by Overall account of BOP is always in equilibrium. This balance or equilibrium is only in accounting sense because deficit or surplus is restored with the help of capital account.
In fact, when we talk of disequilibrium, it refers to current account of balance of payment. If autonomous receipts are less than autonomous payments, the balance of payment is in deficit reflecting disequilibrium in balance of payment.
Causes of disequilibrium in BOP
There are several factors which cause disequilibrium in the BOP indicating either surplus or deficit.
Such causes for disequilibrium in BOP are listed below:
(i) Economic Factors
- Imbalance between exports and imports. (It is the main cause of disequilibrium in BOR)
- Large scale development expenditure which causes large imports
- High domestic prices which lead to imports
- Cyclical fluctuations (like recession or depression) in general business activity
- New sources of supply and new substitutes.
(ii) Political Factors
Experience shows that political instability and disturbances cause large capital outflows and hinder Inflows of foreign capital.
(iii) Social Factors
Changes in fashions, tastes and preferences of the people bring disequilibrium in BOP by influencing imports and exports
High population growth in poor countries adversely affects their BOP because it increases the needs of the countries for imports and decreases their capacity to export.
Other Causes of Disequilibrium in the Balance Payments
Cause 1. Cyclical Disequilibrium
Cyclical disequilibrium is caused by the fluctuations in the economic activity or what are known as trade cycles.
During the periods of prosperity, prices of goods fall and incomes of the people go down. These changes in incomes of the people and prices of goods affect exports and imports of goods and thereby influence the balance of payments.
“If prices rise in prosperity and decline in depression, a country with a price elasticity for imports greater than unity will experience a tendency for a decline in the value of imports in prosperity, while those for which imports price elasticity is less than one will experience a tendency for increase. These tendencies may be overshadowed by the effects of income changes, of course. Conversely, as prices decline in depression, the elastic demand will bring about an increase in imports, the inelastic demand a decrease.”
Cause 2. Secular or Long-Run Disequilibrium
Secular (long-run) disequilibrium in balance of payments occur because of long-run and deep-seated changes in an economy as it develops from one stage of growth to another. The current account in the balance of payments follows a varying pattern from one stage to another. In the initial stages of development, domestic investment exceeds domestic savings and imports exceed exports. Disequilibrium arises due to lack of sufficient funds available to finance the import surplus, or the import surplus is not covered by available capital from abroad.
Then comes a stage of growth when domestic savings tend to exceed domestic investment and export outrun imports. Disequilibrium may result because the long-term capital outflow falls short of the surplus savings or because surplus savings exceed the amount of investment opportunities abroad. At a still later stage of growth domestic savings tend to equal domestic investment and long- term capital movements are , on balance, zero.
Thus we see that a secular disequilibrium will occur when either the long-term capital movements get out of adjustment with deep-seated factors affecting savings and investment, or planned savings and investment change without an offsetting change in the movement of long-term capital. If investment adjusted itself readily to the amount of domestic savings plus foreign capital there could be no tendency for secular disequilibrium.
The balance-of-payments position will be in equilibrium, if the international capital flow falls into line with the requirements of domestic investment minus domestic savings. There is a tendency to secular disequilibrium, because of domestic savings and domestic investment are independent of the foreign capital flow and are of different magnitudes.
There is a strong tendency for underdeveloped countries to over-invest and/or under save. The underdeveloped countries are investing larger than their domestic savings and exports allow them because they are eager to accelerate the rate of economic growth. This tendency to over-invest causes a secular disequilibrium in the balance of payments.
Cause 3. Technological Disequilibrium
Technological disequilibrium in the balance of payments is caused by various technological changes. Technological changes involve inventions or innovations of new goods or new techniques of production. These technological changes affect the demand for goods and productive factors which in turn influence the various items in the balance of payments.
Each technological change implies a new comparative advantage to which a country adjusts to. The innovation leads to increased exports if it is a new good and export-biased innovation. The innovation may lead to decline in imports if it is import-biased. This will create a disequilibrium. A new equilibrium will require either increased imports or reduced exports.
Cause 4. Structural Disequilibrium
Let us see how the structural type of disequilibrium is caused. “Structural disequilibrium at the goods level occurs, when a change in demand or supply of exports alters a previously existing equilibrium, or when a change occurs in the basic circumstances under which income is earned or spent abroad, in both cases without the requisite parallel changes elsewhere in the economy.”
Suppose demand in foreign countries for Indian handicrafts falls. The resources engaged in the production of these handicrafts must shift to some other line or the country must restrict imports, otherwise the country will experience a structural disequilibrium. A change in supply may also cause a structural disequilibrium. Suppose Indian jute crop falls because of the change in the shift in the crop-pattern, Indian jute exports will fall and a disequilibrium will be created.
Apart from goods, a loss of service income may also upset the balance-of-payments position on current account. Besides, the loss of income may arise because foreign investment has proved a failure or it has been confiscated or nationalised, e.g. nationalisation of Anglo-Iranian Company in Iran. A war also produces structural changes which may affect not only goods but also factors of production.
A deficit arising from a structural change can be filled by increased production or decreased expenditure, which in turn affect international transactions in increased exports or decreased imports. Actually, it is not so easy because the resources are relatively immobile and expenditure not readily compressible. Under such circumstances, more drastic steps are called for to correct a serious disequilibrium.
“Structural disequilibrium at the factor level results from factor prices which fail to reflect accurately factor endowments … i.e., when factor prices, out or line with factor endowments, distort the structure of production from the allocation of resources which appropriate factor prices would have indicated.” If, for instance, the price of labour is too high, it will be used more sparingly and the country will import highly capital-intensive equipment and machinery. This will lead to disequilibrium in the balance of payments on the one hand and unemployment of labour on the other.
Measures to correct disequilibrium in BOP
Sustained or prolonged deficit has to be settled by short term loans or depletion of capital reserve of foreign exchange and gold.
Following remedial measures are recommended:
(i) Export promotion
Exports should be encouraged by granting various bounties to manufacturers and exporters. At the same time, imports should be discouraged by undertaking import substitution and imposing reasonable tariffs.
(ii) Import
Restrictions and Import Substitution are other measures of correcting disequilibrium.
(iii) Reducing inflation
Inflation (continuous rise in prices) discourages exports and encourages imports. Therefore, government should check inflation and lower the prices in the country.
(iv) Exchange control
Government should control foreign exchange by ordering all exporters to surrender their foreign exchange to the central bank and then ration out among licensed importers.
(v) Devaluation of domestic currency
It means fall in the external (exchange) value of domestic currency in terms of a unit of foreign exchange which makes domestic goods cheaper for the foreigners. Devaluation is done by a government order when a country has adopted a fixed exchange rate system. Care should be taken that devaluation should not cause rise in internal price level.
(vi) Depreciation
Like devaluation, depreciation leads to fall in external purchasing power of home currency. Depreciation occurs in a free market system wherein demand for foreign exchange far exceeds the supply of foreign exchange in foreign exchange market of a country (Mind, devaluation is done in fixed exchange rate system.)
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