Balance of Payments: Current Account

Macroeconomics

Current Account Balance of Payments

G: Net trade in goods (visible trrade)

S: Net Trade in services (invisible trade)

I: Investment Income (primary income)

T: Net Transfers

How long has the current account deficit been occurring in the UK/

Since 1984

In 2022, how much of the UK economy comprised of the service sector?

79%

Service Sector

Consists of tertiary and quaternary jobs.

MPI

Marginal Propensity to Import

Main reason for a current account deficit (UK)

Trade in goods as the UK has a high MPI. e.g, 50% of all foods imported

Reason for a limited manufacturing capacity:

The UK has shifted from industrial to post-industrial economy. This means the UK mainly relies on high end goods, which require skills and qualifications.

What does the continuous deficit imply about the UK economy?

That it's unbalanced and we have become too over-dependent on capital inflows.

Capital Inflows

Purchases of domestic assets by foreign households and firms

Why has the manufacturing industry fallen?

The UK has become uncompetitive in the trades of goods. We rely on the exportation of services.

What is the reliance of capital inflows based on?

The assumption that the UK will remain an attraction prospect for international investors.

Why is there a possibility for an unsustainable current account deficit?

A fall in demand for high-end services will mean there's no longer a surplus in the financial account which is what is financing the CA deficit.

BofE Governor ____ Carney said that the UK relies on the "________ of strangers".

BofE Governor Mark Carney said that the UK relies on the " kindness of strangers".

Consequences of the UK's over-reliance on the import of goods.

The UK is vulnerable to supply-side shocks which can lead to shortages and a dry-up in supply.

An example of the UK's over-reliance on a certain good.

The UK imports 50% of its natural gas and the invasion of Ukraine by Russia meant lower supply and higher prices.

Explain why higher energy costs will end in decreased standard of living for UK households.

As energy is a necessity, households will have to pay for this good -> leading to a reduction in discretionary spending -> decreased SOL.

Consequences of firms over-reliance on imported energy and raw materials?

- Vulnerable to supply-side shocks which can cause increased production costs and a limited production capacity.

Consequences of an increasingly conflict riven world:

Global market supply could be compromised, resulting in extreme shortages and increased cost push inflation.

Decline in the manufacturing sector has resulted in:

The UK being barred from taking full advantage of export led growth.

Consequences of an increase o=in the demand of UK goods:

- Reduced structural unemployment and income inequality

Where is income inequality experienced in the UK?

In the North of England and South Wales due to major manufacturing companies hubs that were there previously, employing local residents being shut down. As a result, employees struggled to find a job as those secondary jobs require minimal-none qualifications, meaning it was harder to find jobs matched to their skillsets.

Example of Deindustrialisation resulting in unemployment

Port Talbot, Tata Steel in South Wales

How would increased exports have a knock-on effect in demand?

There'd be an increase in demand leading to lower levels of unemployment -> increased tax revenue -> reduction in the UK's sovereign debt.

Increased demand in exports leads to (in terms of the exchange rate):

Upward pressure on the £ pound sterling due to an increased demand in exports -> leading to cheaper imports.

- Lower production costs for domestic firms

- Larger production capacity for domestic firms due to cheaper FOP

Consequences of Cheaper Imports

- Increased standard of living for UK households as they can purchase imports for cheaper.

Why is a deficit on the current account not necessarily harmful?

There's no clear correlation between a CAD or CAS.

Name a strong/weak economy with a substantial deficit/surplus?

Weak: Nepal has a substantial current account surplus but weak economy.

Strong: USA has a significant current account deficit but a strong economy.

What is Brazil doing to reduce the country's reliance on the exportation of primary goods?

Importing capital goods to help with supply-side growth and increase industrialisation.

Why do some countries have a current account surplus but weak economy?

E.g, Botswana has a strong supply of a primary sector good but it doesn't translate well into a high standard of living or MPI hence the surplus.

What HDI does the UK have?

0.93 indicating a high standard of living.

The UK is the _th largest economy.

The UK is the 6th largest economy.

GDP per capita of the UK is in the top ?% of global economies?

GDP per capita of the UK is in the top 10% of global economies?

Why is a deficit on the current account not necessarily harmful? (2)

The severity depends on what has to be done to finance it.

Why has the UK got a financial account surplus?

Due to its attractive destination for global investment and capital, in addition to its mature institutions having low levels of corruption and an established rule of law.

How has the devaluation of the pound sterling been blocked?

Foreign firms are incentivised to buy UK assets, invest in UK equity and purchase UK debt.

Why is there a shortage of UK housing?

Increased demand and inelastic supply, as well as the buying up of UK property by foreign investors due to the asset growth.

Why is the CAD not a priority for politicians?

The UK will continue to attract foreign capital so the financial account surplus will remain to finance the CAD.

Current Account Deficit in the short run:

It seems to be insignificant compared to the many other problems being faced by the UK, e.g, the cost of living crisis/low productivity and cost of debt servicing.

What runs a surplus on the financial account?

Capital Inflows

Current Account Deficit in the long run:

It highlights the unbalanced economy and over-reliance on the financial account surplus as well as the 'kindness of strangers'.

Expenditure Reduction: Name the 2 Ways

• Increase in taxes (Contractionary Fiscal Policy)

• Increase in interest rates (Contractionary Monetary Policy)

Why may increasing I.R and Taxes not likely be used?

Increasing I.R conflicts with the government objective of having price stability.

Evaluation of Expenditure Reduction:

A left shift in AD may occur making conditions worse... e.g, higher rates of unemployment, reduced profits for domestic firms and increased govt. spending

Expenditure Switching: Name one Policy

Imposing of Tariffs, as imports are more expensive for firms, who will pass costs onto consumers, decreasing demand for the good. -> as a result, consumers witch to the cheaper domestic alternative, if available

Automatic Stabiliser: What does it rely on?

Marshall Lerner Condition

Automatic Stabiliser

Expenditure Switching: Tariffs Graph