Balance of Payments | The Canadian Encyclopedia


Balance of Payments

The balance of payments, or balance of international payments, is an accounting statement of the economic transactions that have taken place between the residents of one country (including its government) and the residents of other countries during a specified time, usually a year or a quarter.

The term also refers to the difference between receipts and payments in some categories of international transactions, often merchandise trade or the current account. This in turn may be the subject of economic analysis (what explains the state of this balance or what the consequences of such a balance are) and the object of government policy (how to attain what is judged to be a desirable state of this balance).

The balance-of-payments statement is based on double-entry bookkeeping in which each economic transaction gives rise to a credit and a debit. Any transaction which results in a receipt from foreigners is entered as a credit and is given a positive sign. Any transaction which results in a payment to foreigners is entered as a debit and is given a negative sign. For example, exports of goods by Canadians result in payments to Canadians by foreigners and constitute a credit. Canadians are likely to be paid for these exports with an increase in a bank balance, an increase in the indebtedness to them of the foreign residents or a decline of their own indebtedness to foreigners. The increase in the bank balance and loans to foreign residents or the decrease in liabilities to the foreign residents would be debits that match the credit created by the exported goods. When transactions without payment occur (eg, exports of personal gifts, unreciprocated foreign aid or remittances by immigrants to relatives in another country), the debit side is recorded to maintain the equality of credits and debits.

Because all transactions have both a credit and a debit side, a difference between the sum of credits and debits can only occur for some categories of transactions, not for the entire balance of payments. Because some transactions are incorrectly recorded and others are not recorded at all, a difference between recorded credits and debits arises which is offset by an arbitrary balancing entry entitled "statistical discrepancy."

Canada's balance of payments for 1997 is summarized in the Table. In keeping with the philosophy of the balance of payments account, net payments to foreigners are recorded with a minus sign. The balances in the last column are the sums of receipts and payments in the individual categories. Transactions are measured in millions of Canadian dollars. These values are not adjusted for the depreciating real value of transactions due to inflation.

Major categories of transactions in the Canadian balance of payments accounts include the merchandise trade balance, the current account and the capital and financial account. The merchandise trade balance records the value of receipts from exported goods less the value of imported goods. The current account balance equals the merchandise trade balance plus the net value of transactions in services, investment income and unilateral transfers (see International Trade). The capital and financial account equals payments to Canadians for the acquisition of Canadian assets (net of the sale or liquidation of such assets) minus payments by Canadians to foreigners for the acquisition of assets abroad (net of the sale or liquidation of such assets).

The most important current transactions are those for merchandise trade. In 1997 exports accounted for 79.8% of current receipts and imports for 71% of current payments. Other current transactions are for services and income from investments abroad. In 1997 Canada's merchandise trade surplus was $24.26 billion. However, the total current account was in deficit of $12.82 billion, because of a deficit in non-merchandise current transactions.

The principal nonmerchandise current receipts of Canadian residents were for the sale of travel, business services and freight to foreign residents and the earnings from Canadian investments abroad. Canadian residents made payments to foreigners for travel and freight, but the largest nonmerchandise payments, in the form of interest and dividends ($58.65 billion), went to nonresidents for the use of their capital in Canada.

A country's purchases of goods and services from other countries need not equal its sales. Canada usually incurs more current payments than receipts, though it did not do so in the recession of the early 1980s. The current balance is equal to Canadians' total income from all sources (production and sale of goods and services, income from foreign investments and income from unilateral transfers) minus its total expenditures. Just as an individual whose expenditures exceed total income must finance the difference by running down assets or by incurring debts, Canada's negative current account balance must be financed by net borrowing or by the net sale of equity (capital that represents ownership). Canadian residents, including governments, are net debtors internationally (and are among the world's highest per capita net debtors). Canada's traditional merchandise trade surplus can be explained partly by the need to generate the income to pay the interest on its debt and dividend payments to foreigners for the use of their capital.

The capital and financial account records the net international transactions in different types of assets. The capital account records the net balance of capital transfers in the form of inheritances, federal government superannuation and debt forgiveness, and the acquisition or disposal of intangible assets such as patents and leases

The financial account records investments of all other types and changes in official reserves. In 1997 there was a net outflow (payment) of direct investment capital from Canada of $9.55 billion. This net flow resulted from large gross flows in each direction. Foreigners channelled a net $9.88 billion into the acquisition of Canadian enterprises while Canadians increased their ownership of foreign enterprises by $19.43 billion.

In addition to their direct investment abroad, Canadian residents channelled $11.2 billion into the purchase of foreign portfolio securities (stocks and bonds) in 1997, and acquired loans, deposits, and other assets valued at $24.48 billion. Total foreign investment in Canada in 1997 exceeded Canadian investment abroad, reflecting Canada's need to finance its substantial current account deficit. The balance on the financial account showed a surplus (net capital inflow) of $12.26 billion in 1997. Changes in the Bank of Canada's official reserves are entered in the payments column since they represent changes in foreign assets held by Canadian residents. The $3.39 billion dollar entry in the 1997 balance of payments indicates that the Bank of Canada's holdings of foreign assets decreased by the indicated amount.

In 1997 the surplus of $19.87 billion on the capital and financial account more than covered the deficit of $12.82 billion on current account. The difference ($7.05 billion) could not be identified and appears as a statistical discrepancy.

Mercantilist policy, dominant until the end of the 18th century, advocated the development of a surplus of receipts over payments in a country's merchandise trade or on current account. Foreign residents paid the surplus with gold or silver and therefore increased the stockpile of precious metals considered the measurement of a nation's wealth. International flows of precious metals were the only kind of capital transaction recognized at the time. This is the origin of the term "favourable" balance of payments to denote a surplus, and "unfavourable" to denote a deficit on merchandise or current account.

Other mercantilists believed that a surplus created employment, and advocated policy to create a merchandise surplus for that reason. In 1752 the Scottish philosopher David Hume undermined the theoretical basis of the mercantilist balance-of-payments policy by explaining that a permanent surplus on current account was impossible to achieve, because the inflow of gold and silver necessary to finance it would increase the money supply and so raise domestic prices, with a resulting increase in imports and decrease in exports.

According to modern economic analysis, a current-account surplus allows a country to offset temporary fluctuations in its income by borrowing or lending to smooth consumption. The balance of payments is also viewed as a means of distributing the world's capital resources. Residents in an area of high capital productivity will import more goods and services than they export and use that balance to build up domestic productive capacity.