Balance of Trade and Balance of Payments
Definitions and Basics
Balance of Payments, from the Concise Encyclopedia of Economics
The balance of payments accounts of a country record the payments and receipts of the residents of the country in their transactions with residents of other countries. If all transactions are included, the payments and receipts of each country are, and must be, equal. Any apparent inequality simply leaves one country acquiring assets in the others. For example, if Americans buy automobiles from Japan, and have no other transactions with Japan, the Japanese must end up holding dollars, which they may hold in the form of bank deposits in the United States or in some other U.S. investment. The payments of Americans to Japan for automobiles are balanced by the payments of Japanese to U.S. individuals and institutions, including banks, for the acquisition of dollar assets. Put another way, Japan sold the United States automobiles, and the United States sold Japan dollars or dollar-denominated assets such as Treasury bills and New York office buildings….
Although the totals of payments and receipts are necessarily equal, there will be inequalities—excesses of payments or receipts, called deficits or surpluses—in particular kinds of transactions. Thus, there can be a deficit or surplus in any of the following: merchandise trade (goods), services trade, foreign investment income, unilateral transfers (foreign aid), private investment, the flow of gold and money between central banks and treasuries, or any combination of these or other international transactions.
Imports, from AmosWEB’s Economics Gloss*arama.
IMPORTS: Goods and services produced by the foreign sector and purchased by the domestic economy. In other words, imports are goods purchased from other countries. The United States, for example, buys a lot of the stuff produced within the boundaries of other countries, including bananas, coffee, cars, chocolate, computers, and, well, a lot of other products. Imports, together with exports, are the essence of foreign trade–goods and services that are traded among the citizens of different nations. Imports and exports are frequently combined into a single term, net exports (exports minus imports)….
Exports, from AmosWEB’s Economics Gloss*arama.
EXPORTS: The sale of goods to a foreign country. The United States, for example, sells a lot of the stuff produced within our boundaries to other countries, including wheat, beef, cars, furniture, and, well, almost every variety of product you care to name. In general, domestic producers (and their workers) are elated with the prospect of selling their goods to foreign countries–leading to more buyers, a higher price, and more profit. The higher price, however, is bad for domestic consumers. In that domestic consumers tend to have far less political clout than producers, very few criticisms of exports can be heard….
Balance of Trade, from AmosWEB’s Economics Gloss*arama.
BALANCE OF TRADE: The difference between the value of goods and services exported out of a country and the value of goods and services imported into the country. The balance of trade is the official term for net exports that makes up the balance of payments. The balance of trade can be a “favorable” surplus (exports exceed imports) or an “unfavorable” deficit (imports exceed exports). The official balance of trade is separated into the balance of merchandise trade for tangible goods and the balance of services….
A balance of trade surplus is most favorable to domestic producers responsible for the exports. However, this is also likely to be unfavorable to domestic consumers of the exports who pay higher prices.
Alternatively, a balance of trade deficit is most unfavorable to domestic producers in competition with the imports, but it can also be favorable to domestic consumers of the exports who pay lower prices….
In the News and Examples
Popular myth: Aren’t imports bad? Aren’t exports good? Isn’t a trade deficit a bad thing? The very word “deficit” sounds bad! Economic reality: An excess of imports over exports merely sends dollar bills overseas while bringing real goods and services into the country for immediate use. If foreigners want to hold onto those dollars, while we get to put their goods to immediate use benefiting our consumers and creating new investment for our industries, then we get an even better deal! Prohibiting trade severely limits what you can accomplish.
- Don Boudreaux on the Economics of “Buy Local”. Podcast at EconTalk, April 16, 2007.
Proponents of buying local argue that it is better to buy from the local hardware store owner and nearby farmer than from the Big Box chain store or the grocery store headquartered out of town because the money from the purchase is more likely to “stay in the local economy.” Don Boudreaux of George Mason University talks with EconTalk host Russ Roberts about the economics of this idea. Is it better to buy local than from a seller based out of town? Is it better to buy American than to buy foreign products? Does the money matter? In this conversation, Boudreaux and Roberts pierce through the veil of money to expose what trade, whether local, national, or international, really accomplishes.
- The Buy-Locally-Owned Fallacy, by Karen Selick. November 3, 2008.
An advertisement appears regularly in the newspaper in my community (Belleville, Ontario, Canada) sponsored by a group of local businesses. It reads: “Buy locally owned. Your money stays in the community. Think about it—everybody wins.”
- Photos of the 100-Mile Suit. Buying local example. At Wired, March 31, 2007.
Last year, educator and costume designer Kelly Cobb asked her students at Drexel University to trace the provenance of their clothes. When the task proved impossible, she realized how far removed we are from what we wear.
It was then that Cobb came up with the idea of creating a suit of clothes made entirely from materials prepared within a 100-mile radius of her home.
- Don Boudreaux on Globalization and Trade Deficits. Podcast at EconTalk, January 21, 2008.
Don Boudreaux, of George Mason University, talks about the ideas in his book, Globalization. He discusses comparative advantage, the winners and losers from trade, trade deficits, and inequality with EconTalk host Russ Roberts.
- The Balance of Trade, by Frédéric Bastiat. Chapter 6 in Economic Sophisms, first published 1845 in France.
There is still a further conclusion to be drawn from all this, namely, that, according to the theory of the balance of trade, France has a quite simple means of doubling her capital at any moment. It suffices merely to pass its products through the customhouse, and then throw them into the sea. In that case the exports will equal the amount of her capital; imports will be nonexistent and even impossible, and we shall gain all that the ocean has swallowed up.
“You’re just joking,” the protectionists will say. “We couldn’t possibly have been saying anything so absurd.” Indeed you have, and, what is more, you are acting upon these absurd ideas and imposing them on your fellow citizens, at least as far as you can.
The truth is that we should reverse the principle of the balance of trade and calculate the national profit from foreign trade in terms of the excess of imports over exports. This excess, minus expenses, constitutes the real profit….
- Why not just buy American? Foreign Trade, or The Wedding Gown, by Jane Haldimand Marcet in John Hopkins’s Notions on Political Economy. 1831.
One evening, when John returned from his work, he found his daughter Patty showing off a new silk gown to her mother. It was a present which her lover had just given her, for the approaching wedding day. Patty’s eyes, which had seldom beheld any thing so beautiful, shone with delight, as her mother admired it; and her father gave her a hearty kiss, and said she would be as smart a bride as had ever been married in the village. “Ay, and it is a French silk, too, mother,” exclaimed Patty.—”Why, as for that,” replied her mother, “I don’t see the more merit in its being French; and I did not think, Patty, you were such a silly girl as to have all that nonsense in your head. No, indeed, it is bad enough for the great lady—folks to make such a fuss about French finery, so that they can’t wear a bit of honest English riband. I don’t like your gown a bit the better for being French. No; and I should have thought that your husband, that is to be, might have given you an English silk instead.”…
- Don Boudreaux on the Economics of “Buy Local”. Podcast at EconTalk, April 16, 2007.
A Little History: Primary Sources and References
Mercantilism, from the Concise Encyclopedia of Economics
Mercantilism is economic nationalism for the purpose of building a wealthy and powerful state. Adam Smith coined the term “mercantile system” to describe the system of political economy that sought to enrich the country by restraining imports and encouraging exports. This system dominated western European economic thought and policies from the sixteenth to the late eighteenth century. The goal of these policies was, supposedly, to achieve a “favorable” balance of trade that would bring gold and silver into the country. In contrast to the agricultural system of the physiocrats, or the laissez-faire of the nineteenth and early twentieth centuries, the mercantile system served the interests of merchants and producers such as the British East India Company, whose activities were protected or encouraged by the state….
Exports and Imports, from Lalor’s Cyclopedia of Political Science
By imports is meant all the merchandise brought into a country from other countries; by exports, all the merchandise which leaves a country for other countries….
Balance of Trade, from Lalor’s Cyclopedia of Political Science
Balance of Trade, in commerce, the term commonly used to express the difference between the value of the exports from, and imports into a country: the balance used to be said to be favorable when the value of the exports exceeded that of the imports, and unfavorable when the value of the imports exceeded that of the exports. And in many countries this was long believed to be the case, and to a late period they were annually congratulated by their finance ministers on the excess of exports over the imports….
Mercantile System, from Lalor’s Cyclopedia of Political Science
The theory of the balance of trade and the consequences which were drawn therefrom constitute what is called the mercantile system, because the whole of this system tends to consider foreign commerce as the most productive branch of a nation’s labor. It is supposed that a nation can sell more than it buys, in a way to ruin neighboring nations by absorbing their precious metals by the greatest possible exportation and the least possible importation. This false theory still prevails in the minds of the masses, and still serves as a rule for many administrations and governments; it forms the basis of the economic ideas of all the writers of the eighteenth century, who did not belong to the physiocratic school or to that of Adam Smith; it is still appealed to in our days by statesmen, and by all those who, by conviction or for financial considerations, defend prohibition, high tariffs and custom impediments….