AQA Specification focus:
‘The current account comprises trade in goods, trade in services, primary income and secondary income.’
The current account records a nation’s transactions with the rest of the world. It includes trade, income flows, and transfers, reflecting overall external economic performance.
Overview of the Current Account
The current account is a key component of the balance of payments, which measures all financial transactions between residents of a country and the rest of the world. It shows whether a nation is a net borrower or lender internationally and is critical for assessing external stability.
The current account consists of four major components:
Trade in goods
Trade in services
Primary income
Secondary income
Trade in Goods
Trade in goods refers to the export and import of tangible products such as raw materials, semi-manufactures, and finished consumer or capital goods.
Trade in Goods: The value of physical items (e.g. cars, machinery, oil, food) exported and imported between a country and the rest of the world.
Countries with significant manufacturing capacity, like Germany or China, often record large surpluses in goods. Conversely, countries dependent on imports for essential products, such as oil or advanced machinery, may face persistent deficits.
Factors influencing trade in goods include:
Relative productivity: Efficiency compared to international competitors.
Exchange rates: A strong currency makes imports cheaper but exports less competitive.
Global demand: International business cycles affect demand for manufactured exports.
Resource endowment: Availability of natural resources shapes import dependency.
Trade in Services
Trade in services has become increasingly important, especially for developed economies transitioning to service-based structures. Services include financial, insurance, tourism, education, and transport sectors.
Trade in Services: The export and import of intangible economic activities, such as banking, consultancy, education, tourism, and professional services.
The UK, for instance, often runs a significant surplus in services, particularly in financial and business sectors centred in London. Developing nations may show deficits if their economies rely less on high-value service exports.
Key determinants of trade in services:
Globalisation of finance and outsourcing.
Human capital and skill specialisation.
Tourism flows and international travel.
Technological development in digital trade and online services.
Primary Income
The primary income account records cross-border earnings from ownership of assets. This includes profits, interest, and dividends flowing in and out of a country.
Primary Income: Income flows from the ownership of factors of production abroad, including profits, dividends, interest, and compensation of employees.
Examples include:
A UK firm earning profits from a factory in India (credit).
Interest payments made by the UK to overseas bondholders (debit).
This balance is highly influenced by foreign direct investment (FDI) and portfolio investment flows. A country with extensive outward investment may earn large inflows, supporting a positive balance, while reliance on inward investment can generate outflows.
Secondary Income
The secondary income account records unilateral transfers between countries, where no good, service, or asset is exchanged in return.
Secondary Income: Net transfers between countries including aid, remittances, contributions to international organisations, and military support, without direct exchange for goods or services.
Examples include:
Remittances sent home by migrant workers.
UK government contributions to the United Nations.
Foreign aid given to developing countries.
This component is often negative for developed economies that contribute substantial aid or support international organisations, while countries receiving remittances may show positive balances.
Importance of Each Component
Each component of the current account provides insight into an economy’s global interactions:
Goods: Reflects industrial strength and resource dependency.
Services: Shows competitiveness in modern, knowledge-based industries.
Primary income: Indicates international investment positions.
Secondary income: Reveals political, humanitarian, and migrant linkages.
Current Account Balance
The overall balance on the current account is the sum of these four elements. A surplus indicates the country is a net lender abroad, while a deficit shows net borrowing.
Current Account Balance = Trade in Goods + Trade in Services + Primary Income + Secondary Income
Trade in Goods = Value of exports – Value of imports (physical goods)
Trade in Services = Value of service exports – Value of service imports
Primary Income = Net factor income from abroad
Secondary Income = Net current transfers
Persistent deficits may signal reliance on foreign borrowing, while persistent surpluses can suggest under-consumption or global trade imbalances.
Key Influences on the Components
Several factors influence the current account components:
Exchange rate fluctuations affecting relative prices.
Relative inflation rates altering competitiveness.
Global economic conditions influencing demand.
Domestic productivity growth determining export potential.
Policy decisions on aid, remittances, and international commitments.
Understanding these components equips students with the tools to analyse global economic trends and evaluate the health of a nation’s external position.
FAQ
Primary income refers to earnings from ownership of factors of production abroad, such as dividends, profits, and interest payments. These are tied to productive assets or investment positions.
Secondary income, on the other hand, involves one-way transfers where no good, service, or asset is exchanged in return. Examples include foreign aid, remittances from workers, and contributions to international organisations.
Developed economies frequently rely on imports of manufactured goods from lower-cost producers, leading to goods deficits.
However, their highly specialised and advanced service sectors — such as finance, education, and consultancy — enable them to export services globally. This often results in significant service surpluses, balancing out goods deficits.
Remittances are money transfers sent home by workers living abroad.
For developing countries, inflows of remittances can create a positive secondary income balance, supporting household consumption and investment.
For countries with many emigrants, this inflow boosts foreign exchange reserves and stabilises the current account.
Conversely, for countries where migrant workers are employed, outward remittances appear as debits, worsening the secondary income balance.
The UK is a major host for foreign investment, meaning profits, dividends, and interest are frequently sent abroad to overseas investors.
If returns paid to foreign investors exceed the income UK residents earn from investments abroad, the primary income balance becomes negative. This can persist due to the UK’s reliance on inward foreign direct investment.
A depreciation of the domestic currency:
Makes exports of goods and services cheaper, improving trade balances.
Increases the cost of imports, worsening deficits in goods or services if demand is inelastic.
Alters the value of income flows, as dividends and interest received from abroad may rise in domestic currency terms.
An appreciation has the opposite effects, potentially worsening the overall current account balance.
Practice Questions
Identify two components of the current account of the balance of payments. (2 marks)
1 mark for each correct component identified (maximum 2 marks).
Acceptable answers include:
Trade in goods (1)
Trade in services (1)
Primary income (1)
Secondary income (1)
Explain how a surplus in trade in services could affect a country’s overall current account balance. (6 marks)
Up to 2 marks for knowledge: recognising that trade in services is a component of the current account (1) and defining it as trade in intangible services (1).
Up to 2 marks for application: use of an example such as financial services, tourism, or education exports (1–2 marks).
Up to 2 marks for analysis: explaining that a surplus in services would increase the current account balance (1) and may offset deficits in other components such as goods or primary income (1).
Maximum 6 marks.
