Concept of Balance of Trade

In today's 21st century, no country can produce all the goods it needs. Therefore, trade in goods and services occurs between countries.

A country's balance of trade reflects the state of its imports and exports of visible goods with the rest of the world.

The balance of trade only accounts for visible goods and does not include invisible services. Visible goods are tangible items that can be seen, touched, or held and have a specific weight or size.

The import and export of visible goods are measured in monetary value. In international or foreign trade, a country may export more and import less, while another country may export less and import more. It is also possible for a country's exports and imports to be equal.

At any given time, the balance of trade of a country involved in international trade can exhibit one of the following three states:

(a) Balanced Balance of Trade: If, over a specific period, the total monetary value of all goods imported into a country is equal to the total monetary value of all goods exported from that country, the country's balance of trade is considered to be in equilibrium. However, this situation is difficult to achieve in reality.

(b) Favorable Balance of Trade: If, over a specific period, the total monetary value of all goods exported from a country exceeds the total monetary value of all goods imported into that country, the country's balance of trade is considered favorable.

(c) Unfavorable or Deficit Balance of Trade: If, over a specific period, the total monetary value of all goods exported from a country is less than the total monetary value of all goods imported into that country, the country's balance of trade is considered unfavorable or negative.

Balance of Payments

The balance of payments is a broader concept than the balance of trade. The balance of trade is only a part of the balance of payments. The balance of payments includes both tangible or visible goods and intangible or invisible services. 

Intangible or invisible services cannot be seen or touched. Examples include transportation, shipping, banking, insurance, and communication services. These invisible services are also measured in monetary value.

The balance of payments refers to a systematic record of all economic transactions related to visible goods and invisible services that occur between a country and the rest of the world within a specific period, typically one year. 

A country's balance of payments reflects a summary of all its economic transactions with the rest of the world. The balance of payments mainly consists of three types of accounts: the current account, the capital account, and the financial account. These are also considered components of the balance of payments.

The current account includes exports and imports under goods trade. Similarly, it includes service income and service payments under service trade. Furthermore, it includes income from labor and capital investment and payments made for labor and capital investment under the income receipts and payments heading.

Transfer income and payments are also included under the current account. The capital account includes capital transfers and the acquisition and disposal of non-financial assets. The financial account includes foreign direct investment and investment liabilities.

The balance of payments account always balances in theory. However, if, over a specific period, a country's total receipts from the rest of the world exceed its total payments to the rest of the world, its balance of payments is considered favorable.

Conversely, if a country's total receipts from the rest of the world are less than its total payments to the rest of the world, its balance of payments is considered unfavorable.

In the context of international trade, the policies adopted by any country are analyzed by dividing them into two categories: free trade policy and protectionist trade policy.