Balance of Payments

Why is international trade important for a country like the UK?

• It is difficult and expensive to produce goods here 
• we have a lack of space in the UK, lack of spare capacity in developed countries 
• lack of natural resources
• comparative advantage (David Riccardo) says its more efficient to import rather than produce our own 
• specialisation of labour (Adam Smith) says the country can become more productively efficient 

(goods coming in, money going out)

The European Union (27 countries) is the biggest source of imported goods and services for the UK, but China is now ahead of the USA as a supplier of products

Within the EU there is no additional tax or limit of value of goods and services, also a decrease in transport costs due to the proximity

China is now importing more to the UK, as iit is cheaper and there are now a larger range of products available 

• helps reduce scale of extreme poverty
• increased market competition
• better access to new technologies from different countries
• inflows of specialist knowledge 
• exploiting of economies of scale in bigger markets 
• better use of scarce resources 

The free movement of people, capital, goods and services between countries.

• big expansions of financial capital flows between countries
• rise in foreign direct investment (FDI) and cross border mergers and acquisitions (takeovers)
• rise of global brands - including many from emerging countries
• deeper specialisation of labour - ie components from many nations 
• global supply chains and new trade investment routes 

Records all financial transactions made between consumers, businesses and the government in one country with other nations 

Inflows of foreign currency are counted as a positive entry (eg exports sold overseas)

Outflows of foreign currency are counted as a negative entry (eg imported goods and services)

The current account of the balance of payments is the main measure of external trade performance 

Current account deficit - imports > exports 

Current account surplus - imports < exports 

Trade balance in goods:

• finished manufacturing goods, components, raw materials 
• energy products, capital, technology 

Trade balance in services:

• banking insurance, consultancy
• tourism, transport, logistics 
• shipping, education, health
• research, cultural arts 

Net money transfers:

• overseas aid/ debt relief 
• private money transfers eg from migrants to family members

Net investment from overseas assets - profits, interest and dividents from investment in other countries eg profits from transnational businesses

Trade balance in goods:

• finished manufacturing goods, components, raw materials 
• energy products, capital, technology 

Trade balance in services:

• banking insurance, consultancy
• tourism, transport, logistics 
• shipping, education, health
• research, cultural arts 

Net money transfers:

• overseas aid/ debt relief 
• private money transfers eg from migrants to family members

Net investment from overseas assets - profits, interest and dividents from investment in other countries eg profits from transnational businesses

Poor price and non-price competitiveness:

• higher inflation than trading partners 
• low levels of capital investment and research 
• weakness in design, branding, performance 

Strong exchange rate affecting exports and imports

• high currency value increases prices of exports
• appreciating currency also making imports cheaper (^demand for imports)

Recession in one or more major trade partners countries:

• recession cuts value of exports to these countries 
• might be barriers to switching to other markets abroad 

Volatile global prices (eg commodities)

• exporters of commodities might be hit by falling prices 
• importing nations hit by higher commodity prices

A fall in exports will reduce AD and the final impact on GDP, jobs and investment is amplified by multiplier and accelerator effects 

Many industries rely heavily on key exports industries remaining competitive. These include:

• transportation / freight / logistics businesses
• trade finance businesses eg insurance and trade credit
• service businesses that operate in ports and airports 

more imports than exports

• loss of aggregate demand which causes slower real GDP growth and reduced living standards 
• loss of jobs in domestic based industries, may contribute to regional decline and structural unemployment problems (import more so decreased demand for labour)
• can lead to currency weakness and higher inflation and a country may run short of vital foreign currency reserves 
• trade deficit might be a reflection of lack of competitiveness supply side weaknesses 

exports greater than imports

• if GDP is close to capacity, a rise in the trade surplus might cause demand - pull inflation
• persistent trade surluses might lead to threat of protectionism from trade deficit nations 
• if the surplus is due to high saving/ low consumption, living standards might be too low
• surplus might be result of exporting high-priced commodities-prices are volatile/unpredictable 

• demand management - a tightening of fiscal and/or monetary policy reduces real spending power of consumers and leads to lower spending on imports 
• Lower exchange rates reduce the foreign price of exports and makes imports more expensive - causes changes in demand 
• Supply side improvements - policies to rise labour productivity and encourage start-ups with export potential eg life sciences, digital etc. Investment in human capital to boost productive capacity and competitiveness in high-value industries such as bio-technology, engineering, medicine, tourism
• Protectionist measures such as import qoutas and tariffs (UK limited by global trade agreements)

• High income elasticity of demand (YED) for imported goods and services - demand for imports grows strongly when consumer spending is rising
• Some weaknesses of supply side of the economy (low research and development spending, low rate of capital investment). low quality, low productivity, ^COP, ^price, lower demand for exports ^trade deficit 
• Many UK businesses finding it hard to finance a rise in exports (credit squeeze). less available credit (low lending), can't finance growth so an ^demand so only ^inflation
• Majority of British exports go to slower-growing countries in Europe eg Ireland, Spain and the USA. Less successful in exporting to emerging nations. Developed nations have low growth so less increase in demand for exports. ^COP ^price makes UK exports too expensive for emerging nations

Exchage rates are the price of one currency in terms of another 

They can be influenced by many things including interest rates.

A higher interest rate increases the demand for pounds attracting capital flows (money) into the currency. The increased demand causes the pound's exchange rate to rise - strong pound

(^IR ^reward for saving, investors put money in UK as they get a higher reward. Money is moved around often to get the highest reward)

SPICED                                                                WPIDEC

If the pound is getting stronger, this means that we can buy more foreign currency for £1. The UK's X are more expensive abroad so less price competitive abroad appreciating pound 

If the pound is getting weaker this means that we can buy less foreign currency for £1. Decreased M as less price competitive may ^ demand for domestic goods. UK X more price competitive so increase demand and increase revenue depreciating pound