Revision presentation on the balance of payments

1. AS Macro Revision
Macroeconomics, Macro Objectives and
the Circular Flow of Income
Spring 2014

2. www.tutor2u.net/blog/index.php/economics/categories/C59
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to our Economics blogs
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3. The Balance of
Payments (BoP)

4. The Balance of Payments
For AS economics emphasis is on the current account of the BoP
and in particular the balance in trade in goods and services
• The balance of payments (BOP) 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 (e.g. exports sold overseas)
• Outflows of foreign currency are counted as a negative
entry (e.g. imported goods and services)
• The current account of the balance of payments is the
main measure of external trade performance

5. Items in the Current Account of the BoP
• Finished manufactured goods, components,
raw materials
• Energy products, Capital technology
Trade Balance in
Goods
• Banking, Insurance, Consultancy
• Tourism, Transport, Logistics
• Shipping, Education, Health,
• Research, Cultural Arts
Trade Balance in
Services
• Overseas aid / debt relief
• Private money transfers e.g. From migrants
Net Money
Transfers
• Profits, interest and dividends from
investments in other countries e.g. The
profits from transnational businesses
Net Investment
Income from
Overseas Assets

6. Worked Example of the BoP Current Account
Item of the Balance of Payments Net Balance
$ billion
Current Account
(1) Balance of trade in goods -25
(2) Balance of trade in services +10
(3) Net investment income -12
(4) Net overseas transfers +8
Sum of 1+2+3+4 = Current account balance -19
The current account comprises the balance of trade in goods
and services net investment incomes and net transfers.
If a country is running a current account deficit, there is a net
outflow of demand and income from the circular flow.

7. Causes of a Balance of Payments Deficit
• Higher inflation than trading partners
• Low levels of capital investment and research
• Weaknesses in design, branding, performance
Poor price and non-
price competitiveness
• High currency value increases prices of exports
• Appreciating currency also makes imports cheaper
causing switch of demand to them
Strong exchange rate
affecting exports and
imports
• Recession lowers exports to countries affected
• Might be barriers to switching to other markets
Recession in one or
more major trade
partner countries
• Exporters of primary commodities might be hit by a
fall in world prices of their major export products
• Importing nations could be hit by higher prices for
essential goods
Volatile global prices
(e.g. Commodities)

8. The Export Multiplier Effect
A fall in exports will reduce AD and the final impact on GDP, jobs
and investment is amplified by multiplier and accelerator effects
Real GDP
GPL1
Y1
AD1
AS
Y2
AD2
GPL2
GPL
The Export Multiplier Effect
Many industries rely heavily on key
export industries remaining
competitive – these include:
• Transportation / freight /
logistics businesses
• Trade finance businesses e.g.
Insurance and trade credit
• Service businesses that operate
in ports and airports
Exports particularly important for
regional economic performance

9. Balance of Payments Deficit and Surplus Countries
Examples of Countries that run
Current Account Deficits
Current account, % of GDP, data is
2012, Source: World Bank
Mongolia -49.5
Cyprus -22.3
Jamaica -11.4
Ghana -8.6
Portugal -5.0
South Africa -4.6
Sri Lanka -4.4
India -3.6
Examples of Countries that run
Current Account surpluses
Current account, % of GDP, data is
2012, Source: World Bank
Kuwait +39.7
Saudi Arabia +31.8
Norway +18.2
Singapore +17.7
Switzerland +13.9
Taiwan (China) +8.1
Germany +5.3
China +3.1

10. Economic Problems from Persistent Trade Deficits
Loss of aggregate demand which causes slower real GDP
growth and reduced living standards
Loss of jobs in home-based industries, may contribute to
regional decline and structural unemployment problems
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

11. Possible Problems from Running Trade Surpluses
If GDP is close to capacity, a rise in the trade surplus might
cause demand –pull inflation
Persistent trade surpluses 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

12. Economic Policies to Reduce a Trade Deficit
• Demand management: A tightening of fiscal and/or monetary
policy reduces real spending power of consumers and leads to
lower spending on imports (fall in M improves trade balance)
• Lower exchange rate reduces the overseas price of exports and
makes imports more expensive – causes changes in demand
• Supply-side improvements:
• Policies to raise labour productivity and encourage start-
ups with export potential e.g. 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 quotas and tariffs (NB:
limited by global trade agreements e.g. EU and WTO rules)

13. Economic Effects of a Currency Depreciation
This will have an effect on a number of economic indicators
Domestic production  Trade deficit  Domestic jobs 
Changes in import and export prices will affect demand
Import sales will CONTRACT Export sales will EXPAND
When the pound depreciates against the US dollar
It makes UK import prices RISE It makes UK export prices FALL

14. Will an Exchange Rate Depreciation improve the BoP?
Time period after
depreciation
Trade
surplus
Trade
deficit
Currency
depreciation
here
Trade deficit may
grow in initial
period after
depreciation
Net improvement
in trade provided
certain conditions
are met
The diagram below shows the “J Curve effect” – it shows the time
lags between a falling currency and an improved trade balance

15. Some Reasons for the UK’s Persistent Trade Deficit
High income elasticity of demand (Yed) for
imported goods and services
Some weaknesses on supply-side of the economy
(i.e. Low research / investment)
Many UK businesses finding it hard to finance a
rise in exports (effects of credit squeeze)
The majority of our exports go to slower-growing
countries in Europe e.g. Ireland, Spain and also
the USA. Less successful in exporting to BRICs.

16. Get help on the AS
macroeconomics course
using twitter
#econ2
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