Page 140 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes ‘Full Employment’ Equilibrium or ‘True’ Balance
Finally, a word on what is called ‘full employment’ equilibrium or ‘true’ balance in BOP. We have
already seen that when the sum of accommodating transactions is zero, there is ‘equilibrium’ in the
balance of payments (as well as a ‘balance’ in BOP). It is, however, possible that such an ‘equilibrium’
has been produced by (a) imposing trade and payment restrictions such as import tariffs, import
quotas, export duties, restrictions on foreign travel, exchange controls, exchange rate support policies
and other monetary and fiscal policy applications; and (b) by causing internal imbalance i.e. by causing
inflation, or unemployment in the economy. If the BOP ‘equilibrium’ is produced by causing (a) or
(b) or both, then it is not to be considered as ‘true’ balance or ‘full employment’ equilibrium.
If, on the other hand, equilibrium in the BOP is produced without (a) using commercial policy and
(b) causing inflationary or deflationary gaps in the GNP of the country, then what we have is a ‘true’
balance or ‘full employment’ equilibrium in the BOP. As such, ‘full employment’ equilibrium or
‘true’ balance is inconsistent with the existence of commercial policy and internal imbalance (defined
as presence of inflation or unemployment). Ragnar Nurkse and James E. Meade, have introduced
this concept of ‘full employment’ equilibrium or ‘true’ balance. In their terminology, ‘external balance’
must be consistent with ‘internal balance’ on the one hand and ‘free trade’ in goods and services and
factor flows on the other.

Balance of Payments and Economic Policy
Before going into this question, a word of caution must be inserted at the very outset. National
accounting system is not completely standardized among countries; different countries use different
systems. This is reflected also in the construction of balance of payments. There is agreement on the
broad features, but differences in detail do exist. Our aim is to understand how basic questions of
economic analysis and policy can be elucidated by the use of BOP statistics and to gauge what factors
one has to take into account to be able to interpret a country’s BOP situation in any meaningful sense.
Having understood the sense in which the BOP is always in ‘balance’ and the sense in which the BOP
might be in ‘disequilibrium’ one can talk about suggested economic policy in relation to a given BOP
situation of a country. For example, if a country has a deficit and an accommodating capital inflow,
it must in general try to implement policy measures aimed at reducing the deficit; but a country with
a surplus in its BOP and an accommodating capital outflow need not take immediate measures.
Because surpluses do not usually create great problems, so we are not specially concerned with
surplus countries. For economic policy purposes one is specially concerned with BOP problems of
deficit countries.
To understand the nature of a deficit, one has to judge it against the background of the general
economic policy of a country and the policy options, the country has at its disposal. If a country is
already pursuing a tight monetary and fiscal policy and has tariffs and import controls, but yet it has
a serious deficit, it may be very difficult for such a country to get rid of a deficit. We can then talk
about actual and potential deficits. The actual deficit which has appeared on the surface is in that case,
much smaller than the potential deficit that could have surfaced but has indeed been suppressed by
tight domestic and foreign trade economic policies of the country. The possibility or scope of pursuing
a more restrictive policy to close the actual deficit may no longer exist for a country, because it already
has reached its upper limit. Furthermore, if the economy is already experiencing politically
unacceptable levels of high unemployment, it will be almost impossible to try to cut down BOP
deficits by pursuing still contractionary monetary, fiscal and other policies. In such tight situations
only international capital flows can play a vital role in equilibriating the BOP. Once again the nature
of capital flows is very crucial. We have already said that accommodating capital inflows, especially,
if they are continued over several years, are a sure warning signal. It is left to the ingenuity of the
country’ planers and policy makers to adopt ways and means of converting accommodating capital
imports of short-term nature into planned long term autonomous capital imports. If that can be done,
the country need not change its economic policy. It can proceed without having to worry about the
BOP situation for the next 15-20 years. We shall return to these policy-oriented questions concerning
BOP later in the other chapters; but in the following chapters let us study the relation between foreign
trade and the national economy.

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