The Balance of PaymentsA2 Economics 10th http://www.youtube.com/watch?v=Pbj9auFz9Ck&safe=active

Balance of Payments accountRecords financial transactions between the UK and all other countriesAt AS you learned about the current account of which there are 4 main partsThe balance of trade in goods (visible trade)The UK imports more than it exports - it runs a trade deficitThe balance of trade in services UK comparative advantage in financial, insurance and ICT services has led to an overall balance of trade surplusThis trade surplus is not large enough to cover the trade deficitNow many more services are imported because British firms are outsourcing services e.g. call centres to India

Balance of Payments accountNet income flowsNot all flows of money are from trade in goods and servicesIncome flow from use of factors of production overseasInterest, profits and dividends on UK assets abroadThese also flow out of the country to overseas ownersNet income flows are the difference between inward and outward flowsThese tend to be positive in the UKCurrent transfersNet current transfers consist mainly of government transfers to and from overseas organisations e.g. the EU

Task 1 Look at the graph, What 3 sectors provide the largest contribution to exportsCan you find more recent data on exports and imports by sector for the UK?Can you think of examples of such products

Can you think of companies that produce them

The capital and financial accountsAt A2 you are expected to have some knowledge of the other two accountsCapital accountFinancial accountThese record flows of financial capital arising from saving, investment and currency speculationCapital account is relatively unimportantConsists largely of repatriation of financial capital from people entering or leaving the UKGovernment transfers including some type of foreign aidFinancial account records the vast majority of flows of financial capital into and out of the UK and has 3 main componentsNet FDI difference between UK acquisitions abroad and Foreign acquisitions in the UKNet portfolio investment purchase of financial assets e.g. sharesOther capital flows hot money

Task 2 Foreign Direct Investment- Can you find out who is the biggest foreign investor in the UKWhere does the UK invest its money internationallyIn 2013 can you find if FDI was positive or negative.Using the data write a paragraph discussing the significance of FDI to the UK in recent years.

Financial Services and the City of LondonFinancial services industry one of the UKs largest industriesMostly based in the City of LondonOver a million people employedNearly a quarter of Londons contribution to GDP is financial servicesSee graph opposite to see growth of services in terms of their share of UK exportsRead the golden gateway on P200

Task 3 What is the UKs largest export market

Can you think of any reasons why export declined in this period to many countries

What products grew as export product and which ones fell?

Causes of a trade (goods) deficitIt is useful to group the explanations for a trade deficit in goods into short-term, medium-term and long-term factorsSome relate to the demand-side of the economy and others to supply-side economic influences Short-term factors Strong consumer demandreal household spending has grown more quickly than the supply-side of the economy can deliver, leading to a high level of demand for imported goods and servicesResearch evidence suggests that UK consumers have a high income elasticity of demand for overseas-produced goodsdemand for imports grows quickly when consumer demand is robustNicholas Fawcett and Professor Mike Kitson estimated that the income elasticity is around +2.3 suggesting that a 2% increase in real incomes boosts demand for imports by 4.6%Because the overseas demand for UK exports rarely keeps pace with the surging demand for imported products, so the trade deficit widens when the economy enjoys a period of consumption-led growth.

Causes of a trade (goods) deficitThe strong sterling exchange rate has helped to reduce the UK price of imports causing an expenditure-switching effect away from domestically produced outputConsumers have taken advantage of the high pound! In technical terms, the high pound has improved the terms of trade between the UK and other countries, allowing the British people to buy and consume more imports with each pound they earn

Causes of a trade (goods) deficitMedium-term factors UK trade balances have been affected by important shifts in comparative advantage in the international economyfor example the rapid growth of China as a source of exports of household goods and other countries in South-east Asia who have a cost advantage in exporting manufactured products. The availability of imports from other countries at a relatively lower price inevitably causes a substitution effect from British consumers.

Causes of a trade (goods) deficitMedium-term factors Much of the UKs trade deficit is due to structural rather than cyclical factorsTrade performance has been hindered by supply-side deficiencies which impact on the price and non-price competitiveness in global marketsnon-price competitiveness factors such as design and product quality are now more important for trade than merely price alone. A relatively low rate of capital investment compared to other industrialised countries The persistence of a productivity gap with major competitors linked to low investment and also to the existence of a skills-gap between UK workers and employees in many other countries A relatively weak performance in terms of product innovation linked to a low rate of business sector spending on research and development

Exports and Capital inflows- Today we will look at what Britain exports wellWhy it might not be good at exporting some products

Why the UK seems to attract so much foreign investment.

Task 4Describe what has occurred in the overall current account.Can you find any Data that reverses the fall in the balance of trade- Is there any sign of an export led recoveryOf the data you have found in your research- what are the key changes compared to this data

Capital flows- Good or Bad?International Capital flows have grown very rapidly in recent decades reflecting the process of globalisationThis growth brings the following benefitsPromotes growth of world tradeSource of finance for firms which is particularly important in less developed countriesFDI facilitates the transfer of technology, information and best practice between firms and countries bringing about supply side improvementsThis growth in capital flows can bring the following disadvantagesDifficulties in one sector of the financial systems can affect the whole global financial system Sub prime mortgage crisis in the USA in 2007 led to a UK credit crunch where banks tightened lending criteriaFDI may lead to global dominance by multinational firmsLarge scale hot money flow can destabilise exchange rates

homeworkExplain the main factors which might help determine the volume of UK exports and imports. (15 marks)

the UK may adopt a strategy of export-led growth (1 mark). This may be because it isperceived as the most rapid way of achieving economic growth (1 mark) and/orbecause it feels itself to be very competitive in world markets (1 mark). It mayrecognise that a good export performance will initiate a multiplier effect (1 mark) whichshould benefit the economy beyond the export sector (1 mark) and that exports maywell encourage supply-side improvements (1 mark) such as innovation and higherproductivity to sustain good external performance (1 mark) favourable terms of trade (examiners note that this term is not included in thespecification but candidates may well discuss relative export/import prices even if theterm is not used) the need for imports of raw materials, energy and/or finished goods, e.g. because theUK has lost so much of its industrial base a sustained favourable exchange rate motivates an export drive absolute/comparative advantage, e.g. UK comparative advantage in financial services the impact on UK exports of overseas recession, especially the US and the EU as faras the UK is concerned exchange rate movements relative inflation rates relative rates of productivity (traditionally unfavourable for the UK) and impact oncompetitiveness the ability of the UK to impose protectionist policies any other valid point. Up to 7 marks per explanation(1 mark for identification and 6 marks for the explanation)However, it may be that a candidate devotes much of his/her answer to the issue ofcomparative advantage and develops the point with a numerical example. If this is thecase award up to 10 marks for an explanation of comparative advantage.make use of diagrams in the analysis Up to 2 marks per diagram

Homework- Research and find examples of industries and why they have been successful?

Causes of a trade (goods) deficitLong-term factors The UK manufacturing sector has been in long-term decline for more than twenty years.Although there are some world class manufacturing companies, the size of the manufacturing sector is not large enough both to meet consumer demand in the UK and also to export sufficient volumes of products to pay for a growing demand for imports

Does a current account deficit really matter?Should we be concerned if, as an economy, we are running a large current account deficit?The UK has run large current account deficits in recent years with barely any effect on the overall performance of the economy.The United States economy is also experiencing a huge trade deficit at the moment. What are the implications of this?In the 1950s, 60s and 70s, small balance of payments deficits in the UK caused economic crises with periods of strong speculative selling of sterling on the foreign exchange markets and much political instability.The devaluation of the pound in 1967 led directly to the resignation of the then Chancellor, James Callaghan.These days, trade deficits of enormous proportions seem to have little effect in global currency markets.

Does a current account deficit really matter?Some policymakers and economists believe the balance of payments no longer matters because of globalisation and financial liberalisationtrade and current account deficits can be more easily financed by globally integrated capital markets freed from the capital controls that have been dismantled since the end of the 1970s.This free movement of global financial capital has allowed countries, in principle, to increase their domestic investment beyond what could be financed by a countrys own savings.Increasingly what we want to consume is produced abroad and if a country wants to operate with a sizeable current account deficit, then provided there is a capital account surplus, there is no fundamental economic constraint. Britain has been a favoured venue for inward investment (an inflow of capital) and our relatively high interest rates compared to the USA and the Euro Zone has also attracted large-scale inflows of money into our banking systems.In this way the current account has been financed with little economic pain.

Evaluation

Does a current account deficit really matter? Arguments ForThe main arguments for being relaxed about a current account deficit are as follows: Partial auto-correction: If some of the deficit is due to strong consumer demand, the deficit will partially-self correct when the economic cycle turns and there is a slowdown in spending Investment and the supply-side: Some of the deficit may be due to increased imports of new capital and technology which will have a beneficial effect on productivity and competitiveness of producers in home and overseas markets

Does a current account deficit really matter? Arguments ForCapital inflows balance the books - Providing a country has a stable economy and credible economic policies, it should be possible for the current account deficit to be financed by inflows of capital without the need for a sharp jump in interest rates.The UK has run an average annual current account deficit of 10 billion from 1992-2004 and yet the economy has also enjoyed one of the longest sustained periods of growth and falling unemployment during that time

Does a current account deficit really matter? Arguments AgainstStructural weaknesses - The trade / current account deficit may be a symptom of a wider structural economic problem such asa loss of competitiveness in overseas marketsinsufficient investment in new capitalshift in comparative advantage towards other countries. An unbalanced economy too much consumptionA large deficit in trade is a sign of an unbalanced economy typically the consequences of a high level of consumer demand contrasted with a weaker industrial sector.Eventually these macroeconomic imbalances have to be addressedConsumers cannot carry on spending beyond their means for the danger is that rising demand for imports will be accompanied by a surge in household debt.

Does a current account deficit really matter? Arguments AgainstPotential loss of output and employmentA widening trade deficit may result in lost output and employment because it represents a net leakage from the circular flow of income and spendingWorkers who lose their jobs in export industries, or whose jobs are lost because of a rise in import penetration, may find it difficult to find new employment.Potential problems in financing a current account deficitCountries cannot always rely on inflows of financial capital into an economy to finance a current account deficitForeign investors may eventually take fright, lose confidence and take their money outThey may require higher interest rates to persuade them to keep investing in an economyHigher interest rates then have the effect of depressing domestic consumption and investmentIn the US the current account deficit is so large that the USA must rely on huge capital inflows each year eventually investors in other countries may decide to put their money elsewhere this would put severe downward pressure on the US dollar

Does a current account deficit really matter? Arguments AgainstDownward pressure on the exchange rateA large deficit in trade in goods and services represents an excess supply of the currency in the foreign exchange market and can lead to a sharp fall in the exchange rateThis would then threaten an increase in imported inflation and might also cause a rise in interest rates from the central bankA declining currency would help stimulate exports but the rise in inflation and interest rates would have a negative effect on demand, output and employment.