2.5 Balance of Payments

• Balance of payments:

  A record of all economic transactions between residents of one country and residents of the rest of the world during a given period
• The current account:

  In the balance of payments, records transactions involving the export or import of goods and services.
• Trade in goods:

  Exports and imports of visible or tangible items such as cars, oil and tea
• Trade in services:

  Exports and imports of invisible/intangible products such as financial services, tourism and shipping
• Primary income:

  Income generated from UK nationals employed abroad and UK firms that have invested abroad
• Secondary income:

  Transactions between govenments, such as bilateral aid or transfers to an international institution, together with remittances and govenment transfers of social security payments.
• The capital account:

  This records all capital transfers and is the smallest of the 3 accounts in the UK's balance of payments. The transfer of assets of migrants is recorded here.
• The financial account

  Consists of:

  -Foreign direct investment

  -Portfolio investment

  -Other investments such as currency flos from banking e.g. hot money
• The policy objective of a sustainable balance of payments position:

  As a country becomes more developed and standards of living rise, it is not uncommon for the current account to be in deficit. This is not a problem as long as there is sufficient income flowing into the balance of payments. It can indicate international incompetitiveness. May need to be financed by borrowing from other countries.
• International competitiveness:

  Ability of a country to compete with other nations, determined by price and non-price factors.
• Causes of imbalances on the balance of payments:

  1. Changes in economic activity home and abroad alter the trade in goods and services 2. The exchange rate 3. Economic shocks 4. Inflation 5. Factor input costs e.g. labour 6. Structure of an economy
• Consequences of imbalances on the balance of payments:

  1. Unemployment could rise in exporting industries 2. AD will fall leading to slower real GDP growth & reduced living standards 3. Currency weaknesses 4. Protectionism * All depends whether it's a deficit or surplus
• Factors that the risk of financing a trade deficit by selling UK financial assets abroad depends on:

  1. How reliant is the country on international trade? 2. How flexibile are domestic industries to respond to an economic shock? 3. J-curve effect 4. Marshall-Lerner condition
• Distinguish between internal devaluation & exchange rate devaluation:

  Internal devaluation is an expenditure - reducing policy that aims to reduce the level of AD and so reduce spending on imports. Exchange rate devaluation looks to lower export prices and raise import prices thus restoring competitiveness (expenditure switching)