2.5 - The balance of payments
Buying imports, earning foreign investment income and purchasing overseas assets are different international transactions. Learn how the accounts separate them, calculate balances, and judge whether an external deficit is sustainable rather than treating every deficit as a policy failure.
Recording international transactions
The balance of payments records economic transactions between residents of an economy and non-residents over a period.
Residence concerns the centre of economic activity, not nationality. A UK-resident business selling a service to an overseas customer creates a UK export. The accounts are flows during a period; the stock of overseas assets and liabilities at a date is the international investment position, a different concept.
The current account records trade and income flows. The capital account records capital transfers and transactions in non-produced, non-financial assets, such as certain rights. Most cross-border purchases of shares, bonds, factories and deposits belong to the financial account, not the capital account. The financial account covers direct investment, portfolio investment, other financial investment and reserve assets. Payments and receipts for the goods or income and the corresponding financial transaction are recorded through double-entry accounting.
For example, importing a £10,000 machine is a debit in goods trade. It may be paid by reducing an overseas bank asset or financed by borrowing, which provides the financial counterpart. An overseas investor buying shares in a UK firm is a financial transaction; it is not itself an export of current output. A foreign dividend earned by a UK resident belongs to current primary income, although the share holding itself is a financial asset.
In principle the full accounts balance through counterparts; measurement gaps appear as net errors and omissions. A “balance-of-payments deficit” usually refers to a specified component such as the current account. Always identify that component and the sign convention. Modern statistical financial-account balances often use net acquisition of assets minus net incurrence of liabilities, so do not assume every published positive financial balance means an inward flow.
Trade and income on the current account
The current account combines four balances, each calculated as receipts or credits minus payments or debits.
| Component | A UK receipt or credit | A UK payment or debit |
|---|---|---|
| Trade in goods | A domestically produced car sold overseas | An imported machine purchased from overseas |
| Trade in services | A UK consultancy serving an overseas client | A UK resident buying a foreign hotel service |
| Primary income | Interest, dividends or earnings from overseas received by residents | Investment income or earnings paid to non-residents |
| Secondary income | Current transfers received without an equivalent exchange | Current transfers paid abroad, such as relevant remittances or aid |
Primary income rewards labour or ownership; secondary income is a current transfer without a direct equivalent. Buying an overseas bond is financial investment; interest subsequently received is primary income. An overseas visitor's UK spending on accommodation is a service export, even though the service is delivered in the UK.
An illustrative economy has goods exports £120 billion and imports £160 billion; services exports £100 billion and imports £70 billion; primary income receipts £40 billion and payments £50 billion; secondary receipts £5 billion and payments £15 billion. The balances are −£40 billion, +£30 billion, −£10 billion and −£10 billion. The current account is therefore −£30 billion, despite a services surplus.
Scale, imbalances and financing
A current-account deficit means current payments to the rest of the world exceed receipts, with a corresponding need for net finance after allowing for the capital account.
The finance can involve acquiring fewer overseas assets, selling existing assets, or incurring liabilities to overseas investors or lenders. It is not necessarily government borrowing: households, banks and firms can be involved. Direct investment in a productive business and short-term foreign borrowing provide different risks, even if both help finance today's external position. An inflow is not automatically new productive investment when it purchases an existing asset.
Use a ratio to compare economies of different sizes. With current balance −£30 billion and annual nominal GDP £1,000 billion, the current-account balance is of GDP. A deficit growing from £30 billion to £36 billion increases by 20%, but if GDP also grows from £1,000 billion to £1,200 billion its share remains 3%. A more negative balance is a larger deficit; a rise from −5% to −3% means the deficit narrows by two percentage points.
A deficit in one component can coexist with a surplus elsewhere. Equally, the whole current-account balance need not track goods trade: foreign investment income can change sharply. A surplus indicates net current receipts; it can accompany net acquisition of overseas assets. Neither surplus nor deficit shows welfare or sustainability on its own.
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