There is no country in the world that has achieved self-sufficiency. The only way to acquire things that a country does not produce is to trade with other countries. Interactions between countries involve trade of goods and services as well as investments that generate income. A country receives payment for the services it renders and goods that it sells to other countries.
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It makes payment to countries that offer goods and gives services. Balance of payment, as defined by Dunn and Mutti (2004, p. 43) refers to “records of payment and receipts of the residents of a country in their transactions with residents of other countries”.The payment made and that received should always balance. Failure to balance implies that a country is getting a raw deal from its partner.
Japan has being selling vehicles and other machineries to the United States of America. The United States sells dollar assets to Japan. Balance of trade envisions that the value Japan makes from selling vehicles to America must be commensurate to the value that America’s bank institutions get by selling dollar assets to Japan.
However, the balance of payment between countries is not achievable all the times. If America gets more value that it gives to Japan, it experiences surplus while Japan experiences deficit. The imbalance in payment may occur because of several factors. The first is an excess or limited trade in goods and services. Secondly, a country may accrue lots of profit from its investment in another country.
Thirdly, foreign aid may upset the balance of payment, as it is the case between America and most developing nations. Mastrianna (2010, p. 65) notes that the “flow of gold and money between central banks and treasuries can easily upset the balance of payment”. Economists argue that people can only understand balance of payment in reference to particular transactions (Dunn & Mutti 2004).
In other words, one can only measure the balance of payment when he or she considers services versus services, not goods versus goods. Economists use current account deficit to determine whether there is a deficit or surplus in balance of payment. According to Mastrianna (2010, p. 66), a country is experiencing a deficit “when its government, businesses, and individuals imports more goods, services and capital than it exports”.
To measure the deficit, several yardsticks are required. The first one is trade. United States for instance sells surplus natural gas to Europe. The second yardstick is income accrued from international contracts, for instance construction of roads by federal corporations. The third is investment. A country can invest in another country and this will count in determining deficit or surplus.
In the past, people assumed that a current account deficit was a sign that the government was in financial crisis. Economists have however established that this is not always the case (Soukiazias & Cerqueira 2012). The government can actually precipitate a deficit to spur growth.
Trade deficit is the major factor that precipitates a deficit (Barschel 2007). If a country buys more than it sells, chances of causing a deficit are high. Additionally, countries that pay foreigners more money than they do accrue from the foreigner’s host countries risk running into a deficit. In developed nations, donations to other nations and international organizations can lead to a current account deficit.
Countries, just like individuals, are either big or low spenders. Big spenders attract creditors easily. The creditors will be inclined to lend if the two countries have a history of importing and exporting services and goods. If the interest charged will surpass the net income, deficit will slowly set in.
A financial account is a constituent of the balance of payment. In isolation, the account cannot be a predictor or indicator of the financial situation of a country. However, economists can use it together with other accounts in the balance of payment to forecast economic condition of a country. Countries with robust economy have large amounts of goods bought and sold across the border.
A decline in volume is a predictor that a country has diminished cross-border activities. Mastrianna (2010, p. 67) avers financial account entails “government-owned assets, private sector assets in foreign countries, foreign direct investment, bonds and stocks”. If money is transferred from one country to another, it is recorded in the debit section. If such money goes to an investment, there is a promise of a return.
The accrued profit falls under the credit section. There is a financial account deficit when investments in foreign countries do not bring expected income. In other words, the country has more liabilities than claims in foreign countries. This limits the government’s ability to invest further and sustain its operations.
Current account and financial account deficits have various implications for the government. A current account deficit is beneficial to a country but can be disastrous if it lasts for long. In the short-term, a deficit attracts foreign investors who put more money into the economy. Increased foreign investments may reduce the economic competitiveness of a country in the global platform.
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The government should worry when foreign investors control the economy. A good case to consider is Zimbabwe. The change of government policy drove away foreign investors (Barschel 2007). The spiral effect was escalating inflation that now ranks among the highest in the world. Current deficit diminishes the value government’s bonds. The result is a weakened local currency that has a debilitating effect on value of assets in a country.
A financial account deficit could be devastating on the government as it happened during the 1997 Asian crisis. The deficit forced the governments to invite foreign investors. Foreigners owned most of the investments though most of them were short-term portfolios. In the short-term, the countries enjoyed stable economies because it was easy to change investments into cash.
The lack of long-term investments meant that the government could not consolidate the gains made. With the change in political climate, foreign investors fled from those countries. Cash flowed out of the countries faster than it had come in. The economy crumbled as their currencies lost value.
The governments faced crisis of dormant stock market, unsustainable wage bills, and increasing unemployment. It is therefore in order to conclude that current and financial accounts deficit should worry governments. As discussed in the paper, balance of payment is difficult to attain especially for advanced countries such as the United States.
While trade deficit is the major cause of the imbalance, foreign aid and payment to foreign workers exacerbates current account deficit. Contrarily to what many people believe, a deficit is not a sign of a poor economic condition. Soukiazias and Cerqueira (2012, p. 43) argue that if assets are “denominated in foreign currency, deficit will lessen”. Governments should exercise some degree of control in order to prevent deficits that could cripple the economy.
Barschel, H 2007, The U.S. current account deficit – Whose problem is it? A short overview, GRIN Verlag, München.
Dunn, R & Mutti, H 2004, International economics, Routledge, London.
Mastrianna, V 2010, Basic economics, Cengage Learning, Southwestern.
Soukiazias, E & Cerqueira A 2012 Models of balance of payments constrained growth history, theory and empirical evidence, Palgrave Macmillan, Basingstoke.