Difference Between Balance of Trade and Balance of Payment

Introduction

When an economy makes a transaction with another country, it gives rise to the need to record those transactions to understand whether an economy is in profit or not. One is the Balance of Payments and the other is Balance of trade.

Let us dive deep into the concept of these accounts to understand the difference between them.

Balance of Trade

As the name suggests, Balance of Trade represents the record of imports and export from one country to another.

As we know, if the export of a country is higher than the import it is in trade surplus, and the other way too. We record the Balance of Trade under the current account where all the other transactions like income and international investments.

How to Calculate Balance of Trade?

The formula to calculate the balance of trade is quite simple. All you have to do is subtract total exports from total imports.

Let us take an example of how to calculate the trade balance.

Let’s say India imported $100 billion of goods and services in July 2021 and exported $179 billion of goods and services. If we use the formula here, we can say that India has a surplus trade balance of $79 billion. Because India exported more and imported less.

(Even as the pandemic has reduced global trade, China's trade surplus has grown. China generated a $110 billion surplus in manufactured products in July 2020, based on $230 billion in exports—so, even if imported parts are included, China is close to exporting $2 worth of manufactured goods for every manufactured good it imports.)

The trade surplus or deficit is not necessarily a reliable predictor of an economy's health, and it must be viewed in conjunction with other economic indicators such as the business cycle. In a recession, for example, countries like to export more to generate jobs and demand. Countries prefer to import more during periods of economic expansion to stimulate price competition and hence limit inflation.

History of Balance of Trade

Mercantilism: This is where everything related to import and export started. In the 16th century, there was a theory roaming around in Europe that if a country wants to grow big they have to start doing export more than importing.

The first record of the Balance of Trade was found in Discourse of the Common Wealth of this Realm of England, the 1549 goes like this "We must constantly be careful not to buy more from strangers than we sell, lest we bankrupt ourselves while enriching them."

Effect of Balance of Trade on GDP

Export and import directly affect the GDP of a nation cause if there is an increase in the import that means the country’s expenses are increasing and if the export increase that means a country is earning. The Surplus and Deficit of the Balance of Trade will affect GDP.

Balance of Payment

Balance of Payment is where a country records all the transactions they make with other countries. Now if you understand the definition clearly you will find the difference between balance of trade and balance of payment.

One records all the transactions related to imports and export and the other one records all the transactions that a country makes with another country. The type of transactions you can record in Balance of Trade is related to Goods exported and imported, and in Balance of Payment, we record transactions including transfers, products, and services.

Economic plans are frequently aimed toward specific goals, which have an impact on the balance of payments.

For example, one government may pursue policies aimed specifically at attracting foreign investment in a given area, while another may seek to keep its currency at an artificially low level to boost exports and build up currency reserves. The effects of these measures are eventually reflected in the balance of payments data.

What is a BOP Crisis?

A balance-of-payments crisis, often known as a currency crisis, arises when a country is unable to pay for basic imports or service its foreign debt. This is usually accompanied by a sharp drop in the value of the affected country's currency. Large capital inflows, which are initially associated with high economic expansion, usually precede crises.

Data on the balance of payments and international headcount is crucial in developing national and international economic strategies. Balance of payments (BOP) imbalances and foreign direct investment (FDI) are critical issues for policymakers to address. The balance of payments data shows the influence of national and international policies.

For example, a policy to attract foreign investment could be implemented by a country. Another country, on the other hand, would seek to maintain its currency cheap to boost exports.

FAQs

1. What are the types of Balance of Trade?

Ans: There are three types of balance of trade. They are -

• Favorable Trade Balance

• Unfavorable/deficient Trade Balance

• Balance of Trade Equilibrium

2. What is the Balance of Trade Equilibrium?

Ans: The "balance of trade equilibrium" is described as a condition in which trading between countries is such that the trading partners are generally debt-free over a reasonable time. In other words, the value of a country's imports and exports would be the same.

3. What affects the trade balance?

Ans: These include factors such as factor endowments and productivity, trade policy, exchange rates, foreign currency reserves, inflation, and demand.

4. What is BOP imbalance?

Ans: A country's balance of payments (BOP) is said to be in disequilibrium when its current account is in deficit or surplus. The balance of payments of a country is a record of all transactions with other countries over a certain time.

5. What affects BOP?

Ans: There seem to be differing viewpoints on the major cause of BoP imbalances, with most focusing on the United States, which has by far the largest deficit. Current account issues, such as the exchange rate, the government's fiscal deficit, company competitiveness, and private behavior, such as consumers' propensity to go into debt to finance excess spending, are thought to be the key reason.