Answer to Question #21202 in Economics of Enterprise for Muhammad Yousuf

Question

What is the concept of Balance of Payment of a State? How would you distinguish the composition of the current, capital and monetary accounts of BOP? Differentiate between BOP and Balance of Trade between two countries.

Answer 1

Balance of payments (BoP) accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers. The BoP accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items.

The balance of trade, or net exports (sometimes symbolized as NX), is the difference between the monetary value of exports and imports of output in an economy over a certain period. It is the relationship between a nation's imports and exports. A positive balance is known as a trade surplus if it consists of exporting more than is imported; a negative balance is referred to as a trade deficit or, informally, a trade gap. The balance of trade is sometimes divided into a goods and a services balance.

Balance of payments should be distinguished from balance of trade. Balance of trade refers to the export and import of visible items, i.e., material goods. It is the difference between the value of visible exports and imports.
Visible items are those items which are recorded in the customs returns; for example, material goods exported and imported. If the value of visible exports is greater than that of visible imports, the balance of trade is favorable.
If the value of visible imports is greater than that of visible exports the balance of trade is unfavorable; if the value of visible exports is equal to that of visible imports, the balance of trade is in equilibrium. Balance of trade is also known as merchandise account of exports and imports.

Balance of payments, on the other hand, is a more comprehensive concept because it covers (a) visible items (i.e., balance of trade or merchandise account) and (b) invisible items.

Invisible items are those items which are not recorded in the customs returns; for example, services (such as transpiration, banking, insurance, etc.), capital flows, purchase and sale of gold, etc.

Thus, balance of payments is a broader term than balance of trade; balance of payments includes both visible as well as invisible items, whereas balance of trade includes only visible items.