The structure of the balance of payments

The balance of payments is a systematic record of all financial transactions between a country's residents and those in the rest of the world over a specific period.

Main accounts in the balance of payments

• Current account - Covers day-to-day transactions.
• Capital account - Records transfers of capital.
• Financial account - Deals with investments.

Types of items in the balance of payments

• Credit items - Represent money flowing into the country, shown with a positive sign.
• Debit items - Indicate money leaving the country, recorded with a negative sign.

The balance of payments as a whole must always balance, though individual sections may show surpluses or deficits.

Components of the current account

The current account is a key part of the balance of payments that focuses on regular international transactions.

Trade in goods

This involves the export and import of physical items, such as machinery, clothing, and electronics. It is also known as the visible balance or merchandise balance.

Key features:

• Exports of goods create credit items.
• Imports of goods result in debit items.
• A surplus occurs if export earnings exceed import spending.

Trade in services

This covers non-physical items, often called invisibles, including areas like tourism, transport, banking, and consultancy.

Key features:

• Exports of services generate credit items.
• Imports of services lead to debit items.
• A deficit arises when spending on imported services is higher than earnings from exported services.

Primary income

This includes earnings from investments abroad and payments to foreign investors.

Credit items:

• Profits, interest, or dividends received from overseas investments.
• Wages earned by residents working abroad (employees' compensation).

Debit items:

• Similar payments made to foreigners for their investments in the country, such as interest on foreign-held bank accounts.

Secondary income

This consists of transfers where no goods or services are exchanged in return.

Examples:

• Government aid to or from other countries.
• Contributions to international bodies.
• Private transfers like workers' remittances (money sent home by people working abroad).

In some nations, such as Indonesia, remittances represent a significant credit item.

Calculating trade and current account balances

Balances within the current account are calculated by comparing credits and debits in each section.

Formula for trade in goods balance

$\text{Trade in goods balance}=\text{value of exports of goods}-\text{value of imports of goods}$

Where:

• Value of exports of goods = Revenue from selling physical items abroad (£)
• Value of imports of goods = Expenditure on physical items bought from abroad (£)

A positive result indicates a surplus; a negative result shows a deficit.

Formula for trade in services balance

$\text{Trade in services balance}=\text{value of exports of services}-\text{value of imports of services}$

Where:

• Value of exports of services = Earnings from providing services to other countries (£)
• Value of imports of services = Spending on services obtained from other countries (£)

Formula for balance of trade in goods and services

$\text{Balance of trade in goods and services}=\text{trade in goods balance}+\text{trade in services balance}$

Formula for current account balance

$\text{Current account balance}=\text{balance of trade in goods and services}+\text{balance of primary income}+\text{balance of secondary income}$

Worked example - Calculating trade and current account balances

A country exports goods worth £820 million and imports goods worth £950 million. It exports services valued at £170 million and imports services worth £80 million. The balance of primary income is £40 million, and the balance of secondary income is £15 million. Calculate the trade in goods balance, trade in services balance, balance of trade in goods and services, and current account balance.

Step 1: Identify the values

• Exports of goods = £820 million
• Imports of goods = £950 million
• Exports of services = £170 million
• Imports of services = £80 million
• Balance of primary income = £40 million
• Balance of secondary income = £15 million

Step 2: Calculate trade in goods balance

$\text{Trade in goods balance}=\pounds 820\text{ million}-\pounds 950\text{ million}=-\pounds 130\text{ million}$

Step 3: Calculate trade in services balance

$\text{Trade in services balance}=\pounds 170\text{ million}-\pounds 80\text{ million}=\pounds 90\text{ million}$

Step 4: Calculate balance of trade in goods and services

$\text{Balance of trade in goods and services}=-\pounds 130\text{ million}+\pounds 90\text{ million}=-\pounds 40\text{ million}$

Step 5: Calculate current account balance

$\text{Current account balance}=-\pounds 40\text{ million}+\pounds 40\text{ million}+\pounds 15\text{ million}=\pounds 15\text{ million}$

Implications of surpluses and deficits in the current account

The current account balance reflects whether a country's international transactions result in a net inflow or outflow of funds.

Current account surplus

This happens when total credit items across trade in goods, services, primary income, and secondary income exceed debit items.

Current account deficit

This occurs when debit items outweigh credit items overall.

Global perspective on current account balances

• Deficits in some countries are offset by surpluses in others.
• The worldwide current account always balances, as every debit in one nation corresponds to a credit in another.