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The balance of payments and the current account

Edexcel IAL Economics · WEC12 Macroeconomic performance and policy

The balance of payments records all transactions between a country's residents and the rest of the world. In Unit 2 the focus is the current account.

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Components

Current account: trade in goods; trade in services; primary income (wages, profits, interest and dividends from overseas investments); secondary income (transfers such as remittances, foreign aid and contributions to international bodies).
Capital account: small transfers of capital assets, such as debt forgiveness.
Financial account: flows of investment: foreign direct investment, portfolio investment (shares and bonds), loans and changes in reserves.

Overall the balance of payments must balance: a current account deficit is matched by a net inflow on the capital and financial accounts (plus a balancing item for errors).

Trade balances

Trade in goods balance = exports of goods - imports of goods (the 'visible' balance).

Trade in services balance = exports of services - imports of services (tourism, finance, shipping, insurance).

The trade balance = goods balance + services balance. A deficit means more imports than exports.

Current account deficits and surpluses

Current account balance = trade in goods + trade in services + primary income + secondary income.

A deficit means the country spends more abroad than it earns, so it must borrow or sell assets to finance it. A surplus means it earns more than it spends abroad, so it builds up assets abroad. Causes of a deficit include strong consumer demand for imports, an overvalued currency, high inflation relative to rivals, weak productivity and non-price competitiveness. Note that net trade (X - M) is the AD component, so a worsening trade balance reduces AD.

Worked example

Use these figures ($ bn): Trade in goods -42, Trade in services 25, Primary income -8, Secondary income -6. Find the trade balance and the current account balance.

Trade balance = -42 + 25 = -17
Current account = -42 + 25 + -8 + -6 = -31

Answer: Trade deficit $17 bn; current account deficit $31 bn

Key idea: Current account = goods + services + primary income + secondary income. Trade balance = goods + services. A deficit must be financed by net inflows on the financial account.

Check yourself

Exports of goods are $310 bn and imports of goods $355 bn. Find the trade in goods balance in $ bn (use a negative for a deficit).
Show answer
-45 bn. 310 - 355 = -$45 bn, a deficit.
Trade in goods -20, trade in services +12, primary income +5, secondary income -4 ($ bn). Find the current account balance in $ bn.
Show answer
-7 bn. -20 + 12 + 5 - 4 = -$7 bn.
A current account deficit is $36 bn and GDP is $900 bn. Express the deficit as a % of GDP.
Show answer
4 %. 36 / 900 x 100 = 4% of GDP.
Profits sent home by a foreign-owned car factory to its parent company abroad are recorded as
- an import of goods
- an outflow in secondary income
- an inflow in the financial account
- an outflow in primary income
Show answer
an outflow in primary income. Investment income (profits, interest, dividends) is primary income.
Remittances sent home by migrant workers to their families abroad are recorded in
- primary income
- secondary income
- trade in services
- the capital account
Show answer
secondary income. Transfers with nothing received in return are secondary income.
A tourist from abroad spends money in a country's hotels. For that country this is
- an import of services
- an export of goods
- a secondary income credit
- an export of services
Show answer
an export of services. Money flows in for a service provided to a non-resident.
Which is most likely to cause a current account deficit to widen?
- A depreciation of the currency with elastic demand for exports and imports
- Rapid growth of consumer spending on imported goods
- Faster productivity growth than trading partners
- A recession at home
Show answer
Rapid growth of consumer spending on imported goods. Higher spending on imports raises M relative to X.
Explain what is meant by a current account deficit.
Show answer
The value of money flowing out for imports of goods and services, primary income and transfers is greater than the money flowing in, so the country spends more abroad than it earns.. Outflows on the current account exceed inflows.

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Sources

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2 (June 2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.