Balance of Payments

2.1.4
Topic Objectives

 a) Components of the balance of payments, with particular reference to the

current account, and the balance of trade in goods and services
 b) Current account deficits and surpluses
 c) The relationship between current account imbalances and other
macroeconomic objectives
 d) The interconnectedness of economies through international trade
Balance of Payments

 the difference in total value between payments into and out of a country over
a period.
What are the circumstances that might
cause a trade deficit?
Clues:

AD components
CA
 The Current Account

• Current Account
• (1) Balance of trade in goods
• (2) Balance of trade in services
• (3) Net primary income (interest, profits, dividends and
migrant remittances)
• (4) Net secondary income (transfers i.e. contributions
to EU, military aid, overseas aid)

Note: The X-M (trade balance) is the figure used when calculating
aggregate demand

Note: FDI coming into the country will be a surplus on the financial
account but the repatriation of that firm’s profits back to its home
country will be a deficit on the current account
 Items included in the current account of the BoP

• Finished manufactured goods, components,

Trade Balance in raw materials
Goods • Energy products, Capital technology

• Banking, Insurance, Consultancy

Trade Balance in • Tourism, Transport, Logistics
Services • Shipping, Education, Health,
• Research, Cultural Arts

Net Primary Income • Profits, interest and dividends from investments

from Overseas in other countries
• Net remittance flows rom migrant workers
Assets

Overseas aid / debt relief

Net Secondary Military grants
Income UK Payments to the European Union
 The Capital Account

• Capital account
• Sale/transfer of patents, copyrights, franchises, leases
and other transferable contracts (example would be
international buying and selling of land by businesses)
• Debt forgiveness/cancellation (forgiving debt counted
as a negative)
• Capital transfers of ownership of fixed assets (i.e.
international death duties)

Note: The old capital account is now called the financial account. The
capital account in the new Balance of Payments system is now a tiny
part of the overall figure
 The Financial Account

• Financial Account – includes transactions that result in a

change of ownership of financial assets and liabilities
between UK residents and non-residents
1. Net balance of foreign direct investment flows (FDI)
2. Net balance of portfolio investment flows (e.g.
inflows/outflows of debt and equity)
3. Balance of banking flows (e.g. hot money flowing
in/out of banking system)
4. Changes to the value of reserves of gold and foreign
currency
 Balance of Payments Accounts in Summary
• Current Account
• (1) Balance of trade in goods
• (2) Balance of trade in services
• (3) Net primary income (interest, profits, dividends and migrant remittances)
• (4) Net secondary income (transfers i.e. contributions to EU, military aid, overseas aid)
• Capital account
• Sale/transfer of patents, copyrights, franchises, leases and other transferable
contracts (example would be international buying and selling of land by businesses)
• Debt forgiveness/cancellation (forgiving debt counted as a negative)
• Capital transfers of ownership of fixed assets (i.e. international death duties)
• Financial Account – includes transactions that result in a change of ownership of financial
assets and liabilities between UK residents and non-residents
• Net balance of foreign direct investment flows (FDI)
• Net balance of portfolio investment flows (e.g. inflows/outflows of debt and equity)
• Balance of banking flows (e.g. hot money flowing in/out of banking system)
• Changes to the value of reserves of gold and foreign currency
• Balancing item (estimated net errors & omissions)
• Overall balance of payments = zero
 UK TRADE BALANCE IN GOODS
Goods trade balance
15,000

10,000

5,000
Balance of trade £ million

-5,000

-10,000
UK trade in goods deficit increased from
-15,000
£133.5 billion (6.3% of GDP) in 2020 to
-20,000 £153.8 billion (6.8% of GDP) in 2021.

-25,000

-30,000
Jan 97Jul 98Jan 00Jul 01Jan 03Jul 04Jan 06Jul 07Jan 09Jul 10Jan 12Jul 13Jan 15Jul 16Jan 18Jul 19Jan 21Jul 22
 UK TRADE BALANCE IN GOODS AND SERVICES
Goods trade balance Services trade balance
20,000 The trade in services surplus decreased
15,000 from £141.1 billion (6.7% of GDP) to £136.3
billion (6.0% of GDP) in 2021.
10,000
Balance of trade £ million

5,000
0
-5,000
-10,000
-15,000
-20,000
-25,000
-30,000
Jan 97Jul 98Jan 00Jul 01Jan 03Jul 04Jan 06Jul 07Jan 09Jul 10Jan 12Jul 13Jan 15Jul 16Jan 18Jul 19Jan 21Jul 22
 UK TRADE BALANCE IN GOODS AND SERVICES
Goods trade balance Services trade balance Overall trade balance
20,000
15,000
10,000
Balance of trade £ million

5,000
0
-5,000
-10,000
-15,000
-20,000
-25,000
-30,000
Jan 97Jul 98Jan 00Jul 01Jan 03Jul 04Jan 06Jul 07Jan 09Jul 10Jan 12Jul 13Jan 15Jul 16Jan 18Jul 19Jan 21Jul 22
REMITTANCES AND THE CURRENT ACCOUNT
 UK CURRENT ACCOUNT (BALANCE OF PAYMENTS)
Current Account of the Balance of Balance (£ billion) Brief comment
Payments (1st quarter 2023)
Trade in goods - £55.8 billion UK runs a large trade deficit in goods

Trade in services + £36.4 billion Strong trade surplus in services

a) Balance of Trade - £19.4 billion Adding together goods and services

b) Net Primary Income + £6.6 billion Large rise in investment income from overseas

c) Net Secondary Income - £4.1 billion This is always negative for the UK

Current account balance - £17 billion Balance of A + B + C

The UK's current account balance is a measure of the country's balance of payments
with the rest of the world in trade, primary income and secondary income.
 UK CURRENT ACCOUNT (BALANCE OF PAYMENTS)

Trade Balance Primary Secondary Current

in Goods and Income Income Account
Services Balance Balance Balance

% of GDP % of GDP % of GDP % of GDP

2020 0.4 -2.2 -1.3 -3.2

2021 -0.8 -0.4 -0.8 -2.0

The UK's current account balance is a measure of the country's balance of payments
with the rest of the world in trade, primary income and secondary income.
 UK CURRENT ACCOUNT (BALANCE OF PAYMENTS)
Components of the UK Current Account (BoP) £ billion
50.0

0.0

-50.0

-100.0

-150.0 Employee income balance for the UK is close to zero which is why it does not show up on this chart.

-200.0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
Trade balance Investment income balance
Employee income balance Transfers balance
 UK CURRENT ACCOUNT (BALANCE OF PAYMENTS)

Trade Balance Primary Secondary Current

in Goods and Income Income Account
Services Balance Balance Balance
% of GDP % of GDP % of GDP % of GDP

2020 0.4 -2.2 -1.3 -3.2

2021 -0.8 -0.4 -0.8 -2.0

A current account deficit places the UK as a net borrower with the rest of the world, indicating that
overall expenditure in the UK exceeds national income. The UK must attract net financial inflows to
finance its current (and capital) account deficit. This can be achieved through either disposing of
overseas assets to overseas investors or accruing liabilities with the rest of the world.
 COUNTRIES WITH HIGHEST TRADE DEFICIT(2022)

Trade Balance, $ billion, source: IMF

-1,400 -1,200 -1,000 -800 -600 -400 -200 0
United States -1,311.41
United Kingdom -294.43
India -269.87
France -200.18
Turkey -109.54
Spain -74.71
Philippines -65.69
Hong Kong -57.63
Mexico -48.13
Greece -40.3
Pakistan -40.14
Egypt -36.48
Romania -35.78
Israel -33.68
Bangladesh -33.54
 COUNTRIES WITH HIGHEST TRADE SURPLUS (2022)
Trade Balance, $ billion, source: IMF
0 100 200 300 400 500 600 700 800 900 1,000
China 877.6
Russia 291.5
Saudi Arabia 222.06
United Arab Emirates 173.98
Norway 144.26
Australia 103
Qatar 96.61
Germany 84.02
Kuwait 69.47
Ireland 68.14
Netherlands 66.98
Malaysia 58.07
Indonesia 54.53
South Korea 47.78
Switzerland 45.26
 TRADE BALANCE FOR SINGAPORE
180 Singapore is a good example of a country 169.18
160 running a structural trade surplus – which
Net trade in goods and services in bil-

149.45
reached a record level in 2022
140
120 111.19 111.11 108.71
lion U.S. dollars

100 91.49
84.08 83.61
80 71.09 73.8
60
40
20
0
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
 TRADE BALANCE FOR BANGLADESH
0

-5
Net trade in goods and services in bil-

-10
-9.93 -10.61 -10.51
-12.12
-15
lion U.S. dollars

-20 -17.59 -18.3

-19.27
-21.46
-25

-30

-35 Bangladesh runs a trade deficit -33.68

-36.01
-40
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
 TRADE BALANCE FOR VIETNAM
25
20.42
20 19.14
Net trade in goods and services in bil-

15 12.86
10 7.45 8.6
6.78 6.82
lion U.S. dollars

5.6
5 2.61 1.96
0
-5 -3.43 Notice the steep drop in the Vietnamese
-10 -7.6 trade surplus in 2021 – perhaps the result of
-11.19 -10.03 a decline in tourism exports due to the
-15 -13.73 pandemic.
-20
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Practice
1. UK income increases relative to other countries. Does the balance of payments
move toward a deficit or a surplus?
- Increase in real disposable income
- Domestic consumers import more
- Foreginers import less
- Net exports (X-M) decrease
- The current account balance decreases and moves toward a deficit.
2. If the UK £ depreciates relative to other countries does the balance of
payments move toward a deficit or a surplus?
- UK exports are desirable
- UK exports more
- Net exports (X-M) increase
- The current account balance decreases and moves toward a surplus.
Imbalances

Some countries will run current account deficits but capital account surpluses
and vice versa.

However, the nature of these deficits and surpluses is important. In other words,
what are they being caused by?
Does a BoP Deficit cause problems?

 It depends on the size and nature of the deficit!

 The larger the deficit, over a longer period of time the greater the problems
will be!

 If it’s cheap imports & an increase in M???

 If it’s the UK not being competitive and there is a fall in X???
Short run V long run deficit!

 In the Long
Shortrun…
run….

 A deficit might cause

mean that
UK businesses
UK households
to suffer,
haverising
a better
standard of living…
unemployment …. and falling standards of living!
The Causes

 High level of consumption causing excessive spending on foreign

products/services
 High levels of investment causing capital goods being imported from abroad
 Change in comparative advantage leading to cheaper goods and services to be
produced abroad instead of domestically
 Over-valued exchange rate
 Structural weaknesses leading to poor international competitiveness because
of low productivity, investment or too high labour costs
Expenditure switching policies

Policies that increase the price of imports and/or reduce the price of exports in
order to reduce demand for imports and increase demand for exports.

1. Fall in exchange rate

2. Tariffs on imports
3. Subsidising exports
Expenditure reducing policies

Policies that reduce the overall level of national income in order to reduce the
demand for imports

1. Increase taxes
2. Reduce G
3. Raise interest rates
Curing BoP deficit…

Deflation The 3
D’s
Direct controls
All have
Devaluation issues with
use!
Can a surplus BoP cause problems?

 A surplus suggests lots of economic success

 Exporting more than Importing! Again it depends on the size of the surplus!

 And if one country is more successful than others… then this can cause other
countries to act to reduce their deficit … and use direct controls!

 Surplus can cause inflation… as an increase in X = an injection = outward shift

in AD!
 Curing a BOP surplus …
• Reflation
The 3
R’s
• Remove import controls

All have
• Revaluation issues with
use!
 UK balance of payments in context
• The current account balance plus the capital account
balance measures the extent to which the UK is a net
lender (that is, in surplus) or net borrower (that is, in
deficit).
• Countries that run current account deficits have to be net
borrowers in the international financial system. This is the
case for the UK at present with a current account deficit in
2015 of more than 5% of UK GDP
• Countries that run current account surpluses can be net
lenders i.e. they can export surplus US $s etc. in overseas
investment – good example is China and their purchase of
US treasuries + investments made by Sovereign Wealth
Funds
 Economic Growth and the Balance of Payments

A period of rapid economic growth may come into conflict with a

country’s balance of payments. Much depends on the income elasticity
of demand for internationally traded goods and services

When real incomes are rising at a rapid rate,

consumers will tend to buy more imports –
leading to a worsening of the trade balance

Fast growing countries may suffer from high

inflation which worsens the competitiveness
of domestic industries including exporters

Businesses will need to import extra raw

materials, components and capital equipment
to help expand production.
Policies to Reconcile the Growth/Trade Trade Off

Supply-Side Policies
• Reforms to improve labour productivity
• Incentives to boost research & development & innovation
• Measures to increase investment in export sectors

Exchange Rate Depreciation

• A depreciation of the currency (in theory) makes exports more
price competitive and imports are more expensive
• But the effects are dependent on price elasticity of demand

Sound / Effective Macro Economic Policies

• Monetary policy to help keep inflation low relative to the
inflation of major trading competitors
• Infrastructural investment to increase export competitiveness