AEB 4283: International Development Policy Section III: International Problems and Policies Week 11: Macroeconomic Policy Today: Discuss make-up exams schedule Exam #3: Wednesday Nov 16th Class Project deadline: December 5th, Monday, 5pm by email Review and complete Chapter 13 “Balance of Payments and Debts” and “Capital Flows & Debt Forgiveness” Next week: Start Chapter 14 on Foreign Finance and Aid Monday: In-class Group Assignment #3 Assignment: Read Chapter 14 & Sachs article (download)

Balance of Payments (REVIEW) The Balance of Payments (BOP) is the statistical record of a country’s international transactions over a certain period of time presented in the form of double-entry bookkeeping. Record of Payments to & Receipts from Foreign Entities When we say “a country’s balance of payments” we are referring to the transactions of its citizens and government. The BOP accounts are those that record all transactions between the residents of a country and residents of all foreign nations.

Balance of Payments (REVIEW) Record of Payments to & Receipts from Foreign Entities Double-entry bookkeeping system. Every transaction has two entries → a credit (+) and a debit (-)! Payment = Debit (-) e.g. on imports Receipt = Credit (+) e.g. on exports Multiple Accounts The BOP accounts are those that record all transactions between the residents of a country and residents of all foreign nations. Current Account (CA) and Capital/Financial Account (KA) Is a summary (net) record of capital flows, not stocks

Balance of Payments (REVIEW) Multiple Accounts: Current Account (CA) If the debits exceed the credits → Imports > Exports → country is running a trade deficit. If the credits exceed the debits → Exports > Imports → country is running a trade surplus. Capital/Financial Account (KA) The capital account measures the difference between U.S. sales of assets to foreigners and U.S. purchases of foreign assets. The capital account is composed of Foreign Direct Investment (FDI), portfolio investments and other investments.

Balance of Payments (REVIEW) Foreign Direct Investment (FDI) FDI is any form of investment that earns interest in enterprises which function outside of the domestic territory of the investor Eg: Warren Buffet (a U.S. citizen and investor) buying a controlling share in a Taiwanese electronics firm. Forms of investment → measure of foreign ownership of productive assets, such as factories, mines and land It is also a measure of growing economic globalization Consistent economic growth, de-regulation, liberal investment rules are all the factors that help increase the inflow of FDI Portfolio investments → purchase of stocks, bonds, and money market instruments by foreigners for the purpose of earning income, no managerial control

Balance of Payments BOP Example: Suppose that Maplewood Bicycle in Maplewood, Missouri, USA imports $100,000 worth of bicycle frames from Mercian Bicycles in Darby England. Payment = Debit (-) e.g. on imports Receipt = Credit (+) e.g. on exports There will exist a $100,000 credit (+) recorded by Mercian that offsets a $100,000 debit (-) at Maplewood’s bank account. International Trade Implications in England → This will lead to a rise in the supply of dollars and the demand for British pounds. Credit transactions in England’s BOP are any transaction that creates a demand for British pounds

Current Account (CA) (REVIEW) Includes all imports and exports of goods and services → Payments for Goods, Services, Resources, etc. If the debits exceed the credits, then a country is running a trade deficit Imports (-) > Exports (+) Expenses going out of the country > Income coming in from exports If the credits exceed the debits, then a country is running a trade surplus Exports (+) > Imports (-) Country sells more than its buys from foreign markets Revenue coming into the country from exports > payments going out for imports

Capital/Financial Account (KA) (REVIEW) Purchase or Sale of Assets Purchase: U.S. resident purchases asset from foreign company debit (-); similar to imports in CA Payment → capital outflow (K-out); lending to rest of world increase in U.S. financial claims on foreign assets decrease in foreign financial claims on U.S. Sale: Foreign company purchases asset from U.S. resident credit (+); similar to exports in CA Receipt → capital inflow (K-in); borrowing from rest of world decrease in U.S. financial claims on foreign assets

Record transactions in the following accounts: Example Transactions Record transactions in the following accounts: CA: A = Merchandise; B = Services; C = Invest. income; D = Unilateral Transfers KA: E = Change in U.S. claims on foreign assets; F = Change in foreign claims on U.S. assets U.S. firm sells $1m wheat to Romania, paid for out of Romanian-owned deposit account in U.S. A (+), F(-) CA → A (+): merchandise export is credit KA → F(-): decrease in foreign-owned dollar deposits = K-out = decreased foreign claims on U.S.

Record transactions in the following accounts: Example Transactions Record transactions in the following accounts: CA: A = Merchandise; B = Services; C = Invest. income; D = Unilateral Transfers KA: E = Change in U.S. claims on foreign assets; F = Change in foreign claims on U.S. assets U.S. tourist spends DM10,000 deposit in German bank while traveling in Germany B(-), E(+) B(-): tourist spending abroad is service import ~ a debit E(+): decrease in U.S. claims on foreigners ~ K-in (K-in → receipt (+); foreign purchases from U.S. resident); borrowing from rest of the world Deutsche Mark (DM) is the currency in germany

Record transactions in the following accounts: Example Transactions Record transactions in the following accounts: CA: A = Merchandise; B = Services; C = Invest. income; D = Unilateral Transfers KA: E = Change in U.S. claims on foreign assets; F = Change in foreign claims on U.S. assets U.S. citizen receives DM10k interest payment from German bonds, deposits in German bank → C (+), E(-) E(-): debit = increase in U.S. claims on foreign assets U.S. citizen converts DM to US$ at German Bank → E (+), F(-) E (+): credit = receipt = K-in = decrease in U.S. claims on foreigners (we gave up DM) F(-): debit =payment=K-out =decrease foreign claims on U.S.(they gave up $)

Record transactions in the following accounts: Example Transactions Record transactions in the following accounts: CA: A = Merchandise; B = Services; C = Invest. income; D = Unilateral Transfers KA: E = Change in U.S. claims on foreign assets; F = Change in foreign claims on U.S. assets U.S. Bank loans US$ to German Bank → F(+), E(-) F(+): credit = K-in = increase in foreign claims on U.S. (acquire $) E(-): debit = K-out = increase in U.S. claims on foreigner (future debt payments) German resident sells U.S Government Bond to French resident does not show on U.S. Balance of Payments! U.S. charity donates medicine to Nicaragua → A (+), D(-) A (+), D(-): merchandise export, gifts: payments to persons abroad Deutsche Mark (DM) is the currency in germany

U.S. Balance of Payments Data, 2000   Credits Debits Current Account 1 Exports $1,418.64 2 Imports ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39) Balance on Current Account ($444.69) Capital Account 4 Direct Investment $287.68 ($152.44) 5 Portfolio Investment $474.39 ($124.94) 6 Other Investments $262.64 ($303.27) Balance on Capital Account $444.26 7 Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73 In 2000, the U.S. imported more than it exported, thus running a current account deficit of $444.69 billion.

U.S. Balance of Payments Data, 2000   Credits Debits Current Account 1 Exports $1,418.64 2 Imports ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39) Balance on Current Account ($444.69) Capital Account 4 Direct Investment $287.68 ($152.44) 5 Portfolio Investment $474.39 ($124.94) 6 Other Investments $262.64 ($303.27) Balance on Capital Account $444.26 7 Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73 During the same year, the U.S. attracted net investment of $444.26 billion — clearly the rest of the world found the U.S. to be a good place to invest. In the real world, there is a statistical discrepancy.

Dividing the pie: How is it used? How is it made? How is it earned? Oct. 22, 2002 Dividing the pie: How is it used? How is it made? How is it earned? 15