"Balance of payments" refers to the amount of money that a nation's citizens, government bodies and businesses take in from the rest of the world minus the money that they send out. If more money leaves the nation than is coming in, there is a balance of payments deficit. While most money entering and leaving the country is the result of purchases and sales of goods and services, other factors contribute as well. Non-trade factors that can impact the balance of payments include foreign aid paid or received, people moving in and out and taking their money with them, and individuals sending cash to family members in other nations.
Make Domestic Companies More Competitive
A balance of payments deficit is likely if foreign corporations produce better goods at a cheaper price than domestic companies. In this case, consumers will purchase imported products, while domestic manufacturers will have a hard time selling their goods to other nations. This will increase the money leaving the nation and decrease the funds coming in. An increase in the quality of domestic products can change the equation. This might involve developing a better educated and more highly trained workforce, lowering the corporate tax burden or improving the country's infrastructure. Such interventions take time, however, and will take a while to pay off.
One short-term solution to a balance-of-trade deficit is making the nation's currency less valuable. Suppose one Euro equals one U.S. dollar, and therefore a product costing 10 Euros in Germany also costs $10 in the U.S. If the dollar is devalued, so that one Euro now buys 1.2 U.S. dollars, the same European-made product will now cost American consumers $12. This will reduce its consumption, shifting some demand to local manufacturers, whose price will not increase as a result of currency devaluation. Governments can influence exchange rates through various means, such as lowering or raising interest rates.
Import Taxes and Quotas
A direct intervention that will have an immediate impact on a balance-of-trade deficit is simply putting a cap on the number of certain types of products that can be bought from abroad. Such import quotas will reduce the amount of foreign goods and the associated fund outflow, no matter the quality of domestic made products. A less dramatic measure involves charging importers some form of import tax or duty. This will not limit the number of imported quantities, but it will make them more expensive and typically reduce their consumption. However, such measures can backfire because foreign nations might take similar steps to reduce the exports of the nation in question. With fewer exports, a country's balance-of-trade deficit will not improve.
Slowing Consumer Demand
Sometimes the balance of payments deficit results from extravagant spending, such as citizens taking expensive trips or gravitating towards luxury and exotic products that can only be sourced from abroad. This is usually accompanied by an increase in consumer credit balances, as such spending is most easily done on credit cards and borrowed money. Governments can partially curb the resulting deficit by slowing economic growth and general consumer demand. This can be done through less government spending, which results in less money in the economy; a rise in interest rates, which raises the cost of borrowing; and increasing taxes to reduce disposable income.
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.