SummaryAn economy’s openness must be measured considering multiple variables. For instance, all countries are considered open economies to some degree, but not all allow free movement of capitals across borders. Others might have governments that control information flows and Internet service. In this LP, we learn to analyse an open economy from a purely economic point of view, looking at their net exports and their Balance of Payments.
The current account is one of the components of the balance of payments. It mainly shows the value of movements in exports and imports and income derived form transactions related to net purchases of goods and services. As stated in the sixth edition of the Balance of Payments Manual (BPM), by the International Monetary Fund, “the current account shows flows of goods, services, primary income, and secondary income between residents and nonresidents”. Let’s review all these components:
“The goods and services account shows transactions in items that are outcomes of production activities”. The first thing to mention is that, even though goods are physical, and services are a production that changes the consuming units, or facilitates some kind of exchange, both are considered as products, and are measured at the moment of exchange and at market value. The table below, taken from the BPM, shows an overview of the goods and services account.
“The primary income account shows primary income flows between resident and nonresident institutional units”. In other words, these are income flows concern to some extent governments and other institutions. For instance, taxes, subsidies or other income associated with the production process and with the ownership of financial assets and renting natural resources. It’s worth mentioning that cross-border primary income flows constitute a link between gross domestic product and gross national income. The table below, taken from the BPM, shows an overview of the primary income account.
“The secondary income account shows current transfers between residents and nonresidents”. These transfers, which might be in cash or in kind, do not include capital transfers, which are shown in the capital account. This is because, as opposed to secondary income, capital transfers do not affect disposable income. The table below, taken from the BPM, shows an overview of the secondary income account.
The balance on these three account is known as the current account balance, which shows the difference between the sum of exports and income receivable, and the sum of imports and income payable. It’s also worth mentioning that the current account balance equals the savings-investment gap for the economy, as seen in the following formula:
S – I = CAB
S = savings
I = investment
CAB = current account balance