Thursday, March 26, 2009

DISEQUILIBRIUM IN BALANCE OF PAYMENT

Disequilibrium in balance of payment
The balance of payment of a country is said to be in equilibrium when the demand for foreign exchange is exactly equivalent to the supply of it . The balance of payment is in disequilibrium when there is either a surplus or deficit in the balance of payments. When there is deficit in the balance of payments, the demand for foreign exchange exceeds the demand for it.
A number of factors may cause disequilibrium in the balance of payments. These causes may be broadly categorised into:
1. Economic factors ;
2. Political factors ;
3. Sociological factors.
1. Economic factors
i. Development Disequilibrium
Large scale development expenditures usually increase the purchasing power, aggregate demand and prices, resulting in substantially large imports. The development disequilibrium is common in developing countries, because the above factores, and large scale capital goods imports needed for carrying out the various development programmes, give rise to a deficit in the balance of payments.
ii. Capital Disequilibrium
Cyclical fluctuations in general business activity are one of the prominent reasons for the balance of payments disequilibrium. As Lawrance W. Towle points out, depression always brings about a drastic shrinkage in world trade, while prosperity stimulates it. A country enjoying a boom all by itself ordinarily experiences more rapid growth in its imports than its exports, while the opposite is true of other countries. But production in the other countries will be activated as a result of the increase exports to the boom country.
iii. Secular disequilibrium
Sometimes, the balance of payments disequilibrium persists for a long time because of certain secular trends in the economy. For instance in a developed country, the disposal income is generally very high and, therefore, the aggregate demand, too, is very high. At the same time, production costs are very high because of the higher wages. This naturally results in higher prices. These two factors-high domestic prices may result in the imports being much higher than the exports. This could be one of the reasons for the persistent balance of payments deficits of the USA.
iv. Structural disequilibrium
Structural changes in the economy may also cause balance of payments disequilibrium. Such structural changes include the development of alternative sources of supply, the development of better substitutes, the exhaustion of productive resources, the changes in transport routes and costs, etc.

2. Political Factors
Certain political factors may also produce a balance of payment disequilibrium. For, instance a country plagued with political instability may experience large capital outflows, inadequacy of domestic investment and production, etc. These factors may sometimes, cause disequilibrium in the balance of payments. Further factors like wars, changes in world trade routes, etc. may also produce balance of payments difficulties.

3. Social Factors
Certain social factors may also produce a balance of payments. For instance, changes in tastes, preferences, fashion, etc. may affect imports and exports and thereby affect the balance of payments.

Correction of disequilibrium
A country may not bother about surplus in the balance of payment; but every country strives to remove or at least to reduce, a balance of payment deflects. A number of measures are available to correcting the disequilibrium. Some of them as follows
1. Automatic corrections
The balance of payment may be automatically corrected under the paper currency standard. The theory of automatic correction is that if market forces of demand & supply are allowed to have free play the equilibrium will automatically be restored in course of time.

1 comment:

  1. It is not clear abbout the Automatic corrections.

    ReplyDelete