Balance of payments in international trade economics

Balance of Payments

Review of Subject. The concept of balance of payments refers to the monetary transactions between a given country and the rest of the world. The balance of payments is comprised of three different transaction categories -- the current account, the financial account and changes in official international reserves. Within the current account, the trade balance is the measure of the value of the country's imports and exports. Every time a good or service is sold to another country or purchase from another country, this impacts the trade account, and therefore the balance of payments.

Trade transactions are one of the critical drivers of the balance of payments. Any foreign trade in goods or services that results in money coming into the country results in a credit to the trade account; any trade that results in money leaving the country results in a debit to the trade account. There are four components to the current account, two of which are counted as trade transactions (merchandise trade and services); the other components are not considered trade transactions (Federal Reserve Bank of New York, 2009).

There are two main implications for this in business. The first is the impact that the business has on the balance of payments. When conducting business overseas, each transaction made, either buying or selling, will impact the balance of payments for both the home country and for the country with whom the trade is being conducted. Few businesses have the ability to make an impact on the balance of payments on their own -- only in aggregate. An exception, however, would be a company such as Wal-Mart, which as of 2006 represented 11% of all U.S. trade with China. This contributed nearly $27 billion to the merchandise trade deficit with China that year (Scott, 2007).

The other implication is the impact of the balance of payments on the business. The negative balance of payments represents an outflow of wealth, which slows domestic economic growth. The U.S. becomes less competitive as a result. For most companies, this places downward pressure on costs. In many cases, the downward cost pressure results in offshoring, which exacerbates the balance of payments deficit. Griswold (1999) argues that this is beneficial to the U.S. economy overall. Increases in the trade deficit are correlated with positive economic outcomes. For a company involved in importing it certainly means a higher level of activity -- more goods are coming in because more people are buying them.

Conclusion: Trade transactions are directly reflected in, and an important component of, the balance of payments. For business, the balance of payments is relevant for its impact on the economy. A negative balance of payments places downward pressure on costs, which can affect strategic decision-making. In addition, the balance of payments can impact on key economic variables such as interest and exchange rates, again impacting decision-making. Firms therefore need to monitor the balance of payments for trends that may have an impact on the business. Firms that are sufficiently large to move the balance of payments should be especially mindful of their impacts.