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4.1.7 Balance of payments

Balance of payments

The current account and capital/financial accounts must balance, so current account + 
capital/financial accounts = 0. 

Current account:

Balance of Trade

- Trade in goods. So value of good exports - value of good imports  
- Trade in services. So value of service exports - value of service imports. 

Net investment income 

Net investment abroad, in the form of interest, profit, dividends, etc 
Net profit income, net interest income, etc 

Net transfers 

Transfers for which no good or service is exchanged such as EU payments, aid, remittances. 


Capital and financial accounts 

Capital account + financial account 

The value of change in ownership of assets, currency, etc. Records net change in ownership of foreign assets, flows of money associated with loans, investment and speculation. 


To have a current account surplus, a country must run a capital/financial account deficit and vice versa. This is because if you were for example importing more than exporting, you would need something to pay for the imports with, so you could sell assets, take out a loan, etc (leading to a capital/financial account surplus) 


Causes of current account deficit: 


 - A lack of competitiveness (strong XR, high inflation, high unit labour costs) - eval is this is all relative and also ceteris paribus
- A lack of non-price competitiveness, improvement can be achieved by investment (as long as it is effective!) 
- Economic growth - as real incomes rise, vol of imports will also rise, the rate at which it rises depending on the MPM 
- Decrease in protectionism leads to more imports. 
However, in US, President Trump increased protectionism in order to decrease the current account deficit. however, because he relaxed taxes at the same time, deficit rose. This is because relaxing taxes meant that people had more disposable income, so more was spent on imports (as MPM remained the same). At the same time, firms' who import had lower costs so also imported more. SO protectionism only decreases current account deficit ceteris paribus
- Changes in taxation - less tax means more disposable income. Anything that increases consumption and shifts out the AD curve (fiscal policy) will increase the deficit as imports will increase. Increasing gov spending may not have the same effect on deficit as it can be more carefully controlled, whereas consumer spending preferences are fixed. 

To reduce imbalances in current account: 


Reducing deficit - increase productivity, decrease unit labour costs by decreasing NMW, regulations, etc. All of this will increase competitiveness, increase no. of exports. 
Devalue currency if fixed (dependent on Marshall-Lerner condition) 
Recession will lead to reduction as AD shifts in, less spent in general. 

Reducing surplus - measures that boost economic growth and shift out AD. e.g through relaxing taxes. 
Why does the UK run a current account deficit? 

Goods exports:

Retail: hotels, tourist attractions, high street banks
Financial and creative services (e.g advertising) 

Services exports: 

On the whole are expensive and not very good, so we tend to run a deficit. 
This is because production costs are higher due to the NMW, regulation and expensive land. 

Competitiveness - the UK is less price competitive than China for example, and less non-price competitive than Germany (i.e quality of their goods isn't as good). This is due to low productivity and high unit costs. 

The UK also net transfers a lot out of the country in aid, remittances and EU/IMF payments. 

UK consumers have a high standard of living and import a lot of goods. A low MPS means we spend more on imports than other countries like China, who have a higher MPS.


To increase exports: 

- Education. Most importantly STEM as this increases innovation. e.g grants for STEM HE. 
- Decrease the NMW 
- Decrease regulation (e.g safety, working hours, pension age) 
- Increase base interest rate (but many side effects) 
- Make ISAs easier to use/advertise them so more people use them. 
- Focus on R&D and increase innovation 
- Improve infrastructure, better transport links between north and south England 
- Lower corporation tax 
- Make it easier for immigrants to get visas - increases the working force and increases productivity 
- Trade tariffs 
- Subsidise goods that the UK exports.  


Example of a current account surplus: 

CHINA: 

Has a surplus due to: 

- Low labour costs due to very low minimum wages 
- Low land costs due to less regulation (e.g building restrictions). Also as there is more unused land so buildings don't have to be built on pre-existing land. 
- Less regulation in general (e.g health and safety) 
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