International Economic Accounts: BOP, IIP, and National Identity
The Balance of Payments (BOP)
The Balance of Payments (BOP) is an accounting framework that records transactions between residents of an economy and non-residents over a given period of time. Transactions can include exchanges of goods, services, rights, and financial assets, as well as transfers without compensation.
Sections of the Balance of Payments
Current Account Transactions
Records transactions related to:
- Goods and services (e.g., travel, transportation, financial services)
- Primary income (e.g., wages, interest, and dividends)
- Secondary income (e.g., contributions to the EU)
Capital Account Transactions
Records transactions related to:
- Capital transfers
- Acquisition and disposal of non-produced non-financial assets (e.g., intellectual property)
Financial Account Transactions
Records transactions related to:
- Acquisition and disposal of financial assets and liabilities (e.g., direct investments, portfolio investments, derivatives)
The Balance of Payments provides important information on a country’s economic position vis-à-vis the rest of the world and helps to understand trends and dynamics of international transactions.
BOP, National Accounts, and Economic Identity
National Accounts Identity in an Open Economy
The National Accounts Identity in an open economy is expressed as:
GDP = C + I + G + EX – IM
Where:
- C = Consumption
- I = Investments
- G = Public Expenditure
- EX = Exports
- IM = Imports
The term EX – IM approximates the current account balance (excluding income and transfers for simplicity), representing net foreign demand. This can also be expressed as:
B = S – I
Where B is the current account balance, and S is national savings. This identity shows that the current account balance is the excess (or shortcoming) of national savings with respect to investment. In national accounts, B represents the net credit or borrowing of the economy.
Implications of the Balance (B)
If B > 0, the country is accumulating financial wealth vis-à-vis the rest of the world. This means the Current Account Balance equals the change in a country’s net foreign assets.
External Constraint and Debt Risk
A country cannot accumulate high current account deficits indefinitely, as it risks excessive financial indebtedness. This can lead to a debt-interest vicious circle and a possible ‘sudden stop’ of capital inflows, potentially resulting in ‘default’ in extreme cases.
The International Investment Position (IIP)
The International Investment Position (IIP) is a statistical framework that shows the stock of financial assets and liabilities of a country’s residents vis-à-vis non-residents at the end of each reference period.
Key Components of the IIP
Financial Assets Explained
Assets held by residents of a country in foreign entities, such as:
- Direct investment
- Portfolio investment
- Reserve assets (e.g., foreign exchange reserves, gold)
Financial Liabilities Explained
Liabilities of residents of a country to non-residents, such as:
- Direct investment
- Portfolio investment
- Other investment (e.g., loans, deposits)
Net International Investment Position (NIIP)
The difference between financial assets and liabilities is the Net International Investment Position (NIIP), which represents a country’s net creditor or debtor position vis-à-vis the rest of the world.
Factors Affecting Changes in NIIP
Changes in NIIP can be due to:
- Transactions: Recorded in the Balance of Payments financial account.
- Valuation Adjustments: Changes in prices and exchange rates.
If a country has a current account surplus (B = EX – IM > 0), its international investment position will generally improve, net of valuation adjustments.