The balance of payments on current account

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items in the balance of payments current account

  • current account refers to trade in g/s. It is in 4 parts:
    • trade in goods
    • trade in services
    • investment income 
    • current transfers
  • an export is noted as + in the accounts as it ADDS to the UK income
  • an import is noted as - as money is LEAVING the UK. 
  • At present the UK economy is in deficit. In the recent Budget, the Chancellor of Exchequer proposed that the govt should try and get the UK economy into surplus. 

the balance of trade in goods:

  • this only refers to visible trade - the balance of trade is visible exports minus imports
  • the UK tends to import a lot because some are cheaper to import than manufacture thus the UK manufacturing sector has shrunk - deindustrialisation. Globalisation shaped the economy.
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the balance of trade in goods

  • large firms that trade internationally have been able to manufacture anywhere and have moved operations to where production costs are minimised and so high cost countries are no longer competitive. This has affected the UK's industrial structure, balance of trade, balance of payments on current account and macroeconomy. 
  • reasonably free international trade increases the standard of living for consumers as they have a greater range of choice. it also increases competitiveness of domestic firms who have to compete with foreign innovation. 
  • to improve our balance of payments and international competitiveness, we need to increase levels of research and development and investment both public like transport and private e.g. new tech. We are less competitive in the production of basic goods due to developing countries' imports into the UK.. We are good in areas of enterprise, innovation and research. 
  • Why is our trade balance important:
    • exports are an injection into the circular flow and boost national income level. The multiplier amplifies the effect of exports on the economy. 
    • Levels of employment in the manufacturing industry depends on exports (thus incomes)
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Trade in services

  • covers both imported and exported services. 
  • UKs two most important export services are financial: banking, insurance and tourism. 
  • growth of service income tends to be for developed countries with education, skills and expertise to provide thse services, like UK. However, the UK is reliant on other countries for manufactured goods. 
  • This part is usually in surplus

Investment income:

  • measures earnings made from investments overseas - income flowing from foreign investments in the UK. 
  • a flow of capital OUT OF the UK generates future investment income for the UK; a flow of capital INTO the UK will lead to future outward capital flows into the UK in terms of interest profits and dividends. e.g. UK banks are active in overseas markets and vice versa.
  • The London Stock Exchange offers shares in company's worldwide and both domestic and foreign investors are large, leading to shareholders in numerous countries. 
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Transfers:

  • Measures transfers of money between countries
  • Private transfers are exchanges between individuals e.g. money sent home from foreign family
  • Govt. transfers include:
    • grants to overseas countries
    • UK contribution to EU budget
    • contributions to international organisations e.g. International Monetary Fund, World Bank and World Trade Organisation
    • maintenance of troops abroad
    • maintenance of embassies and consulates
  • private transfers vary but Govt transfers are in deficit due to overseas expenditure.
  • The overall balance of payments in usually negative due to being in a deficit. 
  • Strong trading countries are expected to be in surplus
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  • Changes in a country's current account can come from:
    • changes in value of the currency affecting imports, exports and consumers' decisions
    • changes in AD - a rise in national income may lead to an increase in the trade deficit as imports increase. 
    • a country with higher inflation than that of its trading partners will become less competitive; exports will fall, imports will grow. 
    • increases in labour productivity make a country more competitive, increasing exports.
    • innovation can lead to new products that increase the country's competitveness. 
  • the benefits for citizens in a country with a deficit is that they are able to consume more g/s as they are in effect consuming more than producing. 
  • In the long term, in order to move to a surplus, we need to reduce levels of consumption below production levels so X>M. 
  • the benefit of a surplus is that in the long term, they are building up assets allowing them to consume more than they currently produce
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the current account and the AD/AS model

  • a current account deficit will affect the economy through changes in AD. 
  • with a surplus, foreign demand will increase AD for UK goods, increasing exports. 
  • a current account surplus shifts AD to the right, increasing both real output and price level. 
  • a balance of payments deficit will shift the curve to the left, reducing output and price. 
  • the UK authorities want to achieve a current account equilibrium as this would lead to a greater level of stability in the economy as it doesn't impact AD.. Equilibrium usually shows that the current account is at zero i.e. imports = exports. 

does a deficit matter? some say that:

  • due to capital movements, there is no problem with a country operating with a current account deficit as long as foreign capital flows in to finance it. 
  • the deficit will self correct if it is due to strong consumer demand as the economic cycle will at some point reduce demand. 
  • some of the deficit may be due to imports of new capital equipment that will increase UK productivity. 
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However others argue that:

  • the deficit may indicate that the UK has lost competitivenessin foreign markets due to insufficient investment, low productivity, and loss of comparative advantage to other countries
  • continuous excess of imports over exports leads to withdrawals from the circular flow, leading to reduced output and employment
  • those who lose jobs in the manufacturing sector may not readily be employed in the service sector. The UK needs growing export markets in order to maintain full employment. 
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