Definition of balance of payments
Balance of payments is an account that records the flows of money from the dealings between the residents of a country and other countries over a period of time. The inflow of money is recorded as a credit item with a positive sign, while an outflow is debited with a negative sign. The balance of payments comprises three components, namely the current account, capital account and financial account.
Current account
The current account is made up of trade in goods, trade in services, primary income and secondary income. The overall balance in the current account is the sum of the four parts. If the outflows (debits) exceed the inflows (credits), there is a current account deficit. But if the inflows surpass the outflows, a current account surplus arises.
Table 1: U.S. Current account-Trade in goods (in millions of dollars)
| 2020 | 2021 | |
| Exports of goods (credits) | 1,432,218 | 1,761,364 |
| General merchandise: | 1,407,355 | 1,729,061 |
| Foods, feeds, and beverages | 139,280 | 164,749 |
| Industrial supplies and materials | 450,606 | 616,784 |
| Capital goods except automotive | 462,894 | 520,769 |
| Automotive vehicles, parts, and engines | 128,834 | 144,066 |
| Consumer goods except food and automotive | 174,009 | 221,720 |
| Other general merchandise | 51,731 | 60,974 |
| Net exports of goods under merchanting | 835 | 832 |
| Nonmonetary gold | 24,028 | 31,472 |
| Imports of goods (debits) | 2,346,103 | 2,851,660 |
| General merchandise: | 2,284,441 | 2,825,919 |
| Foods, feeds, and beverages | 155,445 | 183,323 |
| Industrial supplies and materials | 429,307 | 641,595 |
| Capital goods except automotive | 647,208 | 764,758 |
| Automotive vehicles, parts, and engines | 309,865 | 347,898 |
| Consumer goods except food and automotive | 639,900 | 767,137 |
| Other general merchandise | 102,717 | 121,207 |
| Nonmonetary gold | 61,662 | 25,741 |
| Balance on goods | -913,885 | -1,090,296 |
Source: Data from the U.S. Bureau of Economic Analysis
Trade in goods
Trade in goods is made up of the export and import of goods. Goods are visible items such as computers, cars, etc. Export of goods results in the flow of money into a country (credit item) while import of goods leads to the flow of money out of a country (debit item). The difference between the export of goods and the import of goods is referred to as the balance of trade in goods, the balance of visible trade or the balance of merchandise. A surplus occurs when exports are more than imports (positive balance) and a deficit occurs when imports exceed exports ( negative balance). In Table 1 above, there was a balance of trade deficit of $913,885 million ($1,432,218 million minus $2,346,103 million) in 2020 and $1,090,296 ($1,761,364 minus $2,851,660 million) in 2021.
Table 2: U.S. Current account-Trade in services (in millions of dollars)
| 2020 | 2021 | |
| Exports of services (credits) | 726,433 | 795,273 |
| Manufacturing services on physical inputs owned by others | n.a. | n.a. |
| Maintenance and repair services n.i.e. | 13,196 | 12,526 |
| Transport | 57,168 | 65,777 |
| Travel (for all purposes including education) ¹ | 72,481 | 70,214 |
| Construction | 2,395 | 3,129 |
| Insurance services | 20,277 | 22,741 |
| Financial services | 151,033 | 171,740 |
| Charges for the use of intellectual property n.i.e. | 115,558 | 124,613 |
| Telecommunications, computer, and information services | 56,456 | 59,797 |
| Other business services | 195,046 | 217,426 |
| Personal, cultural, and recreational services | 20,820 | 23,915 |
| Government goods and services n.i.e. | 22,003 | 23,394 |
| Imports of services (debits) | 466,537 | 550,025 |
| Manufacturing services on physical inputs owned by others | n.a. | n.a. |
| Maintenance and repair services n.i.e. | 6,203 | 7,982 |
| Transport | 72,763 | 105,255 |
| Travel (for all purposes including education) ¹ | 34,159 | 56,851 |
| Construction | 1,131 | 1,495 |
| Insurance services | 57,673 | 59,377 |
| Financial services | 45,314 | 49,529 |
| Charges for the use of intellectual property n.i.e. | 47,708 | 43,342 |
| Telecommunications, computer, and information services | 39,728 | 43,142 |
| Other business services | 112,979 | 129,601 |
| Personal, cultural, and recreational services | 24,325 | 28,304 |
| Government goods and services n.i.e. | 24,553 | 25,147 |
| Balance on services | 259,896 | 245,248 |
Source: Data from the U.S. Bureau of Economic Analysis
N.B.
1. All travel purposes include 1) business travel, including expenditures by border, seasonal, and other short-term workers and 2) personal travel, including health-related and education-related travel.
n.i.e., Not included elsewhere
n.a. Transactions are possible, but data are not available.
Trade in services
Trade in services is a record of the export and import of services, e.g., banking, transport, etc. The difference between the export of services and the import of services is known as the invisible balance, the balance on services or the balance of trade on services. In Table 2 above, the U.S. recorded balance on services surplus of $259,896 million ($726,433 million minus $466,537 million) in 2020 and $245,248 ($795,273 million minus $550,025 million) in 2021.
Table 3: U.S. Primary and secondary income and capital account (in millions of dollars)
| 2020 | 2021 | |
| Primary income receipts | 936,236 | 1,052,080 |
| Investment income: | 929,608 | 1,045,181 |
| Direct investment income | 474,585 | 582,837 |
| Portfolio investment income | 380,207 | 403,207 |
| Other investment income | 74,561 | 59,220 |
| Reserve asset income | 255 | -84 |
| Compensation of employees | 6,628 | 6,899 |
| Primary income payments | 773,146 | 912,587 |
| Investment income: | 758,716 | 895,030 |
| Direct investment income | 178,380 | 303,136 |
| Portfolio investment income | 492,302 | 521,780 |
| Other investment income | 88,033 | 70,114 |
| Compensation of employees | 14,430 | 17,557 |
| Balance on primary income | 163,090 | 139,493 |
| Secondary income (current transfer) receipts ² | 165,209 | 171,436 |
| Secondary income (current transfer) payments ² | 294,008 | 312,236 |
| Balance on secondary income | -128,799 | -140,800 |
| Capital account | ||
| Capital transfer receipts and other credits | 372 | 3,864 |
| Capital transfer payments and other debits | 5,903 | 6,338 |
| Balance on capital account | -5,531 | -2,474 |
Source: Data from the U.S. Bureau of Economic Analysis
N.B.
2. Secondary income (current transfer) receipts and payments include U.S. government and private transfers, such as U.S. government grants and pensions, fines and penalties, withholding taxes, personal transfers (remittances), insurance-related transfers, and other current transfers.
Primary income
Primary income represents the inflow and outflow of income accruing to factors of production such as dividends, interest, profit and wages. This is also known as income flows because it is from working (e.g. wages) and possession of financial investments (e.g. dividends). It comprises incomes from direct investment, portfolio investment, reserve assets and other investments (see Table 3 above).
Secondary income
Secondary income, also known as current transfers, is payments made by a country’s residents to another country’s residents without receiving anything in return, e,g, grants or aids from international organisations to the government, international transfers by individuals, etc. The balance on secondary income is the difference between secondary income receipts and payments (see Table 3 above).
Capital account
The capital account is a relatively small part of the balance of payments. It contains flows from capital transfers and non-financial assets. Capital transfers include grants for capital projects, the sale/purchase of fixed assets (e.g. land), debt forgiveness and money brought in/taken out by migrants. The non-financial assets in this account are intangible assets such as copyrights, patents, trademarks, brand names, right to use land or water for mining or fishing.
Financial account
Financial account records change in ownership of assets, flow of money for bank deposits and investment. It is a relatively large component for some countries. It includes direct investment (e.g. factories), portfolio investment (e.g. shares), other financial investments (e.g. deposits and bonds) and central bank reserve assets (gold and foreign currencies). Reserves are assets controlled by the central bank for policy objectives such as intervention in the foreign exchange market and to assist the government in meeting its commitments to the International Monetary Fund (IMF) (see Table 4 below).
Table 4: U.S. Financial account (in millions of dollars)
| 2020 | 2021 | |
| Net U.S. acquisition of financial assets excluding financial derivatives (net increase in assets / financial outflow (+)) | 943,091 | 1,278,599 |
| Direct investment assets: | 271,798 | 421,749 |
| Equity | 291,207 | 426,081 |
| Debt instruments | -19,409 | -4,332 |
| Portfolio investment assets: | 406,364 | 719,095 |
| Equity and investment fund shares | 395,995 | 154,795 |
| Debt securities: | 10,369 | 564,299 |
| Short term | -24,946 | 75,613 |
| Long term | 35,315 | 488,686 |
| Other investment assets: | 255,956 | 23,763 |
| Other equity | 1,847 | 1,206 |
| Currency and deposits | 92,767 | -47,977 |
| Loans | 169,652 | 68,611 |
| Insurance technical reserves | n.a. | n.a. |
| Trade credit and advances | -8,311 | 1,922 |
| Reserve assets: | 8,974 | 113,993 |
| Monetary gold | 0 | 0 |
| Special drawing rights | 81 | 113,685 |
| Reserve position in the International Monetary Fund | 8,814 | 460 |
| Other reserve assets: | 78 | -153 |
| Currency and deposits | -73 | -64 |
| Securities | 151 | -89 |
| Financial derivatives | 0 | 0 |
| Other claims | 0 | 0 |
| Net U.S. incurrence of liabilities excluding financial derivatives (net increase in liabilities / financial inflow (+)) | 1,634,965 | 1,977,294 |
| Direct investment liabilities: | 148,914 | 448,325 |
| Equity | 167,803 | 380,786 |
| Debt instruments | -18,889 | 67,539 |
| Portfolio investment liabilities: | 946,560 | 676,112 |
| Equity and investment fund shares | 687,417 | -19,562 |
| Debt securities: | 259,144 | 695,674 |
| Short term | 269,163 | -61,466 |
| Long term | -10,019 | 757,140 |
| Other investment liabilities: | 539,490 | 852,857 |
| Other equity | n.a. | n.a. |
| Currency and deposits | 319,425 | 318,654 |
| Loans | 207,501 | 402,011 |
| Insurance technical reserves | n.a. | n.a. |
| Trade credit and advances | 12,564 | 19,358 |
| Special drawing rights allocations | 0 | 112,834 |
| Financial derivatives other than reserves, net transactions ³ | -5,107 | -41,902 |
| Financial account balance | -696,981 | -740,597 |
Source: Data from the U.S. Bureau of Economic Analysis
N.B.
3. Transactions for financial derivatives are only available as a net value equal to transactions for assets less transactions for liabilities. A positive value represents net U.S. cash payments arising from derivatives contracts, and a negative value represents net U.S. cash receipts.
Net errors and omissions
Net errors and omissions ensure that the total of all debits is equal to the total of credits of the balance of payments. In Table 5 below, it is -$71,751 in 2020 and $108,231 in 2021. This will bring the overall balance in the balance of payments to zero (e.g. -$619,698 + $619,698 in 2020). When this happens, there is a balance of payments equilibrium. Net errors and commissions represent a balancing figure necessitated by the imbalance arising from delays and omission of items. A country is usually engaged in a large volume of transactions.
Table 5: U.S. Balances (in millions of dollars)
| 2020 | 2021 | |||
| Balance on current account: | -619,698 | -846,354 | ||
| Balance on goods | -913,885 | -1,090,296 | ||
| Balance on services | 259,896 | 245,248 | ||
| Balance on primary income | 163,090 | 139,493 | ||
| Balance on secondary income | -128,799 | -140,800 | ||
| Balance on capital account | -5,532 | -2,474 | ||
| Balance on financial account | 696,981 | 740,597 | ||
| Statistical discrepancy | -71,751 | 108,231 | ||
| Total | -619,698 | 619,698 | -846,354 | 846,354 |
Source: Data from the U.S. Bureau of Economic Analysis
Balance of payments disequilibrium
One of the macroeconomic objectives of the government is to maintain a Balance of Payments (BOP) equilibrium. BOP equilibrium occurs when a country’s receipts and payments from its international transactions are equal. The overall balance in the BOP account is zero, i.e. total debits and total credits are equal. BOP comprises the current account, capital account and financial account.
If the total money inflow is greater than the total money outflow, there is a BOP surplus. A BOP deficit occurs when the total money outflow exceeds the total inflow of money. A BOP surplus is a positive balance while a BOP deficit is a negative balance.
Current account disequilibrium
The current account is part of the BOP and comprises trade in goods, trade in services, incomes and current transfers. A deficit on the current account means the total outflow from its components exceeds the total inflow. The overall balance in the account is negative when there is a current account deficit. It means that there is a net outflow of currency from the country and the country may run into a problem if the deficit is large. It may may have to draw down its foreign reserve or borrow form the International Monetary Fund (IMF) unless it can attract a lot of foreign funds.
A surplus means that the current account has a positive balance as the total inflow is greater than the total outflow. A surplus is an indication that there is a net inflow of money and the country has a surplus to boost the financial account section of its balance of payments. A country can also build up its foreign reserve from the surplus. However, a current account surplus may suggest that a country’s standard of living is low as rising income necessitates importation of variety of products that can improve the citizens’ living standards.
Reasons for current account deficit
Some of the causes of a deficit in the current account are temporary and self-correcting while others are severe requiring government intervention through policies. Policies, however, can interfere with other government objectives. For example, a deficit caused by a recession in trading partners is not a serious problem because recession is temporary. But a loss of competitiveness of a country’s exports requires government attention because it could be a long-term problem. If the deficit is one-off or forms a small percentage of the country’s Gross Domestic Product (GDP), it is not a cause for concern.
Rising income
A rising income due to economic prosperity or growth fuels demand for many consumer goods more than what can be produced locally. Increased demand for goods and services would grow a country’s imports. Imports may exceed exports, thereby causing a current account deficit.
Raw materials and components requirements
A country that is experiencing economic growth would need to import raw materials, machinery, spare parts and other components. This massive importation would produce a deficit in the current account even though it is temporary. A reversal of the deficit will begin after production for both domestic use and export.
Lack of competitiveness
A relatively high inflation rate in the domestic economy reduces the price competitiveness of its products in the international market. Besides, lower quality products causes a decrease in the demand for its products in foreign markets. Less exports could lead to a current account deficit. This is a serious problem requiring government actions.
Slowdown in trading partner
A temporary decline in economic activities in a trading partner due to recession would reduce the demand for a country’s exports. This could lead to a current account deficit. But the situation would improve as soon as the recession is over.
Overvalued exchange rate
An overvalued exchange rate occurs when the relative value of a currency is more than what it should be. One way to determine whether a currency is overvalued is by comparing the cost of the same basket of goods in two countries (Purchasing Power Parity). For example, if the same basket of goods cost $10 in the US and £2 in the UK the exchange rate should be $10 to £2 or $5 to £1. But if the actual exchange rate is $6 to £1, the pound is overvalued because it can buy more dollars than it should buy. An overvalued exchange rate makes imports cheaper and exports more expensive. A rise in imports coupled with a fall in exports would cause a current account deficit. This often requires the attention of the government.
Deindustrialisation
The continuous decline in manufacturing activities is a reason for the fall in exports and a rise in imports in many developed countries. It is relatively cheaper to produce in less developed countries of Asia and Africa. This explains why a lot of the developed countries record deficits in their current accounts. Deindustrialisation is a long-term problem.
Capital account deficit
A deficit in the capital account means that there is more money going out of the country than coming in due to a rise in the purchase of assets in other countries. There will be an inflow of money when those foreign assets are sold. If non-financial assets like copyrights and patents are bought in other countries, there is a possibility of an income inflow into the country later. But if it is due to grants for capital projects abroad or money taken out by migrants, there is no future income inflow expected by the country.
The currency of a country could depreciate due to money outflow. Depreciation encourages exports as they are cheaper. This will correct the deficit in the current account and create job opportunities.
Financial account deficit
An increase in investments overseas will result in a deficit in the financial account. There is a net outflow of money due to investments. This is good because those investments will yield income in the future. The incomes, such as profits and dividends, will increase the inflow of income in the current account in the future. But if there is net outflow due to the inability of the country to attract investments, there is a problem. Government would need to work on creating enabling environment that can attract foreign investors.