30 mark essay: Discuss three measures which could improve the

UK current account deficit.

The current account is the total sum of the balance of trade
in goods and services, net income from abroad and net current
transfers. The UK currently has a current account deficit of 73
billion or 6 per cent of GDP.
Firstly, the UK could attempt to reduce their trade deficit in
order to reduce the current account deficit by increasing their
exports. Currently the UK has a balance of trade deficit of 32.1
billion, fuelled by extremely high imports. The UK has a continental
lifestyle which has led to the need to import many goods resulting
in a massive debit of over 100 billion but the trade in services
resulted in a credit of almost $75 billion. The Government could
invest in improving the nations exports. The UK mainly exports
manufactured
goods,
machinery
and
foodstuffs.
Many
of
the
manufactured goods and machinery firms are foreign with Honda and
Toyota both present within the UK. New fiscal policy could be
introduced to reduce corporation taxes for firms, which would
attract new firms to enter the UK market in order to benefit from
reduced taxes. With car manufacturers exporting across the World,
the exports for the United Kingdom would increase. The Government
could also introduce new monetary policy which would reduce the
interest rate further past the current 0.5%. By reducing the current
rate more investment would be encouraged leading to firms improving
their companies which would increase the nations exports. Savers
would be discouraged from keeping their money which would lead to
more consumption, which would shift aggregate demand to the right
firstly, and would potentially lead to more spending on domestic
goods reducing the deficit.
Secondly, Protectionist measures could be introduced which
would reduce the amount of imports in the UK economy and potentially
increase UK exports and spending on domestic goods. Greater tariffs
would lead to a raised price of imported goods leading to a decrease
in quantity sold and the domestically produced goods would increase
their sales due to their relative price of the more expensive
imported goods. Larger tariffs would lead to greater tax revenue for
the Government which could fund subsidy and export subsidy spending.
By introducing subsides, the quantity of domestic produce would
increase and the firms would earn more profit because their total
cost per unit would decrease with the government subsidy. An export
subsidy would encourage production by lowering their costs per unit,
which would increase the quantity and decrease the price of the
goods in overseas markets. By introducing quotas, which limit the
level of imports allowed, the deficit would be reduced by less
imported goods, which could be passed onto the overall current
account. By introducing preferential state procurement policies

where Government favours local/domestic producers, which would lead

to large contracts for UK firms. The state spending would directly
help domestic spending and would not increase the deficit. By
favouring domestic firms there is reduced capital movement with
withdrawals from the circular flow of income. The contract for the
domestic firm would be given to UK workers which would allow for the
multiplier effect to occur. The multiplier effect is the added
effect of an injection into the economy greater than the initial
injection. The multiplier effect would allow for the injection to
spread to other domestic firms allowing for reduced imports from the
previous year, reducing the trade deficit. The Government could
pursue tightened fiscal and monetary policy which would reduce
aggregate demand. By raising interest rates and taxation, with
reduced spending, this would lead consumers with less disposable
income. With reduced income, the marginal propensity to import
reduces significantly, which would have benefits on the balance of
payments of trade and services. This would lead to deflation which
has positive as it can lead to firms cutting their costs which would
lead to increased exports as the price of UK goods decrease.
However protectionism is potentially not feasible to introduce
in the United Kingdom. As the UK is a member of the trading bloc,
the European Union, they agree to the free movement of capital,
output and labour. EU imports are not taxed and have free movement
into the United Kingdom. 51% of the UKs imports are from the EU,
which cannot be restricted in any forms of protectionism as they
would breach the terms of the trading bloc. While the other 49%
could be limited all EU trade could not be and any restrictions on
other nations could lead to an increase in trade with the EU due to
the dependence from the United Kingdom for continental goods.
Measures such as preferential state procurement and export subsidies
are against EU legislation and could not be carried out by the
Government. Trade protectionist measures such as tariffs are
counter-productive as they increase the price of goods leading to
the consumer being forced to purchase more expensive goods than what
they would have had to without the tariff being imposed which
results in a welfare loss for society. The tariffs while raising the
prices would lead to rising inflation rates, which has negatives
effects on consumption, which makes up the bulk of Aggregate Demand.
While contracts to domestic firms would initially be beneficial,
these firms would need goods and labour. Many resources are imported
by the UK which would lead to withdrawals from the economy and
potentially with tariffs being imposed the price to domestic firms
would actually be raised leading to reduced profits or greater
spending from a Government with a budget deficit. The workers on
these contracts could potentially be foreign workers who could send
their earnings out of the United Kingdom to family in their origin
nation. This would exacerbate the withdrawals from the UK which
would reduce the level of reduced deficit of trade and services. By

reducing corporation taxes, this could have negative effects on the

budget deficit by reducing the income but the problem is increased
due to the added expenditure from protectionist measures such as
subsidies. Restrictive monetary policy can have negatives as lower
aggregate demand leads to low growth and increased unemployment
rates.
Thirdly, the UK could attempt to reduce the deficit in the
primary income account. This account measures receipts from UK
investment overseas and UK payments to foreign investors. The
deficit increased from 8.2 billion in the second quarter of 2013 to
12.6 billion in the third. The final figure was just over a 13
billion debit. The investment income leaving the nation was just
over 170 billion with the injections only 158billion. The UK could
decrease the Primary income deficit by increasing investment into
other nations. With new markets emerging in India and Brazil an
increase in investment could lead to increased investment income
credits. The deficit could be reduced by raising corporation tax
which would result in decreased profits and therefore decreased
dividends for foreign nationals. The rise would increase tax revenue
for the government which could supplement other measures which
involve increased spending. In order to remove primary income debits
the Government could introduce a closed economy. By restricting all
money coming into the nation this would reduce all investment from
foreigners leading to a balanced primary income because of the
closed economy.
However
foreign
investing
has
potential
problems.
The
uncertainty of earning profits could either lead to a decrease in
the deficit or potentially losses. Investment also reduces the money
supply in the circular flow of income as a withdrawal, which could
be money better spent within the domestic economy. Raising
corporation taxes could lead to capital flight, with firms exiting
the UK economy and resituating in another nations with smaller
corporation taxes. This has the potential for redundancies which
could result in increased government spending through benefit
payments and reduced tax revenue with the firms leaving removing all
corporation tax and reduced income tax from the newly redundant.
This would also lead to increased spare capacity in the UK. A closed
economy would be unfeasible due to the UKs membership of the
European Union.
While 170billion exited the UK economy through
dividends to foreign nationals, this is profit on top of initial
investments which potentially had positive effects for the UK
economy, therefore the UK should attempt to invest into other
nations rather than decrease the investment income exiting the
economy.
Fourthly, the UK Government could introduce devaluation
measures. By reducing the value of the Pound Sterling against other

currencies, through selling pounds, the price of importing goods

would increase resulting in a reduction in the trade deficit. The
price of the UKs goods would decrease, resulting in more exports as
the price lowers for other currencies. Assuming demand in priceelastic, devaluation would result in an improvement in the balance
of payments of goods and services, which would reduce the deficit of
the current account. The J-Curve effect would state the current
account would initially worsen before improving due to initial
inelastic demand however in the long the current account would
improve, leading to longer term success for the UKs accounts.
Devaluation with tariffs could lead to significantly reduced
imported goods due to the greatly increased prices, resulting in a
reduction in the trade deficit.
In conclusion, many measures to reduce the deficit of the
current account are counter-productive such as restrictive monetary
policy which risks high unemployment for a deficit reduction, which
has the potentially for inelastic movement leading to a slow
implementation. Other measures such as devaluation could lead to
imported inflation. Due to the UKs high marginal propensity to
import as a first world nation, the country could have extremely
inelastic demand leading to the UK still importing the expensive
goods. The higher inflation would lead to rising prices, which has
negative effects on employment therefore the benefits of devaluation
may only be medium term, with the short and long term effects
actually worsening the current account deficit. For the UK to
improve the current account deficit the most important factor would
be the reduction in the balance of payments of trade and services.
By using supply side policies such as subsidies the country could
become more competitive, resulting in firstly reduced imports as the
UK goods are cheaper and the exports could increase due to the more
competitive prices. But supply side policies would have a time lag
before improving the current account, which could limit the success.
In the long run the best measure would be to improve the exports of
the nation, as this would allow for sustained growth and would not
limit the economy or create spare capacity, with protectionist
measure which reduce imports.