8.4 The balance of payments on current account

The current account

are the balance of trade in goods, the balance of trade in services, net income flows and net current transfers. The current account is usually regarded as the most important part of the balance of b]payments because it reflects an economy’s international competitiveness and the extent to which the country is living within its means.

current account deficit

occurs when currency outflows in the current account exceed currency inflows. It is often shortened to ‘exports less than imports’

current account surplus

occurs when currency inflows in the current account exceed currency outflows. It is often shortened to ‘exports greater than imports’

The balance of trade in goods

shows the extent to which the value of exports of goods exceeds the value of exports and imports, which were respectively £306,810 million and £417,006 million in 2013. The balance of trade in goods was therefore in deficit to the tune of £110,196 million.

The balance of trade in goods can also be disaggregated (broken up) into different forms of trade in goods, such as the balance of trade in manufactured goods and non-manufactured goods

The balance of trade in goods

the part of the current account measuring payments for exports and imports of goods. The difference between the total value of exports and the total value of imports of goods is sometimes called the balance of visible trade.

The balance of trade in services

is part of the current account and is the difference between the payments for the exports and services and the payments for the imports and services

The balance of trade in services

The decline of manufacturing and the growth of service industries mean that the UK now has a post-industrial and service sector economy

Whereas most manufactured goods are internationally tradable, the same is not generally true for services such as retailing, car repair and hairdressing. services such as these are produced and consumed in the non-internationally traded economy, or sheltered economy. However, many services which were previously produced within the UK are now being imported. This is an important part of the globalisation process.

UK companies, which used to produce services ‘in house’ now outsource or buy in the services from outside suppliers, often located in countries with cheap labour. UK-based companies are locating ‘back office’ service activities overseas, including many financial and ICT-related services. Many call centres providing customer services and direct marketing services have moved to India. 222

Net investment income

the difference between inward and outward flows of investment income is positive, the UK is earning more income generated by the direct and portfolio investments held abroad than it is paying to overseas owners of capital assets in the UK. Investment income is the main component of primary income flows in the current account of the balance of payments.

Examples of Net investment income

BP investing in the construction of of a new oil refinery in the US Gulf Coast region would be an example of overseas direct investment. Profits generated by the oil refinery and flowing back to the UK in future years would be inward investment income. But whereas direct investment involves spending on physical capital such as factories, shopping malls and oil refineries, portfolio investment is the acquisition by financial firms such as pension funds and insurance companies of financial assets such as shares and bonds issued by firms and governments outside the UK. Dividend income paid by overseas companies, and interest paid, for example, by overseas governments, which then flow into the UK are examples of inward flows of income generated by portfolio investments.

How has it changed

For many years, UK net investment income was strongly positive, the result of decades of outward investment which built up a huge stock overseas-located assets owned by British companies and residents.

However this has changed and the investment income account is now in deficit. Between 2012 and 2013, the investment income deficit for the UK increased from £4,841 million in 2012 to £12,337 million in 2013, according to the ONS’s estimate published in September 2014

The large surplus in investment income in the pre - recession years was largely the result or the willingness of banks and companies to build up ownership of assets in other countries by taking risky, but high yielding bets. In the more cautious post-crisis environment, rich people living in the rest of the world have invested heavily in the UK, which they see as ‘haven’ safe from political turbulence in other countries. The rapid build-up of UK assets now owned by overseas-based companies and rich individual has led to an investment income outflow. The fall in income earnt by UK investments overseas and persistent UK budget deficits financed by overseas borrowing have also been contributary factors.

Transfers

payments flowing between countries in forms such as foreign aid, grants, private transfers and gifts. They are payments that are made without anything of economic value being received in return. Not to be confused in this context with the part of gov spending in which tax revenues are paid to people such as pensioners, without any output being produced in return.

Applying AD/AS analysis to the current account of the balance of payments

export-led growth

in the short run, economic growth resulting from the increase in exports as a component of aggregate demand. In the long run, economic growth resulting from the growth and increased international competitiveness of exporting industries.

Do current account deficits pose problems?

• A short-term current account deficit or surplus is not necessarily problematic, but a persistent imbalance signals economic disequilibrium.

• The severity of the deficit depends on its size and cause—the larger the deficit, the greater the problem.

• If the deficit results from uncompetitive industries, it can be particularly harmful in the long run, reducing living standards.

• In the short term, a deficit can boost living standards by allowing higher imports.

• In developing countries, deficits may be justified for importing capital goods to modernize infrastructure and support economic growth.

• However, there is a risk that deficits may be misused, as seen in Nigeria, where they have financed luxury lifestyles for the ruling elite instead of benefiting the economy.

Do current account surpluses pose problems?

• A persistent current account surplus can also lead to economic problems, despite being seen as a sign of national success.

• A surplus reflects strong export performance but can be undesirable if excessively large.

• Two arguments against a large surplus:

  1. One country’s surplus is another country’s deficit – Since global trade must balance, if some countries run large surpluses, others must run deficits. This can force deficit countries to impose import controls, harming global trade and potentially triggering recessions.

  2. A surplus can cause inflation – An increase in national income from the surplus can drive up demand, which may lead to inflation, especially if the economy is already near full capacity.