OF

Who Is This

Balance of Payments

How economies are connected Globalisation means economies are very connected Check your clothes label; where do they come from? Your iPad, iPhone? Goods are produced all around the world and sold all around the world Some components for the iPhone may come from Japan, be assembled in China and sold in Kingston When you need support when your iPhone stops working, you may speak to someone in India Parts of Airbus planes are produced all over Europe, and sold anywhere in the world Firms and investors own assets (physical and monetary, eg shares) all around the world Individuals may work in many countries. For example, there is free movements of labour within Europe Governments measure this interconnectedness with the balance of payments

What is the balance of payments The balance of payments is a record of all economic transactions between the residents of a country and the rest of the world There are two main parts to the balance of payments Overall, the balance of payments must, er, balance This means all the deficits in any of the accounts will be balanced by surpluses in others In Theme 2 we are only interested in the current account, in particular in the trade in goods and the trade in services. Current account – the trade in goods and services account, plus the primary income account and secondary income account Financial account and capital account – refers principally to net purchases of financial and other assets. Look at next year

Current Account Net trade in goods (sometimes called visibles) exports of goods minus imports of goods Net trade in services (sometimes called invisibles) exports of services minus imports of services Primary income flows From the net lending of factors of production overseas Earnings being transferred to a workers home country (small for UK) Net interest, profits and dividends from overseas assets Secondary income flows When the payment is not as a result of an economic transaction, so transfers Mostly government transfers, such as our payments to the EU

The UK’s current account £ billion 2013 2014 Trade in goods and services Trade in goods -115.2 -123.7 Trade in services 81.0 89.1 Total trade -34.2 -34.5 Primary income Compensation of employees -0.3 -0.4 Investment income -16.0 -32.0 Other primary income -0.5 -0.7 Total primary income -16.8 -33.1 Secondary income General government -22.7 -20.9 Other sectors -4.1 -4.3 Total secondary income -26.8 -25.2 Current balance (current account) -77.9 -92.9 The current account deficit in 2014 was equivalent to 5.2% of GDP – too big

What do we export and import? And services? £ billion, 2014 Exports Imports Trade balance Food, beverages and tobacco 19.1 38.5 -19.4 Basic materials 7.0 11.8 -4.8 Total oil 32.7 43.0 -10.4 Total semi-manufactured goods 76.9 96.5 -19.6 Total manufactured goods 147.5 210.8 -63.3 Services Transportation 26.6 18.7 7.3 Travel 28.3 38.4 -10.1 Financial services including insurance 69.3 11.4 58.0 Royalties and fees 10.9 5.9 5.0 Other business 57.1 35.5 21.6 Total 219.8 130.6 89.1 Other business includes law, management consulting, engineering, research and development, advertising etc.

Exports and Imports as % GDP (2010)

Task In small groups consider the effect on exports or imports on the factors listed below. Take 2 minutes to discuss and then feed back to the rest of the class The questions you have been asked to consider are: What happens to UK exports if the pound falls in value against other currencies What happens to imports if the pound falls in value against other currencies What happens to imports if the government cuts income taxes What happens to exports if Europe goes into recession What happens to exports and imports if there is an increase in labour productivity in the UK

Factors affecting exports and imports What happens to UK exports if the pound falls in value against other currencies UK goods would become cheaper in overseas markets. Demand will rise, and so exports would rise – improving the current account What happens to imports if the pound falls in value against other currencies Imported products will be more expensive, so demand will fall and so (the volume of) imports will fall What happens to imports if the government cuts income taxes Disposable income rises so consumers spend more so demand will rise. Some of the increase in spending will be on imports, so imports will rise, worsening the current account

Factors affecting exports and imports What happens to exports if Europe goes into recession Well European economies are already weak. A further weakening would lower demand in Europe, meaning lower demand for UK exports, worsening the current account What happens to exports and imports if there is an increase in labour productivity in the UK This means UK goods and services are cheaper to produce, which should mean an increase in exports, and a switch to UK goods rather than imports Note if other countries improve their competitiveness, then the reverse happens

Current Account Deficit So why does the UK have a current account deficit? Our export markets are weak because the world economy is weak? Imports are growing because the UK economy is recovering The pound has been too strong, and so exports are weak? Perhaps, though some may think the Pound has been a bit weak We have lost competitiveness – other countries have improved productivity faster than us, particularly in manufacturing Clearly this has happened to come extent. However, we are clearly very competitive in services

Do countries need a Current Account Surplus? Adding together all the current account balances of all countries, the answer must be: Zero. One country’s exports are another country’s imports So is it OK for a country to run a permanent current account deficit or surplus? Not in the long run, particularly if the deficit/surplus is too large relative to the economy. Why? A deficit means a country is spending more than it is producing. This must be financed by borrowing, or selling assets. Cannot be done forever! Generally governments will aim for near balance on current account in the long run. Small deficits or surpluses are acceptable