The Current Account - Transactions in goods and services between the residents of a country and the rest of the world including:
- Imports
- Exports
- Current transfers
- Interest
- Dividends
- Profit
The Capital Account - Transactions in physical capital between the residents of a country and the rest of the world
The balance of payments is always balanced overall. A deficit on one account is always balanced by a surplus on another. However, different accounts can be in deficit. In the UK we tend to have a current account deficit. This is because the UK tends to import a larger volume of goods than it exports. In the last quarter of 2010, the UK deficit on trade in goods was £26.8 billion. On the other hand, the UK has a productive services sector and so tends to have a surplus on its trade in services - in the last quarter of 2010 the surplus in trade in services was £12.1 billion. As you can see, although the trade in services surplus goes some way to offset the trade in goods deficit, it is not enough. The financial account of the balance of payments offsets the rest. This is maintained by inflows of 'hot money' (temporary inflows of short term capital) and open market operations sales of government securities e.g. bonds.
It is questionable whether this practice is sustainable in the long run. Selling assets or borrowing abroad to finance a current account deficit has future implications for the current account as there will be outflows of investment income and debt repayment in the future. Also if a country wishes to attract hot money it must set high interest rates. Right now, due to the financial crisis, interest rates in the UK are at a record low of 0.5% which doesn't attract inward investment and yet we still have a current account deficit to finance.
Large current account deficits can indicate that the country in question has an underlying structural weakness (for example it has not invested enough into efficient technology), or that the economy is unbalanced and there is too much consumption. If the deficit is due to a fall in output this could come with increased unemployment.
It is considered relatively unimportant for a developed country to have a balance of payments deficit, especially if the country is import rather than export driven. However a large current account deficit, if left unchecked, can lead to less investment due to adverse perception of the country. This is particularly dangerous for developing countries such as Mumbai (see article).
http://articles.economictimes.indiatimes.com/2011-02-24/news/28627846_1_current-account-deficit-private-remittances-capital-flows
How could a country be 'import driven' as imports are leakages and a rise in imports would not 'drive forward' but would 'reverse'?
ReplyDeleteAlso you write:
" If the deficit is due to a fall in output this could come with increased unemployment."
If there was a fall in output then demand for imports would fall - so why an increase in a deficit?
What is an unbalanced economy? Cappuccino?
ReplyDeleteI meant to say import led rather than import driven, though i see your point. I'm not sure how to answer that but here is a quote from an article which explains import led growth well:
ReplyDelete"What we now (2005) have is import-led growth. Eight years ago, when New Labour took office, our overseas trade, taking goods and services together, was in surplus. Next year the gap reappeared, and in every subsequent year it has widened. No wonder that all this growth has seemed so effortless. No need, this time, for struggle and effort. Let the foreigners do the work and we can buy from them.
Consumers led the way, borrowing and spending tenaciously. A timely boom in house prices gave them the security to borrow more. If their appetite, by now, is flagging, then public spending is here to take over. It has surged ahead under this Chancellor and his revenues have not kept pace with it. Never mind: he, too, can borrow."
(http://www.telegraph.co.uk/finance/2913646/Import-led-growth-someday-soon-it-will-have-to-go-into-reverse.html)
"If there was a fall in output then demand for imports would fall - so why an increase in a deficit?"
ReplyDeleteI didn't mean that this would increase the deficit - it would be a result of the deficit. If demand for imports falls as a result of decrease output and increased unemployment, this should help to improve the balance once more (although if imported goods are income inelastic this will not be the case e.g. oil for petrol)
A cappucino economy is where there's frenzied growth in one sector and stable growth in another. An example of this could be countries dependent on primary products (just a guess). A discovery of raw material in a country (e.g. oil in mexico) can lead to huge inflows of investment into that economy meaning that the exchange rate is very high. Therefore the oil producing sector which is in popular demand will grow very well despite high prices. Other sectors (like agriculature, textiles) may suffer as their prices are now uncompetitive on the world market due to the strong exchange rate - these sectors are experiencing less growth than the oil producing sector, so the economy is unbalanced.
ReplyDelete