Wednesday, August 26, 2009

Social Accounting in an Open Economy

An open economy is an economy having economic dealings with other countries of the world. Simple representation of an economy discussed in closed economy seems to be unrealistic when we think of what happens in the economic system actually. We find that in practice economic system are seldom self contained. On the other hand, they enter into extensive economic relationship with other economic system. To put it into simple language we can say that no country in the world is self sufficient. There may have been a time when various territorial units were ignorant of the existence of one another and led a self contained economic life. It is said that villages of our country were at one time self-sufficient economically i.e. they consumed what they produced and produced only for domestic consumption. Such a situation no longer exists. On other hand we find that there are extensive trading and capital transaction taking place between one country is not self sufficient. Thus we find that economic system of the world represented by individual countries is very closely interrelated. In social accounts are to be realistic we have to introduce this new element in social accounts which may be represented by rest of the world. Hence for an open economy we can classify the social accounts into (a) Production (b) Consumption (c) Rest of the world and (d) Accumulation. The rest of the world stands for the totality of other economies with which the economy in question is connected by virtue of economic relationship i.e. buying and selling, borrowing and lending etc.

In this diagram imports and exports of the country in question from and to the rest of the world have been shown. These are shown by flows connecting production with the rest of the world. In the view of the fact that the value of the exports and imports is seldom equal to each other, we show in the diagram an arrow towards the rest of the world from accumulation. This flow is called net lending abroad. This is a situation in respect of a country which has a favourable balance on current account which has a favourable balance on current account which it lends to abroad.

In the above diagram the flow into any given box sum up to the same total as the flows which go out of that box. The total has to be same, it can not be otherwise. We therefore get the following equations.

Y=C+S…………….(1)

S=I+L………………(2)

X=M+L…………….(3)

In the above equations Y stands for income (paid on payable to the factors of production) C is consumer’s expenditure on commodities, S is the saving and I is investments, the X stands for exprts M for imports and L for net amount lend. By substituting for L from equation 3 into 2 and then for s in from 2 into 1 we get the equation.

Y=C+I+X-M

This equation shows that income payments are equal to consumption expenditures plus capital expenditure on real assets. Plus the excess of the value of exports over the value of imports.

There is no doubt that this diagram is more realistic but is not sufficiently detailed as to give a complete picture of the economic system actually in operation. It does not contain provision for deprivation which is very necessary since buildings and machinery do not last for ever. Provision for deprivation is taken directly to accumulation to serve as source for funds meant for the replacement of real assets.

Secondly we have to take into account taxes, both direct and indirect levied by government and its subsidies given by it. We also to take not of the fact that the number of transactions between the economy in question and the rest of the world is much greater than described here.

Thus the actual situation to be represented by social accounts becomes very much complicated. If the social accounts are to be realistic the flow & called consumption expenditure going from consumption to production should include not only the consumption expenditures of the individuals and non-profit institution but also public consumption i.e. of public agencies. It may be more convenient to route these expenditures abroad through the domestic productive system which will therefore appear both as imports and as purchases from production. Similarly the flows of savings going from consumption to accumulation should include no only the savings of individuals, non profit institutions and business ferias but also savings by government agencies. In case the government has a deficit on current accounts showing negative saving the flow of saving by the private sector over the negative saving of public sector.

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