Question

In 2001, the United Kingdom's economy exported goods worth \(£ 192\) billion and services worth another E77 billion. It imported goods worth \(£ 225\) billion and services worth \(£ 66\) billion. Receipts of income from abroad were \(£ 140\) billion while income payments going abroad were \(£ 131\) billion. Government transfers from the United Kingdom to the rest of the world were \(£ 23\) billion, while various U.K government agencies received payments of \(£ 16\) billion from the rest of the world. a. Calculate the U.K. merchandise trade deficit for 2001. b. Calculate the current account balance for 2001 . c. Explain how you decided whether payments on foreign investment and government transfers counted on the positive or the negative side of the current account balance for the United Kingdom in 2001.

Short answer

The merchandise trade deficit for the UK in 2001 was -£33 billion, indicating that the UK imported £33 billion more worth of goods than it exported. The current account balance for 2001 was -£10 billion, meaning that the UK had a net outflow of £10 billion to the rest of the world. Payments on foreign investment and government transfers were counted as positive or negative in the current account balance, depending on whether they represented inflows or outflows of funds from the country.

Step-by-step solution

Part a: Calculate the merchandise trade deficit

Subtract the value of imported goods (£225 billion) from the value of exported goods (£192 billion): Trade Deficit = Exports of goods - Imports of goods \[Trade Deficit = £192\, billion - £225\, billion\] \[Trade Deficit = - £33\, billion\] The merchandise trade deficit for 2001 was -£33 billion, meaning that the UK imported £33 billion more worth of goods than it exported.

Part b: Calculate the current account balance

The current account balance is calculated by summing the following components: merchandise trade balance (calculated in part a), services balance, income balance, and government transfers balance. 1. Services Balance = Exports of services - Imports of services \[Services Balance = £77\, billion - £66\, billion\] \[Services Balance = £11\, billion\] 2. Income Balance = Receipts of income from abroad - Income payments going abroad \[Income Balance = £140\, billion - £131\, billion\] \[Income Balance = £9\, billion\] 3. Government Transfers Balance = Government transfers received from the rest of the world - Government transfers paid to the rest of the world \[Government Transfers Balance = £16\, billion - £23\, billion\] \[Government Transfers Balance = -£7\, billion\] Now, sum up all the balances we calculated above: \[Current\, Account\, Balance = Trade\, Deficit + Services\, Balance + Income\, Balance + Government\, Transfers\, Balance\] \[Current\, Account\, Balance = -£33\, billion + £11\, billion + £9\, billion - £7\, billion\] \[Current\, Account\, Balance = -£10\, billion\] The current account balance for 2001 was -£10 billion, meaning that the UK had a net outflow of £10 billion to the rest of the world.

Part c: Explain the rationale behind classifying payments and transfers

In the context of the current account balance, the following describes how various payments and transfers are counted: 1. Payments on foreign investment: Receipts of income from abroad are counted as positive, as they represent inflows of funds into the country. On the other hand, income payments going abroad are counted as negative, as they represent outflows of funds from the country to foreign entities. 2. Government transfers: Government transfers received from the rest of the world are counted as positive, representing inflows of funds into the country. Government transfers paid to the rest of the world are counted as negative, representing outflows of funds from the country to other nations or international organizations. The rationale for counting these payments and transfers as positive or negative is based on their contribution to the overall balance of the country's international transactions. If the amounts received are higher (positive), it indicates more inflows of funds, thus improving the current account balance. Conversely, if the amounts paid are higher (negative), it means more outflows of funds, which reduces the current account balance.

Key concepts

Merchandise Trade Deficit

A merchandise trade deficit occurs when a country imports more goods than it exports, leading to an outflow of funds. For the UK in 2001, the merchandise trade deficit was calculated by subtracting the value of exported goods ( £192 billion) from the value of imported goods ( £225 billion). This resulted in a deficit of -£33 billion.

• The negative sign indicates the deficit, meaning the UK spent £33 billion more on importing goods than it earned from exporting them.
• Having a trade deficit can be seen as either a sign of a strong consumer economy or a potential economic issue if it becomes unsustainable.
• It shows the reliance on foreign goods and can affect the domestic industry if not balanced over time.

Services Balance

The services balance accounts for the difference between a country's exports and imports of services. Unlike merchandise, services include intangible products such as finance, tourism, education, and technology.

• For the UK in 2001, the services balance was positive, calculated by subtracting imports of services ( £66 billion) from exports of services ( £77 billion).
• This resulted in a services balance of £11 billion, indicating a net inflow of funds from services.
• A positive services balance can help offset a merchandise trade deficit, contributing to the overall health of the current account balance.
• Strong service sectors can enhance a country's economic resilience by providing steady inflows and less susceptibility to material trade variances.

Income Balance

Income balance refers to the earnings or payments related to investments and work done abroad. This includes profits, interest, and wages received from foreign sources or paid to them.

• In 2001, the UK had a positive income balance, as it received £140 billion from abroad, while sending £131 billion out.
• The resulting income balance was £9 billion, indicating net income receipts from abroad.
• Positive income balances contribute positively to the current account balance, representing an important aspect of international financial flows.
• Stable or increasing income receipts suggest solid foreign investments and international workforce contributions.

Government Transfers

Government transfers include unilateral transfers specific to government actions, such as aid, donations, and remittances. They are inflows and outflows that do not involve a direct exchange of goods or services.

• For the UK in 2001, government transfers received amounted to £16 billion, while those paid out were £23 billion.
• This led to a negative transfer balance of -£7 billion, showing a net outflow of funds.
• Government transfers are typically considered negative when they outweigh receipts since they represent funds paid without the return of direct economic benefit.
• Such outflows can strain a country's current account balance but may improve international relations or meet humanitarian goals.