EQUILIBRIUM DISEQUILIBRIUM AND ADJUSTMENT
Balance of Payments Equilibrium Before we analyse the conditions of disequilibrium, we would like to explain what is meant by equilibrium balance of payments. “Equilibrium is that state of the balance of payments over the relevant
time period which makes it possible to sustain all open economy without severe unemployment on a continuing basis.” The essentials in this definition are: (a) relevant time period, (lJ) openness of economy (i.e., o undue restrictions on imports), (c) absence of unemployment, and (d) continuing base if of the cquilibrium
(i.r., it is capable of being sustained). Th e period is generally one year. Thus, seasonal inequality between exports and imports is not a sign of disequilibrium A distinction is also made between static equilibrium and dynamic equilibrium, the distinction between static and dynamic equilibrium depends upon the time period. In static equilibrium, exports equal imports including exports and imports of services as well as goods and the other items on the balance of ayments-short-term capital, long-term capital and monetary gold, are on balance, zero. Not only should the balance of payments be in equilibrium, but also national money incomes should be in a equilibrium vis-a-vis money incomes abroad. The foreign exchange rate must also be in equilibrium. equilibrium. condition of dynamic equilibrium for short periods of time is that export sand imports differ by the amount of short-term capital movements and gold (net) and there arc no large destabilizing short-term capital movements. condition for dynamic equilibrium in the long run is that exports and imports differ by the amount of ong-term autonomous capital movements made in a normal direction, i.e.. “from the low-interest-rate country to those with high rates? When the balance of payments of a country is in equilibrium, the demand for domestic.
currency is equal to its supply. The demand and supply situation is thus neither favourable nor unfavourable. If the balance of payment moves against a country, adjustments must be made by encouraging exports of goods, services or other forms of exports, or by discouraging imports of all kinds. No country can have a permanently unfavourable balance of payments, though it is possible-and is quite
common for some countries-to have a permanently un favourable balance or trade. Total liabilities and total assets of nations, as of individuals. must balance in the 10 llg run.
ally with every other country with which she has trade relations. This is not necessary nor is it the case in the real world. Trade relations are multilateral. india, for instance, may have an active balance of payments with the United States and passive balance with the United Kingdom and/or other countries. But each country,
in the long run, cannot receive m re value than she has exported to other countries taken together. Equilibrium in the balance of payments, therefore, is a sign of the soundness of a country’s economy. But disequilibrium may arise either for short or long periods. A continued disequilibrium indicates that the country is heading towards economic and financial bankruptcy. Every country, therefore must try to
maintain balance of payments in equilibrium. To know how this can be done involves the study of the theories and causes of disequilibrium in the balance of payments of a country.
Types and Causes or Disequilibrium There are several variables which join together
to constitute equilibrium in the international economic position of a country, I’;;:.. national incomes at horne and abroad, the prices of goods and factors, the supply of money. the rate of interest, etc. At the back of these variables lie the supply of factors, production functions, the state of technology, tastes, the distribution of income.tthe state of anticipations, etc. If there is a change in any of these variables and there are no appropriate changes in other variables, disequilibrium will be the result. The bulk of balance-of-payments difficulties is the result of’ ululation; and disinflation i the obvious remedy. The decline in income will reduce domestic demand for goods an release them for sale abroad. The reductive n rn pri will make the country a better country to buy from than 10 sell 10 thus increase. exports and . Halting of inflation and correction of exchange rate lend to reverse peculation and which had depleted foreign exchange reserves and will lead to a return now of domestic capital and build up again reign working balances. There arc three main types of disequilibria: (a) Cyclical Disequilibrium, (b) Secular Disequilibrium, and (c) Structural Disequilibrium.
Cyclical Disequilibrium. Cyclical disequilibrium is caused by countries having different cyclical patterns of income for the san ie income patten! with different
income elasticities, ur identical income patterns and income elasticities by different price elasticities. “If prices rise in prosperity and decline in depression, a ountry 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 who 1 import 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.”! It is said hat the under-d veloped countries suffer in terms of the balance of payments both from low p ices in depression which hurt exports and from high incomes in prosperity which give rise to heavy imports. TIle developed countries arc hurt consistently by high import prices during periods of world prosperity, and by low incomes abroad during periods of depression.
But these are too sweeping statements and arc also contradictory. There is no doubt that the balance of payments of under-developed countries is adversely affected by the income effect in prosperity and the terms-of-trade (price) effect in depression. but before any conclusion call be drawn about the net impact on such countries of trade cycles. one must study the income effect in depression and the terms-o of trade (price) effect in prosperity; and the converse for developed cuuntries.