Balance of Payments & the Distribution of Income
The Balance of Payments
Every time the UK buys a foreign car or sells a software licence abroad, a record is made. The balance of payments is the account that tracks all money flowing into and out of the UK economy. The most important section for GCSE Economics is the current account, which covers trade in goods and services as well as investment income flowing in or out of the country.
The UK buys goods and services from other countries — these are imports. It also sells goods and services abroad — these are exports. When you subtract the value of imports from the value of exports, you get the balance of trade. If exports are greater than imports, there is a trade surplus; if imports exceed exports, there is a trade deficit.
A current account surplus means money flows into the country because exports exceed imports. A current account deficit means money flows out because imports exceed exports. The UK has run a current account deficit for most of the past four decades.
Why Do Surpluses and Deficits Arise?
A current account deficit can arise for a number of reasons. First, if consumer spending is high, households tend to buy more imports — trainers made overseas, electronics assembled abroad, food sourced internationally. Second, if domestic firms are relatively uncompetitive — perhaps because their costs are higher than foreign rivals — overseas products become more attractive to buyers at home and abroad. Third, a strong exchange rate makes UK exports more expensive for foreign buyers and imports cheaper for UK consumers, both of which worsen the current account.
A current account surplus tends to arise when a country produces things the world wants to buy. Countries like Germany have sustained surpluses because their manufacturers export high-value engineering goods in strong demand worldwide.
A persistent deficit has real costs. If the UK consistently spends more on imports than it earns from exports, it must borrow money from abroad or attract investment to cover the shortfall. Over time this can weaken the value of the pound — because more pounds are being sold to buy foreign currency to pay for imports — and it can make the country dependent on foreign creditors. Firms that produce goods facing strong import competition may cut jobs or close entirely.
However, a deficit is not necessarily a crisis. A growing economy naturally sucks in imports. If the deficit is financed by foreign investors buying UK assets and businesses because they believe in the UK’s long-term prospects, that is a sign of confidence. The key question is whether the deficit is sustainable — can it be financed without causing a damaging fall in the exchange rate or a rise in borrowing costs?
Government Policies to Influence the Current Account
Governments have several tools to try to reduce a current account deficit. They can use supply-side policies to make domestic firms more competitive — investing in education and training so workers are more skilled, or funding infrastructure to lower firms’ costs. A more competitive domestic industry exports more and is less undercut by imports. They can also allow the exchange rate to fall, making exports cheaper for foreign buyers and imports dearer for domestic consumers, though this tends to raise inflation. Import controls such as tariffs or quotas can limit imports directly, but these may provoke retaliation from trading partners.
Current account balance = Exports − Imports (plus net income flows and transfers). A positive value is a surplus; a negative value is a deficit. Performing simple calculations using current account figures is an assessed quantitative skill — always check whether the figure is positive (surplus) or negative (deficit).
The Distribution of Income
The distribution of income describes how earnings are divided across households. In the UK, as in most market economies, income is not shared equally. Some people earn much more than others because of differences in skills, qualifications, the type of work they do, and whether they own assets that generate income such as property or shares.
It is important to distinguish between income and wealth. Income is the flow of money a person receives over a period — wages, rent, profits and interest. Wealth is the stock of assets someone has built up over time. A person can have a high income but little wealth (for example, a well-paid worker who spends everything), or modest income but significant wealth (for example, someone who inherited property). Wealth inequality tends to be even more pronounced than income inequality.
Several factors drive the gap between higher and lower earners. Education and skills raise productivity and therefore wages — a software engineer earns more than an unskilled labourer partly because their skills are scarce and highly valued by firms. Inheritance means some households start with a significant asset base, allowing them to generate investment income that widens the gap over time. Market power of firms can hold wages down at the bottom of the labour market if workers have few alternatives.
Structural changes in the economy also play a role. Deindustrialisation reduced well-paid manual jobs in regions like the Midlands and North of England, leaving pockets of unemployment and lower earnings that persist across generations.
Consequences of Inequality
Inequality has consequences for individuals and for the economy as a whole. At the individual level, people on low incomes may struggle to afford adequate housing, food and healthcare. Children from poorer households may have less access to private tutoring and extracurricular activities, which can limit their future earnings — a cycle that can repeat across generations. From a macroeconomic perspective, very high inequality may reduce consumer spending overall if those at the top save most of their income rather than spend it, holding back demand.
On the other hand, some degree of inequality provides incentives. Higher rewards for skilled work or successful entrepreneurship encourage people to invest in their own education and training, which can raise the overall productivity of the economy. The debate over how much inequality is acceptable involves judgements about fairness and efficiency that go beyond economics alone.
The main tools of redistribution are taxation and government spending. A progressive tax such as income tax takes a bigger percentage from high earners than from low earners. This narrows the gap between gross (before-tax) and net (after-tax) incomes. The additional revenue can be spent on transfer payments — benefits such as Universal Credit, housing benefit and child benefit — which boost the incomes of lower-earning households.
The government can also reduce wealth inequality through inheritance tax, which taxes large transfers of wealth between generations, and by providing public services such as the NHS and state education that all households can access regardless of income. However, critics argue that very high tax rates can reduce incentives and may cause high earners to move abroad.
Linking the Two Objectives
The balance of payments and the distribution of income are both government objectives that can come into conflict with other goals. Reducing a current account deficit may require lower consumer spending, which could slow economic growth and raise unemployment. Redistributing income through higher taxes may reduce incentives to work or invest, potentially affecting productivity and long-run economic growth. Effective policy requires balancing these tensions — a judgement at the heart of many GCSE Economics evaluation questions.