IGCSE Economics Notes /Current account of the balance of payments

6.4.1 Structure of the current account of the balance of payments

• Trade in goods: the difference between the export revenue and import spending on physical goods, e.g. cars, washing machines
• Trade in services: measures the difference between export revenue from and import spending on services, e.g. banking, insurance and tourism
• Primary income: interest, profit and dividends flowing in and out of the country
• Secondary income: grants for overseas aid

Calculation of deficits and surpluses

• Current account deficit: the combined value of the debit items in the four sections of the current account is greater than the combined value of the credit items
• Current account surplus: credit items on exports, income and current transfers exceed debit items on imports, income and current transfers

6.4.2 Causes of current account deficit and surplus

Causes of current account deficit

• A high exchange rate would mean high export prices and low import prices
• Inflation makes domestic products less price competitive
• Low productivity of labour will raise wage costs and high prices of domestic products
• High costs of production e.g. raw material cost results in high prices of domestic products
• Low quality reduces demand for exports and raises demand for imports
• Low incomes abroad may result in low demand for exports
• High incomes at home may lead to high demand for imports
• Protectionism abroad e.g. tariffs make it difficult to export
• Absence of protectionism at home may result in dumping

Causes of current account surplus

• Depreciation or devaluation of exchange rate would make exports cheaper and imports dearer
• A country’s exported goods have a reputation for quality and reliability
• Other countries rate of economic growth is higher
• Inflation rate is lower making goods relatively cheaper
• Higher productivity reduces prices and raises quality of goods
• A country is very good in particular services e.g. banking or insurance
• Shipping services can bring in a lot of money
• Tourist expenditure by people visiting a country
• A net positive investment income e.g. money from dividends
• Net surplus from gifts, charitable donations and payments between governments and workers’ remittances

6.4.3 Consequences of current account deficit and surplus

Consequences of current account deficit

• Money leaves a country making the country less well-off
• Output and employment are lower than they would otherwise be
• The deficit will put downward pressure on a country’s exchange rate leading to depreciation
• If one country has a deficit, another country will have a surplus

Consequences of current account surplus

• Aggregate demand increases
• Real GDP and employment may increase
• Higher aggregate demand may cause demand-pull inflation
• The country may be consuming fewer products than it is producing
• An increase in surplus may result in appreciation of the exchange rate

6.4.4 Policies to achieve balance of payments stability

Measures to correct current account deficit

• Reduce imports and increase exports by imposing import restrictions, subsidising exports and reducing exchange rate
• Reduce imports by lowering consumer spending through higher income tax, higher interest rates and higher indirect taxes
• Supply-side policies such as education and training reduce costs and improve quality of goods
• Supply-side policies increase international competitiveness over time

Measures to correct current account surplus

• Revalue a fixed exchange rate
• Encourage appreciation of a floating exchange rate
• Encourage more imports using expansionary fiscal and monetary policy