Introduction

This background paper discusses the compilation of balance of payments statistics and illustrates the calculation of the summary measures (balance of trade and current account balance of payments) employed by economists in analysing balance of payments trends. It is suggested that you consult Thirlwall (1980) to improve both your understanding of this class of statistics and your knowledge of UK balance of payments trends since the mid-nineteenth century. Another useful text is Backhouse (1991, ch. 5) but his account is confined entirely to the postwar period.

Balance of payments: definitions and concepts

Introduction

The difference between exports and imports, as measured in the national income accounts, is termed the balance of trade (or the trade balance). This needs to be distinguished from two other measures: the current account balance and the balance of payments.

 Table BG.4A Balance of payments at current prices (£bn), 1988
 

SOURCE: Backhouse (1991, table 5.1).

Using table BG.4A to assist you, work through the following balance of payments identities (line numbers are given in parentheses):

• Balance of trade (7) = Visible trade balance (3) + Invisible trade balance (6)
• Visible trade balance (3) = Exports of goods (1) - Imports of goods (2)
• Invisible trade balance (6) = Exports of services (4) - Imports of services (5)
• Current account balance (9) = Visible trade balance (3) + Invisible trade balance (6) + Interest, dividends, profits and transfers (8).
• Balance of payments (15) = Current account balance (9) + Total capital account (13) + Balancing item (14).

From this numerical example for 1988 it can be seen that the UK ran a substantial deficit on visible trade, that is imports of goods exceeded exports of goods, which was only partially compensated for by a surplus on the invisibles account, that is exports of services exceeded imports of services. To the resulting deficit on the balance of trade we then add the surplus on interest etc. to obtain the current account balance of payments, thereby producing an overall deficit. The addition of capital transactions and the balancing item produce the overall balance of payments, a measure of the change in Britain’s overall official foreign currency reserves, which in this case is in surplus because of the large balancing item, suggestive that the value of exports had been understated and/or imports overstated.

The current account

The current account of the balance of payments is the account in which the values of the flows of goods and services and other current receipts and payments between residents of the UK and residents of the rest of the world are recorded. It is thus of central importance in the assessment of a country’s international trading performance.

The structure and presentation of the current account of the balance of payments is shown in table BG.4B which records data for the interwar years, 1924-37, and uses the following legend:

1. Exports and re-exports of goods.
2. Exports of services.
3. Property income from abroad.
4. UK taxes paid by non-residents.
5. Current transfers: government and personal.
6. Total
7. Imports of goods.
8. Imports of services.
9. Property income paid abroad.
10. Foreign taxes paid by UK residents.
11. Current transfers: government and personal.
12. Total.
13. Visible trade balance.
14. Invisible trade balance.
15. Balance of dividends, interests and profits.
16. Net investment abroad = current account balance of payments.

The three balances of the current account (visible trade, invisible trade and current account balance) are shown columns (13), (14) and (16) respectively.

Table BG.4B UK balance of payments, current account, current prices (£m), 1924-37
 

SOURCE: Derived from Feinstein (1972, table 15).
 

 
Figures BG.4A and BG.4B chart the key data in table BG.4B as a percentage of GDP. This is a more useful way of presenting balance of payments data because it abstracts from the problem of changes in the price level and permits the use of a central reference point, GDP, to illustrate the importance of foreign trade. Figure BG.4A shows the decline in the openness of the British economy between the wars,  in part because of reduced price and non-price competitiveness  but also in the 1930s as a consequence of the collapse of world trade. Figure BG.4B reveals that current account surplus in the 1920s gave way in 1931 to a deficit of over 2 percentage points of GDP as both the visible and invisible balances deteriorated.
 

Capital account

Clearly, the balance of payments must balance (though the accounts always contain a balancing item to permit this); and thus if the current account balance is in surplus it must be balanced by an equivalent deficit or vice versa in the other two components of the balance of payments:

• capital account, which records the balance of capital transactions (i.e. debt/investments) which pass over the exchanges;
• official settlements account, which records the net receipts and payments of gold and foreign currency from the current and capital account transactions.

A complete summary of the balance of payments for the crisis year of 1967 (the year the Wilson government was financed forced to devalue sterling from $2.80 to $2.40) is given in table BG.4C.

 Table BG.4C UK balance of payments, current prices (£m), 1967
 

SOURCE: Thirlwall (1980, table 1.2).

The current balance, which  is defined as the sum of rows (2) and (3), was in deficit in this crisis year of £294m or 0.7% of GDP (much less than the current account deficits recorded in the late 1980s and early 1990s). To this we have to add row (7), a very large figure for net overseas investment (this was a period when British companies were investing heavily overseas), row (8) the balancing item (approximating to the same size as the current account deficit) and row (9), the operating losses of the Exchange Equalization Account, the Bank of England account which manages the sterling exchange rate. The sum of rows (4)-(9) yields row (10), the official settlements account balance, which shows that the overall balance of payments deficit was financed by government borrowing overseas (row 11) and some reduction in official reserves (row 12).

Balance of payments statistics: reliability

Finally, how reliable is the balance of payments data for the economic historian? Feinstein’s reliability grades are shown in table BG.4D - draw your own conclusions!

 Table BG.4D Feinstein’s reliability grades for balance of payments data, 1870-1965
 

 NOTES:
 A = Firm figures +/- < 5%; B = Good estimates +/- 5%-15%; C = Rough estimates +/- 15%-25%; D = Conjectures +/- 25%
 SOURCE: Feinstein (1972, p. 115).
 
 

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(c)R. Middleton 1997. Last modified 30 June 1998.