Balance of Payments + FDI

Question 1

What does the CURRENT ACCOUNT consist of?

Answer 1

1) Trade in goods (products)
2) Trade in services
^ Trade balance ^

3) Income (wages expenditure location)
4) Transfers (gov.aid)
^ Income balance ^

Question 2

What is the Balance of Payments?

Answer 2

• A record of international transactions.

Question 3

What does the FINANCIAL ACCOUNT consist of?

Answer 3

1) Portfolio investment ~> bonds ~> shares ~> derivatives
2) FDI
3) Reserves ~> Currency ~> Gold

Question 4

Demand-side causes of a CURRENT ACCOUNT deficit?i

Answer 4

1) Strong domestic growth
2) Recession over-seas
3) Strong exchange rate

Question 5

Supply-side causes of a CURRENT ACCOUNT deficit?

Answer 5

1) Low investment ~> low productivity ~> high unit labour cost

2) High relative inflation
^ Price comp.^

3) Poor quality and Reliability

4) Depletion of resources

Question 6

Consequences of a CURRENT ACCOUNT deficit

(pros & cons)

Answer 6

Cons:

1) decreased/ AD/ growth (effectiveness demand on demand-sided/ supply)

2) Unemployment = regressive (inflow of FDI/ finacial account = jobs)

3) decreased value £/ increased cost = stagflation/ (self-correcting/ floating/ long-run) = fall in real incomes

4) Need to run a capital account surplus = attract FDI = sell bonds = unsustainable = investors loose confidence/ how UK gonna finance Current account defecit = fear of sustainability = withdraw money = currency crisis.

Question 7

Demand-side causes of a CURRENT ACCOUNT surplus?

Answer 7

1) High incomes abroad
2) Low incomes at home
3) Weak exchange rate

Question 8

Supply-side causes of a CURRENT ACCOUNT surplus?

Answer 8

1) Strong investment ~> low ULC
2) Low relative inflation
^ Price comp.^
3) New resource discoveries

Question 9

Consequences of a CURRENT ACCOUNT surplus?

Answer 9

Pros:

1) Increased: AD, GROWTH, Inflation, and Exchange rate

2) Decrease in unemployment

Cons:

3) Financial account deficit (countries owe you a lot of money?)/ pay-back problems = uncertainty

4) Sign of an unbalanced economy? (e.g. China - weak domestic demand - too reliant on consumption abroad)/ not enough consumer spending

Question 10

What does the CAPITAL ACCOUNT consist of?

Answer 10

1) Debt forgiveness
2) Inheritance taxes
3) Sales of tangible assets
4) Sales of intangible assets

Question 11

FDI benefits?

Answer 11

• Injection into circular flow –> Decreased unemployment
• Improved living standard + Decreased crime
• Fills savings gap
• Positive effect on the BoP
• Infrastructure development
• Improved productivity –> domestically
• Technology transfer
• Increased TAX rev

Question 12

FDI drawbacks?

Answer 12

• Multinationals take advantage of cheap labour
• Control politics to influence regulation
• Profits sent to shareholders ~> CA DEFICIT
• Environmental impacts (Pollution)
• MNCs may bring their own workforce
• MNCs may extract and ship resources back home (depletion of resources).
• Employment may be short-term

Question 13

Evaluation of FDI?

Answer 13

• Small industries have smaller impacts on the economy as a whole.

Question 14

4 policies to help correct a Current account Deficit?

Answer 14

Demand Control policies:

• Expenditure Reducing policy (contractionary monetary/ fiscal pol.) - (capital flight)
• Deflation
• Spare cap. for exports –> price comp.

Import Controls:

Expenditure Switching:

• Devaluation or Currency Depreciation ( Marshall Lerner Theory?) (Capital flight?)
• Tariffs (retaliation)

Improving macroeconomic Stability:

• Attract inward investment

Supply-side policies:

• Infrastructure improvement –> boost productivity + competitiveness
• Business start-ups —> export potential
• Education and healthcare (time-lag)

Question 15

How would you correct Current account surplus?

Answer 15

Reflating demand

Remove import controls

Revalue currency