Balance of Payments (Edexcel A Level Economics A)

Components of the Balance of Payments

• The Balance of Payments (BoP) for a country is a record of all the financial transactions that occur between it and the rest of the world

• The BoP has two main sections:

  • The current account: all transactions related to goods/services along with payments related to the transfer of primary and secondary income

  • The financial and capital account: all transactions related to savings, investment and currency stabilisation

• It is called the BoP as the current account should balance with the capital/financial account and be equal to zero

  • If the current account balance is positive, then the capital/financial account balance is negative (and vice versa)

• Money flowing into the country is recorded in the relevant account as a credit (+) and money flowing out as a debit (-)

The current account of the balance of payments

• The Current Account is often considered to be the most important account in the BoP

  • It records the net income that an economy gains from international transactions
    

An Example of the UK Current Account Balance For 2017

• Goods are also referred to as visible exports/imports

• Services are also referred to as invisible exports/imports

• Net income or Primary income, consists of income transfers by citizens and corporations

  • Credits are received from UK citizens who are abroad and send remittances home

  • Debits are sent by foreigners working in the UK back to their countries

• Current transfers or Secondary income are typically payments at government level between countries, e.g. contributions to the World Bank, foreign aid

• The Current Account balance is often expressed as a % of GDP

  • This allows for easy international comparisons

Current Account Deficits and Surpluses

• A Current Account deficit occurs when the value of the outflows is greater than the value of the inflows

  • Usually occurs when the debits from imports > credits from exports

• A Current Account surplus occurs when the value of the inflows is greater than the value of the outflows

  • Usually occurs when the debits from imports < credits from exports

• The UK government has a macroeconomic aim to reduce the Current Account imbalance to achieve as close to equilibrium as possible

  • The UK has run a current account deficit since 1985

  • Export-led economic growth would help it become less negative, although realistically this is unlikely for a long time

  • However, with increasing income and wealth in an economy, the value of imports rises

    • Consumers enjoy the variety of goods/services abroad

    • Rising imports push the balance towards a greater deficit

The Relationship Between the Current Account Imbalances & Macroeconomic Objectives

• The UK government has a range of macroeconomic objectives which it attempts to achieve

• Setting policies to target one objective may complicate the possibility of achieving other objectives

  • There is a trade-off or conflict

•  If the Current Account is running a deficit, this has a negative impact on aggregate demand (AD) as (X-M) is net negative

  • Net exports are a component of AD

  • If net exports are negative, then AD decreases

• To correct the current account deficit, the government could raise tariffs 

  • This would likely decrease imports bought by households

  • Firms that rely on imports for raw materials used in production would now face higher costs of production

  • These higher costs are likely to be passed on to consumers in the form of higher prices

  • Reducing the current account deficit has come at the expense of increased inflation in the economy; there has been a trade-off

The Interconnectedness of Economies Through Trade

The world is more connected than ever and there is a high level of interdependence between economies

• COVID-19 and the Ukraine War demonstrated how disruptions in one part of the world cause widespread problems in others

• One country's imports are another country's exports

• Theoretically, the global value of exports will be equal to the global value of imports

• Producers all over the world are often highly dependent on imported raw materials used in production, e.g. a motor car has around 30,000 individual parts

  • Building a car is a global effort and requires a high level of interconnectedness between multiple economies