Econplusdal extract 2 Flashcards
What is meant by the term current account imbalance?
A current account imbalance in the form of a current account deficit occurs when more money is leaving a country than entering it as a result of revenues from exports of goods and services, investment income and current transfers from abroad being less than the expenditure on imports of goods and services, investment income and current transfers going abroad
What is meant by the term current account of the balance of payments?
The current account of the balance of payments measures the flow of money entering and leaving a country from trade in goods and services, investment income and net transfers
Analyse how globalisation has increased balance of payments imbalances in the world (point 1)
- Globalisation has made it easier for countries to exploit their comparative advantages, specialise and trade. This is because a driver of globalisation has been reduced trade barriers around the world in the form of tariffs and quotas making it easier for countries to access international markets. As a consequence, countries like China who have a large comparative advantage in manufacturing are able to export in huge volume and at high value around the world leading to large current account surpluses whereas countries without dominance in such industries like the USA become net importers
Analyse using figure 2.1 in the extract how both China and the USA are dealing with their current account imbalances (point 1)
The USA is running and maintaining a large current account deficit measured at approx $400bn in 2013. This can occur because the USA is a very attractive place for foreign businesses to set up and operate known as FDI. Once more, USA debt in the form of USA government bonds, is lucrative and offers a good rate of return, hence it is very easy for the USA can balance their current deficit by running an equally large financial account surplus by running surpluses in the direct investment and portfolio investment balances in the financial account.
Analyse using figure 2.1 in the extract how both China and the USA are dealing with their current account imbalances (point 2)
China is running a large current account surplus measured at approx $200bm in 2013. This means that China is sitting on huge excess cash reserves coming from the rest of the world as it sells exports, money which if invested can generate a significant rate of return. China invests this income where debt exists and where the best and a safe rate of return can be found, often debt of countries that run large current account deficits like the UK and USA. As a consequence money will be leaving the Chinese economy to buy USA govt. bonds and other financial instruments abroad leading to a deficit in the Chinese financial account balancing out their large current account surplus.
Analyse why savings from developing countries have ‘flooded into the USA’ (point 1)
One reason is that financial institutions either do not exist, are undeveloped or cannot be trusted in developing countries. This is because with low incomes and a general lack of education regarding the benefits of savings in developing countries, individuals simply don’e save in the volume seen in the developed countries therefore banks lack a profit motive to set up or be large enough to have a presence. Even if they do exist, many are western branches that exploit locals by charging very high interest rates on loans and low interest rates on savings. As a consequence, those with savings in developing countries will look abroad to strong, stable economies like the USA to keep their savings and generate a good rate of return
Analyse why savings from developing countries have ‘flooded into the USA’ (point 2)
A second reason is that the USA is seen as a lucrative investment for individuals in developing nations. This is because returns on government bonds for example are high in dollar terms for developing nations where exchange rates can often be weak and unstable against the dollar. Once more it is easy to access such credit markets with tech. improvements in the banking industry and through the development of the internet. As a consequence, individuals will seek to incest their money in USA government bonds for example as a safe investment guaranteed to make a return instead of taking more of a risk investing it at home
Analyse, making reference to international financial flows, how a country like the USA can run persistent current account deficits (point 1)
The USA can attract a huge amount of FDI. This is because the USA is an attractive place for foreign businesses to set up and operate given the size of the market, stability and tradability of the currency and the highly skilled workforce. As a consequence, the USA can balance their large current deficit by running an equally large financial account surplus by running surpluses in the direct investment balance in the financial account
Analyse, making reference to international financial flows, how a country like the USA can run persistent current account deficits (point 2)
The USA can finance its current account deficit easily by issuing debt to portfolio investors overseas. This is because USA debt in the form of USA government bonds is lucrative and offers a good rate of return, with the USA seen as a safe investment very unlikely to go bankrupt. As a consequence countries like China who run extremely large current account surpluses and look to invest this money to make a return will invest in USA government bonds and other financial assets allowing the USA to run a financial account surplus, with a positive portfolio investment balance, thus financing the current account deficit.
