Balance of payments

Balance of Payments

The balance of payments provides us with important information about whether or not a country is “paying its way” in the international economy.

What is the Balance of Payments?

·         records all of the many financial transactions that are made between consumers, businesses and the government in the UK with people across the rest of the World.

·         tell us about how much is being spent by British consumers and firms on imported goods and services

·         how successful UK firms have been in exporting to other countries and markets. Why is the export sector of the economy vital for the UK?

Trade in goods includes items such as:
Manufactured goods
Semi-finished goods and components
Energy products
Raw Materials
Consumer goods
(i) Durable goods e.g. DVD recorder and new cars
(ii) Non-durable goods e.g. foods and beverages
Capital goods (e.g. new plant and equipment)

Trade in services includes:
Banking, insurance and consultancy services
Other financial services including foreign exchange and derivatives trading
Tourism industry
Transport and shipping
Education and health services
Services associated with research and development
Cultural arts

Trade in goods

·         includes exports and imports of oil and other energy products

·         manufactured goods, foodstuffs, raw materials and components.

·         exporting and importing of tangible products

Trade in services

·         Overseas trade in services includes the exporting and importing of intangible products

·         for example, Banking and Finance, Insurance, Shipping, Air Travel, Tourism and Consultancy.

Measuring the current account

·         comprises the balance of trade in goods and services plus net investment incomes from overseas assets

·         Net investment income arises from interest payments, profits and dividends from external assets located outside the UK

·         We also add in the net balance of private transfers between countries and government transfers (e.g. UK government payments to help fund the various spending programmes of the European Union).

The current account of the balance of payments

·         essentially a reflection of whether the British economy is paying its way with other countries

·         The annual balance is volatile from year to year, because each of the four component parts is subject to wide fluctuations.

What does a current account deficit mean?

·         means that the UK economy is not paying its way in the global economy.

·         here is a net outflow of demand and income from the circular flow of income and spending

·         The current account does not have to balance because the balance of payments also includes the capital account. The capital account tracks capital flows in and out of the UK

The exchange rate and the balance of payments

·         Changes in the exchange rate can have a big effect on the balance of payments

·         these effects are subject to uncertain time lags

·         When sterling is strong then UK exporters found it harder to sell their products overseas and it is cheaper for UK consumers to buy imported goods and services because the pound buys more foreign currency than it did before.

The Balance of Payments and the Standard of Living

·         In the short term if a country is importing a high volume of goods and services this is a boost to living standards because it allows consumers to buy more consumer durables.

·         However, in the long term if the trade deficit is a symptom of a weak economy and a lack of competitiveness then living standards may decline.