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The Balance of Payment

The Balance of Payment. at the end of the lesson you should be able to: identify negative consequences of CA deficit identify causes of CA deficit evaluate whether CA deficit is necessarily undesirable. Negative consequences of Current Account Deficit (X < M). Economic effects of CA Deficit.

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The Balance of Payment

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  1. The Balance of Payment at the end of the lesson you should be able to: • identify negative consequences of CA deficit • identify causes of CA deficit • evaluate whether CA deficit is necessarily undesirable

  2. Negative consequences of Current Account Deficit (X < M)

  3. Economic effects of CA Deficit •  X ,M •  profits, plant closures, •  National output •  unemployment

  4. Economic effects of CA Deficit •  X ,M   ER •  ER  SOL

  5. Causes Current Account Deficit

  6. Causes of CA Deficit • Boom in consumer demand • period of boom  sucks in imports • developing nations - industrialisation programs necessitated large scale import of machinery, plant n machinery, raw materials, expertise etc. • Eg. Malaysia’s KLIA, LRT projects in 1990s.

  7. Causes of CA Deficit • Exchange Rate • high ER  sucks in cheap imports   spending on imports e.g. US, UK • low ER  pay more for imports   total expenditure on imports e.g. less developed countries

  8. Causes of CA Deficit • Lack of productive capacity (Lack of ss) • In less developed countries, home producers have very limited domestic production and have to rely on imported goods for much of their consumer demand.

  9. Justification of Current Account Deficit

  10. Justification of CA deficit • Nature of CA deficit • Where the deficit is offset by an inflow of foreign direct investment. • This means foreign firms are setting up factories and businesses which can create employment and growth for the country

  11. Justification of CA deficit • Nature of CA deficit • If the CA deficit is due to import of capital goods, this is also not worrisome. • Capital goods imported are used to further produce G & S. This will cause further economic growth in the future. • The income from economic growth will be able to sustain the deficit.

  12. Justification of CA deficit • Reflects higher SOL • In the short run (SR), if a country is importing high volume of G &S, this boost SOL as consumers are able to enjoy a higher amount of G & S. • This could be due to economic boom which afforded them imported luxuries

  13. Justification of CA deficit • To finance economic development • 3rd world countries – need to borrow much for development purposes for infrastructural projects. A lot of expertise and machinery are also required to undertake development projects. In doing so they inevitably ran CA deficits. • South Korea and Malaysia ran CA deficits in 1990s but they have benefited because projects undertaken strengthen their growth potential and generated future income streams.

  14. Justification of CA deficit • Size of CA deficit to GDP • If economy is growing at a rate larger than the deficit, accumulated foreign debt as a % of GDP is likely to fall. Even if foreign debt is growing, income of the country is available to repay is growing even faster! • In the1980s, US ran persistent CA deficits but was not worrying because it was a small fraction of its GDP.

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