Impact on GDP, employment, inflation and foreign exchange rate

International Trade and Globalisation – Current Account of the Balance of Payments

1. What is the Current Account?

The current account records all transactions that involve the export or import of goods and services, income earned from abroad and paid to foreign residents, and unilateral transfers such as remittances and foreign aid.

• Trade in Goods (Merchandise) – exports and imports of physical products.
• Trade in Services – tourism, transport, insurance, consulting, etc.
• Primary Income – earnings on investments (interest, dividends) and compensation of employees.
• Secondary Income (Transfers) – gifts, remittances, foreign aid.

2. Current Account and GDP

GDP can be expressed as:

\$\text{GDP}=C+I+G+(X-M)\$

where X is exports and M is imports. The term (X‑M) is the net export component and is the direct link between the current account and GDP.

• A current‑account surplus (X > M) adds to GDP.
• A current‑account deficit (M > X) subtracts from GDP.

3. Impact on Employment

Employment effects depend on the structure of the economy and the type of trade.

1. Export‑oriented sectors – growth in exports raises demand for labour in manufacturing, agriculture, tourism, etc.
2. Import‑competing sectors – a rise in imports can reduce domestic production and lead to job losses unless the economy shifts resources to more competitive industries.
3. Service exports – high‑skill employment in finance, IT, and education can increase.
4. Transfer payments – remittances boost household income, potentially increasing labour‑market participation.

4. Impact on Inflation

Trade influences price levels through two main channels:

• Import Prices – cheaper imports exert downward pressure on domestic inflation; expensive imports can raise it.
• Exchange‑Rate Pass‑Through – changes in the foreign‑exchange rate affect the domestic price of imported goods.

When a country runs a current‑account deficit, demand for foreign currency rises, potentially depreciating the domestic currency and increasing import prices, which can fuel inflation.

5. Impact on the Foreign‑Exchange Rate

The current account is a major determinant of the supply and demand for a country’s currency in the foreign‑exchange market.

Key relationships:

\$\Delta E/E \approx \frac{\Delta \text{CA}}{\text{CA}}\$

where E is the exchange rate (domestic currency per unit of foreign currency) and CA is the current‑account balance.

• Surplus → higher demand for domestic currency → appreciation.
• Deficit → higher demand for foreign currency → depreciation.

6. Summary Table – Effects of Current‑Account Movements

7. Policy Implications

Governments may intervene to influence the current account and its macro‑economic effects:

• Fiscal policy – adjusting taxes or subsidies to promote exports or curb imports.
• Monetary policy – changing interest rates to affect exchange rates and thus the current account.
• Trade policy – tariffs, quotas, or trade agreements to manage the flow of goods and services.