Balance of trade refers to the difference between the total value of goods a country exports (sells to other countries) and imports (buys from other countries) during a specific period, usually a year. Balance of Trade (BOT) is also known as the Trade Balance.
The formula is: Terms of Trade = (Index of Export Prices ÷ Index of Import Prices) × 100.
The Balance of Payments (BOP) is a report that outlines all economic and financial transactions between a country and other nations over a specific period.
That is, it is a more expansive and detailed concept that not only covers the balance of trade but also incorporates net earnings from foreign investments and net transfer payments. The BOP consists of the current account, the capital account and the financial account.
Table of Contents
Current Account:
This outlines the trade of goods and services (exports and imports), income from investments, and current transfers (like foreign aid or remittances).
Capital Account:
This records capital transfers and the acquisition/disposal of non-produced, non-financial assets, like land rights or patents.
Financial Account:
This records investments like foreign direct investment (FDI), portfolio investment (e.g., stocks and bonds), and changes in reserve assets held by the central bank.
Methods for Correcting Balance of Payments Deficit
A country facing a balance of payments deficit can take various measures to address or reverse the situation including:
1.Borrowing: The country can borrow from international financial markets, friendly governments, or international organisations such as the International Monetary Fund (IMF) and the World Bank.
2.Raising Tariffs: Increasing tariff rates, raising import duties, or imposing quantitative restrictions (e.g., import quotas or embargoes) on certain goods can help reduce imports.
3.Tight Monetary Policies: This involves reducing the money supply, limiting bank lending, and increasing domestic interest rates to curb inflation and reduce spending.
4.Tight Fiscal Policies: Governments can reduce public spending or raise taxes to reduce domestic demand and help improve the balance of payments.
5.Exchange Control Measures: These are policies to regulate foreign exchange, limiting the outflow of currency and controlling access to foreign currency for imports.
6.Export Promotion: Various policies aimed at boosting exports, as discussed in the chapter, can help improve the balance of payments by increasing foreign revenue.
7.Encouraging Capital Inflows: Promoting foreign direct investment (FDI) and controlling capital repatriation, such as profits sent abroad, can boost foreign currency reserves.
8.Exchange Rate Policies: Depreciating the domestic currency (e.g., the Naira) makes imports more expensive and boosts exports by making them cheaper for foreign buyers. This devaluation aims to reduce imports and increase exports, ultimately correcting the balance of payments deficit.
Reasons for Imposing Tariffs/Restrictions in Foreign Trade
What is Tariff?
A tariff is a tax imposed by a government on goods or services being imported into or exported out of the country. When a country imposes a tariff, it raises the cost of imported goods, making them more expensive for consumers.
The primary goal of tariffs is to reduce the competitiveness of foreign products compared to domestic ones, thereby safeguarding local industries from foreign competition.
Why are Tariffs Imposed?
Governments impose import duties for various reasons, which include the following:
Revenue Generation:
Import tariffs are a significant source of government revenue. In Nigeria, for example, tariff income ranks second only to revenue from petroleum activities.
Protection of Domestic Economic Activities:
Higher tariffs raise the landing cost and price of imported goods, making domestically produced alternatives more competitive. This promotes local production, boosts income, and creates employment.
Infant Industry Protection:
Newly established industries, often called infant industries, may lack the efficiency to compete internationally. Tariffs protect these industries from foreign competition, allowing them time to grow and stabilise.
Anti-Dumping Measures:
Foreign suppliers sometimes sell goods at extremely low prices, a practice known as predatory dumping, which can drive out local competitors. Tariffs counter this by making such imports less attractive. Countervailing duties may also be imposed to offset subsidies provided by foreign governments to their exporters.
Discouragement of Undesirable Goods:
Tariffs are used to discourage the consumption of socially undesirable goods, such as tobacco and alcoholic beverages, by making them more expensive.
Improvement of Balance of Payments and Conservation of Foreign Reserves:
By reducing imports, tariffs help improve a country’s balance of payments and conserve scarce foreign reserves, which can be redirected toward other needs, such as repaying external debt.
Protection of Domestic Currency:
Lower import volumes due to tariffs reduce pressure on the exchange rate, helping to stabilise or prevent depreciation of the domestic currency.
Retaliatory Measures and Trade Negotiations:
Countries may impose tariffs in response to similar measures taken by trading partners, leading to trade disputes or tariff wars. However, these measures often lead to trade negotiations aimed at reducing or eliminating tariffs.
Redistribution of Income:
Tariffs encourage domestic production, benefiting the owners of production factors used locally. For instance, higher duties on food imports could boost the income of domestic farmers.
Political Motivations:
Tariffs can be used as a tool to penalize goods from countries considered politically unfriendly, serving as a means of settling political scores.
Also check: Introduction to Commerce (Scope, Characteristics & Functions)
