Balance of Payments

1
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. -
  Philip Allan Updates, Unit 6 Student Unit Guide,
  pg. 34

2
Current Account

• Net trade in goods
• Net trade in services
• Net income flows (interest on foreign bank
  accts, dividends on shares held in foreign
  companies, income from FDI)
• Net current transfers payment from one govt
  to another (development aid, EU subscription
  payments)

3
Financial Account

• Financial flows investment from one country to
  another, purchasing of foreign shares/bonds, FDI
• Money saved in banks overseas
• Official changes in govt foreign exch. reserves
• Should offset the current acct balance!

4
B of P Disequilibrium (a structural current
account deficit)

• For the UK the persistent trade deficit has short
  and long term causes
• high propensity to buy imported goods / services
  UK consumers prefer foreign produced output
  this is cyclical (a consumer boom often
  accelerates imports)
• lack of productive capacity of UK firms - if
  domestic producers have insufficient capacity to
  meet domestic demand then imports will make up
  the balance
• ? comparative advantage - UK manufacturing has
  suffered from low-cost production in newly
  Industrialising countries in other parts of
  Europe (net x capital gds, chemicals net m
  food, cars, aircraft, consumer gds)

5
B of P Disequilibrium cont

• poor price and non-price competitiveness of UK
  firms - cost levels decrease competitiveness, but
  non-price factors are also important eg.
  quality, design, reliability and service
• over valued exchange rate? - some economists
  think trade problems stem from the exch. rate
  being too high
• ? surplus in UK's trade in oil - UK used to be a
  major exporter of oil from the North Sea oil
  production is now well past its peak and net
  surplus from oil trade no longer contribute as
  much to the balance of visible trade
• current transfers generally negative UK is net
  contributor to EU budget gives more in
  membership subscriptions than it gets in agr.
  subsidies inner city development

6
Positive Trends for UK Current Acct

• Income acct is positive UK multinational
  investment in 1990s is now returning income
  flows to the UK
• Services acct is positive esp. financial,
  insurance, advertising, computer services (but
  travel services are negative)

7
Correcting BofP Disequilibrium

• In order to need correcting, current account
  deficit must be structural rather than cyclical
• Structural deficit could be sustainable with a
  surplus on the financial account but it requires
  hot money which is very vulnerable to
  speculation sentiment

8
Correcting BofP Disequilibrium

• Exchange Rate Adjustment depreciation to raise
  international competitiveness (not a policy tool
  in the UK!)
• Achieved by cuts in interest rates or increase in
  foreign currency reserves
• But, this is a loosening monetary policy which
  could cause inflation
• Also, rapid outflow of hot money could threaten
  funding for current acct deficit

9
Correcting BofP Disequilibrium

• Demand Management reducing AD by tightening
  fiscal or monetary policy - ? disposable income ?
  ? imports
• Dependent on YED of imports
• Will also ? output ? unemployment

10
Correcting BofP Disequilibrium

• Supply-Side Policies raise labour productivity
  make UK more competitive may also focus on
  quality of production
• May reduce working conditions rights of workers
• Tend to have long-term effect but limited in the
  short-run