Balance of payment theory ppt

BALANCE OF PAYMENTS DATA COLLECTION 16

Challenges to Balance of Payments Data Collection and its effect on International Business

International Economics

Running Head: BALANCE OF PAYMENTS DATA COLLECTION 1

Abstract
Globalization has resulted to an increase in trade between countries irrespective of geographical location. However, the state of economies in these countries is not always the same, causing a few challenges to emerge. This is why the monetary and economic transactions made between the countries during the entire process have to be recorded in what is called a balance of payments (BoP). Even so, challenges to the collection of data on balance of payments oftentimes result from the problems associated with individual countries. For instance, a country will be unwilling to release data that indicates how badly the economy is in a BoP disequilibrium. Additionally, there may be errors and omissions (statistical discrepancies), fluctuating exchange rates, change in the value of money and other accounting conventions. In order to illustrate the challenges in Balance of Payments Data Collection and its effect on International Business, this study collected the available data on the current account, capital account, financial account and the net errors omissions from trade between USA and China. Results indicated that all the independent variables have a coefficient of 1 (with p values of 0.00), implying that when the data is collected without any issues/challenges, then the formula tallies with the formula asserted by the balance of payment theory. In conclusion therefore, it is clear that having the perfect data collected over a given period of time will always result to accurate BoP that reflects the ability of a country to engage in international business.

Table of Contents Abstract 2 Introduction 4 Literature Review 6 Data Presentation 10 The Balance of Payment Theory 12 Data Analysis 13 Conclusion 14 References 15

Challenges to Balance of Payments Data Collection and its effect on International Business

Introduction
Business in the modern world is a continuous process that knows no boundaries. As such, it is common for a country on one end of the globe to engage another in a completely different end of the world. The monetary and economic transactions made between the countries during the entire process have to be recorded in what is called a balance of payments (BoP). Therefore, a BoP can be described as a statement of all transactions (monetary and economic) between two or more countries during a specific period of time (Stern, 2017). It is important to note that business can take place between governments, companies and individuals alike. So regardless of the parties involved, all transactions have to be recorded for purposes of monitoring the financial activities between countries. According to the Federal Reserve Bank of New York, the BoP is used to account for all transactions made by a country over a specific period of time. They include all payments received (credits) as well as payments made (debits).

In order to account for these transactions, three separate accounts are used. These are the current account, the capital account, and the financial account (Scitovsky, 2016). The current account records all transactions that indicate an inflow or outflow of goods and services, including income and money transfers. These are further divided into merchandise trade, services, income receipts, and unilateral transfers. The capital account, on the other hand, reflects all of a country's international transfers. Finally, the financial account identifies monetary flows associated with bonds, stocks, investments, business, real estate etc.

Challenges to the collection of data on balance of payments oftentimes result from the problems of BoP. For instance, a country will be unwilling to release data that indicates how badly the economy is in a BoP disequilibrium. To be sure, the disequilibrium has a huge impact on the amount of foreign reserves that a country keeps and if it is negative, the economy could be in an economic crisis within a short period of time. Such are events that external investors do not want to hear since it influences their investment decisions in bonds and securities of foreign countries. Another aspect of BoP that will be assessed is how the disequilibrium and how it affects foreign currency reserves affects the monetary and fiscal policies within the economy.

For this analysis, a quantitative structure will be the most appropriate since the variables under study will be quantitative in nature. Further, a quantitative structure will enable the researcher to draw more accurate conclusions from the data that will collected. Further, the study will rely on the official data sources for the United States and China (since the study will specifically use the two countries to carry out the analysis of the topic). For the United States, the study will rely on the official data portal (data.gov) since it has comprehensive data on all areas under analysis. On the other hand, data from the National Bureau of Statistics of China will help provide relevant data on China’s BoP. Further, the World Bank data portal will provide an additional data source just in case the sovereign data portals fall short.

Understanding how the balance of payments works in a country is critical to keeping the right kind of records. Of importance to note is that the BoP follows a double entry bookkeeping accounting practices such that all inflows should ideally balance with the outflows. However, this is not always the case as is reflected by surpluses or deficits in the national economy. However, sometimes these discrepancies are as a result of various challenges, including errors, and omissions (statistical discrepancies), fluctuating exchange rates, change in the value of money and other accounting conventions (Kyle, 2015). All these create significant discrepancies in the balance of payments accounts, an area that this research paper intends to focus on.

Literature Review
International trade is on the rise especially in this era of globalization. Trillions of dollars’ exchange hands every year between countries as people buy and sell goods and services across international borders. The growth of ecommerce accelerated the rate at which the goods and services move across borders to unprecedented levels. Globalization implies that people are able to conduct business in other countries on the globe in an effort to cut down on cost of production and to increase the profit margin. According to Basu (2016), globalization of markets implies that an American steel company can set up a mill in China and be able to conduct its business quite smoothly. In the long run, the company will be able to boost its bottom line and to attract more investors.

Unfortunately, international trade as a result of globalization of markets is turning up concerns that were initially thought of as simple economic variables that would be corrected by the “invisible hand”. Notably, major problems arise in cases where there are challenges to the collection of data concerning the Balance of Payments and how those challenges impact international trade. According to Razmi (2015),

Collection of data concerning BoP today is a huge challenge especially if it involves markets that are not completely open. As per the author, it would be a huge challenge to collect reliable data on current account deficit or surplus in a hybrid economy like that of China due to the fact that the state has a very tight grip on the recording and flow of such data.

This problem results in the lack of accurate data that could be used to correctly place the competitiveness of such a hybrid economy in context. For instance, it is difficult to correctly measure the value of trade between the United States and China since some data that comes out of China is highly tainted by government action. Further, the effect of this lack of reliable data denies economists and other analysts the opportunity to make correct analyses regarding the constraint of the country’s BoP on its economic growth (Razmi, 2015). Interestingly, Fávaro, Da Silva & Pirtouscheg (2016) agree with Razmi where they argue that some countries restrict the complete transparency of the BoP data to protect their economies. To be sure, the countries see the controlled independence of their key current account or financial account data is a show of sovereignty and an effort to protect the competitiveness of their local products.

According to Bouchet, Fishkin & Goguel (2018), many countries face BoP problems that also affect the investor sentiment on their economy. As such, there is a clear effort to ensure that they mask the correct numbers to encourage false confidence in the economy and hence the debt instruments like bonds and securities the country offers. Further, the authors identified another challenge to the collection of data for balance of payments as lack of comprehensive data. Although data recording for BoP and other areas is a common practice globally, some counties do not have data that could be actionable. Interestingly, it could be that the data collection and recording systems are ineffective or simply a general lack of due diligence while collecting the data.

Also, another challenge to BoP data collection is the case where the relevant agencies refuse to cooperate or out rightly deny people access to the data. As per Des Roches & Betancourt (2016), countries under dictatorial leadership have the tendency to mismanage their economies. As a result, their balance of payment data is always ugly and could adversely affect the exchange rate of their currency to cause a serious plunge. As such, governments like these hold onto their data with the hope that international investors and even bond-investors may not be spooked into pulling their assets out of the country (Des Roches & Betancourt, 2016). Such challenges usually lead to problems in international business.

Ko & Ha (2018) wrote that these challenges of BoP data collection sparked a trade war between China and the United States. According to the authors, the United States has become the largest export market for Chinese goods since when international firms began producing their products in China. Notably, as the size of exports increased, the BoP balance began to tip in China’s favor. For instance, the month if October 2018 saw the Americans buy $34 billion more that they sold to China (Guilford, 2018, October 12). As a result, the US kicked off a trade war by threatening to increase the tariffs on Chinese goods from the current 10% to a punitive 25%. In particular, Ko & Ha (2018) identified a problem with China and how much the government is said to meddle in economic processes. To be sure, the authors established that the government China had undue influence on the kind of data released to the public.

International trade thrives on trust and the ability for rival countries to estimate a competitor’s position (Edmond, Midrigan & Xu, 2015). However, such an exercise becomes difficult if he data that one will depend on to make such estimations cannot be trusted to be the correct one. Interestingly, it is this suspected misrepresentation that sowed the seeds of a trade war that is threatening to impose 25% on $200 billion worth of Chinese goods that enter the US. Also, there are clear upheavals in the world economy which is likely to enter a recession if the acrimonious relationship between the two worlds’s best performing economies engage in cat fights over tariffs.

From the foregoing, it is clear that one of the major effects of problems in data collection for BoP is that it leads to global economic problems. Notably, state control brings certain imbalances in trade between a country and its rivals because most of its policies deny the markets to freely determine such things as the official currency exchange rate. According to Davis, Fuchs & Johnson (2019), state control of the economy limits access to key data like the current account and analysts cannot come up with estimates to help affect policy in other countries. Notably, China has official government agencies that are tasked with the collection and distribution of data related to economy and other key indicators. The idea is that the country wants a huge control over the official narrative about the economy and also to be in position to handle surprise developments within the domestic and the global trade environment.

In essence, it is clear that the stability of international trade and relations between the economic superpowers rests on issues that might seem mundane like the ability to access usable and reliable BoP data. Further, it is apparent that trade wars that have the capability to affect the overall growth of the global economy are mostly confined to the inability by competing economies to be honest enough in the data that they put out. Interestingly, there is robust literature that touches on the debilitating effects of trade wars and why there should be concerted efforts to stop the conflicts whenever they arise. However, there is absence of works that comprehensively tackle the challenges of collecting data related to the balance of payments and how the challenges impact the possibility of trade wars. In this light, this paper will undertake the task to explore this area and to bring to the fore new knowledge that could help push international trade away from the possibility of a global trade war.

Data Presentation
In order to illustrate the challenges in Balance of Payments Data Collection and its effect on International Business, this study collected the available data on the current account, capital account, financial account and the net errors omissions from trade between USA and China. Their balance of payment was then calculated using the following formula;

BoP = CuA+CA+FA-NeO

Where BoP=Balance of Payment

CuA=Current Account

CA=Capital Account

NeO=Net Error Omissions

The table of the data collected is as indicated below;

Year

Quarter

Current account (excludes reserves and related items)

Capital account (excludes reserves and related items)

Financial account (excludes reserves and related items)

Net errors and omissions

2017

Q1

-84840

-1

-54163

30437.06

Q2

-133916

0

-115328

18738.66

Q3

-114190

24787

-101682

-12340.65

Q4

-116191

-40

-59001

55686.67939

2018

Q1

-93794

-2

-144647

-50857.66

Q2

-118290

-5

-148497

-27121.10

Q3

-138602

562

-24450

113411.76

Source: IMF (2019)

A visual presentation of this data is included in the bar graphs below;

Figure 1 presents the balance of payments data calculated from the available CuA, CA, FA and NeO. A negative value indicates that there was a deficit

Figure 1: BoP.

Source: IMF (2019)

Figure 2 provides the data for the CA, CuA, FA and NeO in graphic.

Figure 2: CA, CuA, FA and NeO

The Balance of Payment Theory
This theory asserts that the exchange rate of a particular country affects the position of the balance of payments. According to (Conrad, 2015), a favorable balance of payments leads to an appreciation in the external value of the currency of the country while an unfavorable balance of payments causes a depreciation of the external value. Therefore, some factors that affect this position include the price of foreign money in terms of domestic money, which is in turn determined by forces of supply and demand in the foreign exchange market. So when a country has a surplus balance of payments, then it follows that their exchange rate reserves are strengthened which in turn causes an appreciation in the price of home currency in terms of foreign currency. On the other hand, a deficit balance implies an increase in demand for foreign currency and so the domestic-foreign price must rise to keep up. This causes the exchange rate to fall. As such, it is clear that fluctuations in the exchange rate have different impacts on the balance of payments. They all affect the ability of a country to engage in international business, especially when the country in question has a higher (or lower) exchange rate. Challenges in the collection of this data arise when these exchange rates are fluctuating so much, or when there are irregularities when coming up with the exchange rates themselves, which are determined by the current account and financial account. Therefore, the BoP is calculated as follows;

BoP = CuA+CA+FA-NeO

Where BoP=Balance of Payment

CuA=Current Account

CA=Capital Account

NeO=Net Error Omissions

Data Analysis
To illustrate how a slight change might affect the balance of payment, a regression analysis was fitted to the data collected from IMF. It is important to note that this data has no irregularities as it is assumed that IMF did not have any challenges. Therefore, the data depicts a perfect relationship between CuA, CA, FA and NeO as indicated by the following regression model results.

Table 1: Summary Output

Regression Statistics

Multiple R

1

R Square

1

Adjusted R Square

1

Standard Error

6.76652E-12

Observations

7

Source: SPSS Output

Table 2: ANOVA

df

SS

MS

F

Significance F

Regression

4

11227456504

2806864126

6.13043E+31

1.63121E-32

Residual

2

9.15715E-23

4.57857E-23

Total

6

11227456504

Source: SPSS Output

Table 3: Regression Coefficients

Coefficients

Standard Error

t Stat

P-value

Intercept

6.54836E-11

2.03361E-11

3.220073191

0.084410704

Current account

1

2.67639E-15

3.73638E+14

7.16305E-30

Capital account

1

2.69809E-15

3.70633E+14

7.27968E-30

Financial account

1

2.58184E-15

3.8732E+14

6.66591E-30

Net errors and omissions

-1

2.63246E-15

-3.79872E+14

6.92987E-30

Source: SPSS Output

From the regression table results above, with BoP as the dependent variable and Current account, Capital account, Financial account and Net errors and omissions, then the formula derived is as follows;

BoP = 6.54836E-11+CuA+CA+FA-NeO

Where 6.54836E-11= coefficient which is basically 0.00.

BoP=Balance of Payment

CuA=Current Account

CA=Capital Account

NeO=Net Error Omissions

All the independent variables have a coefficient of 1 (with p values of 0.00), implying that when the data is collected without any issues/challenges, then the formula tallies with the formula asserted by the balance of payment theory.

Conclusion
In conclusion therefore, it is clear that having the perfect data collected over a given period of time will always result to accurate BoP that reflects the ability of a country to engage in international business. Data from IMF was used to affirm this claim, and a regression analysis revealed that the formula for calculating BoP as provided for by the balance of payments theory is accurate when the data has been collected in the best possible manner, given that net error omissions were considered. Challenges to the collection of balance of payments identified by this study included errors, and omissions (statistical discrepancies), fluctuating exchange rates, change in the value of money and other accounting conventions (Kyle, 2015).

References
Basu, K. (2016). Globalization of labor markets and the growth prospects of nations. The World Bank.

Bouchet, M. H., Fishkin, C. A., & Goguel, A. (2018). At the Root of Country Risk: The Balance of Payments from Liquidity to Solvency Crisis. In Managing Country Risk in an Age of Globalization (pp. 239-263). Palgrave Macmillan, Cham.

Conrad, D. A. (2015). The Theory of Value‐Based Payment Incentives and Their Application to Health Care. Health Services Research, 50, 2057-2089.

Davis, C. L., Fuchs, A., & Johnson, K. (2019). State control and the effects of foreign relations on bilateral trade. Journal of Conflict Resolution, 63(2), 405-438.

Des Roches, J. D. B., & Betancourt, R. G. (2016). Balance of payments and exchange rates. Chapters, 5-21.

Edmond, C., Midrigan, V., & Xu, D. Y. (2015). Competition, markups, and the gains from international trade. American Economic Review, 105(10), 3183-3221.

Fávaro, F. F. F., Da Silva, G. J. C., & Pirtouscheg, L. A. S. (2016). Bureaucracy, External Trade and Long-Term Growth in a Balance-of-Payments Constrained Growth Model. In Anais do XLIII Encontro Nacional de Economia [Proceedings of the 43rd Brazilian Economics Meeting] (No. 113). ANPEC-Associaà § ã o Nacional dos Centros de Pós-Graduaà § ã o em Economia [Brazilian Association of Graduate Programs in Economics].

Guilford, G.,(2018, October 12). Trump's tariffs on China are doing the exact opposite of what they're supposed to. Retrieved March 5, 2019, from https://qz.com/1422225/the-us-china-trade-war-has-made-chinas-trade-surplus-bigger-than-ever/

Ko, J. H., & Ha, J. W. (2018). A Trade War between China and the United States and Its Likely Economic Impacts. Journal of Global and Area Studies (JGA), 2(2), 47-64.

Kyle, J. F. (2015). The balance of payments in a monetary economy. Princeton University Press.

Razmi, A. (2015). Correctly analysing the balance-of-payments constraint on growth. Cambridge Journal of Economics, 40(6), 1581-1608.

Scitovsky, T. (2016). Money and the Balance of Payments. Routledge.