in
Philippines Architectural blueprints General
Electric 20,000 in India Finance, information
technology Intel 3,000 in India Chip design,
tech support Microsoft 500 in China, India
Software design Philips 700 in China Consumer
electronics, RD Procter Gamble 800 in
Philippines, China Accounting, tech
support Source Drawn from Is Your Job Next?
Business Week, February 3, 2003, pp. 5060.
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Trade in goods and services as percent of Gross
Domestic Product, 2002
Economic interdependence
Country Exports ( of GDP) Imports ( of
GDP) Netherlands 53 46 Canada 37 33 Germany
31 25 South Korea 27 26 Norway 31 18 France
22 21 United Kingdom 18 21 United
States 9 13 Japan 10 8
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Openness of the US economy, 1890-2002
Economic interdependence
Source U.S. Census Bureau, Foreign Trade
Division, U.S. Trade in Goods and Services,
19602002 at http//www.census.gov/foreign-trade/s
tatistics, and Economic Report of the President,
2002.
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Leading trading partners of the United States,
2002
Economic interdependence
Value of US Value of US Country exports (
bill.) imports ( bill.) Canada 160.8 213.9 Me
xico 97.5 136.1 Japan 51.4 124.6 China 22.1
133.5 Germany 26.6 63.9 France 19.3 29.0 Italy
10.1 25.4 Netherlands 18.3 10.3 Venezuela 4.
5 15.8 Australia 13.1 6.8 Belgium/Luxembourg 1
3.8 4.4
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Interdependence Impact
Economic interdependence

• Overall standard of living is higher
• Access to raw materials energy not available at
  home
• Access to goods components made less
  expensively elsewhere
• Access to financing and investment not available
  at home
• International competition encourages efficiency

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Interdependence Impact (contd)
Economic interdependence

• Other impacts - good bad
• Curtails inflationary pressures at home
• Limits domestic wage increases
• Makes economy vulnerable to external disturbances
• Limits impact of domestic fiscal policy on economy

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Comparative advantage means
Comparative advantage

• If the relative cost of making two items is
  different in two countries, each can gain by
  specializing in the one it makes most cheaply -
  each has a comparative advantage in that product
• Even countries that make nothing cheaply can
  benefit from specialization

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Common fallacies of international trade
Economic interdependence

• "Trade is zero-sum" - trade can bring benefits to
  both partners
• "Imports bad, exports good" - if you buy nothing
  from other countries, they have no income to buy
  from you
• "Tariffs and quotas save jobs" - cutting imports
  makes it harder to export, so other jobs are lost

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Competitiveness trade
Comparative advantage

• Competitiveness can be assessed at the level of a
  firm, an industry, or a whole nation
• Main objective of any nation is to generate high
  and rising standard of living
• No nation can efficiently make everything itself
• International trade allows countries to focus on
  producing what they make efficiently
• Inefficient sectors will be squeezed out
• Sectors open to competition become more efficient
  and productive

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Ups and downs of globalization
Economic interdependence globalization

• Advantages
• Productivity increases faster when countries
  produce according to comparative advantage
• Global competition and cheap imports keep prices
  low and inflation at bay
• An open economy encourages technological
  development and innovation with ideas from abroad
• Jobs in export industries pay more than those in
  import-competing industries
• Free movement of capital gives the US access to
  foreign investment and keeps interest rates low

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Ups and downs of globalization
Economic interdependence globalization

• Disadvantages
• Millions of US jobs lost to imports or production
  abroad those displaced find lower-paying jobs
• Millions of other Americans fear getting laid off
• Workers face pressure for wage concessions under
  threat of having the jobs move abroad
• Service and white-collar jobs are joining
  blue-collar ones in being vulnerable to moving
  overseas
• US workers can lose their competitiveness when
  firms build state-of-the-art factories in
  low-wage countries, making them as productive as
  plants in the US

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Balance of Payments
The Balance of Payments

• A record of international transactions between
  residents of one country and the rest of the
  world
• International transactions include exchanges of
  goods, services or assets
• Residents means businesses, individuals and
  government agencies, including citizens
  temporarily living abroad but excluding local
  subsidiaries of foreign corporations

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Double-entry accounting in the BOP
The Balance of Payments

• All transactions are either debit or credit
  transactions
• Credit transactions result in receipt of payment
  from abroad
• Merchandise exports
• Transportation and travel receipts
• Income received from investments abroad
• Gifts received from foreign residents
• Aid received from foreign governments
• Local investments by overseas residents

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Double-entry accounting (contd)
The Balance of Payments

• Debit transactions lead to payments to foreigners
• Merchandise imports
• Transportation and travel expenditures
• Income paid on investments of foreigners
• Gifts to foreign residents
• Aid given by home government
• Overseas investments by home country residents
• Each credit transaction has a balancing debit
  transaction, and vice versa, so the overall
  balance of payments is always in balance

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Current account
Structure of the Balance of Payments

• Components
• Goods and services balance
• Merchandise trade balance
• Services balance
• Investment income (net)
• Unilateral transfers
• Private transfer payments
• Governmental transfers
• Current account balance is synonymous with net
  foreign investment

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Capital and financial account
Structure of the Balance of Payments

• Includes purchases or sales of assets, including
• Direct investment
• Securities (debt)
• Bank claims and liabilities
• Official settlements transactions

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Current account surplus and deficit
Current account

• Current account and capital financial account
  balance each other when one is in surplus the
  other must be in deficit
• Current account surplus means exports of goods
  and services, investment income and transfers
  exceed imports and outflows
• Current account deficit means imports of goods
  and services, and outflows are greater than
  exports and inflows must be financed by
  borrowing (capital account inflows)
• The process can work in reverse strong capital
  inflows can create a current account deficit

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US Balance of Payments, 2003 ( bill.)
Balance of Payments
Current account Merchandise trade exports 713.8
imports -1,263.2 Net -549.4 Services Travel
transport, net -9.3 Military transactions,
net -10.9 Royalties license fees 28.0 other
services, net 51.4 All services,
net 59.2 Balance on goods services -490.2
Contd.
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US Balance of Payments, 2003 ( bill.)
Balance of Payments
Current account (contd) Income receipts
payments investment income, net 21.9 employee
compensation -5.3 All income, net 16.6 Unilatera
l transfers, net US Government
grants -21.8 US Government pensions -5.3 Private
remittances -41.1 All unilateral
transfers -68.2 Balance on current
account -541.8
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US Balance of Payments, 2003 ( bill.)
Balance of Payments
Capital financial account Capital account
transactions, net -3.1 Financial account
transactions, net 579.0 Statistical
discrepancy -34.1 Balance on capital
financial account 541.8
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US Balance of Payments 1970-2001
Balance of Payments
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Current account deficit a problem?
Balance of Payments

• Current account deficit has little to do with
  foreign trade practices or competitiveness
• Determined mostly by domestic macro-economic
  conditions that cause demand to exceed supply and
  increase imports (paid for with borrowing)
• Whether a current account deficit is good or bad
  depends on whether the borrowed funds are used to
  pay for consumption or investment

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Trade balances growth, 1992-7
Balance of Payments
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Trade balances growth, 1992-7
Balance of Payments
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Balance of Payments
Unemployment is increasing
Unemployment
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Balance of international indebtedness
Balance of Payments

• Summarizes one nations overall quantity of
  assets and liabilities against the rest of the
  world
• Shows whether the nation is a net debtor or a net
  creditor
• Indicates sensitive items, such as short term
  debt held by foreigners which could be liquidated
  quickly, straining finances