After World Trade Organization (WTO) which was founded in January 1, 1995, the world became a global village. Now every country freely transects with other countries of the world. In order to keep record of these transactions, the economists analyze two important factors of international trade which are balance of trade and balance of payment. Let’s understand the concept and distinguish between balance of trade and balance of payment.
Balance of Trade
Balance of trade represents the difference between the value of imports and exports for a period of time. The balance of trade can be favorable (surplus) or unfavorable (deficit). It is favorable when exports are greater than imports. Conversely, it is unfavorable when imports are greater than exports. Favorable balance of trade indicates good health of an economy. Balance of trade is the largest of part of balance of payment.
Balance of Payment
Balance of payment is a wider concept than balance of trade. It yields a complete picture of country’s economy. It records all the monetary transactions made by country’s residents. Balance of payment represents value of net exports (exports - exports), value of services, unilateral transfers (e.g. gifts or remittances paid or received from foreigners) and financial capital (borrowing or lending or sale or purchase of assets from foreigners). All these transactions are divided into two accounts which are following:
- Current Account: The current account keeps records of imports and exports, services and unilateral transfers.
- Capital Account: The capital account keeps records of purchase and sale of foreign assets and liabilities.
Difference Between Balance of Trade and Balance of Payment
1. Balance of trade records transaction of goods only. While balance of payment records transactions of both goods and services.
2. Balance of trade includes transactions of imports and exports. On the other hand, balance of payment includes transactions of imports and exports, services, unilateral transfers and capital transactions.
3. Balance of trade is not a true indicator of economic performance of a country. Conversely, balance of payment indicates the actual economic position of a country.
4. Balance of trade does not record transactions of capital nature. While balance of payment records transactions of capital nature.
5. Balance of trade is said to be favorable when exports exceed imports and vice versa. Inversely, balance of payment is said to be favorable when receipts exceed payments and vice versa.