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

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

Component 4: Primary Income (Factor Income)

1. Definition (Cambridge wording)

The primary‑income component records the remuneration of the factors of production (labour and capital) that move across borders. It shows the income residents receive from foreign‑owned factors and the income they pay to foreign‑owned factors.

2. Sub‑categories

  • Compensation of employees – wages, salaries, bonuses and other benefits paid to:

    • Residents working abroad (receipts)

    • Non‑residents working in the domestic economy (payments)

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

    • Dividends from foreign shares

    • Interest on foreign bonds, loans or deposits

    • Reinvested earnings (profits retained abroad)

    • Note: Capital gains on foreign assets are not counted as investment income in the primary‑income component; they belong to the capital account.

3. How Primary Income Is Recorded

Each transaction is entered twice – once as a receipt (inflow) and once as a payment (outflow). The net balance is the difference between total receipts and total payments.

Net Primary‑Income = Primary‑Income Receipts – Primary‑Income Payments

Worked double‑entry example (figures in £ million):

TransactionReceipt (Credit)Payment (Debit)
Dividends received from foreign subsidiary4
Dividends paid to foreign shareholders5
Wages earned by a resident in Country X2
Wages paid to a foreign specialist in the domestic economy1

Net Primary Income = (4 + 2) – (5 + 1) = 6 – 6 = 0 million £ (balanced).

4. Link to the Other Three Current‑Account Components

  • Trade in goods – physical export/import of merchandise.

  • Trade in services – tourism, transport, financial services, etc.

  • Secondary income (current transfers) – gifts, remittances, aid.

  • Primary income – factor payments crossing borders.

All four components add up to the total current‑account balance.

Suggested visual aid: a 2 × 2 matrix showing the four components (Goods, Services, Primary Income, Secondary Income) with arrows pointing to a box labelled “Current‑Account Balance”.

5. Causes of a Primary‑Income Surplus or Deficit (Cambridge‑exact wording)

FactorLeads to a SurplusLeads to a Deficit
High foreign ownership of domestic assets–More profit, dividend and interest payments abroad
Large overseas portfolio of assets owned by residentsHigher dividend and interest receipts–
Export‑oriented labour market (many citizens working abroad)More compensation receipts–
Domestic firms employing many foreign specialists–Higher compensation payments
Changes in world interest rates or dividend policiesHigher foreign interest/dividend receiptsHigher foreign interest/dividend payments
Tax incentives that encourage foreign direct investment (FDI)–More profit repatriation → payments
Currency‑exchange movements that affect the value of foreign‑currency receipts/paymentsAppreciation of the domestic currency can reduce the domestic‑currency value of payments, improving the balanceDepreciation can increase the domestic‑currency value of payments, worsening the balance

6. Economic Consequences

  • GDP vs. GNP – Primary‑income receipts are added to GDP to obtain GNP (national income). Payments are subtracted.

  • Employment – Large compensation receipts indicate a mobile labour force and raise household income and consumption.

  • Inflation – A primary‑income surplus adds to national income; if the economy is near full capacity this can create demand‑pull inflation.

  • External vulnerability – A chronic deficit signals reliance on foreign capital; sudden withdrawal can cause a sharp current‑account deterioration.

  • Exchange‑rate pressure – Surpluses increase demand for the domestic currency (tending to appreciate); deficits increase supply (tending to depreciate).

  • Borrowing costs & credit rating – Persistent primary‑income deficits can raise a country’s borrowing costs and lower its sovereign credit rating.

7. Policy Measures to Influence the Primary‑Income Balance

Policy ToolObjective (Cambridge phrasing)Typical Effect on Primary Income
Exchange‑rate policy (e.g., appreciation)Make foreign assets more attractive to residents and reduce the domestic‑currency value of foreign‑currency liabilitiesIncreases receipts (dividends, interest) and may reduce payments
Taxation of foreign‑source income (withholding tax, corporate tax)Discourage profit repatriation or excessive foreign investmentReduces primary‑income payments, improving the balance
Investment incentives for domestic firms abroad (tax credits, subsidies)Encourage outward FDIBoosts future receipts (profits, dividends) and moves the balance toward surplus
Restrictions on foreign ownership of key sectorsLimit outflows of profit and interestMay reduce primary‑income payments, but can deter foreign capital inflows
Labour‑mobility programmes (overseas training, migration policies)Increase the number of skilled workers abroadRaise compensation receipts

8. Illustrative Calculation

All figures are in £ million.

ItemAmount
Compensation of employees received from abroad5
Dividends received from abroad12
Interest received from abroad8
Compensation of employees paid to foreigners4
Dividends paid to foreigners10
Interest paid to foreigners9

Net Primary Income = (5 + 12 + 8) − (4 + 10 + 9) = 25 − 23 = 2 million £ (surplus).

9. Quick Revision – Key Points

  • Primary income = factor payments (labour + capital) that cross borders.

  • Two sub‑categories: Compensation of employees and Investment income (dividends, interest, reinvested earnings).

  • Recorded on a double‑entry basis; net balance = receipts − payments.

  • Causes of a deficit include high foreign ownership of domestic assets, large interest/dividend payments, many foreign workers, tax incentives for FDI, and adverse exchange‑rate movements.

  • Economic effects: impact on GDP vs. GNP, employment, inflation, external vulnerability, exchange‑rate pressure, and borrowing costs/credit rating.

  • Policy levers: exchange‑rate management, taxation of foreign income, outward‑FDI incentives, ownership restrictions, and labour‑mobility programmes.

  • Primary income together with trade in goods, trade in services and secondary income gives the total current‑account balance.

Suggested diagram: a two‑arrow flow chart showing primary‑income receipts (wages, dividends, interest) entering the domestic economy on the left and primary‑income payments (wages, dividends, interest) leaving it on the right, with the net balance highlighted in the centre.