Components of the current account of the balance of payments: primary income

Published by Patrick Mutisya · 14 days ago

IGCSE Economics – Current Account: Primary Income

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

Objective: Understand the Primary Income component

The current account records all transactions that involve the exchange of goods, services, income and current transfers between residents of a country and the rest of the world. One of its four main components is Primary Income, also known as factor income.

What is Primary Income?

Primary income consists of the earnings that residents receive from, or pay to, foreign factors of production. It reflects the remuneration of labour and capital across borders.

  • Compensation of employees: wages, salaries and other benefits earned by residents working abroad and by non‑residents working in the domestic economy.

  • Investment income: returns on cross‑border ownership of assets, including:

    • Dividends from foreign shares.

    • Interest on foreign bonds or loans.

    • Reinvested earnings (profits) of foreign subsidiaries.

How Primary Income is Recorded

Each primary‑income transaction is recorded twice – once as a receipt (inflow) and once as a payment (outflow). The net figure is calculated as:

\$\text{Net Primary Income} = \text{Primary Income Receipts} - \text{Primary Income Payments}\$

Typical Sources of Primary Income Receipts

SourceExampleTypical Direction
Wages earned abroadBritish engineer working in Saudi ArabiaReceipt
Dividends from foreign sharesUK investor receives dividends from US stocksReceipt
Interest on overseas bondsUK government holds Japanese government bondsReceipt
Reinvested earnings of foreign subsidiariesProfits of a UK‑owned factory in MexicoReceipt

Typical Sources of Primary Income Payments

SourceExampleTypical Direction
Wages paid to foreign workersSaudi oil company employing British engineersPayment
Dividends to foreign shareholdersUK company pays dividends to US investorsPayment
Interest on foreign loansUK government pays interest on Euro‑bond issuePayment
Profits repatriated by foreign subsidiariesUS parent company receives profits from its UK subsidiaryPayment

Why Primary Income Matters

  1. It shows how much a country is earning from its overseas assets versus how much it is paying to foreign owners of domestic assets.

  2. A persistent primary‑income deficit can indicate a reliance on foreign capital and may affect the sustainability of the current account.

  3. Changes in interest rates, dividend policies, or labour mobility directly influence primary‑income flows.

  4. Primary‑income balances are linked to exchange‑rate movements: a surplus can support a stronger domestic currency, while a deficit can exert downward pressure.

Illustrative Calculation

Assume the following annual figures (in £ millions):

  • Compensation of employees received from abroad: 5

  • Dividends received from abroad: 12

  • Interest received from abroad: 8

  • Compensation of employees paid to foreigners: 4

  • Dividends paid to foreigners: 10

  • Interest paid to foreigners: 9

Net Primary Income is calculated as:

\$\text{Net Primary Income}= (5+12+8) - (4+10+9) = 25 - 23 = 2\ \text{million £}\$

The country records a net primary‑income surplus of £2 million.

Key Points to Remember

  • Primary income reflects factor payments – labour (wages) and capital (interest, dividends, profits).

  • It is split into receipts (inflows) and payments (outflows).

  • The net figure influences the overall current‑account balance.

  • Monitoring primary‑income trends helps policymakers assess external vulnerability.

Suggested diagram: Flow diagram showing primary‑income receipts (wages, dividends, interest) entering the domestic economy and primary‑income payments (wages, dividends, interest) leaving it.