6.1 Balance of Payments Accounts

Unit 6: Open-Economy - International Trade and Finance

6.1: Balance of Payments Accounts

Balance of Payments accounts measure all international transactions in a year. This includes the sale and purchase of goods/services and assets. There are two accounts within the balance of payments: (1) the current account, and (2) the capital account.

The current account includes the following components:

• Net exports—The difference in the value of all exported goods and services sold and all imported goods and services purchased, including labor. Exports count as a positive asset and imports count as a negative asset. If a country has more exports than imports, it has a trade surplus. If a country has more imports than exports, it has a trade deficit.

• Net investments—Any interest or dividend paid to or from domestic investors.

• Net transfers—Any aid or grants paid to and from the domestic economy. This includes international aid or the transfer of income. Paid to the domestic economy is positive, from is negative.

The capital account includes the following components:

• Financial Investments—The purchase of foreign and domestic financial assets. Foreign purchase of domestic assets is positive, and domestic purchase of foreign assets is negative.

• Real Investments—The purchase of foreign and domestic land and businesses, including plant capacities and factories. Foreign purchase of domestic assets is positive, domestic purchase of foreign assets is negative.

Let's look at some different examples from the current and capital account:

💡 A quick way to determine if an asset is positive or negative is:

• If the money for the transaction is flowing out of the country it is negative

• If the money for the transaction is flowing into the country it is positive.

Sample Balance of Payments Between Two Countries

Looking at the example above, the United States has a trade deficit of $500 ($300 Exports - $800 Imports) and China has a trade surplus of $500 ($800 Exports - $300 Imports).

The value of the current account for the United States is a deficit of $600. This is calculated by adding the trade deficit of $500 to the $100 in humanitarian aid that is leaving the country, so it is negative. You would also include the purchases made by Chinese tourists and money spent by American tourists but since those amounts are both $1000 they cancel each other out.

The value of the current account for China is a surplus of $600. This is calculated by adding the trade surplus of $500 to the $100 in humanitarian aid that they are receiving from the United States which is positive. You would also include the purchases made by Chinese tourists and money spent by American tourists but since those amounts are both $1000 they cancel each other out.

The value of the financial account for the United States is a surplus of $600. This is calculated by adding the +$600 they receive for the purchase of a U.S. business by the Chinese, the +$200 they received from the Chinese government purchase of U.S. bonds, and the -$200 spent on the American investment in the Chinese stock market ($600+$200-$200).

The value of the financial account for China is a deficit of $600. This is calculated by adding the -$600 spent on the U.S. business, -$200 spent on the purchase of U.S. bonds, and the $200 they received from the investment by the U.S. in the Chinese stock market. (-$600-$200+$200).