Finance Sessions - Post 6

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Finance Post Lesson – 6​

Dear Zevist Family,

The post below is intended to help us better understand the concepts of International Business. I have chosen to prioritize this topic because there is frequent discussion among members regarding decisions made by the United States Government concerning tariffs.

Please note, this is not a political post. Its sole purpose is to clarify and explain the various terms commonly used in discussions related to tariffs.



To avoid overcomplicating things, we will use an imaginary country, “X,” which has only recently come into existence. Starting from the very basics, we observe that this country X has been blessed with certain factors of production. These could be in the form of an abundance of natural resources, such as coal and petroleum products. (Countries like Saudi Arabia experienced a boom in growth primarily due to the availability of crude oil, which brought them significant global prominence.)

Alternatively, X may benefit from the availability of manpower. (Countries like China and India have greatly benefited from this factor to the extent that, for many decades, investment in genuine research and development was sidelined. Instead, cheap copies of products were produced in large quantities and at low cost, due to the abundance of labor.)

Any country, therefore, operates similarly to a business that maintains its books of accounts—tracking the money it receives, the money it pays to other countries, and the resources exchanged between nations, along with their monetary equivalents.



The topics that will be covered to understand the books of account that our country “X” will need to maintain are listed below:

To ensure that no important areas are overlooked, I am referring to the Master’s-level course syllabus from the University of Illinois: International Finance Economics Course.

1. Balance of Payments
   a) Current Account
   b) Capital Account
2. Net International Investment Position
3. Lucas Paradox

TOPIC – 1: BALANCE OF PAYMENTS​

The Balance of Payments, as mentioned above, records and accounts for all the money received and paid by our country “X.”

Definition : Used online sources : Balance of Payments (BoP) is a financial statement that summarizes all economic transactions between the residents of a country and the rest of the world over a specific time period, usually a year or a quarter.

Any country, much like you or me, does not exist for just a year or two , they are here to stay for the long term. Financial decisions made by nations are taken with this long-term perspective in mind.
Therefore, there are primarily three types of accounts that a country maintains to help categorize the various kinds of payments and money received by the country.

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• Topic 1A) Current Account: This account is maintained to record all the incomes and payments that our country “X” makes as a result of its interactions with the rest of the world.
  These interactions can arise from the exchange of the following between nations or their residents:
• Goods: This refers to the transfer of tangible items such as cars, steel, manganese, etc., between countries.
• Services: When these goods or services are sold from our country to the rest of the world, it constitutes an “export” for us. Such transactions bring foreign currency into our nation.
• Conversely, when our country “X” purchases goods such as cars from Germany, then we are “importing” those goods. This results in an outflow of money from our nation.
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• According to Basic Arithmetic, it would be favourable for us when our trade balance is positive i.e. greater than 0.
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• Trade Balance : Export of Goods – Imports of Goods
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• Similar to the exchange of goods between nations, there is also the exchange of services, such as tourism, software development, overseas consulting, and more.
  At the core of these transactions lies a fundamental concept: the flow of money either going out of the country or coming in.
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• Investment Income : This also includes income earned from investments and labor abroad. Examples include: dividends and interest payments received from foreign nations and paid to our nation or its citizens.
  Similarly, when we make payments such as interest on money lent to our nation or its citizens or when profits are earned by multinational companies operating in our nation “X” and those incomes are consolidated and sent back to their headquarters in another country, these transactions are also recorded.
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• Current Transfers:
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• This category includes one-way transfers of money, such as foreign aid. For example, funds lent to our nation by institutions like the World Bank, or aid provided by our nation to a partner country as “relief funds” in response to natural disasters like earthquakes.
• Foreign aid can also be used as a tool of diplomatic pressure or influence, and in some cases, to compel nations or entities into compliance. One such example is the reaction to an article published in the Egyptian newspaper Al-Haram, which discussed the controversial and offensive topic of child ritual sacrifice (commonly referred to as "blood libel"). In response, the Jewish lobby in the United States advocated for a halt in U.S. aid to Egypt.
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• As stated by Morton A. Klein, President of the Zionist Organization of America:
• “We urge Congress to refrain from considering the Clinton Government’s proposal for USD 225 million in extra aid to Egypt until the Mubarak Government publicly apologizes and repudiates the blood libel article and replaces the editor responsible for its publication.”

Topic 1 B) Capital Account: this accounts for transactions made by our country “X” for Capital transfers which involves non -produced, non-financial assets being exchanged between nations

• Capital Transfers:
• These are transactions that occur between nations involving the exchange of capital for the transfer of ownership of assets within a country.
• This can take place in various forms. For example, China has frequently loaned money to developing nations, particularly in Africa. When these nations fail to repay their debts, the Chinese government often takes ownership of strategic businesses or infrastructure in those countries.
• Other examples of capital transactions include situations where individuals move their assets to another country in the form of pensions, savings, or by purchasing property, etc.
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Topic 1C) Financial Account:

This account primarily refers to transactions related to investments made by companies. These are typically large-scale, market-driven investments. Examples include foreign nationals purchasing stocks in the United States or foreign direct investment (FDI) by institutional investors in your country.

For any nation: Current Account + Capital Account + Financial Account + Errors And Omissions = 0

TOPIC – 2: Net International Investment Position (NIIP)​

This indicator reflects the difference between what the citizens of a nation or the nation itself own abroad and what foreign entities own within our country, “X.”

Examples: Foreign Direct Investment (FDI) held abroad and FDI made in our nation are important components to consider. For us, investments made by our citizens or entities abroad are considered assets, while investments made by foreign nations in our country are considered liabilities.

Foreign exchange reserves refer to the amount of foreign currency reserves we hold compared to how much of our currency is held by other nations. Additionally, loans extended to foreign companies represent assets for us, whereas loans received from foreign entities are considered liabilities.



Internet Source: Example: The United States' Net International Investment Position (NIIP) remains significantly negative, reflecting a long-term trend of the country being a net debtor to the rest of the world. As of the first quarter of 2025, the U.S. NIIP stood at -$24.6 trillion. This figure represents a continued deterioration from previous years, with the position declining from -$22.0 trillion in the first quarter of 2024 to -$26.5 trillion in the fourth quarter of 2024.Expressed as a percentage of GDP, the U.S. NIIP reached -90.4% in 2024, according to the most recent data.

Topic 3 : Lucas Paradox​

This is a straightforward economic concept, but it is important to recognize that many economic and financial theories contain paradoxes. These paradoxes arise because classical economic theories often assume linear relationships and rely on assumptions that may not hold true in real-world situations.

The theory in question contradicts the observed reality that most wealthy and advanced countries with abundant capital tend to invest primarily in other wealthy, capital rich countries. According to neoclassical economic theory, to achieve the highest return on investment, capital should be directed toward developing economies where less capital is required per worker. Consequently, the marginal productivity of labor is expected to be higher in these developing countries compared to developed ones.

This as we can all guess is not the reality in which countries run, there are a multitude of reasons for this which are mentioned below:

• Economically weaker nations often have highly unstable governments or economies and due to this there is always a risk that a company that would say invest in Somalia, will be at a risk of losing their entire Capital in case of a military coup taking place in the nation.
• Such countries also have institutions which are inherently corrupt and are plagued by institutional inefficiencies that might prove to be a challenge for companies/nations that invest in them
• Lack of a skilled work force. When most companies come to third world nation for business, they need to incur high amounts of capital to train the work force which is not the case in developed countries. This training might require them to setup entire industrial centres and with the Infrastructure and Technology needing a revival in the new country. An example of this can be if Coca Cola goes to setup a plant of Cola in a third world nation filled with bribery, lack of power facilities to run machines, lack of industrial complexes, lack of skilled workforce to operate their machines that at times cost multiples of hundreds of thousands of dollars.
• There is also the case of Information Asymmetry. Many investors in rich countries have limited knowledge about developing markets primarily since this information might not be made readily available to them.

Thank you!