4.1.7 Balance of Payments

• Balance of payments


  A record of all financial transactions made between consumers, firms and the government from one country with other countries
• Exports


  Goods and services sold to foreign countries, positive in the balance of payments as they are an inflow of money
• Imports


  Goods and services bought from foreign countries, negative in the balance of payments as they are an outflow of money
• Components of the balance of payments

  • Current account
  • Capital account
  • Financial account
• Current account


  Includes all economic transactions between countries, such as trade in goods and services, income and current transfers
• Income transfers


  Net earnings on foreign investment and net cash transfers, including salaries and dividends
• Current transfers


  Transfers that have no return, such as aid and grants, including payments the UK makes for being a member of the EU
• Capital account and financial account

  Capital transfers involve transfers of the ownership of fixed assets, financial account involves investment such as direct investment, portfolio investment and reserve assets
• A current account surplus means there is a net inflow of money into the circular flow of income
• The UK has a net current account deficit, meaning the UK spends more on imports from foreign countries, than they earn from exports to foreign countries
• Appreciation of the currency

  Worsens the current account deficit as imports become cheaper and exports become relatively more expensive
• Economic growth


  Increases demand for imports, worsening the current account deficit
• Increased international competitiveness


  Increases exports, improving the current account deficit or increasing the current account surplus
• Deindustrialisation


  Worsens the current account deficit as goods previously made domestically now have to be imported
• Membership of trade unions

  Leads to negative current transfers due to fees paid for membership
• Where there is a current account surplus, there is a capital and financial account deficit, and vice versa
• Measures to reduce a country's imbalance on the current account

  • Increase income tax to reduce disposable income and imports
  • Reduce government spending to reduce AD and imports
  • Depreciate the currency to make exports cheaper
• Fiscal policy can be effective in the short term but not the long term, as households are likely to revert their expenditure back on imports
• Imposing taxes on trading partners risks retaliation, which could reduce demand for exports
• Implementing 'green taxes' or minimum prices on pollution permits could compromise the competitiveness of domestic firms and reduce exports
• Lowering interest rates to cause currency depreciation


  Can be inflationary and lead to 'hot money' flowing out of the country
• Supply-side policies


  Increase productivity through spending on education and training, make the domestic economy attractive to investors, and increase competitiveness through deregulation and privatisation
• Providing subsidies to some industries could result in retaliation from foreign countries as an unfair protectionist policy
• Significance of global trade imbalances

  Indicates an unbalanced economy and reliance on other economies, can be difficult to finance a current account deficit in the long run, affects economic performance and can lead to policy responses like currency manipulation