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INTERNATIONAL MONETARY
AND
FINANCIAL ECONOMICS
Third Edition
Chapter 1
Keeping Up with
a Changing World
Trade Flows, Capital Flows, and
the Balance of Payments
Joseph P. Daniels
David D. VanHoose
Copyright © South-Western, a division of Thomson Learning. All rights reserved.
International Economic Integration
• International economic integration refers to the extent
and strength of real-sector and financial-sector
linkages among national economies.
• Real Sector: The sector of the economy engaged in
the production and sale of goods and services.
• Financial Sector: The sector of the economy where
individuals trade in financial assets.
• Though economists tend to measure activity in these
two sectors separately, an important point of this
chapter is to show that they are linked.
2
Importance of the Global Market
for Goods and Services
• Over the last 35 years, the volume of world trade in
goods and services has grown by almost 6 percent
annually.
• The cumulative effect of this growth is more than a
five-fold increase in world trade.
• As measured by the share of overall real-sector
activity, world trade in goods and services has
become more important to advanced and developing
economies alike.
3
Growth of World Exports
During the past thirty
years, world trade in
goods and services has
exhibited positive
growth rates for all but
two years.
SOURCE: International Monetary Fund, Economic Outlook, and authors’
estimates.
4
Selected Nation’s Trade
The global market for goods
and services has become more
important for individual
nations. The percentage
shown reflects each nation’s
trade as a share of its overall
economic activity.
SOURCE: International Monetary Fund, International Financial
Statistics, various issues, and authors’ estimates.
5
Growth of Trade
and Foreign Exchange Transactions
FOREIGN EXCHANGE TURNOVER AND WORLD EXPORTS
Foreign Exchange
World Exports of Goods
Turnover
($ trillion)
($ trillion)
1979
$17.5
$1.5
Ratio
12:1
1986
75.0
2.0
38:1
1989
190.0
3.1
61:1
1992
252.0
4.7
54:1
1995
297.5
5.0
60:1
1998
372.5
5.4
69:1
2001
300.0
6.6
45:1
2004
367.2
7.0
52:5
SOURCES: Held, David, Anthony McGrew, David Goldblatt and Jonathan Perraton, Global
Transformations, p. 209; Bank for International Settlements, Central Bank Survey of Foreign Exchange
and Derivatives Market Activity, 1998, p. 5; International Monetary Fund, World Economic Outlook, 1998,
p. 200, and authors’ estimates.
6
Cross-Border Transaction in Bonds
and Equities
In Germany, the United
States, and the United
Kingdom, international
transactions in bonds
and equities have grown
by more than 3,000
percent, 1000 percent,
and 700 percent
respectively.
SOURCE: Bank for International Settlements, International Financial
Statistics, and authors’ estimates.
7
Top Twenty Globalized Nations
1. Ireland
2. Switzerland
3. Singapore
4. Netherlands
5. Sweden
6. Finland
7. Canada
8. Denmark
9. Austria
10. United Kingdom
11. Norway
12. United States
13. France
14. Germany
15. Portugal
16. Czech Republic
17. Spain
18. Israel
19. New Zealand
20. Malaysia
Source: Foreign Policy
8
The Top Global Companies
Ranked by Foreign Assets
Rank
Company
Home Country
Industry
1
Vodaphone
United Kingdom
Telecommunication
2
General Electric
United States
Electrical
3
ExxonMobile
United States
Petroleum
4
Vivendi Universal
France
Diversified
5
General Motors
United States
Motor Vehicles
6
Royal Dutch/Shell
United Kingdom
/ Netherlands
Petroleum
7
BP
United Kingdom
Petroleum
8
Toyota Motor
Japan
Motor Vehicles
9
Telefónica
Spain
Telecommunications
10
Fiat
Italy
Motor Vehicles
9
Transnationality
• Are the activities of the world’s largest firms
really spread out globally?
• A transnationality index measures this.
• It is calculated by averaging the ratios of
– Foreign assets to total assets
– Foreign sales to total sales
– Foreign employees to total empolyees.
10
An Example
• General Electric, a U.S. TNC, ranks second on
the list of the world’s largest non-financial
TCS based on foreign assets.
• Foreign assets are 159,188, total assets
437,006, foreign sales 49,528, total sales
129,853, foreign employment 145,000 and
total employment 313,000.
• Its TNI is only 40.3 and it does not appear on
the list of the top ten TNCs by TNI.
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Calculation
 159,188 49,528 145,000 




 437,006 129,853 313,000 
3
 40.3%
12
The Top Global Companies
Based on Transnationality
Ranking
Company
Home Country
Industry
1
Rio Tinto
U.K. / Australia
Mining
2
Thomson
Canada
Media
3
ABB
Switzerland
Machinery and
Equipment
4
Nestlé
Switzerland
Food and Beverages
5
British American
Tobacco
United Kingdom
Tobacco
6
Electrolux
Sweden
Electronic Equipment
7
Interbrew
Belgium
Food and Beverage
8
Anglo American
United Kingdom
Mining
9
Astrazeneca
United Kingdom
Pharmaceuticals
Netherlands
Electronic Equipment
10
Phillips
Electronics
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Balance of Payments Accounting
• To understand how economists measure international
transactions in the real and financial sectors of an
economy, and how these sectors are linked, we turn to
the balance of payments (BOP) accounting system.
• A system of accounts which is a subset of the
National Income and Production Accounts.
• A double-entry system.
• Debit Entries: Transactions that generate a payment
outflow (e.g., import).
• Credit Entries: Transactions that generate a payment
inflow (e.g., export).
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Balance of Payments
• The current account is the broadest measure of a
nation’s real sector trade.
• Includes:
–
–
–
–
Goods
Services
Income Receipts and Payments
Unilateral Transfers
15
Current Account
• Goods: Exports and imports of tangible items.
• Services: Exports and imports of services, for
example:
– Typical business services such as banking and financial
services, insurance, and consulting.
– Tourism
16
Current Account
• Income Receipts: Includes items such as
– Investment income on US-owned assets abroad.
– Receipts of income on US direct investment abroad.
– Government income receipts
• Income Payments: Includes items such as
– Investment income on foreign-owned assets in the
United States.
– Payments of income on foreign direct investment in the
United States
– US Government income payments
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Current Account
• Unilateral Transfers: Includes items such as:
– Government grants abroad
– Private remittances
– Private grants abroad
• The current account balance is the sum of the debit
and credit entries in the accounts just described.
• A current account deficit occurs when the sum of the
debit entries exceeds the sum of the credit entries. A
current account surplus occurs when the sum of the
credit entries exceeds the sum of the debit entries.
18
US Current Account (2003)
Exports
Millions
Goods
Services
Income Receipts
Imports
Goods
Services
Income Payments
Unilateral Transfers
Current Account Balance
1,314,888
713,122
307,381
266,799
-1,778,117
-1,260,674
-256,337
-261,106
-67,439
-530,668
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Balance of Payments
The Financial Sector
• The Capital and Financial Account tabulates the flows
of financial assets between domestic residents and
foreign residents and governments.
• The private capital account tabulates flows among
private domestic residents and foreign private
residents.
20
The Capital Account
• The Capital and financial Account:
– Records international transactions in the financial sector.
– Includes portfolio and foreign direct investment.
– Includes changes in banks’ and brokers’ cash deposits that
arise from international transactions.
• The main accounts are:
– US-Owned Assets Abroad: Increase or decrease in US
ownership of foreign financial assets.
– Foreign-Owned Assets in the US: Increase or decrease in
foreign ownership of domestic assets.
– Reserve Assets: Primarily the assets of central banks.
21
Portfolio and Foreign Direct
Investment
• Portfolio Investment: Individual or business purchase
of stocks, bond, or other financial assets or deposits.
(An income strategy)
• Foreign Direct Investment (FDI): Purchase of
financial assets that results in a 10 percent or greater
ownership share. (A financial control strategy)
22
Capital and Financial Account
Capital Account, Net
Financial Account
US-Owned Assets Abroad
US Official Reserve Assets
US Government Assets
US Private Assets
-3,079
-283,414
-1,523
537
-285,474
Foreign-Owned Assets
Foreign Official Assets
Other Foreign Assets
829,173
248,573
580,600
Net Financial Account Flows
545,759
23
The Balance of Payments
The Statistical Discrepancy
• The sum of the debit and
credit entries in all of the
BOP should total zero.
• Of course there are errors
and omissions resulting in a
non-zero balance.
• An offsetting entry to this
non-zero balance is made in
the statistical discrepancy
account.
• In this way, the total of the
debit and credit entries
equals zero.
Balance on Current Account
-530,668
Capital Account, net
-3,0790
Net Financial Flows
545,759
Statistical Discrepancy
-12,012
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BOP Examples
U.S. company imports an automobile valued at $50,000
Goods
Debits
(imports)
Credits
(exports)
Services
Income
Payments
and
Receipts
UT
Capital
-50,000
50,000
25
BOP Examples
U.S. government sends $1 million in humanitarian supplies to Afghanistan
Goods
Debits
(imports)
Credits
(exports)
Services
Income
Payments
and
Receipts
UT
Capital
-1 million
1 million
26
BOP Examples
U.S. resident buys a UK Tbill equivalent in value to $1,000
Goods
Services
Income
Payments
and
Receipts
UT
Capital
Debits
(imports)
-1,000
Credits
(exports)
1,000
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BOP Examples
U.S. resident receives $100 in interest on a foreign asset they own
Goods
Services
Income
Payments
and
Receipts
Debits
(imports)
Credits
(exports)
UT
Capital
-100
100
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BOP Examples
A Marquette University student goes to Mexico on break and spends $500
Goods
Debits
(imports)
Credits
(exports)
Services
Income
Payments
and
Receipts
UT
Capital
-500
500
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BOP Examples
Total
Goods
Services
Income
UT
Capital
-1 mil
-1,000
-100
Payments and
Receipts
Debits
(imports)
-50,000
Credits
(exports)
1 mill
Current
Account
-50,400
-500
1,000
50,000
500
100
Capital
Account
50,400
30
Net Creditor and Net Debtor Status
• A net creditor is a nation whose total claims on
foreign residents exceed the total claims of foreign
residents on the residents of the domestic nation.
• A net debtor is a nation whose total claims on foreign
residents are less than the total claims of foreign
residents on the residents of the domestic nation.
• It is not necessarily good nor bad to be either a net
debtor or net creditor.
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The United States as a Net Debtor
The United States has
been a net debtor at
various times in its
history. The United
States was a net
debtor in the late
1800s.
SOURCE: Data from Economic Review of the federal Reserve Bank of Kansas City.
32
The Relationship Between the Current Account
and the Capital Account
• Expenditures Approach to National Income
– National income is the sum of expenditures in the
following categories; consumer expenditures, private
investment expenditures, government expenditures, and net
export expenditures,
y= c + ip + g + (x-m)
• Let the current account, ca equal
ca = (x – m)
• Then
y=c + ip + g + ca
33
The Relationship Between the Current Account
and the Capital Account
• Income Approach
– Income has three possible uses; it can be spent on current
consumption, it can be saved (private saving), and we pay
taxes to the government
y= c + sp + t
• Because both approaches equal national
income, we can set the two identities equal:
c + sp + t = c +ip + g + ca
• or, sp – ip – (g - t) = ca
34
The Relationship Between the Current Account
and the Capital Account
• Private Saving
– Private saving can be used to purchase three types of
assets, domestic private investment, government debt (g –
t) or to accumulate foreign assets (fa),
sp = ip + (g – t) + fa
• where fa is the (net) accumulation of foreign assets
(domestic residents’ purchases of foreign assets in
excess of foreign residents’ purchases of domestic
assets).
• Then, by rearrangement
sp – ip – (g – t) = fa
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The Relationship Between the Current Account
and the Capital Account
• Putting the two together:
ca = sp – ip – (g – t) = fa
• In words, private domestic saving less private
domestic investment less the fiscal balance
(government saving) equals the current account
balance, which also equals the (net) accumulation of
foreign assets.
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An Example of the Relationship Between the
Current Account and the Capital Account
• Using the equality we derived,
ca = sp – ip – (g – t) = fa
• Suppose a nation’s private saving rate is 5.2 percent
of its total output, its private investment rate is 7.3
percent, and its fiscal budget deficit is 3.3 percent
ca = fa = 5.2 – 7.3 – 3.3 = -5.4.
• In words, this nation’s residents must borrow from
abroad (fa = -5.4) to finance their investment
expenditures, resulting in a current account deficit in
the amount of 5.4 percent of total output.
37