Unit 3 AOS3 Economics - Lesson 2 - Balance of Payments

All right. Hello. Hello, everyone, and welcome to video two in our series of Australia and the world economy for unit three areas, day three for economics. Today, we're going to be talking all about the balance of payments and the current account. So bear with me, this is a fairly big part of the topic. It's one that I find students often get confused about. There's a lot of small components to it that you can be asked about in a SAC in the exam. So we're going to go through them bit by bit, try and get through them. But this is kind of one of the topics overall where it makes a lot more sense when you start doing the application. So hopefully once you start applying it through questions and work that you do, it will start making more sense to you overall. So in this, what we're going to look at is the balance of payments and its components. We are going to look at the Australian cause of Australian's current account deficit, including cyclical and structural factors and the relationship between the current account and the capital and financial account. So we're going to go through these one by one to describe them for you and hopefully make them make sense. So the balance of payments is an annual statistical record of the value of money, both current capital and financial transactions receive Australia and the rest of the world, to use some props, basically it's the balance of money coming into Australia and money that's leaving Australia. So it's all about credits, money coming into Australia versus debits, when money leaves Australia. So at the moment, most of the time we've talked about this, it's been all about imports and exports, and that's a big part of this. But then other parts come into it are about like repayment on foreign debt and also foreign aid to overseas and how that factors into our overall balance here, whether we are in surplus or whether we are in a deficit. So the balance of these transactions is known as either the current account surplus or the current account deficit. Most often in Australian history, like up until recently, it's been a current account deficit where total debits exceeds credits. So for the most part of time, we have had far more debits leaving the country than credits coming in. A large part of that has been because the interest repayments on our foreign debt are gigantic. We owe the rest of the world over a trillion dollars. That's only going up with all the government spending that's occurring during this pandemic. And so somehow at the moment, we are in a current account surplus, which means we have more money coming into Australia than the money leaving it. But we are trending back towards a deficit in this time of pandemic and everything slowing down. We are starting to export a lot less as other countries slow down and want to buy less of our goods and services. And that's going to be a big issue for our current account. But we'll also talk about further on down the line what a healthy current account means. So measuring the balance of payments accounts. So when we look at the current account, it's like this big overarching thing where on one side we've got the balance of payments and on the other side we have the balance of financial and capital account and those two halves end up being equal. At the end of the day, how they end up being equal is a little bit arbitrary. You don't need to know that. You're not going to have to calculate it other than like little calculations where it will be easy. A multiple choice question. But all you need to know is that the two halves of the balance of payments, which is what we're going to look at on this slide, and the balance of financial and capital account all end up zeroing out. It's like if you do accounting, it's like a balance sheet. The two sides have to be equal because they are there to balance each other. So the balance of current account is broken into four sub accounts. This is one of the main parts. This is the biggest part that gets asked about when of the biggest ones that comes up pretty often and it's probably also the easiest part to understand. So hopefully you get this pretty well. So there are four sub accounts in the balance of payments that we look at the balance of. So we look at net goods, which is exports minus imports. So the total value of export credits minus the total amount of import debits. For the most part, net goods is negative because we import a lot more than we export other than in certain periods where during the mining boom we're exporting a whole lot to China. The net goods section is normally in deficit because we import so much net services the exact same but about services. So I know people often find exporting services to be a weird thing to think about. Think about tourism, not so much at the moment and education as some of our biggest services that we export. So Australian university degrees are massive at targeting foreign students who usually pay a lot more. And that is a service that's being exported back to their home country. Net primary incomes is where this usually gets a little bit more complicated. So net primary incomes is the difference between income credits received from overseas against debits we've paid abroad. So how this works is if you're an Australian working overseas, you earn an income and you bring that income back to Australia, that's a net primary income. So if you go and work in America, get paid a salary and bring that money back to Australia or send that money back to Australia, that is a net primary income credit. A debit would be when someone from overseas comes into Australia, works within Australia and sends that money back overseas. That would be an income debit leaving Australia. Where the net primary incomes account gets a little bit more complicated is that it's also where we include our interest repayments on foreign debt. So one of the biggest reasons why the net primary incomes account is always negative is because the interest on our trillion dollar foreign debt is calculated there. So the interest we were paying on a trillion dollars, which is a significant amount, it's a debit here. And therefore this net primary income is often one of the biggest reasons why the current account is either in deficit or just this section is negative because we're paying so much interest on foreign debt. So always remember that net primary incomes is incomes of people working overseas that come back into Australia versus the incomes of people who work in Australia that send that income overseas. Well as our interest repayments on foreign debt. And that last point is a massively important factor. Next up we've got net secondary incomes and these are just one way transactions when nothing is gained in return. Most of the time all we include in this is foreign aid. So we talked about a little bit in the last PowerPoint about the fact foreign aid has been on the way down, which means there's going to be less debits in foreign aid. We're not going to get all our credits in foreign aid. People aren't sending foreign aid to Australia. There's a little bit during the bushfires, but for the most part it's only really us sending foreign aid to other countries. And so this is a one way transaction where nothing is gained in return. So when we are sending foreign aid to other countries, that is a net secondary income, most often this is going to be a negative value overall as well. So these figures all added together equals the overall balance on current account. So we just add up the dollar values of all of these accounts and that ends up being the current account surplus if it's positive or the current account deficit if it's negative. So it's relatively simple there. Some of the ways VCAR tries to trick you with this is sometimes in multiple choice questions they can have, they'll say like net goods credits, net goods debits, net service credits, net service debits. But other times I'll call them imports and exports and they'll put them in weird orders. You just need to know which one is a credit coming into Australia and which one's a debit leaving and making sure that you are always subtracting the debits from the credits and then you'll get the correct number at the end and that will be the balance of current account, whether that be a current account surplus or deficit. Like I said earlier, at the moment we are in a current account surplus, but it's trending towards a deficit based on the current financial and economic climate. On the other side, and where it gets a little bit more confusing for a lot of students is the balance of capital account. This includes net capital transfers, net acquisition of non produced and non financial assets. So these two things, capital transfers include net inflow of funds to Australia by permanent migrants. This part's pretty simple. If you were to move to Australia from overseas with your family, this is about all of the money that you bring to Australia with you. That's a capital transfer and that is a credit on the current account. It would also work in the opposite way. There'd be a debit for it. If you moved overseas and took all your money with you overseas, that would be a debit because you're taking all your capital with you over to a foreign country. The next part, the net acquisition of non produced, non financial assets is all about the credits and debits of sales of copyright, patents, franchises, trademarks of a tangible and non tangible nature. So it's all about if say you're a band and your music's on Spotify and you're getting royalties from it being played in America, that would be a credit to Australia because those royalties are coming into Australia as someone's income. Things like, if you look at TV programs like at the moment MasterChefs on TV and MasterChef is a franchise. The TV format of it was made in Australia and they sold it to other countries. So when they play that format in other countries they get royalties for that and that is a credit into Australia. It would be the opposite when we do things like say, for example when they use Survivor in Australia, that's an American format that we have paid to use the license for and that would be a debit where that money to pay for that licence goes back over to America. That would be a debit in the capital account where these non financial assets are being paid for. Then we have the balance on financial account which is broken up into four little sections here. So we've got net direct investment which is all about the purchase or expansion of companies and assets in Australia by foreigners. So it's like if people invest in land or businesses in Australia, that's net direct investment. So if you're buying say a franchise in Australia or you're bringing your business into Australia, that's net direct investment. That is a credit on the financial account. Net portfolio investment is all about shares, debt and securities. So if you're buying shares in Australia or someone from overseas is buying shares in Australia, that's an credit for net portfolio investment. So someone from overseas is buying shares in say Channel nine. That is a credit for net portfolio investment. If you're buying shares on the American stock market that would be a debit because that's money going over as net portfolio investment in America. Then we have reserve assets which is about the RBA and government transactions that involve foreign currencies, gold special drawing rights and required contributions to International Monetary Fund. Basically this is all of it's almost like what I refer to the RBA's savings for a rainy day where they have all different currencies, etc. For if they want to do certain things with currency that's there for them to use potentially for different reasons. You don't need to know much about this other than the fact it exists. You're rarely, you're never going to get a question about it specifically. To be honest, I've never ever in my life seen a question about reserve assets. So I wouldn't worry too much about it except knowing that it's part of the financial account. And the last part is the reason why the balance of payments balances is we have a sub account for net errors and omissions. And basically this reflects the inaccuracies in the above calculations and estimations across both this and the other side of the balance of payments and basically gives a dollar value that makes the whole two sides balance. So no matter what this net errors and omissions will make the whole thing balance. Why that's the case, I couldn't tell you to be honest. That's like I've looked, tried to look it up for years, tried to find out more information about it. All you can possibly find out at the moment is that this net errors and omissions is there to make the whole thing balance. So what you need to know is that the balance of payments balances, because the balance of payments cancels out the balance of capital account and the balance of financial account. You don't need to know why they balance, which I know a lot of students struggle with, because they really want to know the why of certain things. So the next part and part of the key knowledge is about causes for Australia's current account deficit. The key knowledge is clearly a little bit out of date if we're in a current account surplus at the moment. But there are reasons why the majority of the time we're in a current account deficit, and we're going to talk about those briefly now. So the structural or aggregate supply side causes of a current account deficit. So some of the reasons why we're normally in a current account deficit are that Australia is a relatively young country with a small population and a large quantity of natural resources and therefore investment is required to maximize output. And so a lot of the reason why we're able to use our resources like we do is because foreign investment comes into Australia and helps us with that. The issue with that, it means a lot of income is then going overseas. And if the income going overseas outweighs the incoming earned in Australia or coming into Australia, that's going to lead us to having more of a deficit. So if you look at business in Australia, most of the major businesses are foreign owned, which means a lot of profit and income is going overseas. And that's a structural factor that's going to affect our deficit. There's also a savings investment imbalance in Australia. So we have very little savings and we have invested a lot of our money in property, etc. And because we're spending a lot more than we're saving, that gap needs to be filled with foreign funds so it can balance out. So banks will borrow a lot of money from overseas financial institutions and that leads to interest repayments having to go overseas, which leads to more money leaving Australia and more of a current account deficit. And another cause is our low level of international competitiveness due to low efficiency and high costs. So like we've always been saying all year, we have one of the highest minimum wages in the world. And because of that, we can't really compete with a lot of overseas countries. And that can lead to us having to just import things from overseas because we're not as competitive. You look at the car manufacturing industry closing down, you look at a lot of businesses moving a lot of simpler jobs offshore means that because we're not efficient and we have high costs, we end up Importing a lot more than we export and that's because of our low international competitiveness. And these are all structural causes of our current account deficit. Lastly, cyclical components of the cad. So anything aggregate demand side. So this is all about how changing levels or moving along the business cycle ends up affecting aggregate demand and economic growth. So the cat will tend to grow as the gap between savings and investment gets bigger and strong spending spills over. Integrated import spending. This is kind of similar to what I was saying before because we can often get a lot cheaper things from overseas. Often when we get higher disposable incomes and we get access to more money to spend, often it spills over into import spending because when we have more money we want to make the most out of it. And so we buy a lot of overseas products because they're cheaper or there's more choice and that leads to our current account deficit being a lot bigger because of aggregate demand side factors. So when we have more money, we spend more on imports, which means more money is leaving Australia. We spend which means that the current account deficit can be bigger from a cyclical point of view then often on the opposite side when things start to slow down, when we have weaker AG demand and we go into a contraction, one of the first things people stop doing is buying imports because they're going to buy just the staples they need to get by because they don't have as much money for luxuries. And so that import spending starts to slow down and it can make the current account deficit smaller overall when we're in a slower or or weakest period of aggregate demand. That's all for the balance of payments and the current account current account deficit. Hopefully this has been helpful for you. It's a lot to look at. I know it's only been like 17 minutes which can be a short or a long time depending on your opinion, but you're no doubt going to have questions about this, so feel free to leave a comment below or ask me a question about anything here via chat or email. More than happy to help. Make sure you do some application on this work. The application will make it infinitely easier. When you do the application and look at that compared to the theory, it's a very like this topic can be very complex because it's about a lot of international things. It's no longer just in Australia. So make sure you seek the help that you may need. Make sure you check out the other videos in this topic because they could be very useful to you in if there's anything you think could be beneficial to you in the future, let me know and I'll do my best to make that available to you. Other than that, I hope you have a great day. I will see you next time. Goodbye.