International Trade, Globalisation and Exchange Rates: Question 10

Worked solution

Part (a): Defining a current account surplus

A current account surplus exists when the sum of a country’s four current account components (trade in goods, trade in services, primary income (profit, interest and dividends) and secondary income (transfers such as remittances and aid)) is positive for the period. This means the country earns more from these transactions with the rest of the world than it pays out.

Part (b): Finding the missing secondary income value

Fenmoor’s overall current account balance is the sum of all four components, keeping each one’s sign, and this sum is given as a surplus of $250 million. Let the missing secondary income value be $x$:

$180 + 90 - 30 + x = 250$

$240 + x = 250$

$x = 250 - 240 = 10$

Fenmoor’s secondary income is $\boxed{10}$, i.e. a surplus of $10 million.

Part (c): A consequence of a persistent surplus

When Fenmoor consistently earns more from the rest of the world than it pays out, more foreign currency is entering Fenmoor’s foreign exchange market (as foreign buyers exchange their own currency for Fenmoor’s to pay for Fenmoor’s exports and other inflows) than is leaving it. Since demand for Fenmoor’s currency then tends to exceed its supply, this is likely to cause the currency to appreciate. As it strengthens, Fenmoor’s exports become more expensive for foreign buyers and imports become cheaper for Fenmoor’s own consumers, which over time tends to reduce the trade in goods and services surplus that helped create the current account surplus in the first place.

(Other syllabus-based consequences would also be acceptable, such as a persistent surplus reflecting weak domestic spending relative to output, or contributing to inflationary pressure if the associated capital inflows feed into higher domestic spending.)

Part (d): Why a surplus is not necessarily a good sign

Although a surplus means Fenmoor earns more from the rest of the world than it pays out, this is not automatically desirable. A large, persistent surplus can mean Fenmoor is producing more than it consumes or invests domestically, so resources used to generate exports and other income from abroad could instead have gone towards raising the living standards of Fenmoor’s own residents through greater domestic consumption or investment. In addition, running large surpluses against particular trading partners can provoke those countries, which are running the matching deficits, into imposing tariffs or other trade restrictions of their own, which could ultimately reduce Fenmoor’s future export revenue.

Final answers

• (a) A current account surplus: the sum of trade in goods, trade in services, primary income and secondary income is positive, so the country earns more from abroad than it pays out.
• (b) $180+90-30+x=250 \Rightarrow x=\boxed{10}$, so secondary income is a surplus of $10 million.
• (c) E.g. a persistent surplus tends to cause an appreciation of Fenmoor’s currency, which makes its exports dearer and imports cheaper, eroding the surplus over time.
• (d) E.g. resources used to earn the surplus could instead have raised domestic consumption/investment, and persistent surpluses can provoke trade restrictions from deficit-running trading partners.