Edexcel IAL Economics: Balance of payments and competitiveness (YEC11) – Revision Notes

These notes condense statements 1 and 3 of 4.3.3 Balance of payments, exchange rates and international competitiveness in the Pearson Edexcel International Advanced Subsidiary/Advanced Level Economics specification (Issue 2, June 2018). The specification lists Units 1 and 2 as International AS (IAS) and Units 3 and 4 as the extra International A2 (IA2) content, so this Unit 4 material is for the full International Advanced Level only. Full explanations are in the study guide; test yourself with the practice questions. See also the course hub, the printable checklist and the free diagnostics. All figures are invented and illustrative. Exchange rates and their effects are covered in a separate unit.

Balance of payments in one table (1a)

Account	Contains	Remember
Current	Goods, services, primary income, secondary income	“Balance of payments deficit” usually means this account
Capital	Small capital transfers	Often tiny
Financial	FDI, portfolio investment, other investment, reserves	Finances the current account

Current account balance = (goods X - M) + (services X - M) + net primary income + net secondary income. Current + capital + financial + net errors and omissions = 0 (capital inflows counted positive).

Reminder. Goods -30, services +18, primary income -6, secondary +2: current account = -30 + 18 - 6 + 2 = -16. With capital account +1 and no errors, the financial account must be +15.

Causes (1b)

Deficit	Surplus
Fast growth, high income elasticity of imports	Slow domestic growth, weak import demand
Rising unit labour costs, poor quality	Strong competitiveness
High exchange rate	Low exchange rate
Narrow export base, commodity price fall	Resource or specialist export earnings
Interest and profit paid abroad	Net income earned from overseas assets
Low saving	High saving

Distinguish a cyclical deficit (boom, likely to reverse) from a structural one (weak competitiveness, persists).

Measures to reduce an imbalance (1c)

Method in steps:

1. Name the type: expenditure-reducing, expenditure-switching or supply-side.
2. Give the chain: policy → change in price or income → imports or exports → balance.
3. Give one cost and one condition for success.
4. Make a judgement: short-run versus long-run.

Worked reminder: a tariff. Country D imports 100 units at a world price of 8 cu (spending 800). A 20% tariff raises the home price to 9.6. Price elasticity of demand for imports is -1.5.

Quantity change = -1.5 × 20% = -30% → 70 units
Spending on imports at world price = 70 × 8 = 560 (saving of 240)
Tariff revenue = 70 × (9.6 - 8) = 112
Consumers pay 70 × 9.6 = 672

The trade deficit narrows by 240, but consumers pay more, and trading partners may retaliate. Tariffs may also breach trade-agreement commitments.

Worked reminder: cutting incomes. Country E needs imports to fall by 9. The marginal propensity to import is 0.20, so income must fall by 9 ÷ 0.20 = 45. With a multiplier of 3, spending must be cut by 45 ÷ 3 = 15. The price of fixing the deficit this way is lost output and jobs, which is why supply-side policy is the lasting fix.

Chains to learn.

• Deficit by demand: higher incomes → more imports (via income elasticity of demand for imports) → larger trade deficit.
• Deficit by cost: wages grow faster than productivity → ULC rises → export prices rise → exports fall, imports rise.
• Fix by switching: lower exchange rate → cheaper exports abroad, dearer imports → balance improves if demand is responsive enough.
• Fix by supply side: training and investment → productivity up → ULC down → competitiveness and balance improve over time.

Global imbalances (1d)

• Persistent surpluses abroad are the other side of deficits at home.
• Deficit countries: growing external liabilities, vulnerability to capital flight, exchange-rate pressure, and cuts in spending that slow growth.
• Surplus countries: weak spending may depress world demand; risk that debtors default.
• World-level risks: protectionism, competitive depreciation, financial instability.
• Evaluate: size relative to GDP, what the borrowing finances, how fast liabilities grow compared with national income.

Reminder. If the deficit is 5% of GDP and nominal GDP grows 4%, liabilities tend towards 5 ÷ 4 = 125% of GDP.

Measuring competitiveness (3a)

Measure	Formula	Better when
Output per worker	Output ÷ workers	Higher
Relative productivity	Own ÷ rival output per worker × 100	Above 100
Unit labour cost	Total labour cost ÷ output	Lower
Relative ULC	Own ULC ÷ rival ULC, common currency	Falling
Relative export prices	Own index ÷ rival index, common currency	Falling

Worked reminders.

• Firm F: labour cost 2,400,000 for 80,000 units = 30 per unit. Next year labour cost 2,520,000 (+5%) for 82,000 units (+2.5%) = 30.73 per unit, +2.4%.
• Export price indices: Country A 108, Country B 102 (same currency terms). Relative price = 108 ÷ 102 × 100 = 105.9, so A is 5.9% dearer. If A’s currency rises 3%, A’s index in B’s currency becomes 108 × 1.03 = 111.2, and the relative price is 111.2 ÷ 102 × 100 = 109.1.

Worked reminder: productivity growth. Output per worker rises from 40 to 42 in Country G: growth = 2 ÷ 40 = 5%. If hourly pay rises 5%, ULC is unchanged: 1.05 ÷ 1.05 = 1. Pay can rise as fast as productivity without harming competitiveness. If rivals’ ULC fall, though, relative ULC still rise.

Factors and measures (3b, 3c)

Factor	Policy response	Main drawback
Productivity, human capital	Education and training	Time lag, cost
Capital and technology	Investment incentives	Cost; deadweight
Regulations, costs	Privatisation, deregulation	Monopoly, job losses
Exchange rate	Measures to lower it	Inflation, retaliation
Cheap inputs, competition	Trade liberalisation	Adjustment costs
Infrastructure, non-price factors	Public investment; support for design and innovation	Cost; slow

Significance (3d)

• Competitive economy: export-led growth, more jobs, smaller deficit, FDI inflows, rising incomes, stable currency.
• Uncompetitive economy: persistent deficit, job losses in traded sectors, weak growth, lower FDI, falling currency, rising foreign debt.
• Evaluate: competition based on low pay may keep living standards low; a high-value, high-price strategy can be competitive.

Evaluation toolkit

Use these questions to turn a chain into a judgement:

• Time: does the policy act within months (exchange rate, tariffs) or years (education, infrastructure)?
• Size: is the deficit small relative to GDP, or large and growing?
• Cause: is the problem cyclical, structural, or a one-off such as a commodity price fall?
• Cost: what is given up (growth, jobs, living standards, government spending)?
• Side effects: inflation, retaliation, inequality, regional job losses.
• Context: how open is the economy and how responsive are exports and imports to price and income?

A strong conclusion picks the policy mix that suits the cause, and says what would change the judgement.

Must-know distinctions

• Relative productivity (level) versus productivity growth (rate of change).
• Wage growth versus unit labour cost growth: ULC rises only if wages grow faster than productivity.
• Expenditure-switching versus expenditure-reducing.
• Price versus non-price competitiveness.
• Current account versus the whole balance of payments.

Quick self-test

1. Name the two accounts other than the current account.
2. Goods -30, services +18, primary income -6, secondary +2: find the current account.
3. With capital account +1 and no errors, what is the financial account?
4. Define unit labour cost.
5. Output per worker is 50 in A and 40 in B. Give A’s relative productivity.
6. Wages +4%, productivity +1%: find the percentage change in unit labour cost to 2 decimal places.
7. State two expenditure-switching measures.
8. A surplus of 36 in an economy with GDP of 600: express it as a percentage of GDP.
9. Give two non-price factors of competitiveness.
10. Why might a lower exchange rate fail to improve competitiveness for long?
11. Give one problem of international uncompetitiveness.

Answers

1. Capital account and financial account.
2. -16.
3. +15 (the three accounts sum to zero).
4. Total labour cost divided by output.
5. 50 ÷ 40 × 100 = 125%.
6. 1.04 ÷ 1.01 = 1.0297, so +2.97%.
7. Any two: devaluation or depreciation policy, tariffs, quotas, subsidies to exporters.
8. 6.0%.
9. Any two: quality, design, reliability, delivery, after-sales service, branding, innovation.
10. Dearer imports raise costs and inflation, so wages may rise and cancel the gain.
11. Any one: persistent deficit, unemployment in traded industries, slow growth, lower FDI.

Where marks are usually lost

• Writing “the capital account” when the question asks about capital and financial accounts.
• Dividing the wrong way round when calculating relative measures.
• Comparing ULC or export prices without allowing for the exchange rate.
• Saying a deficit is always harmful without asking what the borrowing pays for.
• Listing policies without a chain of reasoning to the balance.
• Offering no evaluation (time lag, cost, side effects, retaliation).
• Ignoring the context given in the question, such as whether the data show a cyclical or a structural problem.
• Mixing up the direction of a relative index: above 100 means the country is dearer or more productive, depending on the measure, so say which.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2, June 2018, Pearson Education Limited: section 4.3.3, statements 1 (a-d) and 3 (a-d).