Balance of payment is a record of a country’s trade dealings with the rest of countries in the world (Irwin, 2009). It is the main measure of imports and exports. For some years, U.K has been experiencing a deficit in the balance of payment. Below are the reasons for the deficit and probable actions U.K government could take to reduce or eliminate the deficit.
Reasons for deficit
A sustained economic growth period and an increase in the consumer demand for goods may have caused the deficit. U.K manufacturing sector is not large enough to cater for the consumers demand for goods .The sector also does not have a comparative advantage in producing goods, making it have a high marginal propensity to import in order to satisfy the excess consumer demand (Cherunilam, 2008).
Decline in export competitiveness
The deficit may be attributed to the emergence of countries like China with low cost of labor and the increase in the productivity of the low-end manufacturing sector. This reduces the export competiveness of UK as the products from China become popular due to the low cost of labor. If the degree of substitutability remains high, UK exports demand fall, which in return causes the decrease in the exports earning. Imports on the other hand, increases as UK people switch their expenditure to purchasing the imported cheaper goods assuming the import price elasticity of demand is above one (Cherunilam, 2008).
Undervaluation of the trading partners’ currency
UK has accused some of the trading partners like China and Japan of keeping their currency undervalued. Undervaluation of currency causes such country’s goods to have lower prices compared to UK Company. UK residences, therefore, prefer the goods from overseas since they are cheaper (Clark, 2002).
Action to reducing the deficit
To improve the balance of payment, UK government may do the following.
This involves restricting the imports demand in UK through fiscal and monetary policies. This is possible since UK has a high marginal propensity to import. Through monetary policies, the government can reduce the demand through increasing rates of interest on borrowing. This will discourage borrowing from the residence and in return increase the rate of saving. Fiscal policy on the other hand, can reduce the demand through imposing high direct taxes that cause a fall in disposable income. It increases linkages and reduce injection of income thereby reducing the imports (Irwin, 2009).
Exchange rates adjustment
This can be done through devaluation where the fixed exchange rate will reduce the external prices of the UK currency. UK exports will appear cheaper to foreigners and the imports will be expensive to the residents preventing them from purchasing more from overseas (Irwin, 2009).
Supply side policies
Use of Supply policies leads to increased exports and reduction of the imports as the quality of goods increase and the cost reduces. Examples of such policies are changes in the quality and the size of labor for production, changes in the cost of unit wage, taxes and subsidies, progress in technology and the impact of innovation.
To sum up, the potential causes of the balance of payments in UK are continuous economic growth, undervaluation of trading partners currency and the decline in export competitiveness and the emergence of competitors with low cost of production. The government could take the action of deflation, exchange rates adjustment and use supply policies to reduce or eliminate the deficit in the balance of payment.
Cherunilam., 2008. International Economics. 5th ed. New Delhi: Tata McGraw-Hill
Clark E., 2002. International Finance. 2nd ed. London: International Thomson Learning
Irwin D. A., 2009. Free Trade Under Fire: 3rd ed, New Jersey: Princeton University press