2.1.4 Balance of Payments

Question 1

What are the components of the Balance of Payments?

Answer 1

It is divided into two main components: the current account and the capital and financial account

Question 2

Describe the components of the Current Account

Answer 2

1. Balance of Trade in Goods: measures the difference between the value of a country’s exports and imports of tangible goods (e.g., machinery, cars, and clothing). A trade surplus occurs when exports exceed imports, and a trade deficit occurs when imports exceed exports. Example: China consistently runs a trade surplus due to its strong manufacturing sector, exporting products worldwide.
2. Balance of Trade in Services: It accounts for the value of services traded internationally, such as tourism, financial services, and consulting. A surplus occurs when a country exports more services than it imports. Example: The United States often has a surplus in services trade due to its leadership in technology and financial services.
3. Income Balance: includes earnings from abroad (e.g., dividends, interest, and wages) and payments made to foreign investors. A surplus indicates that a country earns more from its foreign investments than it pays to foreign investors.
4. Current Transfers: includes foreign aid, remittances sent by migrant workers, and other unilateral transfers. It can be positive (inflows) or negative (outflows).

Question 3

Describe the components of the capital and financial account

Answer 3

1. Capital Account: records transfers of assets between countries and includes:
- Capital Transfers – Large, one-off transactions such as foreign debt forgiveness, migrants’ asset transfers, and inheritance taxes.
- Non-Produced, Non-Financial Assets – Transactions involving natural resources (e.g., land sales between countries) and intangible assets like patents, copyrights, and trademarks.

2. Financial Account: records the flow of financial assets (investment and lending) and includes:
- Foreign Direct Investment (FDI) – Long-term investments in foreign businesses, such as purchasing factories or acquiring firms abroad.
- Portfolio Investment – Buying and selling financial assets like stocks and bonds in foreign markets.
- Other Investments – Short-term loans, trade credits, and banking flows between countries.
- Reserve Assets – Changes in a country’s foreign exchange reserves, including central bank holdings of gold and foreign currencies. In 2024, Ghana’s gold exports totaled $11.64 billion, a 53.2% year-on-year increase. This substantial growth has nearly doubled the nation’s trade surplus to $4.98 billion, solidifying gold’s position as a leading export.

Question 4

What is the Relationship between Current Account Imbalances and Other Macroeconomic Objectives?

Answer 4

1. Exchange Rates: A persistent current account deficit may lead to a depreciation of the country’s currency, making exports more competitive and imports more expensive. This can help correct the deficit.
2. Economic Growth: A surplus can lead to higher savings and investment, potentially boosting economic growth. However, a persistent deficit may lead to unsustainable borrowing.
3. Employment: A trade surplus may support job creation in export-oriented industries, while a deficit can lead to job losses in import-competing sectors.
4. Inflation: A depreciating currency (due to a deficit) can lead to imported inflation, affecting the domestic price level.

Question 5

Explain how economies are interconnected through International Trade.

Answer 5

• International trade fosters economic interdependence among countries. One country’s economic policies and developments can have ripple effects globally. E.g. The 2008 financial crisis in the United States had global repercussions, as it led to reduced demand for imports from other countries, affecting their economic growth.
• Supply chain integration: Many products involve components from multiple countries. Disruptions in one country can disrupt global supply chains. E.g. The COVID-19 pandemic disrupted supply chains worldwide, affecting industries from electronics to pharmaceuticals.
• Benefits of trade: International trade allows countries to specialize in producing what they are most efficient at, leading to efficiency gains and a higher standard of living.