Evaluate the significance for the UK balance of payments on current account of
increased use of protectionist policies around the world
The current account is comprised of the balance of trade, which is the net level of trade
(exports - imports), net investment income, defined as the net income received from
investment assets, and transfer payments which are one-way payments of money for
which no money, good, or service is received in exchange. The UK currently runs a large
deficit on the current account and therefore must borrow large funds on the capital
account. In fact, the UK current account deficit of 2013 was valued at a staggering
£71.1bn (4.4% of GDP) which is only marginally lower than the largest ever recorded of
4.6% in 1989.
Protectionism represents any attempt to impose restrictions on the trade of goods and
services, and it can arise for a number of reasons. One of these might be in an attempt to
improve the balance of payments - something the UK economy might benefit from.
Another key reason why a country might introduce barriers to free trade is to shelter
domestic industries from foreign competition, particularly ‘infant’ industries which are not
yet able to exploit economies of scale which their established foreign competitors can.
Protectionism can take many forms including introducing a tariff, which is a tax that raises
the price of imported products in order to cause a contraction in domestic demand, an
expansion in domestic supply, and also create some government revenue. Another
popular form of protectionism is introducing a quota which puts a limit on the volume or
value of imports which are permitted to be imported in to the country in a given time
period. Often the government sells off the right to import goods in the form of a license and
thus can also create revenue by this form of protectionism.
Fig 1
First we shall consider the likely effect on the balance of payments of the UK introducing
protectionist policies. Fig 1 represents a market for T-shirts where the UK government has
placed a tariff (t) in an effort to reduce the volume of imports of the good. We assume that
the UK is a small country and thus cannot affect the world supply of T-shirts, which we also
assume is able to be supplied at a constant price of Pw. If there is no tariff, the market
price is Pw and the output supplied by domestic producers is Q1. However, the quantity
demanded (Q2) at this price exceeds supply, and thus imports will come in to the country
to satisfy demand, equal to Q1 – Q2. The introduction of a tariff raises the price of imports
and as a result, domestic demand contracts and domestic supply expands. The tariff
raises the cost of imported T-shirts, and thus the world price is increased from Pw to Pw+t,
increasing domestic supply from Q1 to Q3 and reducing domestic demand from Q2 to Q4.
Since domestic supply has expanded and demand has fallen, fewer imports are needed to
satisfy the excess demand.
Therefore, in theory, the introduction of protectionist policies in the UK should reduce the
volume of imports and thus lead to an improvement in the balance of trade, the key
component of the balance of payments on current account. Protectionist policies are
unlikely to have any effect on the net value of transfer payments from the UK. However,
they might affect the third component of the current account, the net value of investment
income. In particular, protectionism in the form of the introduction of ‘red tape’ can create
high entry barriers for foreign companies looking to invest in the UK. This is another way in
increased use of protectionist policies around the world
The current account is comprised of the balance of trade, which is the net level of trade
(exports - imports), net investment income, defined as the net income received from
investment assets, and transfer payments which are one-way payments of money for
which no money, good, or service is received in exchange. The UK currently runs a large
deficit on the current account and therefore must borrow large funds on the capital
account. In fact, the UK current account deficit of 2013 was valued at a staggering
£71.1bn (4.4% of GDP) which is only marginally lower than the largest ever recorded of
4.6% in 1989.
Protectionism represents any attempt to impose restrictions on the trade of goods and
services, and it can arise for a number of reasons. One of these might be in an attempt to
improve the balance of payments - something the UK economy might benefit from.
Another key reason why a country might introduce barriers to free trade is to shelter
domestic industries from foreign competition, particularly ‘infant’ industries which are not
yet able to exploit economies of scale which their established foreign competitors can.
Protectionism can take many forms including introducing a tariff, which is a tax that raises
the price of imported products in order to cause a contraction in domestic demand, an
expansion in domestic supply, and also create some government revenue. Another
popular form of protectionism is introducing a quota which puts a limit on the volume or
value of imports which are permitted to be imported in to the country in a given time
period. Often the government sells off the right to import goods in the form of a license and
thus can also create revenue by this form of protectionism.
Fig 1
First we shall consider the likely effect on the balance of payments of the UK introducing
protectionist policies. Fig 1 represents a market for T-shirts where the UK government has
placed a tariff (t) in an effort to reduce the volume of imports of the good. We assume that
the UK is a small country and thus cannot affect the world supply of T-shirts, which we also
assume is able to be supplied at a constant price of Pw. If there is no tariff, the market
price is Pw and the output supplied by domestic producers is Q1. However, the quantity
demanded (Q2) at this price exceeds supply, and thus imports will come in to the country
to satisfy demand, equal to Q1 – Q2. The introduction of a tariff raises the price of imports
and as a result, domestic demand contracts and domestic supply expands. The tariff
raises the cost of imported T-shirts, and thus the world price is increased from Pw to Pw+t,
increasing domestic supply from Q1 to Q3 and reducing domestic demand from Q2 to Q4.
Since domestic supply has expanded and demand has fallen, fewer imports are needed to
satisfy the excess demand.
Therefore, in theory, the introduction of protectionist policies in the UK should reduce the
volume of imports and thus lead to an improvement in the balance of trade, the key
component of the balance of payments on current account. Protectionist policies are
unlikely to have any effect on the net value of transfer payments from the UK. However,
they might affect the third component of the current account, the net value of investment
income. In particular, protectionism in the form of the introduction of ‘red tape’ can create
high entry barriers for foreign companies looking to invest in the UK. This is another way in
