The Balance of Payments and the International Economic System

In orthodox economic theory the concept of the balance of payments has a threefold character. First, the balance of payments is taken to be simply an account, a record of a nation’s transactions with other nations. Second, it is taken to be a constraint on the nation’s economy (setting a limit to economic growth for example) or an objective for economic policy. In the latter roles (as a constraint or objective) the balance of payments can be said to constitute a problem —the balance-of-payments problem for any nation being the question of how to prevent the balance of payments from limiting, for example, growth, or how to achieve balance on the balance of payments through government policy The analysis of this balance-of-payments problem is fundamentally linked to the analysis of the international payments mechanism or the international financial system. For example, the international financial system established after the Second World War (which centred on the existence of the International Monetary Fund) involved among other things the rule that exchange rates should be relatively rigid, and, as we shall see, the problem of the balance of payments is taken to be quite different in such a system from what it would be in a system in which exchange rates were fully flexible. This link between the balance of payments and the international financial system gives rise to the third aspect of the concept of the balance of payments in orthodox theory. It gives rise to the idea that the historical existence of particular financial systems — the existence at one time of a completely fixed exchange-rate system (the gold standard), at another of relatively flexible exchange rates, and at another of relatively rigid exchange rates (the original International Monetary Fund system) — arises from attempts by the governments of the world to agree on the system which will best enable the world’s nations to overcome the balance-of-payments problem. In other words, the concept of ‘the balance of payments’, in this aspect, is to be seen as the driving force behind changes in institutional arrangements.