OCR A Level Economics: The balance of payments (H460)

This guide follows the OCR A Level Economics (H460) specification, Version 3.0, dated June 2026 and first assessed in 2021. It teaches the topic Balance of payments within Component 2, Macroeconomics (H460/02), under The global context. No content is labelled AS or Extension. Every country, firm and number below is invented for illustration and is not a real statistic.

Related pages: the revision notes, the practice set, the Macroeconomics overview, the hub for OCR A Level Economics, the printable checklist and the free diagnostics.

What this unit covers

Outcome in the specification	Section below
Explain what is meant by the balance of payments	1
Distinguish the current, capital and financial accounts	1
Explain the components of the current account: trade in goods, trade in services, income and current transfers	2
Calculate the balances on the different components	2 and 3
Explain what is meant by imbalances	3
Explain why a sustainable position is an important objective	4
Evaluate the causes of imbalances	5
Evaluate the consequences of imbalances	6
Evaluate policies to correct imbalances	7

Exchange-rate determination, comparative advantage, protectionism and the Marshall-Lerner condition are separate topics. They appear here only where they help to explain a cause or a policy.

1. What the balance of payments is

The balance of payments is the account of every payment that crosses a country’s border, in either direction, during one year or another stated time span. It covers households, firms and the government, and it counts money, not the physical movement of goods. Money coming in is a credit (+). Money going out is a debit (−). The balance on any part is credits minus debits.

It has three accounts.

Account	What it records	Examples
Current account	Flows of trade and income	Exports and imports of goods and services, interest and profit, transfers
Capital account	Small capital transfers and non-produced, non-financial assets	Debt forgiveness, migrants’ transfers of assets
Financial account	Cross-border purchases of assets, borrowing and lending	Foreign direct investment, portfolio investment, loans and deposits, reserves

Every transaction has two sides. If a firm sells goods abroad (a current account credit), it receives payment (a financial account entry). So the accounts together sum to zero once a small item for errors and omissions is included. A country therefore never has an overall deficit in the accounting sense. When people say “the balance of payments is in deficit” they nearly always mean the current account. Say so in your answer.

This guide counts a net inflow of funds on the financial account as positive. Published tables sometimes use the opposite sign, so check the convention before reading any data.

2. The current account and calculating balances

The current account has four components.

Component	Records	Credit example	Debit example
Trade in goods	Physical products	Machinery sold abroad	Imported vehicles
Trade in services	Intangibles	A foreign tourist’s hotel bill; insurance sold abroad	A resident’s overseas holiday
Income	Earnings on factors of production owned abroad	Profit sent home by a domestic firm’s overseas plant; interest on foreign bonds	Profit sent abroad by foreign-owned firms; interest paid to foreign lenders
Current transfers	One-way payments with nothing received in return	Money sent home by migrant workers	Aid given; payments to international bodies

The balance of trade in goods is goods exports minus goods imports. The balance of trade in goods and services adds the services balance. The current account balance adds the income and current transfers balances.

Worked example 1. Country M, Year 1 (illustrative), values in cu bn (currency units, billions). GDP is 1,520.

Component	Credits	Debits	Balance
Goods	182	231	−49
Services	96	64	+32
Income	41	58	−17
Current transfers	14	27	−13

Goods and services together: −49 + 32 = −17. Current account balance: −49 + 32 − 17 − 13 = −47 cu bn, a deficit.

As a share of GDP: 47 ÷ 1,520 × 100 = 3.1%. Scaling by GDP matters because the same 47 would be a serious gap for a small economy but a minor one for a very large economy.

Now complete the picture. The capital account balance is +4 and errors and omissions are +3. The three accounts and the errors item must sum to zero:

−47 + 4 + financial account + 3 = 0, so the financial account balance is +40, a net inflow. Suppose it consists of foreign direct investment +22, portfolio investment +31 and other investment (loans and deposits) −13: 22 + 31 − 13 = 40, which agrees.

The lesson: Country M’s current account deficit is matched by net inflows of funds. Foreigners are buying its assets or lending to it. Spending beyond its earnings is being financed from abroad. A country can also draw down its reserves of foreign currency to pay for a deficit, but reserves are limited.

3. What an imbalance is

An imbalance on the balance of payments means a persistent current account deficit or surplus, rather than a position near zero. The two sides are symmetrical in accounting, since one country’s surplus is other countries’ deficit. In practice economists and policymakers worry more about deficits, because a deficit must be financed.

Four features show whether an imbalance is a problem.

• Size, usually as a percentage of GDP.
• Duration. A single-year deficit is different from one lasting a decade.
• How it is financed. Long-term foreign direct investment is steadier than short-term portfolio inflows that can leave quickly.
• Why it arose. A deficit from importing machinery that raises future output is not the same as one from consumers buying more imported goods because the economy is booming.

4. Why a sustainable position is an objective

A sustainable balance of payments is one the country can maintain without having to make painful adjustments. It does not have to be exactly zero. A small deficit, or a deficit that is matched by stable long-term investment inflows, can be sustainable indefinitely.

Why governments care:

• Debt and income outflows. A deficit financed by borrowing adds to foreign liabilities. Interest and profit paid abroad then enter the income debits. If Country M had net foreign liabilities of 400 cu bn at an average 5% return, it would send 400 × 0.05 = 20 cu bn abroad every year. That worsens the current account on its own (−47 − 20 = −67 before anything else changes) and starts a spiral.
• Exchange rate pressure. A big deficit means a high supply of the domestic currency. This can lower its value, raising import prices and inflation.
• Loss of confidence. If lenders doubt that the country can repay, capital inflows can stop suddenly and interest rates may have to rise sharply.
• Limits on policy. The government may feel forced to cut spending or raise interest rates to calm markets, even if the economy needs growth.

A surplus is not free of cost either: it can mean low consumption relative to output and can provoke retaliation from trading partners.

5. Causes of imbalances

Split causes into short-term (cyclical) and long-term (structural), then weigh them.

Domestic growth outpacing the rest of the world. Imports rise with income. The income elasticity of demand for imports (YED) measures how strongly.

Worked example 2. Country M’s goods imports are 231 and its goods exports are 182 (example 1). Domestic income grows 2.5% and the YED of imports is 1.6. Foreign income grows 3% and the YED of Country M’s exports is 0.8.

• Imports rise by 1.6 × 2.5 = 4.0%: 231 × 1.04 = 240.24.
• Exports rise by 0.8 × 3 = 2.4%: 182 × 1.024 = 186.37.
• New goods balance: 186.37 − 240.24 = −53.87, a worsening of 4.87 cu bn, although both economies grew.

A country whose imports are income-elastic and whose exports are income-inelastic faces a growing deficit as the world grows. Primary-product exporters are an example, since demand for their goods rises less than proportionately with income.

Other causes:

• Uncompetitive prices. High unit labour costs (wages per unit of output) make exports dear and imports cheap by comparison.
• Exchange rate level. An overvalued currency makes exports dear abroad and imports cheap at home.
• Non-price competitiveness. Poor quality, weak design or unreliable delivery.
• Low savings, high consumption. A country that saves little must borrow abroad to invest.
• Falling prices of key exports, which hit a country relying on one or two products.
• Net outflows of income and transfers. High foreign ownership of domestic firms means large profit outflows.

Evaluation. Which cause dominates? Ask how long it lasts, how large it is, and how responsive trade is to price. A fall in competitiveness is a lasting cause. A temporary boom is not. A deficit from a boom may close by itself when growth slows.

6. Consequences of imbalances

	Persistent deficit	Persistent surplus
Debt and assets	Rising foreign liabilities; more income paid abroad	Growing stock of overseas assets, with income returning
Currency	Downward pressure, which raises import prices and may raise inflation	Upward pressure, which hurts exporters’ competitiveness
Growth and jobs	Spending on imports leaks away from domestic producers; manufacturing may shrink	Export-led output and jobs, but possible overheating and inflation
Policy	Pressure to cut spending or raise interest rates	Pressure from partners to expand demand or allow appreciation
Other countries	Partners gain demand	Partners face matching deficits and may use protection

Evaluation. Consequences depend on the size, the financing and the cause. A deficit financed by foreign direct investment that builds productive capacity may raise future exports. A large deficit financed by short-term borrowing is far riskier. Also consider who is affected: importers gain from a strong currency, exporters lose.

7. Policies to correct imbalances

Policies fall into three groups.

Expenditure-reducing policies cut aggregate demand to reduce import spending: higher taxes, lower government spending, higher interest rates.

Worked example 3. Country M’s marginal propensities are to save 0.15, to be taxed 0.25 and to import 0.30. Government spending falls by 14 cu bn.

• Multiplier = 1 ÷ (0.15 + 0.25 + 0.30) = 1 ÷ 0.70 = 1.43.
• Fall in income = 14 × 1.43 = 20 cu bn, about 1.3% of GDP.
• Fall in imports = 0.30 × 20 = 6 cu bn.

A 20 cu bn loss of output improves the current account by only 6 of a 47 deficit. The policy is blunt, slow, and raises unemployment.

Expenditure-switching policies change the relative price of home and foreign goods so that spending moves to domestic output: a lower exchange rate, or tariffs and quotas. Success depends on how price-responsive trade is, and on partners not retaliating. Their detailed analysis belongs to the topics on exchange rates and trade policy.

Supply-side policies raise competitiveness: investment in education, infrastructure, research and development.

Worked example 4. Country M’s hourly wage is 35 cu and output per hour is 25 units, so unit labour cost is 35 ÷ 25 = 1.40. After training, wages rise 4% and productivity 12%: 36.4 ÷ 28 = 1.30, a fall of 7.1%. Exporters can cut prices or raise profit, and import substitutes become more attractive.

Evaluation. Supply-side policies work slowly, so they suit structural deficits, and demand-side policies act sooner but cost growth. Policies also conflict with other objectives: cutting demand to fix the deficit worsens unemployment and growth. Depreciation can raise inflation. The best choice depends on the cause. A deficit from lost competitiveness needs supply-side action. One from a boom may need only patience.

Common errors

• Using the phrase “balance of payments deficit” for what is really a deficit on the current account alone.
• Treating the financial account as a cost. It records how the current account is paid for.
• Calculating a balance as debits minus credits.
• Forgetting income and current transfers when finding the current account balance.
• Listing causes or policies without judging which matters most.

Next steps

Try the practice set, use the revision notes to consolidate, and take a free 10-minute diagnostic.

Official syllabus

OCR, A Level in Economics (H460) specification, Version 3.0 (June 2026), first assessment 2021. Topic: Balance of payments, in Component 2, Macroeconomics.