Cambridge International as and a level Economics Ebook

Net errors and omissions: 
a figure included to ensure the 
balance of payments balances.
KEY TERM
92

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Chapter 4: The macroeconomy 
TOP TIP
There is commonly confusion between the items that go 
in the income part of the current account and those that 
go in the financial account. The names of the two parts 
provide clear guidance. Remember that the financial 
investment goes in the financial account whereas the 
income that the investment generates goes in the 
income part.
Balance of payments disequilibria
When economists discuss balance of payments defi cits 
and surpluses they are discussing defi cits and surpluses 
on one or other of the accounts within the balance of 
payments. Most focus is usually placed on a defi cit on 
the current account of the balance of payments.
Causes of a current account deficit
Th
ese include:
■
 
A growing domestic economy: When firms are increasing 
their output, they may buy more raw materials and 
capital goods from abroad. As well as import expenditure 
increasing, export revenue may decline as a result of 
exports being diverted from the foreign to the domestic 
market. This cause of a current account deficit is not 
likely to be considered to be a problem. This is because 
a growing economy is likely to attract foreign direct 
investment, which will lead to credit items in the financial 
account to off set the debit items in the current account. 
It is also likely to be short-term and to be self-correcting. 
As the country’s firms use the imported raw materials and 
capital goods to produce more products, they are likely to 
sell more products both abroad and at home. So export 
revenue may rise to match the higher import expenditure.
■
 
Declining economic activity in trading partners: If the 
countries that buy this country’s imports experience 
recessions or slowdowns in economic growth, their 
import expenditure may fall or rise more slowly. 
A current account deficit that arises from either change 
in the economic cycle of the domestic economy or the 
economies of trading partners is sometimes referred to 
as a cyclical deficit. It is not usually considered to be a 
problem as, noted above, it will be relatively short-term 
and is likely to be self-correcting.
■
 
Structural problems: A current account deficit that lasts 
over the long run is more of a concern. This is because 
it indicates that domestic firms are not internationally 
competitive and that the country may have to borrow to 
finance the surplus spending. There are a number of causes 
of a lack of international competitiveness. These include an 
overvalued exchange rate, a relatively high inflation rate, 
low labour and capital productivity. A structural deficit is a 
cause of concern as it will not be self-correcting.
TOP TIP
Students oft en write that a trade deficit arises when 
imports exceed exports. Remember, however, a trade 
deficit arises not when the 
quantity
of imports is greater 
than the 
quantity
of exports. It occurs when the 
value
of imports (price 
×
quantity) is greater than the 
value
of 
imports.