a2 macroeconomics - revision on the balance of payments

The Balance of Payments

EdExcel A2 Macro – June 2016

• Examination length: 2 hours• One essay question with two parts from a choice of

three topic areas. Worth 50 marks.• One data response question out of a choice of two

questions. Worth 50 marks.

The Balance of PaymentsWhy is World Trade Growing Slowly at the Moment?WTO Report (2015) Annual Growth of World TradeThe A2 Macro Exam (Unit 4) June 2016

• Understand the different components of the Balance of Payments• Understand the factors influencing the size of deficits and

surpluses on different components of the Balance of Payments• Understand the significance of deficits and surpluses on

the current account• Evaluate measures to correct trade imbalances

The Balance of PaymentsWhy is World Trade Growing Slowly at the Moment?WTO Report (2015) Annual Growth of World TradeA2 Syllabus for the Balance of Payments


• 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

• The financial account measures inflows and outflows of financial capital across national boundaries

Why is World Trade Growing Slowly at the Moment?WTO Report (2015) Annual Growth of World TradeKey Intro for Balance of Payments (BoP)

• Current Account• (1) Balance of trade in goods• (2) Balance of trade in services• (3) Net primary income (interest, profits, dividends and migrant remittances)• (4) Net secondary income (contributions to EU, military aid, overseas aid)

• Capital account• Sale/transfer of patents, copyrights, franchises, leases and other transferable

contracts, and goodwill• Transfers of ownership of fixed assets

• Financial Account – includes transactions that result in a change of ownership of financial assets and liabilities between UK residents and non-residents• Net balance of foreign direct investment flows (FDI)• Net balance of portfolio flows (e.g. inflows and outflows of debt and equity)• Balance of banking flows (e.g. hot money flowing in/out of banking system(

• Balancing item (estimated errors & omissions)

• Changes to the value of reserves of gold and foreign currency• Overall balance of payments = zero

The Balance of PaymentsWhy is World Trade Growing Slowly at the Moment?WTO Report (2015) Annual Growth of World TradeThe Balance of Payments Account

The Major Export (Goods) for each country in the World in 2014

Current account surplus countries (Measured as a % of GDP, Source IMF)

Country 2013 2014 2015Singapore 17.9 19.1 20.8Taiwan Province of China 10.8 12.4 12.4Netherlands 10.8 10.2 9.6Kuwait 41.2 31.0 9.3Germany 6.4 7.4 8.5Switzerland 11.1 7.3 7.2Korea 6.2 6.3 7.1Denmark 7.2 6.3 7.0Norway 10.0 9.4 7.0Sweden 6.7 6.2 6.7Slovenia 5.6 7.0 6.7Thailand -0.9 3.3 6.2Qatar 30.9 26.1 5.0Ireland 3.1 3.6 3.2China 1.6 2.1 3.1Azerbaijan 16.4 14.1 3.0Japan 0.8 0.5 3.0

Causes of current account surpluses

Stru

ctur

alSurplus of savings over

investment

Significant long run competitive advantage

Long run rise in global prices of main exports

Structural increase in net investment income

Trend rise in factor productivity

Cycl

ical

Depreciation of the exchange rate

Strong consumer demand in export

markets

Cyclical improvement in terms of trade

Fall in costs of essential imports

Rise in net inflows of remittances / profits

R&D Spending and Scientists per Million People – By Country (2013)

Economic Policies to Reduce a Trade DeficitWhy is World Trade Growing Slowly at the Moment?WTO Report (2015) Annual Growth of World TradeSignificance of Current Account Surpluses

Contributor to GDP i.e. net external demand is positive

Might cause demand-pull inflationary pressure

Accumulation of foreign exchange reserves

Pressure on the currency to appreciate

Allows a country to be a net exporter of capital

Huge surpluses could trigger protectionist responses


2006 2007 2008 2009 2010 2011 2012 2013 20140

500

1000

1500

2000

2500

3000

3500

4000

4500

1,066.3

1,528.2

1,946

2,399.2

2,847.3

3,181.13,311.6

3,821.3 3,843

Fore

ign

exch

ange

rese

rves

in b

illio

n U.

S. d

olla

rs

China’s persistent current account surpluses built around their export-led economy has been a key factor allowing the country to build up huge reserves of gold and foreign currency – this is shown in the chart


Yuan appreciating against the US dollar

Yuan devaluation in summer of 2015

Current account deficit countries (Measured as a % of GDP, Source IMF)

Country 2013 2014 2015

Libya 13.6 -30.1 -62.2

Liberia -28.2 -28.7 -41.6

Mozambique -40.0 -34.7 -41.0

Djibouti -23.3 -25.6 -31.4

Zimbabwe -25.4 -22.0 -22.9

Lebanon -26.7 -24.9 -21.0

Niger -15.3 -15.2 -19.1

Kyrgyz Republic -15.0 -16.8 -17.7

Algeria 0.4 -4.5 -17.7

Montenegro -14.6 -15.4 -17.0

Oman 6.6 2.0 -16.9

Causes of current account deficits

Stru

ctur

alUnder-investment

Relatively low productivity

Persistently high relative inflation

Inadequate R&D, innovation

Emergence of lower cost competition

Cycl

ical

Over-valued exchange rate

Boom in domestic demand

Recession in key export markets

Slump in global prices of exports

Increased demand for imported technology

Economic Policies to Reduce a Trade DeficitWhy is World Trade Growing Slowly at the Moment?WTO Report (2015) Annual Growth of World TradeSignificance of Current Account Deficits

Net outflow of AD from circular flow – this is a drag on real GDP growth

Loss of jobs in export sectors & industries affected by rising imports – negative multiplier effects e.g. consider steel, coal etc.

Fall in foreign exchange reserves - can be problematic for smaller developing nations who struggle to attract financial capital

Can lead to exchange rate weakness - reducing real living standards and increasing investor risk – higher yields on government debt

Can a deficit be financed by hot money and portfolio investments?

Economic Policies to Reduce a Trade DeficitWhy is World Trade Growing Slowly at the Moment?WTO Report (2015) Annual Growth of World TradeMeasures to Correct a Current AC Deficit

Deflationary monetary policy

Deflationary fiscal policy

Internal devaluation

Expenditure reduction

Depreciation of the currency

Import barriers

Supply-side improvements

Expenditure switching

Economic Policies to Reduce a Trade DeficitWhy is World Trade Growing Slowly at the Moment?WTO Report (2015) Annual Growth of World TradeMeasures to Correct a Current AC Deficit

Cyclical causes of a deficit tend to be partly self-correcting

Floating exchange rate can help to reduce deficits but this depends on Ped and Pes of export industries and Ped for imports

Protectionist measures are limited by existing WTO and EU commitments / policies – bring in game theory aspects here

Supply-side is crucial to restoring competitiveness in the long run

Measures to correct deficit may harm other objectives in short run

Annual UK Trade Balance in Goods and ServicesSource: Office for National Statistics

19851987

19891991

19931995

19971999

20012003

20052007

20092011

20132015

-50000

-40000

-30000

-20000

-10000

0

10000

Trade in Goods & Services: Total balance: £million

UK Trade and Current Account Balance (% of GDP)

2009Q1

2009Q3

2010Q1

2010Q3

2011Q1

2011Q3

2012Q1

2012Q3

2013Q1

2013Q3

2014Q1

2014Q3

2015Q1

2015Q3-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

Trade balance (%, GDP)Current account balance _x000d_(% GDP) In 2015, the UK’s

current account deficit was £96.2 billion, up from a deficit of £92.5 billion in 2014.

The deficit in 2015 equated to 5.2% of GDP at current market prices.

This was the largest annual deficit as a percentage of GDP at current market prices since annual records began in 1948

Economic Policies to Reduce a Trade DeficitWhy is World Trade Growing Slowly at the Moment?WTO Report (2015) Annual Growth of World TradeA2 – Key Focus Points

Global trade imbalances are getting bigger – a threat to globalisation

Focus on the individual context of each country (developed/developing)

Distinguish between cyclical and structural causes

This helps to inform the appropriate policy response

Key question for deficit countries - is it sustainable in the long run?

Volatile profit streams of TNCs having a major effect on the UK current account


EdExcel A2 Macro – June 2016

a2 macroeconomics - revision on the balance of payments

Economy & Finance