AQA Specification focus:
‘The meaning of a deficit and a surplus on the current account.’
Understanding deficits and surpluses on the current account is essential in A-Level Economics, as they reveal whether a country spends more on imports than it earns from exports.
The Current Account: An Overview
The current account is a key component of the balance of payments, recording all trade in goods and services, income from investments, and transfers between countries. It provides a snapshot of a nation’s international economic position.
Main Components of the Current Account
Trade in goods (visible balance)
Trade in services (invisible balance)
Primary income (investment income such as interest, profits, dividends)
Secondary income (transfers such as aid, remittances, EU contributions in the UK’s case before Brexit)
When we talk about deficits and surpluses, we are assessing whether these combined flows are positive (a surplus) or negative (a deficit).
What is a Current Account Deficit?
A deficit occurs when the value of a country’s imports of goods, services, and transfers exceeds the value of its exports and inflows of income.
Current Account Deficit: A situation where a country’s total payments to other countries exceed its total receipts from abroad.
A deficit means the country is a net borrower from the rest of the world, often requiring financing through borrowing, foreign investment, or selling reserves.
Causes of Current Account Deficits
High consumer demand for imports, often due to rising incomes.
Poor competitiveness of domestic industries, leading to weak exports.
An overvalued exchange rate making exports expensive and imports cheaper.
Structural reliance on foreign goods, services, or energy imports.
Implications of Current Account Deficits
Can lead to foreign debt accumulation if persistent.
May weaken the exchange rate if confidence in the currency falls.
Could indicate deeper structural weaknesses in the economy.
In the short term, might not be harmful if financed by capital inflows or FDI.
What is a Current Account Surplus?
A surplus occurs when the value of a country’s exports of goods, services, and income inflows exceeds the value of its imports and income outflows.
Current Account Surplus: A situation where a country’s total receipts from abroad exceed its total payments to other countries.
A surplus means the country is a net lender to the rest of the world, supplying capital to deficit countries.
Causes of Current Account Surpluses
High levels of competitiveness in exports (e.g. Germany, China).
Undervalued exchange rate boosting export demand.
High national savings relative to investment, reducing import dependency.
Structural strengths such as advanced manufacturing or strong service exports.
Implications of Current Account Surpluses
Strengthens the exchange rate if inflows are large.
May allow accumulation of foreign reserves and greater financial stability.
Can cause global imbalances, especially if surpluses are persistent.
May signal under-consumption domestically, with reliance on external demand.
Comparative Significance of Deficits and Surpluses
Both deficits and surpluses are not inherently “good” or “bad.” Their impact depends on:
Duration: Persistent imbalances are more concerning than temporary ones.
Financing method: Deficits financed by short-term borrowing are riskier than those financed by long-term foreign investment.
Economic context: A growing economy may sustain a deficit more easily than a stagnant one.
Short-Term vs Long-Term Effects
In the short term, a deficit may reflect strong domestic demand and economic growth.
In the long term, a sustained deficit could undermine stability.
Surpluses can show competitiveness but may reduce domestic consumption if excessive.
Measurement and Data Recording
The Office for National Statistics (ONS) records the UK’s balance of payments, publishing quarterly data on the current account. Economists use this to identify trends and assess sustainability.
Current Account Balance (CAB) = (Exports of Goods + Exports of Services + Primary Income Inflows + Secondary Income Inflows) – (Imports of Goods + Imports of Services + Primary Income Outflows + Secondary Income Outflows)
CAB > 0 = Surplus
CAB < 0 = Deficit
This formula highlights the need to consider all flows, not just visible trade in goods.
Real-World Context
The UK has traditionally run a current account deficit, driven by a deficit in goods offset partially by a surplus in services.
Countries such as Germany and China have long run surpluses, reflecting strong export sectors.
The USA runs persistent deficits but sustains them due to the dollar’s status as the world’s reserve currency.
Key Takeaways for A-Level Students
A current account deficit = more money leaving the economy than entering, financed by borrowing or capital inflows.
A current account surplus = more money entering the economy than leaving, often creating capital outflows.
The significance of imbalances depends on their size, duration, financing, and the overall economic situation.
FAQ
A cyclical deficit arises due to fluctuations in the business cycle, such as high imports during an economic boom.
A structural deficit occurs when an economy has deeper, long-term issues such as weak industrial competitiveness, high production costs, or reliance on imported resources.
Countries may tolerate short-term deficits if they support economic growth or investment.
Borrowing or inward investment can finance productive projects.
Deficits may be less concerning if debt remains manageable or if the economy has strong growth prospects.
Yes, large surpluses can create global imbalances.
They may force deficit countries into unsustainable borrowing.
Surpluses can contribute to trade tensions, protectionism, or currency disputes.
This imbalance may reduce overall global demand if surplus nations save excessively.
A depreciation makes exports cheaper and imports more expensive, potentially reducing a deficit or increasing a surplus.
An appreciation has the opposite effect, often worsening a deficit or reducing a surplus.
The impact depends on the price elasticity of demand for imports and exports, known as the Marshall-Lerner condition.
Deficits are often funded through capital inflows.
Foreign investors may buy government bonds or invest in businesses.
This provides immediate financing but can increase vulnerability if investors withdraw suddenly.
Reliance on short-term investment flows is riskier than long-term foreign direct investment (FDI).
Practice Questions
Define what is meant by a current account deficit. (2 marks)
1 mark for recognising that a deficit means imports and payments abroad exceed exports and receipts.
1 mark for reference to the current account being part of the balance of payments or including goods, services, income and transfers.
Explain two possible consequences of a persistent current account surplus for an economy. (6 marks)
Up to 3 marks for each well-explained consequence (2 x 3 marks = 6).
1 mark for identification of a relevant consequence (e.g. stronger exchange rate, accumulation of foreign reserves, reduced domestic consumption, global imbalances).
1–2 additional marks for clear explanation:
e.g. Stronger exchange rate leading to reduced export competitiveness in the long run.
e.g. Excessive reliance on external demand causing under-consumption domestically.
Maximum of 6 marks.
