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Simple explanation of Balance of Payments
The purpose of the balance of payments is to record of all financial dealings with foreigners (any imports and exports). The balance of trade in goods is the export of goods from the primary and secondary sectors minus the import of these goods. The balance of trade in services is the export of tertiary sector services minus the import of these services.
Simple explanation of the Current Account
The current account of the balance of payments comprises the balance of trade in goods and services plus net investment incomes from overseas assets and net transfers. Net investment income comes from interest payments, profits and dividends from external assets located outside the UK. For example, a UK firm may own a business overseas and send back some of the operating profits to the UK. This would count as a credit item for our current account as it is profits flowing back into the UK.
Example of a current account:
UK’s CURRENT ACCOUNT 1951 (£billion)
Export of Goods = 700
Import of Goods = 800
BALANCE OF TRADE IN GOODS = - 100
Export of Services = 300
Export of Goods = 100
BALANCE OF TRADE IN SERVICES = + 200
TOTAL EXPORTS = 1000
TOTAL IMPORTS = 900
CURRENT BALANCE = +100
In this case the UK is importing more than it is exporting, overall. On the other hand, the UK is important more goods than it is exporting. It is also exporting more services than it is importing. Overall, the positive invisible balance outweighs the negative balance of trade and the UK has a healthy, positive current balance.
Export of Goods = 700
Import of Goods = 800
BALANCE OF TRADE IN GOODS = - 100
Export of Services = 300
Export of Goods = 100
BALANCE OF TRADE IN SERVICES = + 200
TOTAL EXPORTS = 1000
TOTAL IMPORTS = 900
CURRENT BALANCE = +100
In this case the UK is importing more than it is exporting, overall. On the other hand, the UK is important more goods than it is exporting. It is also exporting more services than it is importing. Overall, the positive invisible balance outweighs the negative balance of trade and the UK has a healthy, positive current balance.
- Why could the UK have a deficit (-) on its balance of goods?
- Decline in manufacturing therefore fewer goods to export
- Lots of imports of goods from abroad
- Cheaper to import
- High exchange rate of the pound sterling (£). This makes it more difficult to export but easier to import
- Loss of comparative advantage in many goods
- A boom in the UK means that consumers and businesses have more money to spend on imports.