Governments And Persistent Deficit In Bop Economics Essay

International Business Economics and

Balance of Payment theory focused on the current account and capital and financial account.

The causes behind PERSISTENT deficit.

The main sources of imbalance in UK.

Explicit reference to the closing case study.

How the government might be used to reduce Balance of Payments deficit or help finance it.

Conclusions

BALANCE OF PAYMENT

INTRODUCTION

In this report, I will analyze the following topics:

Balance of Payment theory focused on the current account and capital and financial account

The causes behind PERSISTENT deficit.

The main sources of imbalance in UK.

Explicit reference to the closing case study detailing the two views on analysing Balance of Payments.

How the government might be used to reduce Balance of Payments deficit or help finance it.

Conclusions

BOP THEORY FOCUSED ON THE CURRENT ACCOUNT AND CAPITAL AND FINANCIAL ACCOUNT

The international trade is each year more important so countries purchase huge amounts of products, services and assets from different countries. Balance of payment is a term integrated in this international trade.

According to the International Monetary Fund definition, “Balance of Payment of a country is a systematic record of all economic transaction between the residents of a country and the rest of the world. It presents a classified record of all receipts on account of goods exports, services rendered and capital received by residents and payments made by theme on account of goods imported and services received from the capital transferred to non -residents or foreigners.”

The Balance of Payment accounting system can be divided into three types: current account, capital account and official reserves account.

Current account, it is an accounts of all international for goods and services. This covers the buy and sell of goods, services (tourism, transportation, etc), income from overseas and financial aid from governments abroad. For examples, if a UK Company set up a business in a foreign country and send to UK some of the operating profits. This is a credit item for the current account of UK because it is a flow of profits that flowing back to UK.

Trade in services contains the exporting and importing of intangible products such as transportation, tourism, education, financial services, medical care, etc.

In the table below are shown the UK current account, it is proportionate by www.oecd.org/statistics/

The table show, UK had a deficit in buy and sell of goods of £100 billion in 2011 for the first time. Although, there was also a figures record in trade in services of £76.4 billion. In general the current account deficit was £29 billion which is a very high figure and this will cause a decrease in the GDP.

Source: www.oecd.org/statistics/

(A)

Trade in goods

(B) 

Trade in services

(C)

Total trade in goods and services

(D) 

Total net investment income

(E) 

Current transfers

Current balance = A+B+D+E

£ billion

£ billion

£ billion

£ billion

£ billion

£ billion

2005

-68.7

33.2

-35.4

21.4

-11.8

-25.9

2006

-76.4

41.4

-35.0

7.8

-11.9

-39.1

2007

-90.5

52.9

-37.6

19.0

-13.5

-32.2

2008

-94.1

61.0

-33.1

32.4

-13.8

-14.4

2009

-82.8

62.2

-20.6

18.0

-15.1

-17.7

2010

-98.5

67.0

-31.5

14.6

-20.4

-37.3

2011

-100.3

76.4

-24.0

17.1

-22.2

-29.0

As Griffin and Pustay (6th edition, p.225) argues, “The capital account is records capital transactions-purchases and sales of assets- between residents of one country and those of other countries.” There are two kind of capital account: foreign direct investment and foreign portfolio investment. FDI are investment made for the reason of actively controlling property, assets, or companies located in a foreign country and the difference with foreign portfolio investments is that in this case the investment made in a foreign country by foreign shareholders without the reason of control.

And finally, the financial account is associated to investment in companies, real estate, bonds and stocks.

DISCUSSION OF THE CAUSES BEHIND PERSISTENT DEFICIT

This balance of payment may not remain balanced always because in some case the debit goes beyond credit or conversely causing an imbalance in the balance of payment. There are some causes that are general and it can take place in any country:

Population Growth: all countries have variations in the numbers of inhabitants, this cause an increase in imports to satisfy the needs of the population. For examples, in China or India the imports are fundamentals because the population is huge and is growing every day.

Development Programmes: some developing countries can need raw materials which there are not in their country or highly expert and specialized workers. During the time of developing, in the balance of payment of this country there will be a deficit in their balance of payment.

Natural Factors: the natural disasters may cause variations in the balance of payment. The exports may turn down while that the imports may increase causing disequilibrium in the balance of payments of the country. For examples, when in Japan occurred the tsunami, the disasters affected agriculture and industrial production so the exports could not be carried out.

Inflation: in developing countries an increase in income and price level, will raise imports and decrease exports causing a deficit in BOP.

( Akrani ,2010)

For example, the balance of payment of UK may not remain balanced always. Since 1980s, UK has had a persistent current account deficit because UK has been importing more goods and intangible goods than it has been selling.

Source: Reuters EcoWInUK current account

Deficit in Goods: UK has had a big deficit in products; it is due the process of de-industrialisation in 1980s.UK is still manufacturer product such as clothes, computers, cars, etc. But UK has deficit in the following goods:

trade-goods

Source: Reuters EcoWin

UK has a deficit in products and it has a surplus in services but it is not overcome the trade deficit. It is due to financial flows, UK has been capable to draw sufficient financial flows and relatively low saving rate compared to some of their competitors.

Source: Reuters EcoWintrade-services

THE MAIN SOURCES OF IMBALANCE IN UK

There are a huge amounts of causes that can affect the balance of payment but not only that, also the performance of the others countries may disequilibrium the balance of payment, overcoat if that country is a world power such as US. UK’s economy depend the largest economy in the world and what happens in this country affect in the developments of UK.

Trade: the USA is the largest export country for the UK over 16% of the trade in UK is with the US so UK has a surplus in the exports with the United States.

Investment: the UK has a lot of investments in the USA and this is the main destinations for all investment so the situation of US depends of the UK’s investment. If the USA’s economy is increasing the UK’s companies that have investment in this country produce a flow of interest, income and bonus back into the UK. This improves the current account of the balance of payments of UK.

Exchange rates and commodity prices: The US dollar is one of the most important currencies in the international financial system. The value of the dollar varies depending on different factors such as interest rates, expected rates of return on foreign investments, the strength of the domestic USA economy, growth and inflation expectations and world demand for the US dollar as a reserve currency.

If the US dollar fail compared with other currencies, this may cause an appreciation in the value of £ against the dollar. Then an increase the value of dollar will produce that the imports of raw material and good are cheaper, this is due many goods are priced in dollars.

EXPLICIT REFERENCE TO THE CLOSING CASE STUDY DETAILING THE TWO VIEWS ON ANALYSING BOP

After analyzing the different types of balance of payments and the main course of imbalance in UK, we can analyze the case study “Recent U.S. BOP Performance: Is the Sky Falling?” (Griffin and Pustay, 6th edition, p.235)

The case study give two different views as to how the U.S. BOP should be understand. One viewpoint is at the last decade’s BOP favourably, while the other is not.

The last decade, the balance of payment of US has revealed a big annual deficit in the current account and a big annual surplus in the capital account. This may mean two things: USA companies are less competitive in foreign markets and foreigners are buying valuable US assets or that the USA is attracting foreign investment using surpluses in foreign countries.

People who believe in the theory “Sky Falling” think that the USA must decrease the BOP deficit and the US companies should be more competitive in foreign markets. In the other hand, people who believe in the theory “Everything is great” think that the country should do everything possible to be more attractive to foreign investors.

Although, companies can calculate the balances of payment the country that they want invest, is risky because there are different viewpoints of country’s performance.

HOW THE GOVERNMENT MIGHT BE USED TO REDUCE BOP DEFICIT OR HELP FINANCE IT.

Countries that have had problems with the disequilibrium of their balance of payment can introduce a number of policies to solve the problem.

Demand management

Reducing the demand of the consumers, would reduce the demand for imports and this would be achieved diminution in government spending, elevated interest rates and higher taxes. If the demand in the country is low, companies have a need to export to foreign countries to replace low expenditure in the home economy.

Exchange Depreciation

Declining in the rate of exchange of home currency in terms of foreign currency. This will stimulate exports and decrease imports because exports will be cheaper and imports more expensive. Therefore, a positive balance of payments would decrease the deficit.

Devaluation

Monetary authorities take down the value of domestic currency against foreign currency. If this happens, the value of the home currencies is lower than foreign currency and this produced that raw material, goods, etc is cheaper in foreign market. In the other hand, the imports for this country are more expensive because the country needs more money to buy goods.

CONCLUSION

It is difficult for countries and their governments try to reduce a current account deficit because the number of policies, that have been analyzed, it may cause other problems in the economy of the country; for example, the deflation is very difficult to carry out because the risk of recession is high and the political difficulties.

Therefore, for most companies think that the only method to improve the sales in the foreign countries and to convince UK consumers to buy more goods produced in their country, it is being more competitive without lowering the price.

For that, the government should help companies of their country, providing tax assistance for capital investment and for research, the development and the innovation. The government may also offer training to develop the skills of the workers and invest more money in education for improve the quality of all habitants of the country.