220 GOVERNMENT

ANDTHEECONOMY 28 BALANCE
OFPAYMENTS
ONTHECURRENT
ACCOUNT

28 BALANCE
OFPAYMENTS
ONTHECURRENT
ACCOUNT
LEARNING
OBJECTIVES

Understandhow to definethe currentaccount

Understandcurrentaccountdeficitsand surpluses
Understandvisibleand invisibletrade
Understandthe relationshipbetweenthe currentaccountand exchangesrates
Understandexamplesof real-worldexchangerates
Understandthe reasonsfor deficitsand surpluses:qualityof domesticand foreigngoods,pricesof domesticand
foreigngoods,and exchangeratesbetweencountries
Understandthe impactof a currentaccountdeficit on: leakagesfrom the economy,inflation,demandfor domestic
exportsand deficit funding

GETTING
STARTED
Mostcountriesin the world haveopeneconomies.Thismeansthat
theytradewith eachother.Detailsof the transactionsbetweenone
countryand all othersare recordedso that the governmentcan
monitorthe flows of trade.Overa periodof time, it is desirablefor
the valueof goodssoldoverseasto be roughlythe sameas the
valueof goodsbought.Lookat the examplebelow.

CASESTUDY:
TRADEIN SOUTH
KOREA
South Korea is considered to be a highly
industrialised country and has important ,- 0 0
trade links with many foreign countries . ~ ~ I'-
c IO IO IO
0
IO
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include semiconductors, petrochemicals, (,It
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automobile/auto parts, ships, flat disp lay 2. 42000 ~
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screens, steel, electronics , plastics and t
1/)
40000
(')

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computers. The country also sells iron, Q.
x 38000
steel and many products made using Q)

0 36000
those metals. South Korea buys goods Q)
::::)
such as crude oil/petroleum products, 34000
~ Jan Feb Mar Apr May Jun Jui Aug Sep Oct Nov Dec
semiconductors , natural gas, coa l, steel,
Month
computers, automobiles, fine chemicals
and textiles, from overseas. Its main A Figure28.1Valueof goodssoldabroadby SouthKorea,January-December
2016
trad ing partners include the EU, China,
Japan and the USA.
GOVERNMENT
ANDTHEECONOMY 28 BALANCE
OFPAYMENTS
ONTHECURRENT
ACCOUNT 221

c 0
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~ 40000 0
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~ Jan Feb Mar Apr May Jun Jui Aug Sep Oct Nov Dec
Month
A Figure28.2Valueof goodsboughtby SouthKoreafromabroad, January-December
2016

South Korea has an open economy.

1 What does this mean?
2 What is the difference between the value of goods bought and the value sold by South Korea in the last quarter
of 2016?
Look at the difference between the value of goods sold (Figure 28.1) and the value bought (Figure 28.2) by South
Korea over the who le period .
3 Do you think South Korea benefits from trad ing with other nations? Account for your answer.
4 In groups , make a list of the goods and services that your country buys and sells abroad . Compare your list w ith
those of other groups in the class .

THECURRENTACCOUNTONTHE
Goods and services which are sold overseas are called exports . In 'Getting
BALANCE
OFPAYMENTS
started ', examples of South Korea's exports included semiconductors ,
SUBJECT
VOCABULARY petroc hemicals , automobile/auto parts and ships. Those goods and services
w hich are bought from other countries are called imports . In 'Getting started'
balance of payments record of all
transactions relating to internat ional
examp les of South Koreas' imports included crude oil/petro leum products ,
trade semiconductors , natural gas, coal, steel and computers . A co untry wil l keep a
record of all transact ions relating to international trade . This record is called t he
capital and financial account that
part of the balance of payments where
balance of payments . It is divided into two parts .
flows of savings , investment and The current account shows the value of all imports and exports over a period
currencies are recorded of time. It includes both visible trade and invisible trade. (This is explained
current account part of the balance below.) It also includes income from interest, profits and dividends on assets
of payments where all exports and owned overseas (exports). And income paid in the form of interest, profits and
imports are recorded dividends to the foreign owners of assets at home (imports).
exports goods and services sold
overseas The capital and financial accounts record flows of money into and out of
a country resulting from t ransactions relating to savings, investments and
imports goods and services bought
from overseas speculation , for example.

CURRENT
ACCOUNT
DEFICITS
AND
It is very unlikely that in any given period of time , the value of a countries
SURPLUSES
exports will be exactly the same as the value of its imports . The diffe rence
SUBJECT
VOCABULARY between the two values is called the current balance . The current account
balance can be in deficit or surplus.
current account deficit when value of
imports exceeds the value of exports A current account deficit occu rs w hen the value of imports is greater t han
current balance difference between the value of exports . This means that t he money flowing out of the economy
tota l exports and total imports (visible resulting from international trade is greater t han the money flowing in. The
and invisib le) current balance will be negative.
222 GOVERNMENT
ANDTHEECONOMY 28 BALANCE
OFPAYMENTS
ONTHECURRENT
ACCOUNT

SUBJECT
VOCABULARY A current account surplus is recorded if the value of exports is greater than
the value of imports . This means t hat the money flowing into the country
current account surplus when
resulting from international trade is greater than the money flowing out. The
value of exports exceeds the value of
imports
current balance will be pos itive.

VISIBLE
ANDINVISIBLE
TRADE
Economists distinguish between visible trade and invisible trade.
Visible trade is to do with the buying and selling of physical goods . Examples
SUBJECT
VOCABULARY might include w heat, iron ore, textiles , leather goods, gems , cars, smartphones
balance of trade or visible balance and jewellery. The diffe rence between the total value of visible exports and
difference between visible exports and imports is called t he balance of trade or visible balance . Figure 28.3 shows
visible imports the visible trade for a country in 2016. The balance of trade is -US$69 181
invisible trade trade in services million (US$96 732 - US$165 913). It has imported more goods t han it has
primary income money received from exported .
the loan of production factors abroad Invisible trade involves the exchange of services . Examples include
secondary income government tour ism, trade in financial services, transport such as shipping and business
transfers to and from overseas consultancy fees. Invisible trade also includes flows of money resulting from
agencies such as the EU the owners hip of assets overseas. Examples might include interest, rents and
visible trade trade in physical goods profits . This is called primary income . Finally, invisible trade also includes
secondary income , whic h results mainly from government transactions.
Examples might be the money flow ing between a government and other
organisations such as the EU.

96732 - 0 -Expor:ts
100000
'2
g 50000 -
D Imports
.E D Balance of trade
f:I'> 0
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2
Q)
(.) - 50000 --- -
c:
GENERAL
VOCABULARY .!2 - 69 18 1
co - 100000
.0
beneficiary someone who gets Q)

advantages from an act ion or change ~ - 150000 -

en
5 - 1659 13
- 200000 -
A Figure28.3Visiblebalancefor a country,2016

Figure 28.4 shows the balance on the current account for a country in 2016.
The current balance is the balance of trade and t he invisible balance added
toget her. It is - US$22 332 million. This is a current account deficit.

100000 - O -earrent -account

'20
.E
_o Invisible balance

f:I'>
50000 46 849 D Balance of trade
Cl)
2
Q)
(.)
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co
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.0
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....
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;;:) - 69.T8 1
(.)

- 100000 ...._--------------~
A Figure28.4Currentbalancefor a country,2016
GOVERNMENT
ANDTHEECONOMY 28 BALANCE
OFPAYMENTS
ONTHECURRENT
ACCOUNT 223

ACTIVITY
1

CASESTUDY:
NIGERIA'S
BALANCE
OFTRADE

Nigeria has the largest economy in Africa and an estimated population

of 186 million. It has a range of trading partners including China, India,
the Netherlands, Spain, Brazil and South Africa. Its main exports are
petroleum, petroleum products , cocoa and rubber. However, about
95 per cent of Nigeria's exports are petroleum. The country was hit
quite hard when the price of oil fell in 2014. In contrast, Nigeria's imports
include machinery, chemicals, transport equipment, manufactured
goods and food. The balance of trade for Nigeria in 2015/16 is shown in
Figure 28.5.

30000
ID 20000~~~~~~-4~~~~~~~~~~~~~~~~-4
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IDE 0 +1-----'-r'-----'-ir'-----'--r.---rr.----rr-
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-30000 1
2015 2016
Time
A Figure28.5 Nigerianbalanceof trade, 2015/16

Most of Nigeria's trade is in visible items .

1 What is meant by visible trade?
2 What is meant by the balance of trade?
3 Describe what has happened to Nigeria's balance of trade over
the t ime period.
4 Describe one possible reason for the pattern of trade shown in
Figure 28.5.

THERELATIONSHIP
BETWEEN
THE The pattern of international trade can be influenced by changes in the
CURRENT
ACCOUNTANDEXCHANGE exchange rate . If a country's exchange rate gets stronger {which means
RATES that one unit of a currency can buy more units of another currency), exports
become more expensive and imports become cheaper. This might result in
SUBJECT
VOCABULARY fewer exports being sold and more imports being bought. This will have a
exchange rate price of one currency in negative impact on the current account. For example, if a country already has
terms of another a current account deficit , the size of the deficit is likely to increase.
The balance on the current account may also have an impact on the exchange
rate. For example, if a country has a surplus on the current account resulting
from rising sales of goods abroad, demand for that country's currency will rise
(foreigners will need to buy that country's currency to pay for the goods). This
increase in demand for currency could drive up the exchange rate. Therefore
that country 's exchange rate gets stronger. Exchange rates, and the impact of
changing exchange rates on the current account, are discussed in more detail
in Chapters 41 (see pages 333-339) and 42 (see pages 340-346).
224 GOVERNMENT
ANDTHEECONOMY 28 BALANCE
OFPAYMENTS
ONTHECURRENT
ACCOUNT

EXAMPLES
OFREAL-WORLD
Exchange rates rarely remain stable over a period of time. The rate at which
EXCHANGE
RATES one country's currency exchanges against that of another is determined
by market forces. Therefore, when there is a disturbance in the market , the
exchange rate is likely to change. For example, when the UK voted to leave the
EU in June 2016 , the value of the pound fell quite sharply. Figure 28.6 shows
the value of the pound against the US dollar. Just before the Brexit vote the
exchange rate was £1 = US$1.50, however, in January 2017 it was around
£1 = US$1.24. This is a fall of about 17 per cent. Sharp changes like this can
have an impact on international trade. This is discussed in detail in Chapter 42
(pages 340-346).

Q)

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+
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.c 1.34 --+
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1.30 -1
1.28 -1

=:~
~:: rrP~Ur~
1.20 +----+----+----+-~-+--+--+---+--+--+-~-+---+-~-+----+---+--
Feb Mar Apr May Jun Jui Aug Sep Oct Nov Dec Jan
Time
• Figure28.6 Pound: dollarexchangerate,2016/17

REASONS
FORDEFICITS
AND Most governments would prefer to have a healthy current account on the
SURPLUSES balance of payments. This might mean that over a period of time a large
deficit is avoided. Some countries, like China and Japan for example , have
often enjoyed quite large current account surpluses. What are the reasons for
deficits and surpluses?

QUALITY
OFDOMESTIC
GOODS
If a country develops a reputation for high-quality goods, it is likely to enjoy
rising sales from overseas buyers. This will drive up the demand for exports and
help to improve a current account balance. For example, the UK has a reputation
in China for the production of high-quality goods. Also, if the quality of domestic
goods is high, demand from the home market will rise as consumers will prefer
them to imports. This will also help to improve the current account.

QUALITY
OFFOREIGN
GOODS
If goods and services from overseas are superior to those produced
domestically , there will be an increase in demand for these imports. Clearly
this will have a negative impact on the current balance. The size of a current
account deficit , for example , would get bigger. There will also be less demand
for home produced goods, which could result in lower domestic output and
employment.
GOVERNMENT
ANDTHEECONOMY 28 BALANCE
OFPAYMENTS
ONTHECURRENT
ACCOUNT 225

PRICEOFDOMESTIC
GOODS
Demand for goods and services is heavily influenced by the price. If domestic
goods are expensive, owing to rapid inflation, for example, then demand from
overseas buyers is likely to fall. This will see a progressive worsening of the
current balance.

PRICEOFFOREIGN
GOODS
If foreign goods are cheaper than those produced at home , there will be a
rapid in demand for imports. This will have a negative effect on the current
account , reducing the size of a surplus , for example. In recent years, Chinese
manufactured goods have been cheaper than those produced at home in
many Western countries. The resulting high demand for them has had a
negative effect on the current accounts of many of these countries.

EXCHANGE
RATES
BETWEEN
COUNTRIES
Since the exchange rate affects the prices of domestic goods and foreign
goods, any changes in the exchange rate can have an impact on the current
account. For example , when the value of the pound fell after the Brexit vote,
there was an increase in demand for holidays in the UK. This helped to boost
invisible exports and had a positive effect on the UK 's current account.

Ferrari, the Italian car manufacturer, produces high performance luxury

supercars. Although there are only a few people in the world who can afford
to buy a Ferrari, it is a famous global brand name. In 2015, it produced
7664 cars and made a record profit. Few people buy Ferraris as a means of
transport. Most Ferrari owners have several cars and as a brand Ferrari is a
status symbol. Enthusiasts say that Ferrari is a special car because it has a
soul. Red stands for passion and the horse logo represents aggression. For
many, Ferrari symbolises power , strength , speed , confidence and boldness.
Ferrari is targeted at a niche market - the luxury segment of the car market
where performance, quality and exclusivity are highly valued. Most Ferrari
sales are in overseas markets. For example , in 2015 , only 285 of the cars
produced were sold in Italy. The other 7379 were exported to markets all over
the world. Total revenue for Ferrari in 2015 was €2854 million.

• Ferrari488

1 What impact will Ferrari sales have on Italy's current account?

2 Using this case as an example , discuss the importance of product

quality in relation to a country's current account.
226 GOVERNMENT
ANDTHEECONOMY 28 BALANCE
OFPAYMENTS
ONTHECURRENT
ACCOUNT

THEIMPACT
OFA CURRENT
If a nation has a persistent current account deficit, it may experience a
ACCOUNTDEFICIT number of effects . For examp le, if consumers buy increasing quantit ies of
imports, domestic output and emp loyment may be negative ly affected.
GENERAL
VOCABULARY
persistent continuing to exist or LEAKAGES
FROMTHEECONOMY
happen, especially for longer than is A persistent current account deficit suggests that a country is becom ing
usual or desirable increasing ly dependent on imports . This means that consumers are buying
goods produced outside the domestic economy. As a result, money flows
out of the economy to overseas businesses . This represents a leakage from
the economy. It means that output and employment levels in the domestic
economy are under threat.

INFLATION
A country running a high current account deficit might be exposed to
inflationary pressures. If the prices of imports go up, this will be reflected in the
general price level since many imported goods will be counted when the CPI
is calculated. Consequently , rising import prices will result in higher domestic
inflation levels. The greater the reliance on imports , the greater the threat of
inflation when import prices rise.

LOWDEMAND
FOREXPORTS
A country with a high current account deficit might be strugg ling to sell goods
and services abroad . If demand for exports is low, it might mean that the quality
of goods and services is poor or the price is too high. Unless the demand for
exports can be reversed, a country may suffer a progressive decline in economic
DIDYOUKNOW? growth and a rise in unemployment. A current account deficit may reflect
In relationtotheamountof structural weaknesses in the economy . This means that domestic firms may
international tradedonebythe struggle because they are not competitive in certain industries .
UK, thesizeofthecountry's
deficitis insignificant.
It is like FUNDING
THEDEFICIT
If a country has a continuing current account deficit, it w ill need foreign
someone earning£25OOO a
currency to pay for the rising quantity of imports that are being purchased .
yearandspending £25005.The If the foreign currency reserves of a country run low, it may be necessary
personhasoverspent by£5; it is to borrow. However, persistent borrowing may cause long-term problems .
verysmallin relationtothetotal Sometimes, a current account deficit can be financed by a capita l account
surplus . For example, flows of foreign currency can be attracted by a country if
amountspent.
its interest rates are high.

MULTIPLE-CHOICE
QUESTIONS ..,. 1 Which of the following is an example of an invisible item of trade?
A Machinery
B Cars
C Insurance
D Confect ionery
..,. 2 The sale of Renault cars from the Morocco factory to Spain, France and
Germany result in which?
A Increase imports
B Reduce exports
C Improve the current account
D Improve the invisible balance
GOVERNMENT
ANDTHEECONOMY 28 BALANCE
OFPAYMENTS
ONTHECURRENT
ACCOUNT 227

CASESTUDY:
THEMOROCCAN
CURRENT
ACCOUNT
BALANCE
The North African state of Morocco has taken advantage of its location
close to Europe and cheap labour to develop a diverse and open market
economy . In 2012, the French car company Renault opened a €1600
million factory in the north of the country . It employs over 7000 people and
has a capacity to produce 340 OOOvehicles . Most of the output is exported
to Spain, Germany and France. The Renault plant is the biggest car
production facility in Africa. However, despite this positive development
in the economy , in the last few years Morocco has experienced several
deficits on its current account. Figure 28 .7 shows Morocco's current
account balance from 2014 to 2016 .
Morocco exports a wide range of goods such as clothing and textiles,
automob iles, electrical components , inorganic chemicals , transistors,
crude minerals, fert ilisers, petro leum products, citrus fru its , vegetab les and
fish . Morocco also has a well-developed tourist industry with destinations
such as the anc ient cities of Marrakesh and Fez attracting thousands of
overseas visitors every year. Morocco 's imports include crude petroleum ,
texti le fabric, telecommunications equipment, wheat, gas, electricity,
transistors and plastics .
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Jan Ju i Jan Ju i Jan Ju i
20 14 20 14 20 15 2015 2016 20 16
Time
A Rgure 28.7 Moroccancurrentaccountbalance

CHAPTER
QUESTIONS
1 What is the difference between visible and invisible exports? Use examp les
from this case to support your answer.
In November 20 16, Morocco 's balance of trade was MAD - 13 866 million.
2 Describe the difference between the balance of trade and the balance on
the current account.
3 During which period did Morocco have a current account surplus?
4 Discuss how a current account deficit might affect the Moroccan exchange
rate w ith other currencies .
5 Consider the possible impact on the Moroccan economy of a persistent
current account defic it. Make a clear judgement in your evaluat ion.