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Study Notes

Balance of Payments - Policies to Improve Trade

AQA, Edexcel, OCR, IB

Last updated 21 Mar 2021

There are a number of policies that can be introduced to achieve an improvement in a country's trade balance – some of them focus on changing the growth of demand, others look to improve the supply-side competitiveness of an economy. As with any macroeconomic 'problem' effective policies are those that target the underlying causes.

Improving Trade Performance in the Short and Long Run

  • Expenditure - reducing policies - designed to control demand and limit spending on imports - squeeze on demand, encouraging rising private sector saving
  • Expenditure-switching policies - designed to change the relative prices of exports and imports - this causes changes in spending away from imports and towards domestic/export production
  • Improving the supply-side performance of the economy - to boost competitiveness - economic reform is a long-run strategy
  • Improving macroeconomic stability to make a country more attractive to inward investment - investment can raise productivity and increase a country's capacity for exporting

Demand management: Reductions in government spending, higher interest rates and higher taxes could all have the effect of dampening consumer demand reducing the demand for imports. This leads to an increase in spare productive capacity which can then be allocated towards exporting.

Natural effects of the economic cycle: One would expect to see a trade deficit fall during a recession – so some of the deficit is partially self-correcting – but this does little to address the problems of a structural balance of payments problem.

A lower exchange rate:

  • The central bank of a country might decide that a lower exchange rate provides a suitable way of improving competitiveness, reducing the overseas price of exports and making imports more expensive
  • For those countries operating with a managed exchange rate, the government may decide to authorise intervention in the currency markets to manipulate the value of the currency

Supply-side improvements:

  • Policies to raise productivity, measures to bring about more innovation and incentives to increase investment in industries with export potential are supply-side measures designed to boost exports performance and compete more effectively with imports. The time-lags for supply-side policies to have an impact are long.
  • Policies to encourage business start-ups – successful small businesses with export potential
  • Investment in education and health-care to boost human capital and increase competitiveness in fast-growing and high value industries such as bio-technology, engineering, finance, medicine
  • Investment in modern critical infrastructure to support businesses and industries involved in international markets

Protectionist measures such as import quotas and tariffs are rarely used because of our commitments to the World Trade Organisation and our membership of the European Union.

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