Balance of Payments

What is it? A record of all financial dealings over a period of time between economic agents of one country and all other countries: Current account (payments for the purchase and sale of goods and services are recorded) Capital account (transactions with fixed assets) Financial account (savings, investment and currency stabilisation) http://www.tradingeconomics.com/united-kingdom/current-account

The current account Current balance = Total Exports– Total imports Trade in services (invisibles): Financial services (Banking & insurance) Transport such as air travel Tourism Trade in goods (visibles): Copper Oil Semi-manufactured Finished manufactured Current balance = Total Exports– Total imports

Financial and capital accounts made up of transfers including government debt forgiveness and money brought into and out of the country by emigrants/immigrants Foreign direct investment Portfolio investment Other investments e.g. loans, purchases of currency

Balance of payments “A useful way to think about the balance of payments is that it is an account that records purchases and sales of sterling by those making international transactions. Purchases of sterling are recorded as positive items, sales as negative ones. Since it is not possible for someone to buy a pound without someone else selling them one, the balance of payments must add up to zero.” http://www.ons.gov.uk/ons/rel/bop/united-kingdom-balance-of-payments/2015/index.html

Deficits and surpluses Money going out of the country must balance with the money coming into the country What is a deficit? What is a surplus?

What may cause a deficit? High income elasticity of demand for imports – when consumer spending is strong, the volume of imports grows quickly Long-term decline in the capacity of manufacturing industry because of de-industrialization. There has been a shift of manufacturing to lower-cost emerging market countries who then export products back into the UK. Many UK businesses have out-sourced assembly of goods to other countries whilst retaining other aspects of the supply chain such as marketing and research within the UK The UK is a net importer of foodstuffs and beverages and has also seen a sharp rise in spending on imports of oil and gas as our North Sea oil and gas production is long past its peak levels The trade balance is vulnerable to shifts in world commodity prices and exchange rates. The UK imports a large volume of raw materials, component parts and pieces of capital equipment.

How might a trade deficit come about? High levels of consumption causing excessive spending on foreign- produced goods High levels of investment spending causing capital goods being imported from abroad A change in the comparative advantage causing cheaper goods and services being imported rather than produced domestically A high over valued exchange rate causing consumers to switch away from domestically produced goods and services to those produced abroad Structural weaknesses in the economy resulting from domestic firms losing competiveness against imported goods due to lack of investment, high labour costs and low productivity

Why do we run a large trade deficit? High income elasticity of demand for imported goods and services Shift of comparative advantage in manufacturing Strong exchange rate before credit crunch – made imports cheaper Some weaknesses on the supply-side

In 2010 the UK ran a current account deficit of £37 billion, equivalent to 2.5% of GDP. Exports of goods and services were worth £447 billion whereas the value of imported goods and services was £479 billion.

Measures to reduce imbalances on the current account: Exchange rate changes Deflationary policies Protectionism Supply side policies Currency controls