Balance of Payments and Trade

EdExcel AS Economics 2.1.4

The Changing Global Economy

The world economy is changing rapidly! Since 1980 the share of global economic output has shifted towards Asian-Pacific countries who now dominate.

1980 1990 2000 2010 20150%

5%

10%

15%

20%

25%

30%

35%

40%

19.6%

22.7%

26.2%28.5%

31.4%

US EU-28 Asia-Pacific

Percentage share of world GDP, at current market prices & exchange rates

Source: IMF World Outlook

UK’s Main Import Partners in 2013

Germany Netherlands China France United States Belgium0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

13.9%

8.5% 8.5%

6% 5.6%5%

Shar

e of

tota

l im

port

s

The European Union (28 countries) is the biggest source of imported goods and services for the UK. But China is now ahead of USA as a supplier of products.

Source: Office for National Statistics

UK’s Main Export Partners in 2013

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0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%13.8%

9% 8.8%7.6%

6.4%5.7%

4.3%

Shar

e of

tota

l exp

orts

More than half of the UK’s exports go to the other nations inside the European Union. Switzerland is our biggest export market but is outside of the EU.

Source: Office for National Statistics

Trade to GDP ratios are rising for most countries

Big expansion of Financial Capital Flows

between countries

Rise in Foreign Direct Investment and Cross

Border M&A

Rise of global brands – including many from emerging countries

Deeper specialization of labour – i.e. components

from many nations

Global supply chains & new trade and

investment routes

Key Aspects of Globalisation

The Balance of Payments

For AS economics emphasis is on the current account of the BoP and in particular the balance in trade in goods and services

• 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

Items in the Current Account of the BoP

• Finished manufactured goods, components, raw materials

• Energy products, Capital technology

Trade Balance in Goods

• Banking, Insurance, Consultancy• Tourism, Transport, Logistics• Shipping, Education, Health,• Research, Cultural Arts

Trade Balance in Services

• Overseas aid / debt relief• Private money transfers e.g. From migrants

Net Money Transfers

• Profits, interest and dividends from investments in other countries e.g. The profits from transnational businesses

Net Investment Income from

Overseas Assets

Worked Example of the BoP Current Account

Item of the Balance of Payments Net Balance$ billion

Current Account (1) Balance of trade in goods -25

(2) Balance of trade in services +10(3) Net investment income -12(4) Net overseas transfers +8

Sum of 1+2+3+4 = Current account balance -19

The current account comprises the balance of trade in goods and services net investment incomes and net transfers.If a country is running a current account deficit, there is a net outflow of demand and income from the circular flow.

UK BoP Current Account Balance in Recent Years

* forecast Current balance = sum of 1 + 2 + 3

(1) Transfers and other

(2) Net trade balance in goods

and services(3) Net investment

income

% of GDP % of GDP % of GDP % of GDP2007 -2.7 -1.0 -2.7 1.02008 -3.7 -0.9 -3.0 0.22009 -2.8 -1.0 -1.9 0.12010 -2.6 -1.3 -2.4 1.12011 -1.7 -1.4 -1.5 1.22012 -3.7 -1.4 -2.1 -0.32013 -4.5 -1.6 -2.0 -0.92014 -5.9 -1.5 -2.0 -2.4

2015* -5.0 -1.3 -1.8 -1.8

The current account measures the UK’s trade in goods and services with the rest of the world, as well as current transfers and income flows in to and out of the UK from cross-border investments.

Trade Balances in Goods and Services for the UK

Britain runs a strong surplus in services but a large and rising deficit in goods

1997 Q1

1998 Q2

1999 Q3

2000 Q4

2002 Q1

2003 Q2

2004 Q3

2005 Q4

2007 Q1

2008 Q2

2009 Q3

2010 Q4

2012 Q1

2013 Q2

2014 Q3

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Net trade Exports Imports

% o

f GD

P

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Net Trade Exports Imports

% O

f GDP

Trade in Services: Exports, imports & balance Trade in Goods: Exports, imports & balance

Source: Office for National Statistics

UK Trade Balances in Goods and Services with the EU

The UK runs a trade surplus with countries such as Ireland but very large trade deficits with countries such as Germany and Spain. Can you explain why?

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013-70000

-60000

-50000

-40000

-30000

-20000

-10000

0

10000

20000

30000

Rest of the EU Spain Netherlands Ireland Germany France

Annual Trade Balance (£ billion)Source: Office for National Statistics

UK BoP Current Account Balance in Recent Years

The current account deficit in 2014 was the highest as a percentage of UK GDP for nearly thirty years. The deficit was nearly 6%of GDP.

Source: Office for National Statistics

Some Causes of a Current Account Deficit

• Higher inflation than trading partners• Low levels of capital investment and research• Weaknesses in design, branding, performance

Poor price and non-price competitiveness

• High currency value increases prices of exports• Appreciating currency also makes imports cheaper

Strong exchange rate affecting exports and imports

• Recession cuts value of exports to these countries• Might be barriers to switching to other markets e.g. UK businesses

struggle to sell to emerging markets

Recession in one or more major trade partner countries

• Exporters of primary commodities might be hit by a fall in world prices• Importing nations could be hit by higher prices for oil and gas

Volatile global prices (e.g. Commodities)

The Export Multiplier Effect

A fall in exports will reduce AD and the final impact on GDP, jobs and investment is amplified by multiplier and accelerator effects

Real GDP

GPL1

Y1

AD1

AS

Y2

AD2

GPL2

GPL The Export Multiplier Effect

Many industries rely heavily on key export industries remaining competitive – these include:

• Transportation / freight / logistics businesses

• Trade finance businesses e.g. Insurance and trade credit

• Service businesses that operate in ports and airports

Exports particularly important for regional economic performance

Country 2009 2011 2013 2015

Brazil -2.0 -2.7 -4.0 -4.1

Mexico -0.9 -1.1 -2.4 -2.1

United States -2.7 -3.0 -2.2 -2.4

China 4.8 1.7 1.6 3.0

India -2.0 -3.4 -2.6 -0.9

South Korea 3.9 1.5 6.2 7.5

Germany 5.7 6.0 6.6 8.0

Russia 4.0 5.2 1.7 5.1

Spain -4.3 -3.2 1.4 0.0

United Kingdom -2.8 -1.7 -4.5 -5.4

Current Account Balances for Key CountriesSource: IMF

Economic Problems from Persistent Trade Deficits

Loss of aggregate demand which causes slower real GDP growth and reduced living standards

Loss of jobs in home-based industries, may contribute to regional decline and structural unemployment problems

Can lead to currency weakness and higher inflation and a country may run short of vital foreign currency reserves

Trade deficit might be a reflection of lack of competitiveness / supply-side weaknesses

Possible Problems from Running Trade Surpluses

If GDP is close to capacity, a rise in the trade surplus might cause demand –pull inflation

Persistent trade surpluses might lead to threat of protectionism from trade deficit nations

If the surplus is due to high saving / low consumption, living standards might be too low

Surplus might be result of exporting high-priced commodities – prices are volatile/unpredictable

Economic Policies to Reduce a Trade Deficit• Demand management: A tightening of fiscal and/or monetary

policy reduces real spending power of consumers and leads to lower spending on imports (fall in M improves trade balance)

• Lower exchange rate reduces the foreign price of exports and makes imports more expensive – causes changes in demand

• Supply-side improvements: • Policies to raise labour productivity and encourage start-

ups with export potential e.g. Life sciences, digital etc• Investment in human capital to boost productive capacity

and competitiveness in high-value industries such as bio-technology, engineering, medicine, tourism

• Protectionist measures such as import quotas and tariffs (NB: UK limited by global trade agreements e.g. EU and WTO rules)

Some Reasons for the UK’s Persistent Trade Deficit

High income elasticity of demand (Yed) for imported goods and services – demand for imports grows strongly when consumer spending is rising

Some weaknesses on supply-side of the economy (i.e. Low research and development spending, low rate of capital investment)

Many UK businesses finding it hard to finance a rise in exports (effects of credit squeeze)

Majority of British exports go to slower-growing countries in Europe e.g. Ireland, Spain and also the USA. Less successful in exporting to emerging nations

The Global Competitiveness Index uses indicators which measure:

Indicator Brief comment on the indicator

Effectiveness of institutions Protection of property rights, rule of law, corruption

Quality of infrastructure Quality of transport, communications, energy etc.

Macroeconomic performance Inflation, fiscal balance, government debt, growth

Health and primary education Malaria incidence, prevalence of HIV, mortality rates

Higher education and training Quality of teaching and attainment e.g. in Maths

Efficiency of goods & labour markets Intensity of competition, tariffs, other barriers

Technological readiness Internet use, availability of latest technologies

Sophistication of business Supplier quality, business clusters,

Innovation Patent applications, research & development spend

Indicators used to judge Competitiveness

Indicator UK ranking out of 144 countries

Overall competitiveness 9/144

Institutions 12/144

Infrastructure 10/144

Macroeconomic environment 107/144

Labour market efficiency 5/144

Technological readiness 2/144

Highlighted problems for UK business

• Access to financing

• Inadequately educated workforce

Data on UK Competitiveness for 2014

Analysis: International (External) Competitiveness

External competitiveness is the ability to sell goods and services at competitive prices in a foreign country

• Cost competitiveness• Differences in unit labour costs – reflected in producer prices

• Non-price competitiveness• Product quality, design, reliability and performance, choice, after-

sales services, marketing, branding and the availability and cost of replacement parts

• Non-wage costs:• Costs of meeting environmental / health regulations• Environmental taxes e.g. carbon taxes and waste taxes• Employment protection laws and health and safety laws• Requirements to provide pensions for employees

Balance of Payments and Trade

EdExcel AS Economics 2.1.4