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Balance of Payments

 

The balance of payments is a record of all the financial dealings of the UK with the rest of the world.  It can be split into two components:

        The current account

        The capital account

 

Our trading performance with other countries has a big effect on prospects for the British economy. Over recent years we have tended to import more goods and services than we have exported. This is shown in the chart below which tracks the quarterly value of exports and imports since the mid 1980s.

 

The Current Account

The current account is split into two sections itself:

        Visible trade

        Invisible trade

 

Trade in Goods (VISIBLE TRADE)

Trade in goods includes:

        Manufactured goods

        Semi-finished

        Components

        Energy products

        Raw materials

        Consumer and capital goods

 

The table overleaf shows the annual deficit in UK trade in goods with other countries since 1995

 


 


The economy has run a trade deficit since 1983 with the gap widening considerably because of the excessive economic growth in the mid-late 1980s. The deficit shrunk in the early 1990s recession and during 3-4 years of exchange rate weakness between 1993-96. However the trade gap has widened again in 1998-99. This is due to the slowdown in export volumes caused by recession in other leading economies and the lagged effects of a sustained appreciation in the exchange rate over the last three years.

 


 


Trade in Services (INVISABLE TRADE)

Trade in services includes:

        Financial services, e.g., banking and insurance

        Transport services, e.g., shipping and air travel

        Tourism

        Transfers resulting from the loan of factors of production abroad, e.g., interest received on a loan of capital to an American firm and a civil engineer working in Brazil on a construction project

 

The long-term growth and development of service sector industries is reflected in an improving trade balance for Britain with the rest of the world. This is shown in the chart below. The UK has now over-taken France and Germany to become the second biggest service exporter in the global economy.

 


 


Is this where our comparative advantage now lies? The surplus in net exports of services has been on an up-ward path since the downturn of the early 1990s as the chart makes clear. In 1997 the surplus reached nearly 12 billion and in 1998 this grew to over 13 billion.

 

Not every service industry makes a net surplus in trade. The UK's main money earner is in business and financial services. Travel and tourism has been in deficit in recent years.

 

The Current Account For The Uk

After recording small surpluses in the early 1980s, the UK balance of payments deteriorated badly in the late 1980s following the consumption driven economic boom. Recent years has seen a clear improvement in the figures although 1999 is forecast to see a return to deficit.

 

 


Often the root cause of a current account deficit is cyclical. During a boom the demand for imported goods and services rises strongly and if exports cannot keep pace the trade figures move into the red. The economic recession of the early 1990s caused the current account deficit to shrink. Then a boom in exports in 1994-96 lead to small quarterly surpluses in the bop accounts.

 


The UK has enjoyed current account surpluses in five of the last seven quarters. This is despite a worsening of the balance of trade in goods. The main reason for the improvement in the figures is the growing surplus in trade in services and very strong net investment income from overseas assets.

 

If the deficit is symptomatic of a lack of competitiveness in those sectors of the economy exposed to international trade, then specific policy measures may be required to help correct the deficit. In the UK's case, some economists believe that there is a structural problem in trade in goods - with the economy failing to export enough products to pay for the imports that we require.

 

If a country has open capital markets where money can flow into and out of an economy with ease, it should not be a problem to attract the capital inflows needed to finance a balance of payments deficit on the current account. However, in the long-term if imports are increasingly taking over from domestic producers, this threatens economic growth, employment and living standards in the deficit country.

 

 

 

 

The Capital Account

To aid simplicity it can be split into two:

        Short term money flows

        Long term money flows

 

Short term money flows

Sometimes we describe this money as hot money or speculative money.  Money is moved from country to country in the hope of making a profit, whether it is from higher interest rates in one country or because changes in the exchange rate are expected.

 

Long term money flows

These are mainly associated with long term savings and investment.  Foreign companies may choose to invest in the UK by building a new factory or widening its share portfolio by investing in the London Stock Exchange.

 

The Balance of Payments Must Balance

If the UK is experiencing a current account deficit, then we have to find the money from somewhere to pay for it.  We could borrow money from abroad to pay for it, run down our savings from abroad or sell some of the gold and foreign currency reserves.

 

Can a country safely ignore a persistent current account deficit?

The answer depends in part on what is causing the net outflow of money from the economy.

        A current account deficit has to be financed. This is normally done by attracting inflows of capital from other economies. The UK has found few problems in achieving this in recent years.

        If the deficit is due to excessive consumer demand a recession or slowdown should help to reduce the problem. Consumers cannot go on spending in excess of their income for ever. Eventually they have to control their spending and start saving again to improve their own finances.

 

 

E-mail Steve Margetts