Balance of Payments Lecture 25 Dr. Jennifer P. Wissink ©2018 Jennifer P. Wissink, all rights reserved. April 30, 2018 1

TABLE 20.1 United States Balance of Payments, 2011 37.7 (11) Net capital account transactions and financial derivatives (13) Balance of payments (5 + 10 + 11 + 12) −89.2 (12) Statistical discrepancy 517.4 (10) Balance on capital account (6 + 7 + 8 + 9) 211.8 (9) Change in foreign government assets in the United States −119.5 (8) Change in U.S. government assets abroad (increase is −) 789.2 (7) Change in foreign private assets in the United States −364.1 (6) Change in private U.S. assets abroad (increase is −) Capital Account −465.9 (5) Balance on current account (1 + 2 + 3 + 4) −133.1 (4) Net transfer payments 227.0 (3) Net investment income −517.6 Income payments on investments 744.6 Income received on investments 178.6 (2) Net export of services −427.4 Imports of services 606.0 Exports of services −738.4 (1) Net export of goods −2,235.8 Goods imports 1,497.4 Goods exports Current Account Billions of dollars TABLE 20.1 United States Balance of Payments, 2011 All transactions that bring foreign exchange into the United States are credited (+) to the current account; all transactions that cause the United States to lose foreign exchange are debited (−) to the current account

TABLE 20.1 United States Balance of Payments, 2011 37.7 (11) Net capital account transactions and financial derivatives (13) Balance of payments (5 + 10 + 11 + 12) −89.2 (12) Statistical discrepancy 517.4 (10) Balance on capital account (6 + 7 + 8 + 9) 211.8 (9) Change in foreign government assets in the United States −119.5 (8) Change in U.S. government assets abroad (increase is −) 789.2 (7) Change in foreign private assets in the United States −364.1 (6) Change in private U.S. assets abroad (increase is −) Capital Account −465.9 (5) Balance on current account (1 + 2 + 3 + 4) −133.1 (4) Net transfer payments 227.0 (3) Net investment income −517.6 Income payments on investments 744.6 Income received on investments 178.6 (2) Net export of services −427.4 Imports of services 606.0 Exports of services −738.4 (1) Net export of goods −2,235.8 Goods imports 1,497.4 Goods exports Current Account Billions of dollars TABLE 20.1 United States Balance of Payments, 2011 All transactions that bring foreign exchange into the United States are credited (+) to the current account; all transactions that cause the United States to lose foreign exchange are debited (−) to the current account

TABLE 20.1 United States Balance of Payments, 2011 37.7 (11) Net capital account transactions and financial derivatives (13) Balance of payments (5 + 10 + 11 + 12) −89.2 (12) Statistical discrepancy 517.4 (10) Balance on capital account (6 + 7 + 8 + 9) 211.8 (9) Change in foreign government assets in the United States −119.5 (8) Change in U.S. government assets abroad (increase is −) 789.2 (7) Change in foreign private assets in the United States −364.1 (6) Change in private U.S. assets abroad (increase is −) Capital Account −465.9 (5) Balance on current account (1 + 2 + 3 + 4) −133.1 (4) Net transfer payments 227.0 (3) Net investment income −517.6 Income payments on investments 744.6 Income received on investments 178.6 (2) Net export of services −427.4 Imports of services 606.0 Exports of services −738.4 (1) Net export of goods −2,235.8 Goods imports 1,497.4 Goods exports Current Account Billions of dollars TABLE 20.1 United States Balance of Payments, 2011 All transactions that bring foreign exchange into the United States are credited (+) to the current account; all transactions that cause the United States to lose foreign exchange are debited (−) to the current account

Example 1: The Wissinks go to France. Hotel/food/train/gifts costs €5,000 Euros The Wissinks need to buy Euros € 1 Euro = $1.20 USD OR $1 USD = € 0.83 Euro So... it all costs $6,000 USD Cool currency converter site: http://www.xe.com/ucc/full/ The Wissinks are importing goods and services. There will be 2 entries in the Balance of Payments.

Example 1: The Wissinks going to France. In the Current Account, “Imports of goods and services” (lines 1&2) shows a - $6,000. Note: a debit item, since we use up foreign exchange! I take $6,000 US dollars and purchase € 5,000 Euros from a French private bank to pay the hotel/tour bill. In the Capital Account, (line 7) “Change in foreign private assets in the United States” (in this case, French holdings of US dollars) are increased by +$6,000. Note: this is a credit item! The net wealth position of the US vis-à-vis the rest of the world has decreased by $6,000.

Example 2: Prof. Wissink decides to buy a British bond from a non-government (private) British issuer. The bond costs £10,000. £1 GBP = $1.40 USD OR $1 USD = £0.72 GBP I take $14,000 USD and purchase the £10,000 GBP bond (which has a US dollar value of $14,000). The Wissinks are dealing with buying a foreign asset. There will be 2 entries in the Balance of Payments

Example 2: Wissink buys a British bond. “Change in foreign private assets in the US” (in this case, British holdings of US dollars) show a +$14,000 in the Capital Account. Reminder: increases in this item get recorded as a “+” item in line (7) of the Capital Account. But now I hold this bond so there is a “change in private U.S. assets abroad”, that is an increase in US assets abroad (the U.S.(me!) now holds more British bonds) and so we show this as a -$14,000 in the Capital Account. Reminder: increases in this item get recorded as a “–” item in line (6) of the Capital Account. So there is still “balance” in the Balance of Payments accounts.

Trade Policy: Free vs. Protection Free Trade - the practice of leaving the markets alone and letting the invisible hand of the price mechanism do its work. Protection - the practice of shielding a sector of the economy from foreign competition via various policies. So… Should we? (Protectionist Policies) Should we not? (Free Trade Policies) Common protectionist policies A tariff is a tax on imports. The average tariff on imports into the United States is about 5 percent. A quota is a limit on the quantity of imports. Export subsidies are government payments made to domestic firms to encourage exports. Dumping refers to when a firm or industry sells products on the world market at prices below the cost of production. The Comprehensive Trade Act of 1988 contains clauses that permit the president to impose trade sanctions when investigations reveal dumping by foreign companies or countries.

The Case For Free Trade The case for free trade is based on the theory of comparative advantage. When countries specialize and trade based on comparative advantage, consumers pay less and consume more, and resources are used more efficiently. When tariffs and quotas are imposed, some of the gains from trade are lost. The Economist’s history and free trade Sep 6th 2013, 13:55 by C.R. | LONDON http://www.economist.com/blogs/freeexchange/2013/09/economic-history Additional justifications Trade keeps us all connected Trade keeps us all at peace with each other

The Case For Protection Protection saves jobs at home. Some countries engage in unfair trade practices, so we need to protect against that. Cheap foreign labor makes competition unfair. Protection safeguards national security. Protection discourages dependency. Protection safeguards infant industries. Often Special Issues emerge with developing economies.

U.S. Trade Policies Long and complicated history. Affected by: economic conditions political conditions social conditions High water mark: the Smoot-Hawley tariff was the U.S. tariff law of the 1930s, which set the highest tariffs in U.S. history (average tariff rate reached 60%). It set off an international trade war and caused the decline in trade that is often considered a cause of the worldwide depression of the 1930s.

Global Trade Policies The General Agreement on Tariffs and Trade (GATT) is an international agreement originally singed by the United States and 22 other countries in 1947 to promote the liberalization of foreign trade. GATT was supposed to be temporary but lasted a long time and in 1995 spawned the WTO through the Uruguay Round negotiations. For all intents and purposes, GATT now lives vicariously through the WTO. [Special Thanks to Barrett Lane (S08) for great detective work provided to me on the history between GATT and the WTO.] The World Trade Organization (WTO) is the only global international organization dealing with the rules of trade between nations. At its heart are the WTO agreements, negotiated and signed by the bulk of the world’s trading nations and ratified in their parliaments. The goal is to help producers of goods and services, exporters, and importers conduct their business. Location: Geneva, Switzerland Established: 1 January 1995 Created by: Uruguay Round negotiations (1986-94) Membership & Observers: 160 countries on 26 June 2014 http://www.wto.org/index.htm Membership: Functions: • Administering WTO trade agreements • Forum for trade negotiations • Handling trade disputes • Monitoring national trade policies • Technical assistance and training for developing countries • Cooperation with other international organizations  

Economic Integration Economic integration occurs when two or more nations join to form a free-trade zone. Two Examples: The European Union (EU) Initially, the EU consisted of just six countries: Belgium, Germany, France, Italy, Luxembourg and the Netherlands. (EEC, aka the “common market” in 1957) Then over time more countries joined! In 1991 they signed the Maastricht Treaty  the EU was born (1993) and the EURO, which 16 of the EU countries adopted. See: http://europa.eu/index_en.htm The North American Free-Trade Agreement (NAFTA) An agreement signed by the United States, Mexico, and Canada in 1994 in which the 3 countries agreed to establish all North America as a free-trade zone. President Trump and Trade NAFTA Trans-Pacific Partnership

The EU Today The European Union is now composed of 28 independent sovereign countries which are known as member states, they are: Members: Austria, Belgium, Bulgaria, Croatia, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and the United Kingdom. BREXIT VOTE on June 23, 2016 Candidates: Albania, FYROM, Iceland, Montenegro, Serbia, Turkey

Our Model and Simple Policy Prescriptions…? So... AEd = C + Id + G + EX – IM and to get equilibirum set Y* = AEd(Y*) and solve for Y* So… it’s good to EX and IM to make your Y* as large as possible… …however, this implies another country’s exports may go and its imports may go which might not be good for them. Get beggar thy neighbor policies Exporting unemployment Retaliation via tariffs and quotas, etc Bad for international trade overall GOOD QUESTION: What really determines EX and IM?

Determinants of Exports & Imports The determinants of imports include the same factors that affect consumption and investment. i.e., Y or Yd, r, wealth and any other stuff you think belongs in the model i>clicker question: Do YOU check for where what you buy is produced? A. Yes. B. No. Imports also depend on the prices of domestically-produced goods relative to foreign-produced goods. prices at home relative to abroad exchange rates matter a lot here The determinants of exports are the same – just from the position of the rest of the world. US exports depend on economic activity in the rest of the world. I.e., If foreign output increases, U.S. exports tend to increase.

Exports and Imports and the so-called “Trade Feedback Effect” The trade feedback effect is the tendency for an increase in the economic activity of one country to lead to a worldwide increase in economic activity, which then feeds back to that original country. Suppose the U.S. economy starts to grow  Y*  IM  Because U.S. imports are somebody else’s exports, the extra import demand from the United States raises the exports of the rest of the world, expanding their economies. Some of the desire for those countries to import creates exports for the US!  a trade feedback effect back in the U.S. In good times, this might appear nice, but in bad times, not so much.

Export and Import Prices and the so-called “Price Feedback Effect” The price feedback effect is the process by which a domestic price increase in one country can “feed back” on itself through export and import prices. Suppose... Inflation picks up in Italy  shoe prices and olive oil prices in Italy go up  Italian imported shoes and olive oil are now more expensive in the U.S. and elsewhere  in the U.S., IM and its EX  AD shifts right and SR-AS eventually shifts left in the U.S. upward pressure on prices in the U.S.  a tendency for even higher prices back in Italy. Inflation can be “exportable” and it might “boomerang” back on you. Need to address exchange rate determination.