The balance of trade denotes the difference between merchandise exports and merchandise imports of a country. The excess of exports over imports denotes favorable balance of trade.
The mercantilists laid emphasis on having a favorable balance of trade so that a country could prosper through import of precious metals in return for its exports. However, the fallacy in the mercantilist doctrine has now been exploded. The mercantilists failed to see that imports and exports of goods, important as they are, form only one element in the total of international payments. In fact, it has now been increasingly realized that a favorable balance of trade is not necessarily an index of a countryâ€™s prosperity. For example, India had a favorable balance of trade in the pre-war period, but she was by no measure a prosperous country. On the other hand, the United Kingdom managed to have an import surplus financed by her receipts on account of interest and dividends on her investments abroad. On the basis of experience, countries could be divided into four categories, viz.: (1) Immature lenders, (2) Mature lenders, (3) Immature borrowers and (4) Mature borrowers.
Immature borrowers have an import surplus as capital borrowed by them is usually spent on imports of capital goods and equipment, and the capital borrowed is, at least in the earlier stages, more than the interests to be paid on the previous borrowings.
Mature borrowers have to pay interest on their previous borrowings and the interest payments usually exceed the new capital borrowings. To meet the interest payment and repayment obligations, mature borrowers have to export more than what they import and therefore they usually have an export surplus, for example, India before 1939.
Immature lenders lend more than what they have to receive by way of interest payments and repayment of funds previously lent. Moreover, the capital lent by them is usually spent by the borrowers for purchasing their goods ands services. As a result, immature lenders have an export surplus.
In the case of mature lenders, the new capital lending are comparatively less than what they have to receive by way of interest on previous lending as also repayment thereof. The borrowers usually meet their debt obligations by exporting to the lenders and, therefore, mature lenders usually have an import surplus, for example, Britain before 1939.
Balance of payments of a country has been defined as â€œa systematic record of all economic transactions between the residents of the reporting country and residents of foreign countriesâ€. Thus balance of payments includes both visible and invisible transaction. The items usually included in balance of payments of any country are payments for merchandise imports and receipts for merchandise exports, loans to and investment in foreign countries and enterprises, foreign investments in domestic enterprises, borrowings from foreign countries, tourist expenditures both by domestic tourists abroad and foreign tourists in the reporting country, money paid to foreign carriers and receipts for foreign goods carried in national bottoms, cable and telegraph payments to foreign communication agencies, insurance premium paid to foreign insurance companies and those received by national insurance companies, commission received by domestic banks and paid to foreign banks, expenses on foreign embassies established in the home country, interest and dividend payments and similar items. The two sides of a balance of payments must always balance i.e. payments to be made to outsiders must equal the receipts from outsiders. The reason is to be found in the simple fact that for everything one gets, he can expect to receive something in return. Ordinarily, balance of payments is prepared for a period of one year, but quarterly balance of payments is also common.