Chapter 2 - International Flow of Funds Flashcards
Balance of Payments Definition:
Summary of transactions between domestic and foreign residents for a specific country over a specified period of time.
- Including transactions by businesses, individuals and government.
Components of the Balance of Payments Statement:
- Current Account: measures the flow of funds between a specific country and all other countries due to purchases of goods and services or to income generated by assets.
- Financial Account: measures the flow of funds between countries that are due to direct foreign investment, portfolio investment, and other capital investment.
- Capital Account: measures the flow of funds between one country and all other countries due to financial assets transferred across country borders by people who move to a different country, or due to sales of patents and trademarks.
Current Account- The main components of current account are payments between two countries for:
- Payments for Goods and Services
–> Merchandise exports and imports represent tangible products that are transported between countries. Service exports and imports represent tourism and other services. The difference between total exports and imports is referred to as the balance of trade.
–> Deficit: total exports-total imports<0
–> Surplus: total exports-total imports<0
- Primary Income Payments
–> Represents income earned by M N Cs on their direct foreign investment (key component) as well as income earned by investors on their portfolio investments.
–> Net primary income =primary income receipts (inflow) – primary income payments (outflow)
- Secondary Income
–> Represents aid, grants, and gifts from one country to another.
–> Net secondary income =secondary income receipts – secondary income payments
Actual U.S. current account balance
The U.S. current account balance has been consistently negative since 1992. Since 2011, the quarterly current account balance for the United States has typically exceeded $40 billion per month, which is primarily due to the U.S. balance-of-trade deficit.
Entry On U.S. Balance-Of-Payments Account for a Cash Outflow:
Debit
Entry On U.S. Balance-Of-Payments Account for a Cash Inflow:
Credit
Components of Financial Account:
- Direct foreign investment
–> Summarizes the new direct foreign investment over a given period.
–> It measures the expansion of firms’ foreign operation - Portfolio investment
–> Summarizes the new portfolio investment (investment in financial assets such as stocks or bonds) over a given period. - Other capital investment
–> Transactions involving short-term financial assets (such as money market securities) between countries.
- Portfolio investment and other capital investment measure the net flow of funds due to financial asset transactions between individual or institutional investors
Capital Account
Summarizes the flow of funds between one country and all other countries due to financial assets transferred across country borders by people who move to a different country, or due to sales of patents and trademarks.
In general, the financial account items represent very large cash flows between countries whereas the capital account items are relatively minor in terms of dollar amount.
Growth in International Trade :
The United States has greatly benefited from international trade
- First, such trade has created some U.S. jobs, especially in industries where domestic firms have a technology advantage. International trade prompts a shift of production to those countries that can produce products more efficiently.
- In addition, it ensures more global competition among producers, which forces those firms to keep their prices low. Hence U.S. consumers have more product choices, and at lower prices, as a result of international trade.
- Nevertheless, not all U.S. residents have benefited from the expansion of international trade. In particular, workers in certain industries have experienced job losses as production has shifted from the United States to countries where labor costs are lower. As a result, international trade has become a more controversial issue in recent years.
Events That Increased Trade Volume:
- Removal of the Berlin Wall: Led to reductions in trade barriers in Eastern Europe.
- Single European Act of 1987: Improved access to supplies from firms in other European countries.
- North American Free Trade Agreement (N A F T A): Allowed U.S. firms to penetrate product and labor markets that previously had not been accessible. It took effect on January 1, 1994.
- The United States-Mexico-Canada (USMCA): became effective on July 1, 2020 to substitute NAFTA to:
–> Create a more level playing field
–> Modernize and strengthen agriculture trade
–> Support a 21st century economy - General Agreement on Tariffs and Trade (GATT): Called for the reduction or elimination of trade restrictions on specified imported goods over a 10-year period across 117 countries. The precursor of the World Trade Organization.
- The World Trade Organization (WTO): an intergovernmental organization that regulates and facilitates international trade. The world’s largest international economic organization.
- The European Union: Free movement of products, services, and capital among member countries.
- Inception of Euro in 2002: For MNCs in the euro-zone to engage in transactions with each other, they don’t need to convert currencies. So they will avoid exposure to exchange rate risk.
To join the euro-zone, a country
–> must be a member of the EU
—> must meet specified fiscal responsibility limitations on its budget deficit and total debt - Other Trade Agreements: The United States has established trade agreements with many other countries such as Singapore (2004), Morocco (2006), Oman (2009), Peru (2009), Jordan (2010), Bahrain (2010), and South Korea (2012).
In addition to trade agreements, outsourcing also _____ international trade.
Increases
Definition of Outsourcing:
The process of subcontracting to a third party in another country to provide supplies or services that were previously produced internally.
Impact of outsourcing:
Increased international trade activity because M N Cs now purchase products or services from another country.
Lower cost of operations and job creation in countries with low wages.
Criticism of outsourcing:
Outsourcing may reduce jobs in the United States.
Managerial decisions about outsourcing:
Managers of a U.S.-based M N C may try to manufacture products in the U.S. to create jobs for U.S. workers. But the same products can be easily produced in foreign countries with the same quality but much lower cost.
Shareholders may suggest that the managers are not maximizing the M N C’s value as a result of their commitment to creating U.S. jobs. The board of directors may pressure the managers to move the production to foreign countries
Managers should consider the potential savings that could occur as a result of outsourcing.
Managers must also consider the possible bad publicity or low morale that could occur among the U.S. workers.
Trade Volume Among Countries:
The annual international trade volume of the United States is between 10 and 20% of its annual G D P.
(Canada: >50%; EU: 30-40%； Japan: 10-20%)
Trade volume between the United States and Other Countries:
About 18% of all U.S. exports are to Canada, while 16% are to Mexico. (Exhibits 2.2 and 2.3)
China, Mexico, Canada, and Japan are the key exporters to the United States. Together, they are responsible for more than half of the value of all U.S. imports.
Trend in U.S. Balance of Trade
During the last decade, the United States has experienced large balance-of-trade deficits, due to strong U.S. demand for imported products that are produced at a lower cost than similar products can be produced in the United States.
The U.S monthly trade deficit has been $40 billion or more per month since 2011.
Much of the U.S. trade deficit is due to a trade imbalance with just two countries: China and Japan.
Since international trade can _____ affect a country’s economy, it is important to identify and monitor the factors that influence it.
Significantly
Factors Affecting International Trade Flows:
- Cost of labor
- Inflation
- National income
- Credit conditions
- Government policies
- Exchange rates
Cost of Labor:
The cost of labor varies substantially among countries.
Firms in countries where labor costs are low commonly have an advantage when competing globally, especially in labor intensive industries.
Inflation:
Current account decreases if inflation increases relative to trade partners.
domestic products more expensive –> export decreases
foreign products cheaper –> import increases
National Income:
Current account decreases if national income increases relative to other countries since consumption of goods will increase that reflects an increased demand for foreign goods
Credit Conditions:
When credit conditions become more restrictive, M N Cs may reduce their corporate spending and reduce their demand for imported supplies.
