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Teaching why the Balance of Payments equals zero.

June 7, 2017 Leave a comment

A HT to colleague Nick Lloyd for this great explanation of the relationship between the current account and the capital and financial accounts. In theory the balance of payments should equal zero and this is one area that students find hard to comprehend. Hope you find it as useful as I did.

The Relationship between the Current Account and the Capital and Financial Account

A few starting points:

  1. Gross Domestic Product (GDP) = C + I + G + (X – M)
  2. Gross National Product (GNP) = GDP plus Net Income (Income Credits (Yc) – Income Debits (Yd))
  3. Saving/Investment Gap (S – I) = Balance on Capital and Financial Account (Capital Outflows (Ko) – Capital Inflows (Ki))
  4. Current Account Balance = Trade Balance (X – M) + Net Income (Yc – Yd)
  5. National Savings = GNP – (Private Spending (C) + Government Spending (G))

Now:

GNP                                      =               GDP + (Yc – Yd) =  C + I + G + (X – M) + (Yc – Yd)

GNP – (C + I + G)                 =               (X – M) + (Yc – Yd)

GNP – (C + G) – I                 =               (X – M) + (Yc – Yd)

S – I                                    =               (X – M) + (Yc – Yd)

Balance on Capital & Financial Account               =               Balance on Current Account

 

Another way to arrive at the same conclusion:

Assuming freely floating exchange rate is in equilibrium:

Demand for Currency = Supply of Currency

Demand comes from:     X + Yc + Ki

Supply comes from:        M + Yd + Ko

Thus when the forex market is in equilibrium:

Demand                         =               Supply

X + Yc + Ki                    =               M + Yd + Ko

(Ki – Ko)                        =               (M – X) + (Yd – Yc)

Balance on CFA               =               Balance on Current Account

 

So, if as a nation you earn more than you spend (current account surplus), you are in effect lending to the rest of the world (exporting savings) by accepting IOUs in the form of your increased holdings of foreign assets (shares, land, government bonds, etc.)

If as a nation you spend more than you earn (current account deficit), you must borrow from the rest of the world (import savings) in the form of increased foreign holdings of your domestic assets (shares, land, government bonds, etc.)

 

 

Categories: Trade Tags:

Tourism booming in New Zealand and Lions tour still to come.

April 30, 2017 Leave a comment

Recent figures show that the tourism industry is now a bigger export earner that the traditional dairy industry. For the year ending December 2016, total exports of dairy and related products were $12.05bn, accounting for 17.2% of all exports. Over the same period, tourism (including air travel) was worth $12.17bn, or 17.4% of exports. These compare to 18.2% and 16.9% (respectively) for 2015, showing the increasing importance of tourism to the NZ economy. After these two industries, the next largest export is meat, all the way back on 8.4% of total exports, leaving tourism and dairy well out in front. If you look at GDP figures – Tourism accounts for 5.6% whilst Dairy is 5% of GDP.

NZ Goods and Services Exports (Values $m)

Exports - Dairy and Tourism

NZ Visitor arrivals.pngWhat are the drivers behind the tourism numbers?
1. The growth of the Chinese middle class who can now afford to travel overseas and additional carriers operating out of China into New Zealand
2. The impact of The Lord of the Rings and Hobbit films
3. The 2011 Rugby World Cup and 2015 Cricket World Cup boosted arrivals significantly.

Also there are two further events which are bound the increase tourist numbers – The World Masters Games that finished today and the British Lions Tour in June/July. The Lions Tour is bound to have a significant impact on the economy especially with the hype that is currently building which largely comes about as the tour only occurs every 12 years.

British Lions Tour 2005 and its impact on NZ Economy

Contribution to New Zealand’s GDP – 16,000 supporters at approximately $10,000 per trip equates to NZ$160 million or 0.1 per cent of GDP. But spending doesn’t equate to value added. Value added is broadly a third of the initial spend therefore this leaves a direct macro impact on value added of $53 million. Second round multiplier effects increase the impact to NZ$132.5 million or broadly 0.1% of GDP.

Retail sales figures for June 2005 were up 1.2%. Accommodation providers, for example, experienced a 5.1% increase in turnover during June. And spending in bars increased by 3.9% in June from May and spending a café and restaurants increased by 1.3% while liquor sales surged 3.7%.

Some economic pricing invariably led to higher prices in some markets. A terrace ticket cost NZ$100 for the Lions vs All Blacks game at Eden Park but excess demand on the black market did mean that some tickets were double the face value. Also prices in bars and cafés increased significantly in the main centres.

Spending Spree
Sales figures for June and July 2005 released by credit card operator Visa International show visiting Lions fans pumped millions of dollars into the New Zealand economy.
UK and Irish-based Visa card holders spent $42.2 million during the two-month period, more than double the amount spent by cardholders during the same period last year. Below is some of the breakdown:

Hotels, motels, resorts: $5,967,931
Travel agencies: $4,927,429
Vehicle rental: $2,574,812
Restaurants: $2,245,621
Tourist attractions: $1,588,492
Air New Zealand: $1,446,342

Although results didn’t go their way, the Lions supporters certainly had a good time. The impact is bound to be significantly greater this year with numbers of supporters up to around 20,000. However as with the 2005 tour there will significant infrastructure problems in meeting this demand.

After the win in Australia four years ago maybe the Lions could pull off a series win – the last time was 1971.

Categories: Sport, Trade Tags: , ,

Will there be a recovery in global dairy prices?

April 9, 2017 Leave a comment

Dairy prices fell dramatically in 2014 and 2015, prompting the RBNZ to reverse 2014 OCR increases in 2015. Average prices on the GlobalDairyTrade auction fell by 38% in 2014/2015 and 20% in the 2015/2016 to mid-March.

Inconsistent Chinese demand and increased European/US dairy supply causing the perfect storm of plummeting whole milk powder prices. Thankfully, for dairy farmers and the NZ economy dairy prices recovered in late 2016 but can it be maintained into 2017? Here are some reasons why prices may recover:

  1. EU production is slowing down
  2. New Zealand production is also likely to fall
  3. Demand from China is likely to increase
  4. ASB rural economist Nathan Penny noted three things that would impact the price of milk. One as the fact that milk production was held back before the removal of annual quotas at the end of March 2015 as countries avoided paying penalties associated with producing above quota. Two, after the April removal of quotas, production surged in the EU with April production rising over 3% on a month-by-month basis. Three that post-quota surge has now passed, with production growth slowing, particularly since July, as farmers have struggled with low milk prices.

Once supply is more aligned to demand, global prices are expected to rise again. Europe collectively is the world’s largest dairy exporter, accounting for nearly a third of global export sales. EU exports increased by 6% in milk equivalent last year.

GDT 2012-26.png

 Sources: National Business Review and PWC

Categories: Growth, Trade Tags:

Brexit and trade – UK can learn from New Zealand’s experience

March 17, 2017 Leave a comment

With the departure of the UK from the EU there have been many questions asked about the future of UK trade. No longer having the free access to EU markets both with imports and exports does mean increasing costs for consumer and producer.

New Zealand’s Experience

A similar situation arose in 1973 when the UK joined the then called European Economic Community (EEC). As part of the Commonwealth New Zealand had relied on the UK market for many years but after 1973 50% of New Zealand exports had to find a new destination. However with the impending loss of export revenue New Zealand had to make significant changes to its trade policy. In 1973 the EEC took 25% of New Zealand exports and today takes only 3%. Add to this the oil crisis years of 1973 (400% increase) and 1979 (200% increase) and protectionist policies in other countries and the New Zealand economy was really up against it.

What did New Zealand do?

1. It negotiated a transitional deal in 1971 with agreed quotas for New Zealand butter, cheese and lamb over a five-year period, which helped to ease the shift away from Britain.

2. New Zealand was very active in signing trade deals of which Closer Economic Relations with Australia was the most important in 1983. The other significant free trade deal was with China in 2008. Below is a list of New Zealand’s current free trade deals and a graph showing the changing pattern of New Zealand trade:

NZ Free trade Deals

NZ exports goods 1960-2015.png

With brexit around the corner it will be imperative that the UK starts to develop trade links with non-EU countries of which New Zealand might be one. The UK is the second largest foreign investor in New Zealand and its fifth largest bilateral trading partner.

NAFTA – Positives and Criticisms

February 26, 2017 1 comment

NAFTA took effect in 1994 during the Clinton administration although he had to rely on support from the Republicans in the House – 60% of congressional Democrats voted against NAFTA. NAFTA got rid of tariffs on more than half of its members’ industrial products and by 2009 the deal eliminated tariffs on all industrial and agricultural goods.

Positives of NAFTA

  • American corporates believed the deal would cut labour costs and therefore increase efficiency and international competitiveness.
  • American consumer would also benefit from lower prices.
  • It would raise Mexico’s living standards especially in the north.
  • Trade between the USA and Mexico has risen 1.3% in 1994 to 2.5% in 2015
  • Mexico’s real income has risen – $10,000 in 1994 to $19000 in 2015
  • Less Mexicans are migrating to the USA – 500,000 a year to virtually nothing.

Criticisms
Mexican incomes are no better, as a share of those in the US, than they were in 1994.  Americans are slightly better off. NAFTA has caused significant job losses in the manufacturing industry.

However there are some unseen circumstances which have affected the deal.

1. The crisis of the Mexican Peso in 1994-95  – Zapatista rebels launched an uprising in Southern Mexico and the leading presidential candidate was assassinated. Worried about stability, foreign investment began to flee the country. It was eventually brought under control by a loan from the US government.

2. September 11th – this terrorist attack increased the cost of moving goods and people

3. The rapid growth on the Chinese economy which accounted for more than 13% of global exports and 25% of global manufacturing value-added. This puts a lot of pressure on global supply chains.

Have job losses been a result of NAFTA?

Brad DeLong (University of California) estimated that NAFTA could be blamed for only 0.1% of job losses in the US economy. This equates to fewer jobs than the US economy adds in a typical month. But to be realistic job losses would have increased without NAFTA for the following reasons:

1. the advances in technology would see labour being substituted
2. the strong US dollar would make US exports less competitive and thereby making overseas production attractive
3. Transport and communications improvements have made overseas production also attractive

Source: The Economist – 4th February 2017
Below is Paul Krugman on Bloomberg news. He talks of the poor performance of NAFTA for Mexico in that the country hasn’t developed as a whole. Some of the northern states have done well but southern Mexico is still very poor.

 

Categories: Trade Tags: , ,
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