IB Economics HLTopic 4 — The Global EconomyPaper 1, 2 & 3Core skill~12 min read
The Components of the Balance of Payments
The balance of payments is a country’s bank statement with the rest of the world. Every payment in, every payment out. The reason it confuses people is the word “balance” — it does balance, always, but not in the way most students expect.
📚 What you need to know
The balance of payments records all financial transactions between a country and the rest of the world.
It has a current account and a capital and financial account.
Money coming in is a credit (+); money going out is a debit (−).
The current account covers goods, services, primary income and secondary income.
The financial account covers FDI, portfolio investment, official borrowing and reserve assets.
A current account deficit must be matched by a financial account surplus, and the other way round.
The structure
The capital account is small enough that most exam questions treat the balance of payments as just two accounts: current, and capital and financial together.
Credits and debits
The sign rule
Money flowing into an account → recorded as a credit (+)
Money flowing out of an account → recorded as a debit (−)
More in than out gives that account a surplus. More out than in gives it a deficit. That is all the vocabulary is.
The current account
This is the one that gets talked about in the news, and the one exam questions almost always mean when they say “the balance of payments”. It records the income a country earns from the rest of the world.
Part
What it records
Credit example
Trade in goods
Physical products in and out. Often called visible trade.
Selling cars abroad
Trade in services
Things you cannot drop on your foot. Often called invisible trade.
A foreign tourist staying in a local hotel
Primary income
Income earned from assets and work abroad: interest, profits, dividends, wages.
A citizen working overseas sending pay home
Secondary income
Transfers with nothing given back, usually at government level.
Foreign aid received, or a payment from an international body
Older textbooks call primary income “net income” and secondary income “current transfers”. Both sets of words are accepted — but use primary and secondary if you can, because that is the current wording.
Working out a current account balance
Here is an invented economy, Marland, with figures in billions of dollars.
Item
$bn
Exports of goods
210
Imports of goods
265
Balance on trade in goods
−55
Exports of services
140
Imports of services
96
Balance on trade in services
+44
Net primary income
−12
Net secondary income
−7
Current account balance
−30
WORKED EXAMPLE 1
Using the table above, calculate Marland’s current account balance and express it as a percentage of GDP, which is $600bn. [4]
Step 1: balance on goods210 − 265 = −55Step 2: balance on services140 − 96 = +44Step 3: add the income items−55 + 44 − 12 − 7 = −30Step 4: as a share of GDP−30 ÷ 600 × 100 = −5.0%A current account deficit of $30bn, or 5% of GDPalways give the sign and the word. A bare “30” without “deficit” often loses the mark.
Why the percentage matters. A $30bn deficit means nothing on its own. As a share of GDP it becomes comparable: economists usually start worrying somewhere above 4 to 5% of GDP sustained over several years.
The capital account
Small and, honestly, not very interesting — but it is on the syllabus. It records minor one-off flows of capital rather than ongoing income.
Capital transfers such as debt forgiveness by a government, or the money migrants carry with them when they move country permanently.
Transactions in non-produced, non-financial assets, which mainly means payments for things like copyrights, patents and royalties.
The financial account
This records changes in the ownership of assets. Not income from assets — that is primary income — but the buying and selling of the assets themselves.
Component
What it means
Foreign direct investment
Buying a controlling stake, usually 10% or more, in a firm abroad, or building facilities there. Money coming in is a credit.
Portfolio investment
Buying foreign shares and bonds without taking control. Money coming in is a credit.
Official borrowing
Government borrowing from abroad. Receiving the loan is a credit; repaying it is a debit.
Reserve assets
Gold and foreign currency held by the central bank, used to influence the exchange rate.
The FDI and primary income confusion catches everyone. Buying a factory in another country goes in the financial account. The profit that factory sends home every year goes in the current account as primary income.
Why the accounts must mirror each other
If you spend more abroad than you earn, the money has to come from somewhere. You either sell assets to foreigners or borrow from them. Both of those are financial account credits.
This is the sentence worth memorising: a current account deficit is financed by a financial account surplus, which means selling assets or borrowing from abroad.
WORKED EXAMPLE 2
State which part of the balance of payments records each item, and whether it is a credit or a debit for Marland. [4]
A German firm buys 60% of a Marland factory
Financial account, credit — foreign money is coming in to buy an asset (FDI).
That factory sends its profits back to Germany
Current account, primary income, debit — income is leaving Marland.
Marland tourists spend money on holiday abroad
Current account, trade in services, debit — Marland is importing a service.
Marland’s government cancels a loan owed by a poorer country
Capital account, debit — debt forgiveness is a capital transfer out.
Ask two questions each time: which account, and which direction?
💡 Exam tip
Always show your working line by line in balance of payments calculations. Marks are given for the method as well as the answer.
Give the figure as a percentage of GDP if you are told GDP. It turns a number into an argument.
Use the phrase “financed by a financial account surplus”. It is the exact wording examiners look for.
Separate buying an asset (financial account) from income earned on an asset (current account, primary income).
If a number looks strange, check the sign. Imports are debits, so they come off the total even though the question gives them as positive figures.
⚠ Common mix-up
A current account deficit is not the same as a budget deficit. A budget deficit is government spending above government revenue.
The balance of payments always balances. When people say it does not, they mean the current account is in deficit.
Tourism is a service, not a good. A foreign visitor spending here is a service export.
Remittances are income, not aid. Money sent home by workers abroad is primary income; government aid is secondary income.
The capital account is not the financial account. The capital account is the small one with debt forgiveness and royalties in it.
Up next: Exchange Rates and the Balance of Payments — the two topics you have just covered, joined together.
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