Actions Taken By the UK Government to Improve Balance of Pay - Essay Example

? Balance of Payment Deficit: The Reason For and the Actions Taken By the Actions Taken By the UK Government to Improve Balance of Pay Institution: The UK balance of payments refers to the country’s transaction records or trade records with the rest of the world. A country’s balance of payments consists of various accounts like the current account which is arrived at by summing up the total values of trade in goods and services, the incomes from investments and the transfers (Nikolas 2010, p. 57). The capital or financial accounts which is arrived at by summing up the values of capital or financial flows, portfolio investments and the net investments. Additionally, an accurate balance of payment deficit must make provisions for errors and omissions to account for the missed out data. When there is a disequilibria in the balance of payments as a result of certain sections of the balance of payments being in deficit, then we can conclude that an economy’s balance of payments is deficit. This in most cases occurs with respect to deficits in a countries and to a smaller extent trade deficits. This is theoretically explained by the fact that for equilibrium to be reached, there must be a balance between capital/ current accounts values and the financial account. This therefore explains the UK situation is that if there is a deficit in current account then there must be a surplus on the capital/financial account (Nikolas 2010, p. 59). The ever persistent UK current account deficit can be traced to mid-1980s with a review of the current account revealing that the imports of goods and services exceed their exports. A critical review of the values of balance of payment account observed from the first quarter of the year 2000 to the last quarter of this year show a deteriorating current account. The study reveals a current deficit of over 12 billion pounds as at the last quarter of 2012 translating to a 3.2% of the GDP. The country’s deficit in current accounts can be attributed to various factors such as excessive growth, high consumer spending, overvalued exchange rate, stiff competitiveness and unbalanced economy. The UK economy growth trend at around 2.5% exemplifies an economy that if experiencing a quick growth above its normal trend making it difficult for the domestic output to cope up with the aggregate demand therefore resulting to a current account deficit. This is majorly attributed to the process of de-industrialisation which accelerated in the early 1980s. A growth in consumer spending that UK been experiencing is majorly as a result of rapid increase in the imports leading to the worsening of the current account. Looking at the 1980s boom, it is evident that the fall in the rate of savings and the resulting rise in the consumer spending of the UK citizens led to the record deficit in current accounts. On the other hand, the recession experienced in 1991 which resulted to the consequent improvement in the current account improvement and subsequent falling in the spending on imports (Guillermo 1978). Another important reason that can be attributed to the deficit in balance of payments is the overvalued exchange rates. This, apart from, other countries like Spain, Greece and Portugal can be attributed to the large account deficits in the countries as it makes exports from the countries more expensive in the international markets while the imports becomes cheaper. This is a motivation to the local consumers to purchase of the imports which are relatively cheap while on the other hand making the market tougher for the exporters since it makes them uncompetitive in the market compared to exporters from other countries. With overvalued exchange rate, there are expectations of general competitiveness in amongst various firms. A decline in relative competitiveness coupled with rising costs, poor quality of goods and industrial unrests which results to difficulties in making exportations which causes deterioration of the current account of the UK (Stijn 1988). Various economists have attribute the balance of payments deficit to the nature of the UK economy which is largely unbalance. The economy gives more focus to consumer spending as opposed to investments and exports which tends to result in a big deficit in current accounts of the UK. Despite this, the country has continued to be a net importer especially on manufactured goods with finished manufactured goods being the most affected followed by net imports in oil and food. The measures available to tackle balance of payments deficits include short term measures such as deflation, import controls, devaluation of a fixed exchange rate or a managed downward float of the exchange rate in the short-run and foreign exchange controls and long term measures such as Export promotion (Stijn 1988). Deflation is a policy of minimizing expenditure in a bid to curb a deficit through reduction of the demand for imports. This reduction of expenditure may be achieved by the use of either fiscal or monetary policy. In addition to reducing demand for imports however, deflationary measures may also have expenditure switching effect upon the balance of payments. The depression of demand may cause the domestic inflation rate to fall relative to that of competitor countries and thus increase the price competitiveness of exports. Consumers in other countries may then switch their demand towards the country’s exports, whilst its own residents switch away from imports, preferring instead to buy home produced substitutes. The difficulty posed by deflation is that it not only reduces demand for imports but also reduces demand for domestically produced goods. This in turn can have a knock on effect in the form of lower output and higher unemployment (Nikolas 2010). Import controls produces an immediate effect on the balance of payments. Quotas and embargos directly prevent or reduce expenditure on imports, while import duties or tariffs discourage expenditure by raising the price of imports, while import duties or tariffs discourage expenditure by raising the price of imports. Import controls also have their limitations and problems like not tackling the underlying cause of this disequilibrium It is also the case that trade agreements such as GATT limit the opportunities for member countries to make use of import controls and the use of subsidies to encourage exports. Devaluation of a fixed exchange rate or the downward float of a managed exchange rate is mainly expenditure switching in its effect. The cure works in a similar manner to the freely floating adjustment mechanism under a floating exchange rate system. In the case of a fixed exchange rate system devaluation consists of an administered reduction in the value of the currency against other currencies. In a managed system the authorities can engineer a downward float by temporarily reducing their support. In both cases the effect is to increase the price of imports relative to the price of exports and so switch domestic demand away from imports and towards home produced goods (Theodore 1974). Certain conditions have to be met for devaluation to have this effect on boosting exports/curbing imports. Competing countries must not devalue at the same time, otherwise there would be no competitive advantage gained and most importantly there must be appropriate domestic policy. However, a devaluation of the currency is not a soft option since there are a number of problems that will be involved, and these must be outlined (Nikolas 2010). When this is used to deny foreign exchange to would be importers, its effects are identical to those of the various import restrictions already discussed. There are various forms of exchange control that can be imposed by a government and enforced by legislation. They all involve restrictions on the actions of holders of its currencies and residents of the country who may hold foreign currency. A long term option of curbing balance of payments deficit is export promotion. This has proved to be the best method of improving a balance of payments in the long run. If the general level of efficiency in an economy can be raised, then exports will benefit. Efficiency can be promoted by mergers in exporting firms (thereby reaping economies of scale), research and economic growth – for it is felt that once an economy is growing it is generating the necessary dynamism and technological improvement that will feed through into a better export performance (Theodore 1974). Another long-term option is enforcing Import Substitution. Economic planning can be used for the replacement of imports by home products. If the defects of home products can be analysed, and the likely future trends in demand can be forecast, then domestic firms can take the necessary action both to improve their product and to expand their capacity. Government support for certain industries can also be helpful here. Reference Nikolas, A. M. (2010) Balance of payments accounting and exchange rate dynamics International Review of Economics & Finance, P. 46-63. Guillermo, A. C. (1978) Optimal seignior age from money creation: An analysis in terms of the optimum balance of payments deficit problem Journal of Monetary Economics, 4 (3), p. 503-517 Theodore, G. (1974) Tax rebating of exports and the balance of payments European Economic Review, 5(3), p. 197-205 Stijn, C. (1988). Balance-of-payments crises in a perfect foresight optimizing model Journal of International Money and Finance, 7(4) p.363-372 Read More