Although retail sales are very nearly coincident with GDP, retail sales figures are published with a much shorter lag. They therefore provide an early indication of economic trends.
A downturn in retail sales could lead to lower wholesale sales, slacker factory orders, an accumulation of stocks and, eventually, a cut in production.
Stocks and orders
Where figures for retail stocks and orders are also available they provide useful advance warning. For example, excess retail demand might show up first in a fall in the ratio of retailers’ inventories to sales. This spells trouble if wholesalers’ and manufacturers’ stocks are also low and there are constraints on manufacturers’ ability to increase output (high capacity use and low unemployment). Look out for price inflation and a surge in imports.
Chapter 10
The balance of payments
No nation was ever ruined by trade.
Benjamin Franklin
The balance of payments is a continual source of misunderstanding and misconception. Yet it is no more than a simple accounting record of international flows. Moreover, trade between two countries is exactly the same as trade between two individuals. Once seen in this light, interpreting external flows is no different from interpreting any other economic transactions.
Accounting conventions
Balance of payments accounts record financial flows in a specific period such as one year. Financial inflows (such as receipts for exports or when a foreigner invests in the stockmarket) are treated as credits or positive entries. Outflows (such as payments for imports or the purchase of shares on a foreign stockmarket) are debits or negative entries. When a foreigner invests in (acquires a claim on) the country, there is a capital inflow which is a credit entry. Conversely, the acquisition of a claim on another country is a negative or debit entry.
Debits = credits
The accounts are double entry, that is, every transaction is entered twice. For example, the export of goods involves the receipt of cash (the credit) which represents a claim on another country (the debit). By definition the balance of payments must balance. Debits must equal credits.
Current = capital
One side of each transaction is treated as a current flow (such as a receipt of payment for an export). The other is a capital flow (such as the acquisition of a claim on another country). Arithmetically current flows must exactly equal capital flows.
Balances
The accounts build up in layers. Balances may be struck at each stage. What follows reflects the IMF’s methodology in the fifth edition of the Balance of Payments Manual. By the late 1990s most countries had moved to the new international standards.
Net exports of goods (exports of goods less imports of goods)
= the visible trade or merchandise trade balance
+ net exports of services (such as shipping and insurance)
= the balance of trade in goods and services
+ net income (compensation of employees and investment income)
+ net current transfers (such as payments of international aid and workers’ remittances)
= the current-account balance (all the following entries form the capital and financial account)
+ net direct investment (such as building a factory overseas)
+ other net investment (such as portfolio investments in foreign equity markets)
+ net financial derivatives
+ other investment (including trade credit, loans, currency and deposits)
+ reserve assets (changes in official reserves), sometimes known as the bottom line
= overall balance
+ net errors and omissions
= zero
Thus the current account covers trade in goods and services, income and transfers. Non-merchandise items are known as invisibles. All other flows are recorded in the capital and financial account. The capital part of the account includes capital transfers, such as debt forgiveness, and the acquisition and/or disposal of non-produced, non-financial assets such as patents. The financial part includes direct, portfolio and other investment.
Balancing items
In practice it is impossible to identify all flows: invisibles are hard to track, some speculative flows go unmeasured and some transactions are concealed by tax evasion or organised crime. Even visible trade is sometimes overlooked. In the late 1980s British customs officials stumbled upon £1.5 billion of aircraft imports which had previously gone unnoticed. In addition, the balance of payments accounts relate to specific periods such as calendar years. Lags mean that one-half of a transaction may not be recorded in the same period as the other half.
To cover timing differences and unidentified items, government statisticians make the accounts balance with a residual or balancing item or statistical discrepancy shown as net errors and omissions.
Interpretation
Every country has discrepancies and Britain’s have been among the worst. In 2008 the accounts showed a current-account deficit of £25.1 billion with a capital and financial-account surplus of £21.5 billion, leaving a £3.6 billion figure for net errors and omissions.
Aggregating international current-account figures show that world credits in 2007 exceeded world debits by over $300 billion, a very large amount but only 1.4% of total credits. The implication is that many countries have small current-account deficits rather than surpluses.
Deficits and surpluses
The balance of payments must balance. When commentators talk about a balance of payments deficit or surplus, they mean a deficit or surplus on one part of the accounts.
Attention is usually focusedonthecurrent-account balance, but capital flows have become increasingly important as many industrial countries relaxed exchange controls and other barriers to world capital flows during the 1980s. The stock of foreign direct investment (FDI) more than tripled between 1999 and 2008. FDI is long-term investment in companies in a foreign country, implying a certain degree of control of those companies.
The balance to watch
The bottom line gives an indication of imbalances in the economy. Acute imbalances will trigger changes in the exchange rate. Large negative errors and omissions can be indicative of capital flight or unrecorded outflows to avoid exchange controls. Large positive discrepancies could be proceeds from illegal activities. Adjustments are made to Britain’s import figures to allow for VAT Missing Trader Inter-Community fraud. Carousel fraud relates to goods being imported VAT-free from an EU member state, sold through a series of companies and then re-exported to another EU member state.
Balance of payments accounting quirks
Balance of payments figures must be interpreted with care. As a brief illustration, consider a company which borrows $500 in foreign currency from a domestic bank (which itself borrows the cash from overseas) and invests the money in an overseas operation which earns profits of $1,750, only $750 of which are repatriated.
If the balance of payments accounts are drawn up in accord ance with IMF recommendations and if all transactions are identified, the entries will be as follows.
$
Current account
Income: profits earned abroad 1,750
Financial account
Private investment overseas −1,500
Of which:
Financed by borrowing −500
Unremitted profits −1,000
Banks’ overseas borrowing + 500
Change in reserves (— = additions) −750
At first glance the accounts suggest that there was an investment outflow of $1,500. Yet the net currency movement is the inflow of $750 profits.
Analysis of balance of payments accounts requires careful review of all entries and a good measure of imagination. Do not be misled by changes in reserves, where negative entries indicate an increase in official holdings of foreign currencies.
Published figures
National accounting practices vary, but in general governments produce two sets of figures relating to ext
ernal flows.
Overseas trade statistics (OTS), which measure imports and exports of goods.
Balance of payments (BOP) accounts, which record all cross-border currency flows including movements of capital, with emphasis on transactions rather than physical movement.
Apart from the fact that BOP accounts have a wider coverage, the main difference between the two is that BOP accounts exclude goods passing across borders where there is no change of ownership, but include changes of ownership which take place abroad (such as ships built and delivered abroad).
In addition, overseas trade statistics usually record the value of trade at the point of customs clearance, measuring exports FOB (free on board) and imports CIF (including cost, insurance and freight). For BOP purposes insurance and freight are separated out and imports of goods are shown FOB. Transport and insurance are shown as imports of services if the payments are made to overseas companies; otherwise they are domestic transactions which are excluded from the accounts.
Using OTS figures
Figures on an OTS basis are usually the first available and they are preferable for examining the effect of imports on domestic economic activity. They sometimes show imports CIF which is the cost at the point of arrival and is directly comparable with the cost of goods produced at home, but most OTS figures for developed countries are now shown FOB/FOB.
Using BOP figures
BOP figures should be used for analysis of external trade in relation to GDP, usually as a percentage. Exports and imports of goods and services on a BOP basis match the figures in GDP. The total income plus net current transfers is shown as “net income from abroad” in national accounts statistics (the difference between GDP and GNP). The BOP position can be vulnerable if the current account is being financed by portfolio investment, financial derivatives and external borrowings rather than by long-term funds for direct investment, as an abrupt withdrawal of funds is easier.
Other figures
The briefs in this section should be read in conjunction with the exchange-rate briefs (Chapter 11).
Export and import unit values (prices) are included with other price indicators in Chapter 13.
Exports of goods and services
Measures: Sales in other countries.
Significance: Exports generate foreign currency and economic growth.
Presented as: Value and volume figures in money and index numbers.
Focus on: Growth; total in relation to imports (see trade balance) and as apercentage of GDP.
Yardstick: OECD average growth in the volume of exports of goods and services was4.5% during the period 2000–08.
Released: Monthly, at least one month in arrears.
Overview
Exports generate foreign currency earnings. Export growth boosts GDP which in turn implies more imports, so exports should never be considered in isolation.
10.1 Exports of goods and services
Sources: OECD; World Bank
Goods and services
Merchandise or visible exports relate to physical goods. Exports of services are payments from foreigners for invisibles such as shipping, travel and tourism; financial services including insurance, banking, commodity trading and brokerage; and other items such as advertising, education, health, commissions and royalties.
In practice, many countries give prominence to visible trade figures because they are among the most reliable and rapidly available figures on external flows. Even so, they are available only after a lag, are frequently revised as more information comes to hand and are subject to various errors and omissions. Figures for invisibles are harder to collect, less reliable and are published only quarterly by some countries.
Value and volume
Demand for exports depends on economic conditions in foreign countries, prices (relative inflation and the exchange rate) and perceptions of quality, reliability, and so on. Real exchange rates (see page 168) help to identify inflation and currency effects. Export volume indicates “real changes”, and value gives the overall balance of payments position.
Export composition and destinations
Dependence on a few commodities increases vulnerability to shifts in demand, while dependence on a few countries increases vulnerability to their economic cycle.
Table 10.1 Exports of goods and services
The greater the proportion of exports in relation to GDP, the bigger the boost to domestic output when overseas demand rises. For example, the Netherlands’ exports account for over 70% of GDP and it trades heavily with Germany. Consequently, if German imports rise by 10%, Dutch GDP jumps by 1.5%. A high exports:GDP ratio also implies a larger slump when foreign demand falls.
10.2 Growth in exports of goods and services
Sources: OECD; World Bank
Other special factors
Smoothing
Various special factors can cause swings in trade figures even when there is no change in underlying trends. It is always wise to take at least 2–3 months together to smooth out blips.
Many commentators compare the calendar year so far with the same period of the previous year. This has a certain neatness, but economic figures do not respect accounting periods and comparisons of, say, the two months to February are more susceptible to erratic influences than the 11 months to November. Another option is to look at 12-month rolling totals, as can be found for trade balances in the Indicators pages of The Economist.
Oil and erratics
The movement of high-value items such as ships, aircraft and precious stones can have a significant effect on trade figures. Oil accounts for a large proportion of imports for many countries (typically up to 20%) and the price can fluctuate widely. For these reasons many countries publish figures for imports and exports excluding oil and erratics, which helps to identify underlying trends.
Seasonal adjustment
Most trade figures are adjusted for obvious seasonal factors such as climatic variation and the effect of holidays on industrial output. However, seasonal adjustment cannot cope with shipping and dock strikes, unusually bad weather or the movement of high-value items. Sensible adjustments should be made for any such factors of which you are aware.
Compatibility
Exports are always measured FOB (free on board) or FAS (free alongside ship) at the point of export, so they present fewer compatibility problems than imports which may be FOB or may include insurance and freight (CIF).
Imports of goods and services
Measures: Purchases from abroad.
Significance Imports add to well-being but may displace domestic production anddrain financial resources.
Presented as: Value and volume figures in money and index form.
Focus on: Growth; total in relation to exports (see trade balance) and as apercentage of GDP.
Yardstick: OECD average growth in the volume of imports of goods and services was4.3% a year during the period 2000–08.
Released: Monthly, at least one month in arrears.
Overview
A country imports goods and services because it cannot produce them itself or because there is some comparative advantage in buying them from abroad. Some commentators worry that all imports are a drain on national resources, which is a bit like saying you should not buy from a domestic neighbour who produces something better or cheaper than you do. Of course, you can only buy to the extent that you can finance the purchase from income, savings or borrowing against future production.
This brief should be read in conjunction with the previous brief on exports. Note especially the comments on goods and services (page 136) and special factors (pages 138–9).
Value and volume
Changes in import values reflect changes in foreign prices, exchange rates and quantity (volume). Real exchange rates (see page 168) are useful for identifying price and currency effects. Import volume indicates “real changes”, and value gives the overall balance of payments position.
10.3 Imports of goods and services
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Sources: OECD; World Bank
Cyclical variation
Import volumes tend to move cyclically. In general they increase when home demand is buoyant. For this reason imports might be seen as a safety valve which offsets the inflationary pressures that arise when domestic firms are operating at close to full capacity.
Link to exports
Imports are also linked to exports. An increase in exports boosts GDP because the goods sold overseas are part of domestic production.
When GDP increases, demand for domestic and imported goods rises as well.
Import penetration
Imports of goods and services as a percentage of GDP (or of total final demand) indicates the degree of dependence on imports; the higher the figure the more imports displace domestic output and the more vulnerable is the economy to changes in import prices. A sudden rise in import penetration may signal that domestic companies are operating at full capacity and cannot meet increases in demand.
Import composition and sources
Commodity breakdown
A high volume of imports of intermediate and capital goods is generally good where these are used to manufacture other items or to generate invisible earnings. This adds value to GDP and perhaps contributes to future export growth. For example, a country buying aircraft from abroad records these as imports. In later years the aircraft will be used to move passengers and generate profits which are invisible export earnings.
Table 10.2 Imports of goods and services
Note though that manufacturing output declines in the short term when imports displace locally processed or manufactured items. Developing countries increasingly export semi-manufactures (such as cloth and refined petroleum products) and finished goods rather than raw materials (such as cotton and crude oil) and the industrial countries import more semi-manufactures and finished goods and fewer raw materials.
Guide to Economic Indicators Page 12