How does a country record its dealings with the rest of the world, and what does a deficit mean?
The balance of payments: the structure of the current account, the meaning of a current account surplus and deficit, the causes of a deficit, and policies to correct one.
An SQA Higher Economics answer on the balance of payments, covering the structure of the current account (trade in goods and services, plus income), the meaning of a current account surplus and deficit, the causes of a persistent deficit, and the policies a government can use to correct one.
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What this key area is asking
The SQA wants you to know the structure of the current account of the balance of payments, what a surplus and a deficit mean, the causes of a persistent deficit, and the policies to correct one. The exam skill is to define the account precisely, explain the deficit as imports exceeding exports, and evaluate corrective policies with their drawbacks.
The structure of the current account
The largest element for most countries is trade: the export and import of goods (the "visible" balance) and of services (the "invisible" balance). Adding income from abroad (such as profits and interest) and net transfers gives the overall current account balance. Exports bring money into the country; imports take it out.
Surpluses and deficits
- A current account surplus occurs when credits exceed debits: the country earns more from the rest of the world than it spends, so money flows in on balance.
- A current account deficit occurs when debits exceed credits: the country spends more abroad than it earns, so it must finance the gap with inflows of foreign money (borrowing or investment from abroad).
A small deficit can be sustainable, but a large, persistent deficit means the country is consistently living beyond its means internationally, which can become a problem.
Causes of a current account deficit
A deficit arises when imports (and other debits) persistently exceed exports (and other credits). Common causes include:
- Uncompetitive exports: high costs, low quality or low productivity make domestic goods hard to sell abroad.
- A high exchange rate: a strong currency makes exports dear and imports cheap.
- Strong domestic demand: rising incomes and spending pull in more imports.
- Deindustrialisation: a shrinking manufacturing base reduces what the country can export.
Policies to correct a deficit
The government has several options, each with a trade-off:
- Reduce demand (contractionary fiscal or monetary policy): higher taxes or interest rates cut spending, including on imports, but slow growth and raise unemployment.
- Lower the exchange rate: a cheaper currency makes exports cheaper and imports dearer, improving the trade balance, but can raise inflation.
- Supply-side policy: training, investment and innovation raise productivity and export competitiveness over time, but work slowly.
- Protectionism: tariffs and quotas cut imports directly, but raise prices and risk retaliation.
Worked example: diagnosing and correcting a deficit
Why the balance of payments matters
The balance of payments connects an economy to the rest of the world and is one of the government's four macroeconomic aims. It links directly to trade (the exports and imports it records), to exchange rates (which drive competitiveness), and to multinationals (whose investment and profit flows appear in it), tying the global area to the macroeconomic unit.
Try this
Q1. State what a current account surplus means. [2 marks]
- Cue. A current account surplus means credits exceed debits: the country earns more from exports and income from abroad than it spends on imports and income paid abroad, so money flows in on balance.
Q2. Explain how a fall in the exchange rate could help to reduce a current account deficit. [3 marks]
- Cue. A lower exchange rate makes exports cheaper in foreign currency, so foreigners buy more of them, and makes imports dearer in domestic currency, so residents buy fewer; exports rise and imports fall, improving the trade balance and reducing the deficit (though it can raise inflation).
Exam-style practice questions
Practice questions written in the style of SQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
SQA Higher (style)4 marksExplain what is meant by a current account deficit on the balance of payments.Show worked answer →
Worth 4 marks. Define the current account, then the deficit.
The current account (about 2 marks). The balance of payments records a country's transactions with the rest of the world. The current account is the part covering trade in goods and services, plus income flows (such as wages and investment income) and transfers. Exports earn money for the country (a credit); imports cost money (a debit).
The deficit (about 2 marks). A current account deficit occurs when the value of what the country buys from abroad (imports and other debits) exceeds the value of what it sells abroad (exports and other credits). In other words, more money flows out than in on the current account, so the country is not paying its way internationally and must finance the gap with inflows of foreign money.
SQA Higher (style)6 marksExplain two policies a government could use to reduce a current account deficit.Show worked answer →
Worth 6 marks. Two policies, each explained with its effect and a limitation.
Reducing demand or boosting competitiveness (about 3 marks). The government can use contractionary policy (higher taxes or interest rates) to reduce demand, including demand for imports, cutting the deficit, though this also slows growth and raises unemployment. Allowing or encouraging a lower exchange rate makes exports cheaper and imports dearer, improving the trade balance, though it can raise inflation.
Supply-side and protection (about 3 marks). Supply-side policies (training, investment, innovation) raise productivity and the quality and competitiveness of exports, improving the current account in the long run, but they work slowly. Protectionism (tariffs, quotas) cuts imports directly, but raises prices and risks retaliation. A good answer explains how each policy works and notes its drawback, weighing the trade-offs.
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Sources & how we know this
- Higher Economics Course Specification — SQA (Qualifications Scotland) (2024)