What is Basic Balance?
Basic balance is an economic measure for the balance of payments that combines the current account and capital account balances. The current account shows the net amount of a country's income if it is in surplus, or spending if it is in deficit. The capital account records the net change in ownership of foreign assets. The basic balance can be used to show the likely trend in a country's balance of payments.
- The basic balance is a measure of inflows and outflows that takes the capital account into consideration.
- Most economists want to see a basic balance near zero, but governments tend to like more inflows than outflows.
- When the basic balance gets too far out of range, governments can use a mix of policy tools and regulations to try and bring it back into line.
Understanding Basic Balance
Economists use the basic balance to help determine long-term trends in a country's balance of payments. Like the balance of payments, the basic balance is plotted over time to give policymakers a clearer idea of their nation's current position in terms of global inflows and outflows. The basic balance is less sensitive to short-run fluctuations in the interest or exchange rates and it incorporates international investment fluctuations from the capital account, making it more responsive to long-term changes in a nation's productivity.
Economists use the basic balance for a given period to determine the relationship between the amount of money that is coming into the country and the amount of money that flows out to other countries. Generally countries are more amenable to taking in more money than they are sending out into the world, but in practice this can cause overheating risks and sharp inflation in the short-term. Instead, most economic policy advisors want to see a basic balance within a tight range, neither creating a significant surplus or deficit.
Managing Basic Balance in an Economy
Of course, what policymakers want and what politicians push for can sometimes be very different. There is definitely a tendency to view outflows as more of an issue than inflows. If the basic balance gets too far out of range, governments may intervene to restore the range. Depending on how the domestic market operates, governments have different tools for correcting the basic balance.
To slow inflows of capital, a nation can put up regulatory controls against foreign investment. For example, a law could be written that states all corporations operating in the nation must be at least 51% owned by domestic shareholders. These types of rules tend to scare away or at least slow global investment capital as it suggests a less than laissez-faire government. Again, controls against inflows are less commonly used than controls against outflows.
When it comes to capital outflows, countries can use capital controls to limit how much can be transferred internationally. Taking that step, however, is seen as an extreme reaction to be used in times of crisis rather than in response to a poor basic balance. There are many other policy tools that are used prior to outright regulation of what citizens can do with their money. These range from providing tax-advantaged status to domestic investments to simply requiring a higher level of financial institution scrutiny on outgoing transactions. With this mixture of incentive and friction, governments can subtly influence the public to keep more money at home. That said, if domestic investments are underperforming, the money will usually find its way to better returns regardless of what the government wants.