What this lesson teaches
I can explain the causes of a current account deficit or surplus.
Syllabus K343, 6.4.2. Causes of current account deficit and surplus: reasons for current account deficits and surpluses
Make a guess
Incomes in a country rise quickly and people buy many more imported goods. What happens to its current account?
- It moves towards surplus, because the economy is growing.
- Nothing, because imports do not affect the current account.
- It moves towards deficit.
Show the answer
It moves towards deficit.
Higher incomes raise spending on imports. If exports do not rise as fast, more money flows out than in.
A deficit can come from strong spending on imports, an uncompetitive export sector or a strong currency; a surplus from the opposite.
High domestic incomes: when incomes rise, people buy more goods, including imports. Imports rise and the current account moves towards deficit.
Weak exports: if a country's firms have high costs or poor quality, their goods sell less abroad. Imports then take a larger share of sales at home. Prices rising faster than in other countries also make exports dearer.
A strong exchange rate makes exports dearer and imports cheaper, which also worsens the current account.
Surpluses come from the opposite. Firms make good products at low cost, people at home save a lot, the currency is weaker, or trading partners buy a lot. Countries that earn a lot from investments abroad may also have a surplus on primary income.
- Deficit causes
- High incomes and imports, low competitiveness, high inflation, strong currency.
- Surplus causes
- Competitive exports, high saving, weaker currency, strong foreign demand.
Worked example: Why Singapore runs a current account surplus
Singapore has had large current account surpluses for many years.
- Competitive exports: electronics, pharmaceuticals and financial services sell strongly abroad.
- High saving: Singapore residents save a large share of their income.
- Services: shipping, finance and tourism earn foreign currency.
- Result: inflows from exports and income exceed outflows for imports.
Watch out for this
A current account deficit always means the economy is weak.
A deficit can occur because incomes are rising fast and people buy more imports, or because firms import machines to invest. It is a concern mainly if it is large and lasting.
Check your understanding
What tends to give a country lasting surpluses on its current account?
- Exporters who are productive and competitive
- Households who spend heavily on imports
- A strong currency that makes exports dear
Show the answer
Exporters who are productive and competitive
Right. Competitive firms sell more abroad, so export earnings exceed spending on imports.
Check your understanding
Which change is most likely to worsen a country's current account balance?
- A boom in household spending on imported cars
- A rise in the productivity of its exporters
- A rise in foreign demand for its exports
- A fall in the value of its currency
Show the answer
A boom in household spending on imported cars
Right. Spending on imports rises, so more money flows out of the country.