bop adjustment policies - as level

7/28/2019 BoP Adjustment Policies - AS LEVEL

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Balance of Payments Adjustment Policies



Deficits and Surpluses as a share of GDP

Current account deficit as a percentage of GDP

Current Account Balances - Deficits and Surpluses

GermanyIrelandJapan

SpainUnited KingdomUnited States

West Germany

Source: OECD

98 99 00 01 02 03 04 05 06 07 08

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

P E R C E N T

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

Why might the deficit

as a share of GDPbe a better guide to

the size of a trade

imbalance?



Are deficits self-correcting?

• Some partial self-correction

• Economic slowdown and recession

– Squeeze on real incomes and output

– Fall in import demand

– Releases capacity for exporting

• Deficit might lead to depreciation in theexchange rate

– Change in relative prices of exports andimports

– Expenditure-switching towards exports andaway from imports

– Depends on price elasticity of demand for Xand M and also elasticity of supply



The US trade deficit and their recession

$ billion per month

United States Balance of Trade in Goods

Annual growth of real GDP Trade balance in goods and services $bnSource: Reuters EcoWin

01 02 03 04 05 06 07 08

b i l l i o n

s

-70

-65

-60

-55

-50-45

-40

-35

-30

-25

U S D

( b i l l i o n s )

-70

-65

-60

-55

-50-45

-40

-35

-30

-25

-4

-2

0

2

4

6

8

P e r c e n t

-4

-2

0

2

4

6

8

Note the steep fall in

the trade deficit as the

economy hit recession.

Why is income

elasticity of demand

important in this chart?

But what are the wider

economic effects?



Expenditure switching

• Expenditure switching:

– Change in relative prices of X and M

– Changes incentives for consumers

– Changes profitability of exporting

– Can be caused by

• Movement in the exchange rate

• Introduction of import tariffs and other forms

of protectionism

• Period of high or low relative inflation

– Key point is whether trade volumes respond

to changing prices

– I.e. price elasticity of demand for X and M



Any evidence for the UK?

Quarterly trade balance, £ billion (bottom pane) and exchange rate index

UK Trade & the Sterling Exchange Rate

Effective Exchange Rate Index Balance of Trade in Goods and Services

Source: Reuters EcoWin

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

b i l l i o n s

-15.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

Q u a r t e r l y b a l a n c e

£ ( b i l l i o n s )

-15.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

70

75

80

85

90

95

100

105

S t e r l i n g i n d e x

70

75

80

85

90

95

100

105



The J Curve

• Effect of a depreciation on the trade deficitdepends on price elasticity of demand.

• In the short term, demand is often inelastic – limits extra revenue from exports

• Demand for M is inelastic – higher prices causea rise in total spending on imports

• The J Curve effect says a trade deficit canworsen after a depreciation, but get better in thelong term provided that the elasticity of demandis high enough

• Marshall-Lerner condition: Trade balance willimprove if Ped X + Ped M . 1

• Elasticity of supply of domestic producers isalso important (often forgotten)



The J Curve effect

Tradesurplus

Trade

deficit

A

Time

B

C

Ped X + Ped M > 1 for

the trade balance to

improve



Expenditure Reduction

• Expenditure reduction

– Cutting aggregate demand

– Direct effect on consumption and thereforedemand for imports:

– Possible routes: • Higher direct taxes – lower disposable

income

• Low taxes on saving

• Increased interest rates – to dampen

consumption • Cut in government spending

– Focus here is on income elasticity of demand for imports



Supply-side policies

• To rebalance trade over the medium term

• Focus on

– Improving competitiveness in global markets:

• Innovation

• Research and development

• Product quality / design

• Infrastructure to support trade sectors

– Attracting inward investment – producing outputdomestically and then exporting

– Raising productivity / lowering unit costs

– Developing areas of new competitive advantage

– Raising foreign income elasticity of demand for exports

– Reducing foreign price elasticity of demand for exports



Weaknesses on supply-side and UK trade

• Persistent productivity gap

• Low business investment as a share of

GDP

•

Low levels of research anddevelopment

• Loss of capacity in manufacturing

industry

• Evidence that UK exports have lower income elasticity of demand than our

income elasticity of demand for imports



The Productivity Gap

95

100

105

110

115

120

125

130

135

140

1992 1994 1996 1998 2000 2002 2004 2006

Source: ONS

France

Germany

UK

US

GDP per hour workedComparison, 1996-2007

Index, UK = 100

Source: UK competitiveness indicators, Feb 2009



Investment Gap?

Business investmentComparison, 1992-2007Per cent of GDP in current prices

8

10

12

14

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Germany

France

UK

US

Source: OECD




Research Gap?

1.5

2.0

2.5

3.0

1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7

Source: OECD

France

Germany

UK

US

Gross domestic expenditure on R&DComparison, 1992-2006Per cent of GDP




UK Exports and Imports

Annual value of trade - £billion at current prices

UK Exports and Imports of Goods and Services

Source: Reuters EcoWin

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

b i l l i o n s

100

150

200

250

300

350

400

450

G B P

( b i l l i o n s )

100

150

200

250

300

350

400

450

Imports

Exports

Balance of Payments: Exports: Total Trade in Goods & Services 368.337G

Balance of Payments: Imports: Total Trade in Goods & Services 415.817G



Summary points

• Some trade deficits are partially self correcting

• But recession and a depreciation arenot enough if the root causes lie on thesupply-side of the economy

• Ultimately BoP adjustment requires:

– Period of below trend growth

– Improvement in investment in traded goodsindustries

–Control of price and cost inflation relative tothat of our competitors

– Open trade to drive better exportperformance

– Protectionism is not the answer



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bop adjustment policies - as level

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