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ASA see ADVERTISING STANDARDS AUTHORITY.
ASEAN see ASSOCIATION OF SOUTHEAST ASIAN NATIONS.
Asian Pacific Economic Cooperation (APEC) a regional alliance formed in 1990 with the general objective of establishing a FREE TRADE AREA, specifically creating a free trade zone for industrialized country members by 2010 and for developing country members by 2020. There are currently 17 members of APEC: USA, Canada, Japan, China/Hong Kong, Mexico, Chile, Australia, New Zealand, Papua New Guinea, South Korea, Taiwan, Thailand, Philippines, Brunei, Malaysia, Singapore and Indonesia. The USA, Canada and Mexico are also members of the NORTH AMERICAN FREE TRADE AGREEMENT (NAFTA), and Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand are also members of the ASSOCIATION OF SOUTHEAST ASIAN NATIONS (ASEAN). See TRADE INTEGRATION.
ask price see BID PRICE.
Fig. 8 Arc elasticity. See entry.
asset an item or property owned by an individual or a business that has a money value. Assets are of three main types: (a) physical assets, such as plant and equipment, land, consumer durables (cars, washing machines, etc);
(b) financial assets, such as currency, bank deposits, stocks and shares;
(c) intangible assets, such as BRAND NAMES, KNOW-HOW and GOODWILL. See INVESTMENT, LIQUIDITY, BALANCE SHEET, LIABILITY.
asset-growth maximization a company objective in the THEORY OF THE FIRM that is used as an alternative to the traditional assumption of PROFIT MAXIMIZATION. Salaried managers of large JOINT-STOCK COMPANIES are assumed to seek to maximize the rate of growth of net assets as a means of increasing their salaries, power, etc., subject to maintaining a minimum share value, so as to avoid the company being taken over with the possible loss of jobs. In Fig. 9, the rate of growth of assets is shown on the horizontal axis, and the ratio of the market value of company shares to the book value of company net assets (the share-valuation ratio) on the vertical axis. The valuation curve rises at first, as increasing asset growth increases share value but beyond growth rate (G) excessive retention of profits to finance growth will reduce dividend payments to shareholders and depress share values. Managers will tend to choose the fastest growth rate (G*), which does not depress the share valuation below the level (V
) at which the company risks being taken over. See also MANAGERIAL THEORIES OF THE FIRM, FIRM OBJECTIVES, DIVORCE OF OWNERSHIP FROM CONTROL, PRINCIPAL-AGENT THEORY.
asset specificity the extent to which a TRANSACTION or CONTRACT needs to be supported by transaction-specific assets. Where a contract involves the need to create transaction-specific assets, this creates a fundamental transformation in the nature of the relationship between the parties to the transaction. Before investing in specific assets, the investing partner is likely to have many alternative trading partners, which allows for bidding competition. However, after the investment creates transaction-specific assets these become SUNK COSTS with no alternative use and the parties to the transaction then have no alternative trading partners. The terms of the transaction are then determined by bilateral bargaining between the parties to the transaction.
Bargaining between the parties can lead to opportunistic behaviour where one party in a contractual relationship seeks to exploit the other’s vulnerability. For example, a seller might attempt to exploit a buyer who is dependent on the seller by claiming that the production costs have risen and pressing for an upward adjustment of the negotiated price. Such opportunistic behaviour seeks to exploit or ‘hold up’ one party to the transaction to benefit the other party
Fig. 9 Asset-growth maximization. The variation of share valuation ratio against the company growth rate.
For transactions with high asset specificity, the costs of MARKET transactions are high and such transactions are likely to be ‘internalized’ and conducted within organizations, for example a VERTICALLY INTEGRATED firm. See INTERNALIZATION.
asset-stripper a predator firm that takes control of another firm (see TAKEOVER) with a view to selling off that firm’s ASSETS, wholly or in part, for financial gain rather than continuing the firm as an ongoing business.
The classical recipe for asset-stripping arises when the realizable market value of the firm’s assets are much greater than what it would cost the predator to buy the firm; i.e. where there is a marked discrepancy between the asset-backing per share of the target firm and the price per share required to take the firm over. This discrepancy usually results from a combination of two factors:
(a) gross under-valuation of the firm’s assets in the BALANCE SHEET;
(b) mismanagement or bad luck, resulting in low profits or losses, both of which serve to depress the firm’s share price.
asset-value theory (of exchange rate determination) an explanation of the volatility of EXCHANGE-RATE movements under a FLOATING EXCHANGE-RATE SYSTEM. Whereas the PURCHASING-POWER PARITY THEORY suggests that SPECULATION is consistent with the achievement of BALANCE-OF-PAYMENTS EQUILIBRIUM, the asset-value theory emphasizes that, in all probability, it will not be. In this theory, the exchange rate is an asset price, the relative price at which the stock of money, bills and bonds and other financial assets of a country will be willingly held by foreign and domestic asset holders. An actual alteration in the exchange rate or a change in expectations about future rates can cause asset holders to alter their portfolios. The resultant change in demand for holdings of foreign currency relative to domestic currency assets can at times produce sharp fluctuations in exchange rates. In particular, uncertainty about future market rates and the unwillingness of banks and other large financial participants in the foreign-exchange markets to take substantial positions in certain currencies, especially SOFT CURRENCIES, may diminish funds for stabilizing speculation that would in turn diminish or avoid erratic exchange-rate movements.
If this should prove the case, then financial asset-switching is likely to reinforce and magnify exchange-rate movements initiated by current account transactions (i.e. changes in imports and exports), and in consequence may produce exchange rates that are inconsistent with effective overall balance-of-payments equilibrium in the longer run.
assisted area an area of a country designated as qualifying for financial and other assistance under a country’s REGIONAL POLICY in order to promote industrial regeneration. Assisted areas typically suffer from severe unemployment problems resulting from the decline of local firms and industries and are characterized by INCOME PER HEAD (GDP per capita) levels that are substantially below the national average.
In the UK, the main assisted areas are ‘Tier 1’ areas (formerly DEVELOPMENT AREAS) and ‘Tier 2’ areas (formerly INTERMEDIATE AREAS). These arrangements came into force in 2000 as part of a European Union (EU) programme aimed at establishing a comparable regional aid system across all the then 15 EU member states. Under EU policy, the main criteria for designating an assisted area is a GDP per capita that is below 75% of the EU average.
In the case of the UK, the areas proposed by the government, based on electoral voting ‘wards’, are still under review by the European Commission. Proposed Tier 1 areas are Cornwall and the Scilly Isles, Merseyside, South Yorkshire, West Wales and the Valleys, together with the whole of Northern Ireland. Proposed Tier 2 areas, totalling some 1550 smaller localities, are 79 from the east of England region; 133 from the East Midland region; 44 from the London region; 228 from the Northeast region; 144 from the Northwest region; 440 from Scotland; 129 from the Southeast region; 20 from the Southwest region; 51 from Wales; 197 from the West Midlands region and 91 from the Yorkshire and Humber region. Regarding Tier 2 submissions, the European Commission’s preferred policy is to support ‘clusters’ of adjacent localities, providing sufficient ‘critical mass’ for industrial development rather than isolated localities.
In addition, a ‘Tier 3’ of assisted areas has been designated that covers areas of ‘special need’ (for example, coalfields and rural development areas).
The application of the new Tier structures is subject to an overall population ceiling requirement; specifically, for any country the number of persons residing in the assisted areas should not exceed more than 28.7% of the total population of the country. See REGIONAL DEVELOPMENT AGENCY.
associated company a JOINT-STOCK COMPANY in which another company or group has a significant, but not controlling, shareholding (specifically 20% or more of the voting shares but not more than 50%). In such a situation the investing company can exert influence on the commercial and financial policy decisions of the associated company, though in principle the associated company remains independent under its own management, producing its own annual accounts, and is not a subsidiary of the HOLDING COMPANY.
Association of British Insurers see INSURANCE COMPANY.
Association of Futures Brokers and Dealers (AFBD) see SELF-REGULATORY ORGANIZATION.
Association of Investment Trust Companies see INVESTMENT TRUST COMPANY.
Association of Southeast Asian Nations (ASEAN) a regional alliance formed in 1967 with the general objective of creating a FREE TRADE AREA. The current member countries of ASEAN are Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand. However, only limited progress has been made to date towards the reduction of internal tariffs and quotas. See ASIAN PACIFIC ECONOMIC COOPERATION, TRADE INTEGRATION.
assumptions see ECONOMIC MODEL.
assurance see INSURANCE.
asymmetry of information a situation where the parties to a CONTRACT or TRANSACTION have information available but this information is unevenly distributed between the parties. This information could include the identity of alternative suppliers or customers or product quality or performance.
Asymmetry of information is likely to lead to ADVERSE SELECTION or to MORAL HAZARD in transactions. Asymmetric information also applies to the principal-agent relationship (see AGENCY COST) where the principal cannot observe the agent’s level of effort. See PRINCIPAL-AGENT THEORY.
ATM see AUTOMATIC TELLER MACHINE.
atomistic competition see PERFECT COMPETITION.
attributes model see PRODUCT CHARACTERISTICS/ATTRIBUTES MODEL.
auction a means of selling goods and services to the highest bidder among a number of potential customers. Auctions can take several forms. One form is an open auction, increasing bid, competition in which the bids of all parties are observable and bidders drop out as the price increases until only the highest bidder remains. Another form is an open auction, decreasing price, auction in which the auctioneer starts off from a very high price that is then slowly decreased until one bidder agrees to buy at the last announced price. This form of auction is often called a ‘Dutch auction’. Yet another form is a sealed-bid, closed auction in which all bidders have to submit their bids in sealed envelopes at the same time. In open auctions, bidders can gain some information about the private valuations that other bidders place upon the goods to be sold, while in sealed-bid auctions the private valuations of bidders remain unobservable. The principles of auctions apply to situations where firms seek tenders to supply products.
audit the legal requirement for a JOINT-STOCK COMPANY to have its BALANCE SHEET and PROFIT-AND-LOSS ACCOUNT (the financial statements) and underlying accounting system and records examined by a qualified auditor, so as to enable an opinion to be formed as to whether such financial statements show a true and fair view and that they comply with the relevant statutes. See also ENVIRONMENTAL AUDIT, VALUE FOR MONEY AUDIT.
Austrian school a group of late 19th-century economists at the University of Vienna who established and developed a particular line of theoretical reasoning. The tradition originated with Professor Carl Menger who argued against the classical theories of value, which emphasized PRODUCTION and SUPPLY. Instead, he initiated the ‘subjectivist revolution’, reasoning that the value of a good was not derived from its cost but from the pleasure, or UTILITY, that the CONSUMER can derive from it. This type of reasoning led to the MARGINAL UTILITY theory of value whereby successive increments of a commodity yield DIMINISHING MARGINAL UTILITY.
Friedrich von Wieser developed the tradition further, being credited with introducing the economic concept of OPPORTUNITY COST. Eugen von Böhm-Bawerk helped to develop the theory of INTEREST and CAPITAL, arguing that the price paid for the use of capital is dependent upon consumers’ demand for present CONSUMPTION relative to future consumption. Ludwig von Mises and Friedrich von Hayek subsequently continued the tradition established by Carl Menger et al. See also CLASSICAL ECONOMICS.
authorizedorregisteredornominal share capital the maximum amount of SHARE CAPITAL that a JOINT-STOCK COMPANY can issue at any time. This amount is disclosed in the BALANCE SHEET and may be altered by SHAREHOLDERS at the company ANNUAL GENERAL MEETING. See also ISSUED SHARE CAPITAL.
automatic (built-in) stabilizers elements in FISCAL POLICY that serve to automatically reduce the impact of fluctuations in economic activity. A fall in NATIONAL INCOME and output reduces government TAXATION receipts and increases its unemployment and social security payments. Lower taxation receipts and higher payments increase the government’s BUDGET DEFICIT and restore some of the lost income (see CIRCULAR FLOW OF NATIONAL INCOME MODEL). See FISCAL DRAG.
automatic teller machine (ATM) a cash point (‘hole in the wall’) facility in which a banker’s card can be used by a customer of a COMMERCIAL BANK or BUILDING SOCIETY to withdraw cash both inside and outside banking hours. The ‘Link’ network enables customers to use their cards in the ATMs of other banks as well as their own.
automatic vending a means of retailing products to consumers via vending machines. Automatic vending has been employed extensively in selling, for instance, food, beverages and cigarettes. The use of vending machines has also become prominent in the banking/building society sector as a means of dispensing cash.
automation the use of mechanical or electrical machines, such as robots, to undertake frequently repeated production processes to make them self-regulating, thus minimizing or eliminating the use of labour in these processes. Automation often involves high initial capital investment but, by reducing labour costs, cuts VARIABLE COST per unit. See FLEXIBLE MANUFACTURING SYSTEM, PRODUCTIVITY, TECHNOLOGICAL PROGRESSIVENESS, CAPITAL-LABOUR RATIO, MASS PRODUCTION, COMPUTER.
autonomous consumption that part of total CONSUMPTION expenditure that does not vary with changes in NATIONAL INCOME or DISPOSABLE INCOME. In the short term, consumption expenditure consists of INDUCED CONSUMPTION (consumption expenditure that varies directly with income) and autonomous consumption. Autonomous consumption represents some minimum level of consumption expenditure that is necessary to sustain a basic standard of living and which consumers would therefore need to undertake even at zero income. See CONSUMPTION SCHEDULE.
autonomous investment that part of real INVESTMENT that is independent of the level of, and changes in, NATIONAL INCOME. Autonomous investment is mainly dependent on competitive factors such as plant modernization by businesses in order to cut costs or to take advantages of a new invention. See INDUCED INVESTMENT, INVESTMENT SCHEDULE.
Fig. 10 Average cost (long-run). (a) The characteristic U-shape of the long-run average cost curve. (b)The characteristic L-shaped curve that in practice normally results from expansion.
average cost (long-run) the unit cost (TOTAL COST divided by number of units produced) of producing outputs for plants of different sizes. The position of the SHORT-RUN average total cost (ATC) curve depends on its existing size of plant. In the long run, a firm can alter the size of its plant. Each plant size corresponds to a different U-shaped short-run ATC curve. As the firm expands its scale of operation, it moves from one curve to another. The path along which the firm expands – the LONG-RUN ATC curve – is thus the envelope curve of all the possible short-run ATC curves. See Fig. 10 (a).
It will be noted that the long-run ATC curve is typically assumed to be a shallow U-shape, with a least-cost point indicated by output level OX. To begin with, average cost falls (reflecting ECONOMIES OF SCALE); eventually, however, the firm may experience DISECONOMIES OF SCALE and average cost begins to rise.
Empirical studies of companies’ long-run average-cost curves, however, suggest that diseconomies of scale are rarely encountered within the typical output ranges over which companies operate, so that most companies’ average cost curves are L-shaped, as in Fig. 10 (b). In cases where diseconomies of scale are encountered, the MINIMUM EFFICIENT SCALE at which a company will operate corresponds to the minimum point of the long-run average cost curve (Fig. 10 (a)). Where diseconomies of scale are not encountered within the typical output range, minimum efficient scale corresponds with the output at which economies of scale are exhausted and constant returns to scale begin (Fig. 10 (b)). Compare AVERAGE COST (SHORT-RUN).
average cost (short-run) the unit cost (TOTAL COST divided by the number of units produced) of producing particular volumes of output in a plant of a given (fixed) size.
Average total cost (ATC) can be split up into average FIXED COST (AFC) and average VARIABLE COST (AVC). AFC declines continuously as output rises as a given total amount of fixed cost is ‘spread’ over a greater number of units. For example, with fixed costs of £1,000 per year and annual output of 1,000 units, fixed costs per unit would be £1, but if annual output rose to 2,000 units, the fixed cost per unit would fall to 50 pence – see AFC curve in Fig. 11 (a).
Over the whole potential output range within which a firm can produce, AVC falls at first (reflecting increasing RETURNS TO THE VARIABLE FACTOR INPUT output increases faster than costs), but then rises (reflecting DIMINISHING RETURNS to the variable inputs – costs increase faster than output), as shown by the AVC curve in Fig. 11 (a). Thus the conventional SHORT-RUN ATC curve is U-shaped.
Fig. 11 Average cost (short-run). (a) The characteristic curves of average total cost (ATC), average variable cost (AVC), and average fixed cost (AFC), over the whole output range. (b) The characteristic curves of ATC and AFC and constant line of AVC over the restricted output range.
Over the more restricted output range in which firms typically operate, however, constant returns to the variable input are more likely to be experienced, where, as more variable inputs are added to the fixed inputs employed in production, equal increments in output result. In such circumstances, AVC will remain constant over the whole output range, as in Fig. 11 (b), and as a consequence ATC will decline in parallel with AFC. Compare AVERAGE COST (LONG-RUN). See LOSS, LOSS MINIMIZATION.
average-cost pricing 1 a pricing method that sets the PRICE of a product by adding a percentage profit mark-up to AVERAGE COST or unit total cost. This method is identical in most respects to FULL-COST PRICING; indeed, the terms are often used interchangeably.
2 a pricing principle that argues for setting PRICES equal to the AVERAGE COST of production and distribution, so that prices cover both MARGINAL COSTS and FIXED OVERHEADS costs incurred through past investments. This involves the (sometimes arbitrary) apportionment of fixed (overhead) costs to individual units of output, though it does seek to recover in the price charged all the costs that would have been avoided by not producing the product. See MARGINAL-COST PRICING, TWO-PART TARIFF.
average fixed cost see AVERAGE COST (SHORT-RUN).
average physical product the average OUTPUT in the SHORT-RUN theory of supply produced by each extra unit of VARIABLE FACTOR INPUT (in conjunction with a given amount of FIXED FACTOR INPUT). This is calculated by dividing the total quantity of OUTPUT produced by the number of units of input used. In the SHORT RUN theory of supply, average physical product, together with AVERAGE REVENUE per unit of output, indicates to a firm how many factor inputs to employ in order to maximize profit. See MARGINAL PHYSICAL PRODUCT, DIMINISHING RETURNS, VARIABLE-FACTOR INPUT.
average propensity to consume (APC) the fraction of a given level of NATIONAL INCOME that is spent on consumption:
Alternatively, consumption can be expressed as a proportion of DISPOSABLE INCOME. See CONSUMPTION EXPENDITURE, PROPENSITY TO CONSUME, MARGINAL PROPENSITY TO CONSUME.
average propensity to import (APM) the fraction of a given level of NATIONAL INCOME that is spent on IMPORTS:
Alternatively, imports can be expressed as a proportion of DISPOSABLE INCOME. See also PROPENSITY TO IMPORT, MARGINAL PROPENSITY TO IMPORT.
average propensity to save (APS) the fraction of a given level of NATIONAL INCOME that is saved (see SAVING):
Alternatively, saving can be expressed as a proportion of DISPOSABLE INCOME. See also PROPENSITY TO SAVE, MARGINAL PROPENSITY TO SAVE.
average propensity to tax (APT) the fraction of a given level of NATIONAL INCOME that is appropriated by the government in TAXATION:
See also PROPENSITY TO TAX, MARGINAL PROPENSITY TO TAX, AVERAGE RATE OF TAXATION.
average rate of taxation the total TAX paid by an individual divided by the total income upon which the tax was based. For example, if an individual earned £10,000 in one year upon which that individual had to pay tax of £2,500, the average rate of taxation would be 25%. See STANDARD RATE OF TAXATION, MARGINAL RATE OF TAXATION, PROPENSITY TO TAX, PROPORTIONAL TAXATION, REGRESSIVE TAXATION, PROGRESSIVE TAXATION.
average revenue the total revenue received (price X number of units sold) divided by the number of units. Price and average revenue are in fact equal: i.e. in Fig. 12, the price £10 = average revenue (£10 × 10 ÷ 10) = £10. It follows that the DEMAND CURVE is also the average revenue curve facing the firm.
average revenue product the total REVENUE obtained from using a given quantity of VARIABLE-FACTOR INPUT to produce and sell output, divided by the number of units of input. The average revenue product of a factor is given by the factor’s AVERAGE PHYSICAL PRODUCT multiplied by the AVERAGE REVENUE or PRICE of the product. The average revenue product, together with average cost, indicates to a firm how many factor inputs to employ in order to maximize profit in the SHORT RUN. See MARGINAL REVENUE PRODUCT.
Fig. 12 Average revenue. The demand curve or average revenue curve.
average total cost (ATC) see AVERAGE COST (SHORT-RUN), AVERAGE COST (LONG-RUN).
average variable cost (AVC) see AVERAGE COST (SHORT-RUN), AVERAGE COST (LONG-RUN).
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back door the informal mechanism whereby the BANK OF ENGLAND buys back previously issued TREASURY BILLS in the DISCOUNT MARKET at their ruling market price in order to release money to help the DISCOUNT HOUSES overcome temporary liquidity shortages. This is done as a means of increasing the liquid funds available not only to the discount houses themselves but also to the COMMERCIAL BANKS at prevailing interest rates to enable them to maintain their lending. Compare FRONT DOOR.
back-to-back loanorparallel loan an arrangement under which two companies in different countries borrow each other’s currency and agree to repay the loans at a specified future date. At the expiry date of the loans, each company receives the full amount of its loan in its domestic currency without risk of losses from exchange-rate changes. In this way back-to-back loans serve to minimize EXCHANGE-RATE EXPOSURE.
backward integration the joining together in one firm of two or more successive stages in a vertically related production/distribution process, with a later stage (for example, bread making) being combined with an earlier stage (for example, flour milling) Backward integration is undertaken to cut costs and secure supplies of inputs. See VERTICAL INTEGRATION, FORWARD INTEGRATION.
BACS (Bank Automated Credit System) a money transmission system whereby a payer instructs a COMMERCIAL BANK to debit a specified sum of money from his or her account and transfer it to a named payee’s bank account. This obviates the need for the payer to issue and post a cheque to the payee and for the payee then to bank it, thus saving on time and expense. Many employers now use BACS to pay their employees’ monthly salaries, and many companies use the system to transfer dividend payments to shareholders.
bad debt an accounting term for money owed that is unlikely to be paid because, for example, a customer has become insolvent (see INSOLVENCY). Such bad debts are written off against the PROFITS of the trading period as a business cost. See CREDIT CONTROL.
balanced budget a situation where GOVERNMENT EXPENDITURE is equal to TAXATION and other receipts. In practice, most governments run unbalanced budgets as a means of regulating the level of economic activity.
Where the government spends more than it receives in taxation, then a BUDGET DEFICIT is incurred. Where the government spends less than it receives in taxation, then a BUDGET SURPLUS ensues. See BUDGET, FISCAL POLICY, PUBLIC SECTOR BORROWING REQUIREMENT.
balanced budget multiplier a change in AGGREGATE DEMAND brought about by a change in GOVERNMENT EXPENDITURE, which is exactly matched by a change in revenues received from TAXATION and other sources. The change in government expenditure has an immediate effect on aggregate demand and generates income of an equivalent size. By contrast, the change in taxation does not change aggregate demand by an equivalent amount because some of the increased/reduced DISPOSABLE INCOME will be offset by changes in SAVING. Consequently, an increase in government expenditure and taxation of equal amounts will have a net expansionary effect on aggregate demand and incomes, while a decrease in government expenditure and taxation of equal amounts will have a net contractionary effect. See BUDGET, FISCAL POLICY.
balance of payments
A statement of a country’s trade and financial transactions with the rest of the world over a particular time period, usually one year. Fig. 13 (a), shows a summary presentation of the UK balance of payments for 2003. The account is divided into two main parts:
(a) current account, and
(b) capital and financial account.
The current account shows the UK’s profit or loss in day-to-day dealings. It is made up under two headings. The ‘visible’ trade balance (BALANCE OF TRADE) indicates the difference between the value of merchandise EXPORTS and IMPORTS of goods (raw materials, foodstuffs, oil and fuels, semi-processed and finished manufactures). ‘Visibles’ are so called because they consist of tangible goods that can be seen directly and recorded by the country’s CUSTOMS AND EXCISE authorities as they move into or out of the country. The second group of transactions make up the ‘INVISIBLE’ TRADE BALANCE. These transactions include earnings from, and payments for, such services as banking, insurance, transport and tourism. It also includes interest, dividends and profits on investments and loans, and government receipts and payments relating to defence, upkeep of embassies, etc., and transfers to the European Union budget. (See Fig. 62 (a)).
‘Invisibles’ are so called because basically they represent transactions that cannot be seen directly and can be compiled only indirectly from company returns, government accounts, foreign currency purchases and sales data from banks. Traditionally, the UK has incurred deficits on ‘visibles’ largely because of the need to import basic foodstuffs, raw materials and (until the 1980s) oil. What are worrying to some economists, however, are the large deficits in manufactures, where seemingly the UK has been losing international competitiveness. (See DEINDUSTRIALIZATION.) The service sector has traditionally been in surplus thanks to the City of London’s banking and insurance business, which, together with proceeds from the UK’s position as a leading overseas investor, have been major foreign exchange earners. As can be seen in Fig. 13 (b), the UK has recently been in overall surplus on current account after previously chalking up large deficits.
Fig. 13 Balance of payments. (a) The UK Balance of Payments, 2003. (b) UK Balance of Payments, 1993–2003. Source: UK Balance of Payments, Office for National Statistics (Pink Book), 2004.
In addition to current account transactions, there are also currency flows into and out of the country related to capital items. The capital and financial account is made up of a number of elements including: receipts and payments related to FOREIGN DIRECT INVESTMENT (monies spent by companies on setting up or acquiring overseas manufacturing plants, sales offices, etc.); receipts and payments related to PORTFOLIO INVESTMENT (monies spent by mainly financial institutions in purchasing overseas stocks and shares, government bonds, etc.); and receipts and payments related to interbank transfers (for example, foreign currency deposits with UK commercial banks taking advantage of higher UK interest rates compared to other financial centres). Recently the UK has been a net exporter of capital after a number of years of capital account surpluses – see Fig. 13 (b).
The current balance and the capital and financial account, together with the ‘balancing item’ (which includes errors and omissions in recording transactions and leads and lags in currency payments and receipts), result in the balance for official financing. This figure shows whether the country has incurred an overall surplus or deficit. If the balance of payments is in surplus, the country can add to its INTERNATIONAL RESERVES and, if necessary, repay borrowings; if it is in deficit, this has to be covered by running down its international reserves or by borrowing (for example, from the INTERNATIONAL MONETARY FUND).
Maintaining BALANCE-OF-PAYMENTS EQUILIBRIUM over a run of years is usually one of the four major objectives of a government’s MACROECONOMIC POLICY. A balance of payments surplus or deficit can be remedied in a number of ways, including external price adjustments, internal price and income adjustments, and trade and currency restrictions.
balance-of-payments disequilibrium see BALANCE-OF-PAYMENTS EQUILIBRIUM.
balance-of-payments equilibrium a situation where, over a run of years, a country spends and invests abroad no more than other countries spend and invest in it. Thus, the country neither adds to its stock of INTERNATIONAL RESERVES, nor sees them reduced.
In an unregulated world it is highly unlikely that external balance will always prevail. Balance of payments deficits and surpluses will occur, but provided they are small, balance-of-payments disequilibrium can be readily accommodated. The main thing to avoid is a FUNDAMENTAL DISEQUILIBRIUM – a situation of chronic imbalance.
There are three main ways of restoring balance-of-payments equilibrium should an imbalance occur:
(a) external price adjustments. Alterations in the EXCHANGE RATE between currencies involving (depending upon the particular exchange-rate system in operation) the DEVALUATION/DEPRECIATION and REVALUATION/APPRECIATION of the currencies concerned to make exports cheaper/more expensive and imports dearer/less expensive in foreign currency terms. For example, with regard to exports, in Fig. 14 (a), if the pound-dollar exchange rate is devalued from $1.60 to $1.40 then this would allow British exporters to reduce their prices by a similar amount, thus increasing their price competitiveness in the American market.
(b) internal price and income adjustments. The use of deflationary and reflationary (see DEFLATION, REFLATION) monetary and fiscal policies to alter the prices of domestically produced goods and services vis-à-vis products supplied by other countries so as to make exports relatively cheaper/dearer and imports more expensive/cheaper in foreign currency terms. For example, again with regard to exports, if it were possible to reduce the domestic price of a British product, as shown in Fig. 14 (b), given an unchanged exchange rate, this would allow the dollar price of the product in the American market to be reduced, thereby improving its price competitiveness vis-à-vis similar American products. The same policies are used to alter the level of domestic income and spending, including expenditure on imports.
