International Finance

THE BALANCE OF
PAYMENTS AND
INTERNATIONAL LINKAGES
 OVERVIEW
I. BALANCE-OF-PAYMENT
CATEGORIES
II. THE INTERNATIONAL
FLOW OF GOODS,
SERVICES, AND CAPITAL
III. COPING WITH CURRENT
ACCOUNT DEFICITS
 PART I. BALANCE-OF-PAYMENT
CATEGORIES

THE BALANCE OF PAYMENTS (B-O-P)

1. PURPOSE:
Measures all financial and
economic
transactions over a specified period
of
time.
 PART I. BALANCE-OF-PAYMENT
CATEGORIES

2. Double-entry bookkeeping
a. Currency inflows = credits
earn foreign exchange
b. Currency outflows = debits
expend foreign exchange
 PART I. BALANCE-OF-PAYMENT
CATEGORIES
3. Three Major Accounts:
a. Current
b. Capital
c. Official Reserves
4. Current Account
records net flow of goods,
services, and unilateral
transfers.
 PART I. BALANCE-OF-PAYMENT
CATEGORIES
5. Capital Account
a. Function: records public & private
investment and lending.
b. Inflows = credits
c. Outflows = debits
d. Transactions classified as
1) portfolio
2) direct
3) short term
 PART I. BALANCE-OF-PAYMENT
CATEGORIES
6. Official Reserves Account
a. Function:
1) measures changes in international
reserves owned by central
banks.
2) reflects surplus/deficit of
a.) current account
b.) capital account
b. Reserves consist of
1.) gold
2.) convertible securities
 PART I. BALANCE-OF-PAYMENT
CATEGORIES
7. Net Effects:
Sum of all transactions must be zero:

1.) current account

2.) capital account
3.) official reserves
 PART I. BALANCE-OF-PAYMENT
CATEGORIES
8.The Balance-of-payment measures
a. Some Definitions:
1) Basic Balance
a) consists of current account
and longterm capital flows.
b) emphasizes longterm trends.
c) excludes short-term capital
flows that heavily depend on
temporary factors.
 PART I. BALANCE-OF-PAYMENT
CATEGORIES
8.The Balance-of-payment measures
a. Some Definitions:
2) Net Liquidity Balance:
measures the change in private
domestic borrowing or lending
require
to keep payments equal without
adjusting official reserves.
 PART I. BALANCE-OF-PAYMENT
CATEGORIES
8.The Balance-of-payment measures
a. Some Definitions:
3) Official Reserve Transactions
Balance:

measures adjustments needed

by

official reserves.
 PART II. THE INTERNATIONAL FLOW
OF GOODS, SERVICES, AND CAPITAL
LINKS FROM INTERNATIONAL TO
DOMESTIC
FLOWS
A. Global Linkages
set of basic macroeconomic identities
which link:
domestic spending and production to
current and capital accounts
 PART II. THE INTERNATIONAL FLOW
OF GOODS, SERVICES, AND CAPITAL
B. Domestic Savings and Investment and
the Capital Account
1. National Income Accounting
a. National Income (NI) is either spent
(C)
or saved (S) NI = C + S
b. National spending (NS) is divided into
personal spending (C) & investment (I)
NS = C + I
c. Subtracting (a)-(b) NI - NS = S - I
…(c)
If NI > NS, S > I which implies that surplus
 PART II. THE INTERNATIONAL FLOW
OF GOODS, SERVICES, AND CAPITAL
a. In a freely-floating system, excess
saving
= the capital account balance
e. Implications:
1. A nation which produces more than it
spends
will save more than it invests domestically
with
a net capital outflow producing a capital
account
 PART II. THE INTERNATIONAL FLOW
OF GOODS, SERVICES, AND CAPITAL

2. A nation which spends more than it

produces has a net capital inflow
producing a capital account surplus.
3. A healthy economy will tend to run
a current account deficit.
 PART II. THE INTERNATIONAL FLOW
OF GOODS, SERVICES, AND CAPITAL

THE LINK BETWEEN THE CURRENT AND

CAPITAL ACCOUNTS
1. Beginning identity
NI - NS = X - M (d)
where X = exports
M = imports
X-M =current account balance
(CA)
 PART II. THE INTERNATIONAL FLOW
OF GOODS, SERVICES, AND CAPITAL
2. Combining (c) + (d)
S - I = X - M (e)
3. If S - I = Net Foreign Investment (NFI)
NFI = X - M (f)
4. Implications:
a. If CA is in surplus, the nation must
be a
net exporter of capital.
b. If CA is a deficit, the nation is a
major
capital importer.
c. When NS > NI, the excess must be
 PART II. THE INTERNATIONAL FLOW
OF GOODS, SERVICES, AND CAPITAL
d. Solutions for Improving CA deficits:
1.) Raise national income (output)
relative to domestic
investment (I).
2.) Increase (S) relative to
domestic investment (I).
 PART II. THE INTERNATIONAL FLOW
OF GOODS, SERVICES, AND CAPITAL
GOVERNMENT BUDGETS AND CURRENT
ACCOUNT
DEFICITS
1. CURRENT ACCOUNT BALANCE

CA = Saving Surplus - Gov’t budget deficit.

2. CA Deficit means
the nation is not saving enough to finance (I) and the
deficit.

3. CA Surplus means the nation is saving more than needed

to
finance its (I) and deficit.
 PART III. COPING WITH THE CURRENT
ACCOUNT DEFICIT

POSSIBLE SOLUTIONS UNLIKELY TO

WORK:

A. Currency Depreciation
B. Protectionism
 PART III. COPING WITH THE CURRENT
ACCOUNT DEFICIT
Aad. CURRENCY DEPRECIATION
A. U.S. Experience:
Does not improve the trade deficit.
B. Depreciations are ineffective because
1. It takes time to affect trade.
2. J-Curve Effect (states that a
decline in
currency value will initially
worsen
the deficit before
improvement.)
 THE J - CURVE

Net Trade balance

change Currency improves
in trade depreciation
balanc
e
0 TIME

Trade balance
initially deteriorates
 PART III. COPING WITH THE CURRENT
ACCOUNT DEFICIT
Bad. PROTECTIONISM
A. Trade Barriers used:
1. Tariffs
2. Quotas
B. Results:
Most likely will reduce both X & M.
C. FOREIGN OWNERSHIP
one protectionist solution would
place
limits on or eliminate foreign
ownership
leading to capital inflows.
 PART III. COPING WITH THE CURRENT
ACCOUNT DEFICIT

SUMMARY:
CURRENT-ACCOUNT DEFICITS
- neither bad nor good inherently
1.Since one country’s exports are another’s
imports, it is not possible for all to run a
surplus
2. Deficits may be a solution to the problem
of different national propensities to save
and invest.
16. Jill Holman, 2001, “Is The Large US Current Account
Deficit Sustainable?” 2001, Economic Review
International Trade
Barriers – Global
Borderless Trade
Changing Business Perspectives
International implies an individual’s
or organization’s nationality is held
strongly in consciousness

Move
to

Globalization implies the world is

free from national boundaries and
that it is really a borderless world
 Changing Business Perspectives
In multinational organizations,
the organization is recognized as
doing business with other countries

Move
to

In transnational organizations,
organizations
the global viewpoint supersedes
national issues.
 Changes in Global Perspectives

Collapse of Eastern Europe

Union of East and West Berlin
Perestroika
Expansion of business with China Guanxi –
The Chinese practice of building
networks for social exchange
Creation of the European Union
Establishment of the North American Free
Trade Agreement
 Trade Patterns

World merchandise trade has grown faster than

world production during the last 50 years

Top 5 exporting countries Top 5 importing

countries

United States United States

Germany Germany
Japan Japan
China United Kingdom
France France
FORMS OF ECONOMIC INTEGRATION

Free Trade Area

Customs Union

Common Market

Economic Union
 FORMS OF ECONOMIC INTEGRATION

FREE TRADE AREA.

Member nations:
Remove trade barriers amongst themselves
Keep their own external national trade barriers

Eg: Latin American Free Trade Area (LAFTA).

 FORMS OF ECONOMIC INTEGRATION
FREE TRADE AREA.
Example:
Free Trade Area

Trade barrier
Country A Country D
Trade
barrier
Country B
FORMS OF ECONOMIC INTEGRATION

CUSTOMS UNION.

Member nations:
Remove trade barriers amongst themselves
Have a common set of external trade barriers.
 FORMS OF ECONOMIC INTEGRATION
CUSTOMS UNION.
Example:

Customs union

Country A
Common barrier
Country D
Country B
 FORMS OF ECONOMIC INTEGRATION

Common Market
Same as a customs union plus:
Free flow of capital, technology & labour
among member nations.
Residents of nation A could work in nation
D without a work permit.
Marketing implications of this?
 FORMS OF ECONOMIC INTEGRATION

Economic UNION.

Member nations fully unify their:

Economic policies & currencies.
Eg: common tax regimes, interest rates, etc.
Eg: European Union.
CURRENT FEATURES OF INTERNATIONAL TRADE

Globalization of operations

Liberalization of trade

Facilitation of market access

Importance (relative) of technical

barriers to trade
 CERTIFICATION TODAY

Quality requirements

Environmental requirements

Social and Labour requirements

Sustainable Development
requirements

WHAT NEXT ?????

 ROLE OF “GREEN ECONOMY”
ISO 14 000 standards
37,000 certificates in 112 countries
(ISO 9000 - 510,000 in 161
countries)
Organic food and beverages
Organic - 1% (Total agri-trade-15
billion US$)
Timber
“Certified” forests -0,08% -1.5%
(total forest
area in UNECE region-1494 mln.ha)

MARKET - “GREEN” or still RIPENING?

 Eco-Schemes
BENEFITS
Reward environmentally conscious
producers by:
Creating new markets
Allowing to charge a price premium
Increasing sales
CONCERNS
Market entry barrier
Discrimination
Trade distortion effects
“Certify or Die”
 What are the possible courses of action
for the elimination of barriers?
 Trade barriers regulation
 WTO dispute settlement
 WTO accession negotiations
 EU enlargement negotiations
 Implementation of existing bilateral
agreements
 Negotiation of new free trade agreements
 Other trade consultations
 How does the Trade Barrier
Regulation (TBR) procedure work?
Formal complaint submitted to the European
Commission by single companies, associations
of companies or Member States on trade
obstacles in non-EU countries
Investigation and legal and factual analysis by
the European Commission
If allegation confirmed, consultations between
the European Commission and the government
concerned to remove the barrier
If talks fail, resort to WTO dispute settlement
 Current Situation
New round of negotiations includes
”trade and environment” linkage on
agenda.
Labor rights not on the agenda
Why is there a difference in treatment?

Externalities/sovereignty
Status of international legal institutions
with competence in environmental/labor
issues
 What is a social/environmental clauses
in International Trade Agreements?
A clause in a trade agreement that
”aims at improving labour [or
environmental] conditions in
exporting countries by allowing
sanctions to be taken against
exporters who fail to observe
minimum standards”
 GATT and WTO

GATT: ”General Agreement on

Tariffs and Trade” – signed in
1947, in force 1948-1995
WTO: World Trade Organisation -
established 1 January 1995 – took
over GATT's functions – GATT 1947
was incorporated into GATT 94,
which is one of the WTO-
agreements
 Historical background of the GATT
U.S./U.K. sponsored comprehensive plan
for post-World War II reconstruction and
development – trade liberalization was
one of the basic elements
3 international economic and financial
institutions: World Bank, International
Monetary Fund (IMF) and the
International Trade Organization (ITO)
GATT was supposed to be merely an
interim agreement until ITO charter (the
”Havana charter”) approved
 How GATT worked

GATT’s basic functions: forum for

negotiations on rules governing
market access for goods, monitor
implementation, and resolve
disputes
How GATT worked: negotiation
rounds.
Who performed the organizational
work: an elite group of economists
specializing in trade issues.
 From GATT 1947 to WTO 1995

Problems:
Big tariff reductions in some areas, none
in others
Proliferation of non-tariff trade barriers
Ineffective dispute settlement procedure
GATT = Gentlemen’s Agreement to
Talk and Talk
Solution:
Uruguay Round WTO
 World Trade Organization Agreements

Final Act
Agreement establishing the WTO
GATT 1994 – incorporates GATT 1947,
main rule-book for trade in goods, plus
appendices.
General Agreement on Trade in Services
(GATS)
Trade Related Aspects of Intellectual
Property Rights (TRIPS) Agreement
Dispute Settlement Understanding
Trade Policy Review Mechanism
 Economic theoretical basis for trade
liberalization
Adam Smith’s theory of absolute advantage:
advantage ”If a
foreign country can supply us with a commodity
cheaper than we can make, better buy it of them
with some part of the produce of our own
industry.” Wealth of Nations (1776)
David Ricardo’s theory of comparative advantage:
advantage
mutual gains from free trade regardless of whether
any country had an absolute advantage. All
countries would specialize in the production of the
good in which their opportunity cost was lowest.
 Essence of the GATT: Four core legal
commitments
Article I: “Most Favored Nation”
obligation – same treatment to like
products of contracting parties
Article III: National Treatment
obligation – non-discrimination between
domestic ”like products” and imports
from contracting parties
Article XI: prohibits quantitative
restrictions,
GATT preamble/Article XXVIII: Binding
commitments to reduce tariffs on
imports
 TBT and SPS Agreements
Permit WTO tribunals to invalidate national
health and product safety standards under legal
standards such as “disguised restriction on
trade” or “Unnecessary obstacles to trade”
Encourage governments to use accepted
international standards
GATT panel decisions could be enforced with
trade sanctions--if unanimous approval by all
GATT contracting parties--including the country
found to be in violation of GATT rules.
Permit higher standards if (1) there is a scientific
justification or (2) the country has followed a
prescribed risk assessment procedure.
 GATT Dispute Settlement

Any GATT party could challenge another

GATT party’s law as an illegal trade
barrier before a GATT panel in Geneva.
Enforcement of GATT panel decisions
with trade sanctions only if unanimous
approval by all GATT contracting
parties--including the country found to
be in violation of GATT rules.
 WTO Dispute Settlement

New possibility for appeal

New: panel has the power to approve
sanctions against countries that refuse to
remove laws already found to be GATT-
illegal
New: determinations by WTO tribunals
are automatically binding; cannot be
blocked unless all member countries vote
to do so within 90 days of the decision.
 Arguments for amending/adding to
existing environmental exceptions
Poor record of GATT/WTO panels in
environmentally relevant cases
Sovereignty issues related to effective
protection of domestic environment, e.g.,
Reformulated Gasoline case
Trade restrictions are sometimes essential to
promote/enforce international environmental
agreements, e.g., Mexican Tuna and Shrimp-
Turtle cases
Recent developments in trade economics
 Arguments for adding a social clause

Social dumping
Wide agreement on content of
“fundamental labor rights”
Weakness of ILO as compared with
WTO, i.e. trade restrictions may
sometimes be an effective means of
promoting and enforcing fundamental
labor rights.
Recent developments in trade
economics
 Arguments against an environmental
clause
Art. XX exceptions are sufficient
New, tougher clause would mostly
work to disadvantage of developing
countries
International legal rights and
principles: right to development;
sovereignty over own resources.
If the clause permits removing such
disputes from WTO jurisdiction: no
other effective alternative exists.
 Arguments against a social clause

”social dumping” not empirically

proven, contrary to theory of
comparative advantage
Article XX exceptions are sufficient
A social clause is a political
instrument that does not belong in
the multilateral trading system
 Neo-institutionalists vs. Neo-classical
economists

Neo-classical economists: models

based on perfect markets and
”free” trade
Neo-institutionalists: models
include market distortions and
interaction between negotiations
over trade policy and
determination of labor standards
Examples of trade barrier elimination
Country Course of action
WTO dispute settlement
India system - negotiated
settlement
WTO dispute settlement
Korea system - panel proceeding

Brazil TBR procedure

Taiwan Accession to the WTO

Consultations and the

initiation of a dispute
Ukraine settlement procedure under
the PCA
Free trade agreement
Mexico negotiation
 Examples of trade barrier elimination

India: Balance of Payments Restrictions

Import prohibitions applied since 1960 to a wide
range of consumer goods
The European Commission has received complaints
from business
The European Commission raised the issue in the
framework of the World Trade Organization (WTO)
Negotiations led to a progressive elimination of
restrictions between 2000 (for priority products)
and 2003
Expected additional turnover for EU industry: 2
Billion €
 Examples of trade barrier elimination

Korea: safeguard on dairy products

Korea had imposed safeguard measures taking the
form of quotas on skimmed milk powder
preparations
Negotiations and formal WTO consultations failed to
find a solution
The subsequent WTO dispute settlement procedure
found these measures in breach of the provisions
applicable to safeguards
Korea informed the EU that it had revoked the
illegal measure
 Examples of trade barrier elimination

Brazil: scope non automatic licensing

Brazil applies non-automatic licensing on a wide
range of products
This measure has also been used to implement
minimum prices in certain sectors
In the context of a Trade Barrier Regulation (TBR)
procedure, the European Commission has
obtained the removal of textile and certain steel
products from the list subject to non automatic
licensing and minimum prices
 Examples of trade barrier elimination
Chinese Taipei (Taiwan): discriminatory
taxation of spirits
Taiwan joined the WTO as a customs territory called
Chinese Taipei in 2001
Taiwan has maintained over a long period a tax
system discriminating EU spirits against similar US
and Japanese products (taxes on EU products more
than twice the level applicable to other products)
In the context of its accession to the WTO Taiwan
has agreed to eliminate this discrimination
This Taiwanese commitment was fully implemented
in 1998/99 before accession
 Examples of trade barrier elimination

Ukraine: discriminatory fees for pharmaceuticals

In April 1998, Ukraine set up fees for the registration of

imported pharmaceutical products at 100 times the level
applicable for domestic products
This was in breach of the Agreement on Partnership and
Cooperation (PCA) between the EU and Ukraine
This system significantly impeded market access for EU
industry and was also detrimental for health policy in
Ukraine
Following the initiation of a dispute settlement procedure
under the PCA, the discriminatory fees were eventually
removed in March 2000
 Examples of trade barrier elimination
Mexico: trade related investment measures
in the car sector
Mexico’s investment regime hindered access for EU
car producers which were not manufacturing locally
In the context of the negotiation of the free trade
agreement with the EU, Mexico agreed to open
substantial tariff quotas for these producers,
pending the elimination of the regime in 2004 (in
fact accelerated to 2002)
This will provide for a more equitable market access
 Market Access Strategy

Aims at removing trade barriers on a

global scale

Aims at achieving the largest

economic impact in terms of additional
trade and investment opportunities

Aims at benefiting all sectors of

industry
 World Trade Organization
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. So far, 144 countries (as of 1 January
2002) as members.
On 1 January 1995, the WTO replaced GATT (General
Agreement on Tariffs and Trade), which had been in existence
since 1947, as the organization overseeing the multilateral
trading system. The governments that had signed GATT were
officially known as “GATT contracting parties”. Upon signing
the new WTO agreements (which include the updated GATT,
known as GATT 1994), they officially became known as “WTO
members”.
 World Trade Organization
Cycle of Entry to WTO
Increase in Foreign and
Entry to WTO
Domestic Enterprises •Economic
Growth

•Reduced Tarriffs •More

Diversified
•More Foreign Economy
Presence Increased Competition
•Integration into
•Lower Trade
World Economy
Barrier for Exports
•Capacity-Based
More Efficient Industries Competition

•Better
Infrastructure

Larger Economy
 World Trade Organization
Application ???

What about …
Information on “U.S. International Transactions, Third Quarter
2002” from Bureau of Economics Analysis.