The balance of payments Flashcards
What is the balance of payments?
A systematic record of all the economic transactions between the residents of Australia and the residence of the rest of the world
Examples of economic transactions?
- Exports and imports of goods: Iron ore, coal, gold, wheat, wool, computers, machinery, motor vehicles and clothing
- Exports and imports of services: Shipping, freight, insurance, expenditure by tourists and education services
- Income flows: Dividends, profits and interest payments associated with foreign investment
- Transfers: Foreign aid and funds brought by migrants
- Financial assets: investment in shares, securities and loans
What is a credit?
(money in)
exports of goods and services, income receivable, increase in foreign liabilities, export of currency
What is a debit?
(money out)
imports of goods and services, income payable, increase in foreign assets and imports of currency
What is the structure of Australia’s balance of payments?
Australia usually records a deficit in the current account (debits>credits) and a surplus in the capital and financial account (credits>debits)
What is the current account?
Records transactions that occur in a current financial period
Categories in the current account?
Goods (capital or consumer)
services
Income (primary or secondary)
What is Australia a main exporter of?
Exporter of commodities such as iron ore
What is Australia a main importer of?
Importer of manufactured consumer and capital goods
Statistics about Australia’s trade in goods (2013-14)
- Exported $274 billion worth of goods, of which 61% were resources including iron ore, coal, natural gas and petroleum
- Imported $266 billion worth of goods, 69% comprising of capital and intermediate goods
- The merchandise trade account recorded a surplus of $8 billion
Statistics about Australia’s trade in services (2013-14)
- The export of education services is Australia’s largest service export
- Net services deficit of $14 billion
What is primary income?
Refers to income earned by Australian residents from non-residents (credit) and income paid to overseas residents (debit)
What does primary income consist of?
- Compensation of employees (for the use of labour)
- Investment income (for the use of capital)
Compensation of employees
Compensation of employees is simply the payment of wages to overseas workers
- Is relatively small
- 2013-2014 recorded a deficit of $3.7 billion
Investment income
Investment income comprises of income earned from the provision of financial capital or foreign investment
Types of investment income:
Dividends
Interest
Profits
These are all classed as servicing costs
Statistics about investment income:
- Over 95% of primary income transactions are associated with investment income
- In 2013-14, Australia receive $46 billion of investment income from overseas countries, but paid out $81 billion to overseas residents
- Overall balance in primary income = $39 billion
Example of a credit of investment income:
An Australian resident receiving a dividend payment from an overseas company
Example of a debit of investment income
Payment of interest by an Australian firm to an overseas resident
What is secondary income?
- Involves transactions where real or financial resources are provided (goods, services or financial assets), but nothing of economic value is received in return.
- Labelled as ‘one sided’
- Includes, transactions in foreign aid, gifts, donations and pensions
- Is relatively small (2013-14: $2 billion deficit)
What is the capital account
Comprises of capital transfers and the acquisition and disposal of non-produced and non-financial assets
Capital transfers
Migrant funds and types of aid funds related to fixed capital formation
Non-produced, non-financial assets
Intangible assets such as patents, copyrights, trademarks and franchise
When does a country have a financial account surplus?
When it is drawing on savings from the rest of the world
What is the financial account?
Comprises of transactions which will create a future revenue
Types of investment
Direct investment
Portfolio investment
Other investment
Reserve assets
Direct investment
- The objective is obtaining a lasting interest in a foreign enterprise and exercising a significant degree of influence in its management
- For example: If a resident obtains 10% or more of the ordinary shares of a foreign enterprise, it is deemed to be direct investment
- Includes branches, subsidiaries and other businesses where the foreign resident has the shareholding
Portfolio investment
- Consists of international equity and debit securities (mainly bonds and notes) which are not classified as direct investment or reserve assets
- Short term in nature
- Investor does not have any influence in the operation or decision-making of the enterprise
Other investment
- Includes trade credits, loans, currency and deposits
Reserve assets
- Financial assets controlled by the monetary authority, such as the reserve bank of Australia
- Reserve assets include monetary gold, special drawing rights (SDRs) and foreign exchange
Fluctuation of the net goods balance in 2007-08
- Australia has a large trade deficit
- This was because the economy was at its peak during the mining boom
- Even though we were exporting more, there was still a massive requirement for imported capital goods which pushed us into deficit
- Higher incomes during this period caused imported consumer goods to rise
Fluctuations in the net goods balance
- Goods balance recorded a surplus
- This resulted from the high commodity prices for coal and iron ore
What effects the composition of Australia’s trade
- The value of the traded goods: This is influenced by their prices. Both demand and supply of exported commodities are very price inelastic and are prone to large fluctuations caused by the changing supply and demand of them
- World economic growth: If world economic growth increased it would increase the demand for our commodities
- Australia’s economic growth: An increase in Australia’s economic growth would boost the demand for both consumer and capital goods
- Events in the world economy: Such as a recession of a major trading partner
Growth of China and the resource boom
- Boosted the demand for our resources
- In the early part of the boom, the trade deficit increased due to the mining investment which resulted in large imports of capital machinery and equipment
- Since 2009- trade surpluses due to strong growth in resources
Effect of Australia’s economic growth on the trade account
An increase in economic growth = demand for imports increases, especially capital imports and consumer goods
When the economy is growing, there is increased investment, requiring goods such as machinery and transport equipment to be imported
2002-2008 – mining boom = deficit in the goods balance, due to the increased investment associated with the mining boom
2002-05 – there was a prolonged drought which added to the trade deficit
From 2006, export performance has benefited from strong economic growth in countries such as China and India
The services balance trends
Is usually in deficit
- Australia is a large importer of travel and freight services
- This is because Australia is an isolated country
- Exporter of education services
Tourism- amounted to $25 billion in 2013
Primary income balance trends
- Largest component
- In 2010-11, the primary income deficit exceeded the overall current account deficit. This was because the net goods and services balance was in surplus and therefore reduced the overall CAD
Primary income balance between 2007-08
- recorded a large CAD = 6.7% of GDP
- Australian economy was growing strongly
- Resource boom
- Strong domestic investment and consumption spending. Increased imports
- Outflow of dividends to foreign investors increasing the net income deficit
Primary income balance between 2013-14
- CAD decreased by $13 billion
- Decreased export revenue associated with the completion of many mining projects
- Mining investment decreased, reducing the demand for imported capital goods
- Slower economic growth reduced the demand for imported consumption goods
Factors that determine whether a country has a CAD
- The growth rate of the country
- The relationship between a country’s savings and investment
- The level of economic development
List of the factors that will increase the CAD
- a fall in the terms of trade
- a decline in international competitiveness
- a high rate of economic growth
- increased foreign investment
- a decline in national savings
- an increase in national investment
Fall in the terms of trade
- If export prices fall relative to import prices, export receipts will fall while import payments will increase
A decline in international competitiveness
- If real wages rise more than productivity, then a countries exports will be less competitive
- A rise in inflation will also decrease a nations competiveness, if the price of domestic foods is greater than foreign goods
- A decrease in competitiveness, will decrease the amount of exports and increase the CAD
A high rate of economic growth
- Increase in national income
- Will increase both consumption and investment spending, boosting the demand for imports
Increased foreign investment
- Increase the financial account surplus
- Matching increase in the CAD
- Australia has high interest rates compared to the rest of the world
- There is therefore a large capital inflow into Australia
- Increased CAD due to the servicing costs associated with foreign investment
- Dividends, interests and profits
A decline in national savings
- Create the need for increased foreign investment
- Savings may fall when an economy experiences a recession
- Households will draw on savings to maintain consumption
- Firm profits will fall
- Government budget surplus will fall
Increase in national investment
- An economy undergoing structural changes may require a significant increase in physical and social overhead capital
- A mining boom that requires significant capital investment will at first increase the CAD
- Eventually, mining exports will increase which will decrease the CAD
When is a CAD a positive change?
If a strong economy and increased investment contribute to a CAD
When is a CAD a cause for concern?
If a CAD increased because of a decline in competitiveness
Savings and investment gap
- Australia is a small country in terms of its population
- Therefore, we cannot generate enough savings to fund our investment needs
- We therefore must draw on foreign savings enabling a higher rate of investment and economic growth – funding our resources boom
- Australia does not have a savings problem
- Savings rate = 22% of GDP (high compared to other countries)
- We also have a high investment rate = 27% of GDP
- Higher than most countries due to the costs associated with developing productive mining sites
