Components of the current account of the balance of payments: trade in goods

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

Learning objective

Identify and explain the four components of the current account, understand how each component is measured, analyse the macro‑economic effects of surpluses and deficits, and describe the policy tools that can be used to maintain balance‑of‑payments stability – with a particular focus on trade in goods.

1. The current account – a brief definition

The current account records all transactions that involve the export or import of goods and services, the earnings on foreign assets, and unilateral transfers between residents and non‑residents. It shows a country’s net earnings (or payments) from abroad and is a key part of the balance of payments (BOP).

2. The four components of the current account

• Trade in goods – physical merchandise that crosses the border (exports vs imports).
• Trade in services – intangible products such as tourism, banking, insurance, consulting and software.
• Primary income – earnings on foreign assets (dividends, interest, rent) received by residents and similar payments made to non‑residents.
• Secondary income – unilateral transfers with no quid‑pro‑quo, e.g. remittances, foreign aid and pension payments.

Simple BOP illustration

3. Measuring the components

• Trade in goods & services – recorded by customs authorities (goods) and by national‑account surveys or balance‑of‑payments questionnaires (services). Values are expressed in the reporting country’s currency and then converted to US$ (or another base currency) at the prevailing exchange rate.
• Primary income – compiled from dividend, interest and rent statements supplied by banks, investment funds and tax authorities. Both receipts and payments are summed separately.
• Secondary income – obtained from remittance‑tracking systems (e.g., World Bank’s Migration and Remittances Factbook), foreign‑aid databases and pension‑payment records.

Numerical example – primary‑income balance

4. Trade in goods – definition & examples

Trade in goods is the physical movement of merchandise across a country’s borders.

• Exports of goods (X_g) – goods produced domestically and sold to foreign buyers (e.g., UK‑made cars shipped to the EU).
• Imports of goods (M_g) – goods produced abroad and purchased by domestic residents (e.g., smartphones imported from South Korea).

Calculating the trade‑in‑goods balance

\$\text{Trade‑in‑goods balance}=Xg-Mg\$

Numerical illustration – surplus

5. Full current‑account formula & legend

\$\text{Current Account}= (Xg+Xs+Ir+Tr) - (Mg+Ms+Ip+Tp)\$

Legend

• \$X_g\$ – Exports of goods
• \$M_g\$ – Imports of goods
• \$X_s\$ – Exports of services
• \$M_s\$ – Imports of services
• \$I_r\$ – Primary income received
• \$I_p\$ – Primary income paid
• \$T_r\$ – Secondary income received
• \$T_p\$ – Secondary income paid

6. Factors that influence trade in goods

• Exchange rates – A weaker domestic currency makes exports cheaper and imports more expensive.
• Domestic productivity – Higher productivity lowers unit costs, improving export competitiveness.
• Trade policies – Tariffs raise import prices; subsidies lower export prices.
• Global demand – Economic conditions in trading partners affect export volumes.
• Transport & logistics – Efficient shipping reduces costs and can boost trade volumes.
• Environmental standards – Carbon taxes or “green” regulations can alter the cost of exported and imported goods.

7. Macro‑economic consequences of surpluses and deficits

7.1 Trade‑in‑goods surplus (X_g > M_g)

• GDP – Net exports are positive, adding to aggregate demand and raising real GDP.
• Employment – Export‑oriented sectors (manufacturing, agriculture, mining) tend to expand, creating jobs.
• Inflation – Greater foreign‑exchange earnings can lower the price of imported inputs, reducing cost‑push inflation.
• Exchange rate – Higher demand for the domestic currency to pay for exports creates upward pressure (possible appreciation).
• Reserves – Accumulation of foreign‑exchange reserves strengthens the country’s external position.
• Policy space – A surplus gives the government more flexibility to run fiscal deficits or to lower interest rates.

7.2 Trade‑in‑goods deficit (M_g > X_g)

• GDP – Net exports are negative, pulling down aggregate demand and real GDP.
• Employment – Domestic industries that compete with imports may contract, leading to job losses.
• Inflation – A larger share of consumption is financed by imports; higher import prices can raise consumer‑price inflation, especially for essential goods.
• Exchange rate – Persistent deficits put downward pressure on the domestic currency (possible depreciation).
• Reserves – Financing the deficit may deplete foreign‑exchange reserves or increase external borrowing.
• Policy space – The need to attract capital inflows or to raise interest rates can limit fiscal expansion.

7.3 Overall current‑account surplus / deficit

The same macro‑economic links apply, but the balance also reflects income flows and transfers. A current‑account deficit, for example, means the country is a net borrower from the rest of the world, which can raise vulnerability to sudden stops in capital flows.

8. Policy toolkit for balance‑of‑payments stability

9. Environmental & sustainability dimension

• Carbon border adjustments – taxes on imports based on their carbon footprint, encouraging greener production abroad.
• Eco‑labelling & standards – can give market advantage to environmentally friendly domestic goods.
• Modern trade agreements increasingly contain clauses on sustainable production, which can affect both export opportunities and import costs.

10. Revision checklist

1. Define the current account and list its four components with a one‑sentence definition for each.
2. Explain what “trade in goods” means and give one example of an export and one of an import.
3. Write the formula for the trade‑in‑goods balance and for the full current‑account balance; be able to interpret every symbol.
4. Calculate a surplus and a deficit using the numerical tables provided (goods and primary‑income examples).
5. Identify at least three factors that affect a country’s trade in goods.
6. Describe how a surplus or deficit in trade in goods influences GDP, employment, inflation, exchange rate, reserves and policy space.
7. Recall the main policy instruments governments can use to correct persistent imbalances.
8. Explain one way in which environmental considerations are entering the current‑account discussion.