Balance of payments

The balance of payments, often abbreviated as BOP, is a record of all money moving into and out of a country. It measures the difference between these flows during a specific period, such as a year or a quarter. These transactions involve individuals, private firms, and government bodies. They arise from the trade of goods and services between different nations.

This economic system is divided into several specific components. The current account tracks a country's net income. The financial account records the net change in ownership of national assets. A third part is the capital account. This account includes unilateral capital transfers and the sale of non-produced assets. While the capital account exists, it often has a small effect on the total balance.

History shows that the way nations manage these flows has changed deeply. Before the 19th century, trade was heavily regulated. In the Middle Ages, European towns controlled trade to protect local merchants. Starting in the 16th century, mercantilism became the dominant economic theory. Mercantilist rulers believed that accumulating precious metals made a nation wealthier. They used tools like tariffs to ensure they exported more than they imported. This era saw very little growth. Between 1700 and 1820, global per capita income rose by less than 0.1% per year.

In the 1800s, new thinkers challenged mercantilism. David Hume argued that hoarding metals caused monetary inflation. Adam Smith argued that mercantilism confused money with actual wealth. David Ricardo developed the theory of comparative advantage. This theory remains a major part of modern trade studies. Following the Napoleonic Wars, Great Britain promoted free trade. They often exported more capital as a percentage of national income than other nations. This helped correct global imbalances because British capital exports often rose during British recessions.

Between 1820 and 1914, the world entered a period of high integration. The laying of transatlantic telegraph cables in the 1860s helped trade grow rapidly. Many nations participated in the gold standard, which used gold as a reserve asset. International trade volume grew tenfold between 1820 and 1870. From 1870 to 1914, trade grew by about 4% annually. However, instability still occurred. Between 1880 and 1914, there were approximately eight BOP crises. There were also eight twin crises, which are BOP crises that happen at the same time as a banking crisis.

World War I shattered this stability, leading to a period of deglobalization. During the 1920s, some countries rejoined the gold standard. However, many surplus countries did not follow the informal rules. They often hoarded gold instead of letting it increase their domestic money supply. This forced deficit countries to face the burden of rebalancing alone. During the Great Depression, many nations abandoned the gold standard. This era saw about 16 BOP crises and 15 twin crises. Countries often used "beggar thy neighbour" policies, where they devalued their currency to compete with others.

After World War II, the Bretton Woods system was created to encourage free trade. The International Monetary Fund and the World Bank were established to support this system. The US dollar became the central anchor because it was convertible into gold. This period is known as the Golden Age of Capitalism. However, the system eventually failed because the US could not maintain gold convertibility. This caused the Bretton Woods system to end by 1971. Between 1945 and 1971, advanced economies saw about 24 BOP crises.

Since 1971, the global economy has moved toward more liberalized controls. Many countries now allow the market to determine their exchange rates. In the 1970s and 1980s, developing countries often received large amounts of capital. This was sometimes done through the recycling of petro dollars. However, this often led to crises when investors lost confidence. From 1973 to 1997, emerging economies suffered 57 BOP crises and 21 twin crises. Some leaders, like Manmohan Singh, successfully used economic reforms to manage these challenges.