Trade, Capital Flows and the Balance of Payments

Abstract

With the opening of an economy to the rest of the world, the economic and financial situation of each agent no longer depends solely on the economic decisions made by his or her fellow citizens, but also on the decisions made by foreign economic agents. This dynamic, which introduces more complexity into the economic system, is double-edged. It undeniably increases economic freedom: indeed, the possibility of carrying out transactions with foreign countries opens up new consumption and investment choices for economic agents. But, at the same time, it introduces new constraints: foreign consumers now compete with domestic consumers for goods produced by domestic firms, foreign firms compete with domestic firms for payments from those same consumers, and the complex investment strategies of international banks and asset managers affect investment, exchange rates as well as domestic prices. Not surprisingly, one of the most fundamental and long-standing controversies in economics concerns the effects of economic openness on social provisioning. In the context of the Anthropocene, this problem is now coupled with new questions: what is the impact of trade flows on CO₂ emissions? Should we roll back international financial liberalization? Will the international financial architecture have to be reconfigured to achieve the Sustainable Development Goals? These are some of the issues addressed in this chapter.

Appendix: Accounting Entries in the Balance of Payments

Two accounting rules can be used to record transactions in a country’s balance of payments. These two rules are always checked simultaneously, for each and every transaction.

1.1 Rule A: The Distinction Between Autonomous Transactions and Financing Transactions

Each international transaction gives rise to two opposing accounting entries in the balance of payments: one entry as an autonomous transaction, and one entry as a financing transaction:

• The accounting record of the autonomous transaction describes the real side of the transaction, from the point of view of the domestic economy. It could be an import or export of goods, a purchase or sale of an international service, a direct investment abroad, a purchase of a foreign share or bond…

• The accounting record of the financing transaction describes the cash flow that is the counterpart of the autonomous transaction: an export of goods or services involves a foreign exchange inflow, a direct investment abroad involves a capital outflow…

Autonomous transactions involving a currency inflow are posted as a credit. Autonomous transactions involving a currency outflow are posted as a debit. Each autonomous transaction has a counterpart financing transaction recorded with an opposite sign in the balance of payments.

1.2 Rule B: The Principle of Variation in the Wealth of National Residents

Any international transaction resulting in a decrease in the real or financial wealth of domestic residents is recorded as a credit in the balance of payments. For instance, an export of goods is recorded as a credit because it leads to a decrease in the real wealth of residents; the purchase of domestic financial assets by non-residents is also recorded as a credit because it leads to a decrease in the financial wealth of residents, as is the decrease in the foreign currency reserves of the Central Bank following its interventions on the foreign exchange market…

Conversely, any international transaction that increases the real or financial wealth of domestic residents is recorded on the debit side of the balance of payments. Thus, an import of goods is recorded on the debit side because it leads to an increase in the real wealth of residents; the sale of domestic financial assets by non-residents is recorded on the debit side because it leads to an increase in the financial wealth of residents, as is the acquisition of foreign currency reserves by the Central Bank following its interventions on the foreign exchange market…