What is the Balance of Payments?
All monetary transactions between a country and the rest of the world are recorded in its
balance of payments. This financial document records flows of money into a country
(credits) and money paid overseas (debits).
The Current Account
The current account is one section of the balance of payments and measures net
trade in goods and services and transfers/income flows.
Trade in goods (visible trade) includes: manufactured goods, semi-finished goods,
components, energy products, raw materials and consumer and capital goods
Trade in services (invisible trade) includes banking and insurance, consultancy, tourism,
transport and shipping, education and cultural arts
Balance of trade = exports of goods – imports of goods
If the revenue from goods exported exceeds expenditure on imported goods then there is
a balance of trade _______________
If the expenditure on imported goods exceeds the revenue from exported goods then there
is a balance of trade _______________
Net Income Flows = these consist of dividends, interest and profits flowing into and
out of the country as a return on investment. For examples, profits earned by a U.S. firm
based in China that are sent back to U.S. would be accounted for in Income flows (as a
credit entry in USA’s current account and debit in China’s current account.
Net Transfers/current transfers = these include international transfers of money by
private individuals and firms when no goods or services change hands. For example,
wages sent back to the UK/Korea by an expatriate working in China
Current Account Balance = balance of trade + balance on services + net incomes
flows + net transfers
TASK:
Complete the table below recording whether each transaction represents an inflow
(credit) or outflow (debit) of money for China’s current account and what section each
transaction should be recorded in.
Credit or
debit
French supermarket buys
Chinese made toys
Fillipino
working
in
Shanghai sends wages home
A Chinese resident earns
interest on a bank account
in the US
Chinese citizen studies in
Oxford
Chinese firm buys copper
from Zambia
Chinese company pays a
Korean
company
for
shipping
Chinese firm exports solar
panels to UK
American tourist pays to
walk on the Great Wall
American tourist gets a
tattoo of the Great Wall
while in Beijing
General
Motors
sends
profits made in China back
Balance of
trade (goods)
balance in
services
Net Income
Flow
Net
Transfer
to US
1. Which of these transactions represents visible and invisible exports from the UK, and
visible and invisible imports to the UK?
Visible export
Visible import
Invisible export
Invisible import
2. Calculate the balance of trade and invisible balance from the following figures:
Does a balance of trade deficit matter?
A balance of trade deficit usually occurs when a country _________ more goods than it
__________. This may not be a problem if the country has a large surplus in its balance
on services. However, If it persists for many years it could indicate problems with the
competitiveness of a country’s industries. Domestic firms may be unable to compete
with cheaper and better _____________ imports and exporting firms may suffer from a
similar fate abroad.
A persistent current account deficit can lead to a fall in output for domestic firms and
therefore an increase in ____________________ as the firms have to lay people off. It
can also lead to a fall in the value of the country’s currency as the supply of currency will
increase due to more imports coming into the country (see later).
Correcting a current account deficit
1. Do nothing- the lower exchange rate will fix it
The immediate effect of depreciation is to make exports cheaper in terms of foreign
currency, while imports become more expensive in terms of the home currency.
Example: A pair of Doc Marten shoes (British product) cost £30 in the UK. A Ford
Mustang (American product) costs $30,000 in US. Doc Martens are exported to
USA and Ford Mustangs exported to UK. The British government wants to correct
a trade deficit with the US so it allows the Pound to depreciate.
Exchange rate
Before depreciation
After depreciation
£1 = $2
£1 = $1.80
Price of Doc Martens in USA
Price of Ford Mustang in UK
A lower exchange rate should cause imports into the UK to become relatively more
_____________ leading to fewer _________ from the U.S. On the other hand, UK
exports become ___________ and the UK should be able to export more goods and
services.
2. Import controls/protectionism
There are a variety of methods, including for example ________ and ________, which
can be used to limit imports and direct demand to home produced goods and services.