Balance of Trade and Balance of Payments
A High School Economics Guide
Supplementary resources for high school students
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.
Balance of Payments at Marginal Revolution University.
Balance of Trade, from Britannica.com.
BALANCE OF TRADE: the difference in value over a period of time between a country’s imports and exports of goods and services, usually expressed in the unit of currency of a particular country or economic union (e.g., dollars for the United States, pounds sterling for the United Kingdom, or euros for the European Union). The balance of trade is part of a larger economic unit, the BALANCE OF PAYMENTS (the sum total of all economic transactions between one country and its trading partners around the world), which includes capital movements (money flowing to a country paying high interest rates of return), loan repayment, expenditures by tourists, freight and insurance charges, and other payments…..
If the exports of a country exceed its imports, the country is said to have a favourable balance of trade, or a trade surplus. Conversely, if the imports exceed exports, an unfavourable balance of trade, or a trade deficit, exists. According to the economic theory of mercantilism, which prevailed in Europe from the 16th to the 18th century, a favourable balance of trade was a necessary means of financing a country’s purchase of foreign goods and maintaining its export trade. This was to be achieved by establishing colonies that would buy the products of the mother country and would export raw materials (particularly precious metals), which were considered an indispensable source of a country’s wealth and power….
The assumptions of mercantilism were challenged by the classical economic theory of the late 18th century, when philosophers and economists such as Adam Smith argued that free trade is more beneficial than the protectionist tendencies of mercantilism and that a country need not maintain an even exchange or, for that matter, build a surplus in its balance of trade (or in its balance of payments).
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.
Daniel B. Klein and Donald J. Boudreaux, The Trade Deficit: Defective Language, Deficient Thinking. Econlib, June 5, 2017.
Don Boudreaux on the Economics of “Buy Local”. EconTalk podcast episode, 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.
Trade Imbalances, at Marginal Revolution University
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.”…
A Little History: Primary Sources and References
David Hume on the Balance of Trade, at Marginal Revolution University
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….
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….
Nations Gain When They Trade, But What About Me? EconTalk podcast Extra. March 15, 2016.
Studies in the Theory of International Trade, by Jacob Viner.
Charles L. Hooper, Mercantilism Lives, at Econlib. April 4, 2011.
Benefits of Trade and Comparative Advantage
Trade, Exchange, and Interdependence
Foreign Currency Markets and Exchange Rates