Embedded Files
Helpful prior knowledge and learning objectives
Helpful prior knowledge and learning objectives
Helpful prior learning:
Section 1.1.1 The economy and you, which explains what an economy is and how it is relevant to students’ lives
Section 1.1.2 The embedded economy, which explains the relationship between the economy and society and Earth’s systems
Section 1.3.9 Power in the economy, which explains where power comes from and how it shapes economic relationships
Section 7.1.1 Global exchange as a system, which describes global exchange as a system with parts, relationships, functions and emergence
Section 7.1.2 History of global exchanges, which describes how global exchange systems have evolved over time, shaped by changes in technology, power, and environmental factors
Section 7.1.3 What moves across borders? which describes what flows across borders and explains how visible global flows are linked to less visible social and ecological effects
Section 7.2.1 Why do countries trade and restrict trade? which describes different forms of protectionism and explains arguments for and against freer trade
Section 7.2.2 Currency exchange, which explains what exchange rates are, identifies the factors that cause them to change, and analyses who gains and who loses when exchange rates move
Section S.1 What are systems?, which explains what a system is, the importance of systems boundaries, the difference between open and closed systems, and the importance of systems thinking
Section S.2 Systems thinking patterns, which outlines the core components of systems thinking: distinctions (thing/other), systems (part/whole), relationships (action/reaction), and perspectives (point/view)
Section S.5 Causal loops, feedback and tipping points, which explains the feedback loops that can stabilise or destabilise systems
Learning objectives:
describe what the balance of payments measures, distinguishing between the current account and the financial and capital accounts, using examples of transactions
analyse what a persistent pattern in the balance of payments reveals about the conditions in an economy, including its causes and vulnerabilities
A student in Brazil buys a solar lantern made in China. A British pension fund buys shares in a Chinese electric car company. A German firm opens a bicycle factory in Poland. A state borrows from an international lender to build a large windfarm. Together, transactions like these create a record of money moving between a country and the rest of the world.
This record is called the balance of payments.
Figure 1. The balance of payments records the payments that leave and enter the country for different kinds of transactions.
(Credit: Adapted outline from Wikimedia Commons)
What is the balance of payments?
What is the balance of payments?
The balance of payments is a record of all economic transactions between the residents of a country and the rest of the world over a given period, usually a year. It captures all flows of money into and out of the country.
Current account
Current account
Some of these flows of money happen because individuals, businesses, and states carry out different kinds of transactions with the rest of the world. A business in the UAE buys machinery from China so money flows out of the UAE and into China. A Nigerian student pays tuition fees at a South African university, so money flows out of Nigeria and into South Africa. A British company earns profit from a factory it owns in Vietnam, so the money might flow back into the UK. A nurse from the Philippines working in Germany sends money home to her family.
The part of the balance of payments called the current account records these money flows from:
buying and selling goods and services
income earned abroad
transfers like foreign aid or money sent home by workers living overseas, called remittances.
Figure 2. The current account includes transactions for buying and selling goods and services with other countries.
(Credit: Travel mania, licensed from Adobe Stock)
Financial account and capital account
Financial account and capital account
Other flows of money between countries happen when money is invested abroad, or when a state, business, or person borrows money from abroad. When a US company builds a factory in Germany, money flows into Germany and out of the US. When a British pension fund buys shares in a US technology company, money flows out of the UK and into the US. When a state borrows from an international bank, money flows into the country.
The part of the balance of payments called the financial account records these money flows from:
building or buying businesses and property abroad
buying and selling shares, bonds, and other financial investments abroad
borrowing and lending between states, banks, and other financial institutions.
Figure 3. The financial account includes the money spent by Tesla, a US-based car manufacturer, to build this car factory outside of Berlin, Germany.
(Credit: Markus Mainka, licensed from Adobe Stock)
There is also a third account, the capital account, which records one-off transfers between states where nothing is given in return, such as debt cancellation. It also includes transfers of things like patents and the rights to natural resources, such as land or minerals. For most countries this account is very small, and this textbook section thus mainly focuses on the current and financial accounts.
Note that you may come across older textbooks, articles, or data that use ‘capital account’ to mean what this book calls the financial account. This was standard practice internationally before 1993, and in some US data until 2014. If a source's numbers don't seem to match what you'd expect, check which definition it is using
The balance in balance of payments
The balance in balance of payments
Now consider what happens when these two accounts are seen together. If a country's residents spend more on foreign goods, services, and income payments than they receive from abroad, there is a gap called a current account deficit.
The money to cover the current account deficit has to come from somewhere. The only place it can come from is the rest of the world. Foreigners might buy assets in your country like a factory, a block of flats, or government bonds. Your government might borrow money from abroad. Or the central bank might draw down its stock of foreign reserves that it has saved up over time. These are all money flowing into the financial account. At the same time, money flows out of the financial account too, for example when domestic residents buy assets abroad.
What matters for covering the current account deficit is how much more flows into the financial account than flows out, the financial account surplus. Over the course of a year, any current account deficit has to be matched by a financial account (+ capital account) surplus. The reverse is also true. A current account surplus has to be matched by a financial account deficit (capital account included) as the country lends or invests its excess earnings abroad.
Current account + (financial account + capital account) = 0
A single year's balance of payments tells us relatively little. A pattern that persists over many years tells us something important about an economy’s strengths and weaknesses. The same pattern can mean different things depending on what is driving it.
Persistent current account surplus
Persistent current account surplus
A country running a persistent current account surplus earns more from its exports to the rest of the world than it spends on imports. That extra foreign currency builds up over time as foreign reserves held by the central bank. States often use these reserves to buy assets abroad, including foreign government bonds. These purchases generate income flows back into the country in future years.
A persistent surplus can mean a country makes goods the world wants, like machinery or electronics, especially efficiently. But it can also happen when wages are low, credit is hard to get, or households save heavily, since these all mean people buy less at home. When people buy less at home, more of what the country makes gets sold abroad instead, showing up as a surplus. Workers in export industries may still benefit through jobs and wages, but if wages grow slowly economy-wide, even their gains tend to lag behind the profits flowing to firms and the state.
A surplus also tends to put upward pressure on a country's currency over time, unless that country shares a currency with other economies, as in the eurozone. Currency appreciation makes exports more expensive and can gradually weaken the competitiveness that drove the surplus, like a balancing feedback force.
A large, persistent surplus may also strain trade relations with trading partners. Trading partners running deficits may see the imbalance as unfair. China's large current account surplus, for example, is mirrored by a persistent current account deficit in the United States. The US has responded with tariffs on Chinese exports, which cna shrink the export markets the surplus depends on.
Finally, an economy built around exporting becomes heavily dependent on foreign buyers. If global demand falls, because of recession, shifts in trade policy, or new competitors, an economy with a current account surplus can suffer a sharp shock.
Figure 4 shows Germany's persistent current account surplus. That surplus reflects strong auto exports, a major share of Germany's economy. By the mid-2020s, the dependency on auto exports became a huge risk to the German economy. German manufacturers had already been losing sales to Chinese competitors for years, in a Chinese market that had long been their most profitable. Chinese firms developed electric vehicles more quickly. Sudden high tariffs on German cars from the United States and an energy crisis following the closure of the Strait of Hormuz, then made this loss of competitiveness worse. Germany's persistent current account surplus had long been read as a sign of economic strength. That same success may have made it harder to notice how dependent the country had become on one industry, and how exposed that left it when conditions changed.
Figure 4. Germany has a large and persistent current account surplus. What does this indicate about the economy?
(Credit: World Bank)
Persistent current account deficit
Persistent current account deficit
A country running a persistent current account deficit consistently spends more abroad than it earns. Foreign buyers and lenders cover this gap. They buy the country's assets, or they lend money to the country directly.
A deficit is not automatically a problem. If the financial inflows on the financial and capital accounts build productive capacity, such as new infrastructure and new industries, the country may earn more from exports, or need to import less, in future years.
The concern arises when the gap is large and persistent, and borrowing or asset sales fund it instead of productive investment. A sustained current account deficit tends to put downward pressure on the currency. This happens because residents sell more of the country’s currency to buy foreign goods than foreigners buy to purchase exports. A falling currency makes imports more expensive, which raises prices and erodes living standards but can help to rebalance the trade between countries.
Over time, a country with a persistent current account deficit owns less of its own assets, and it spends more of its future income paying debts accumulated on the financial account. Sustaining a large current account deficit requires that foreign buyers keep purchasing the country's assets, or that lenders keep lending. When confidence falls and foreign money stops arriving or starts leaving, an economic shock can result.
The United States has run a persistent current account deficit for decades, 3.6% of GDP in 2025 (Figure 5). The deficit is partly the counterpart to current account surpluses run by major exporting economies like Germany and China. When some countries consistently sell more than they buy, others must buy more than they sell. Large financial account inflows have covered the US deficit. Foreign governments, pension funds, and investors have purchased US government bonds, shares in US companies, and other assets. The dollar is the world's main reserve currency (Section 7.3.6). This creates persistent global demand for dollar-denominated assets. As a result, the US can sustain a large deficit without the kind of sudden adjustment that smaller economies in similar situations might experience. But this special status does not eliminate vulnerability. If foreign investors were to lose confidence in US institutions and begin moving away from dollar assets, the cost of covering the deficit could rise significantly.
Figure 5. The United States has a large and persistent current account deficit. What does this indicate about the economy?
(Credit: World Bank, click on the link to access the interactive version of this graph)
The key question for a persistent current account deficit is what is funding it, and whether that funding builds productive capacity, such as factories or infrastructure, or simply adds to future debts. For most countries, this question matters right away. For the US, the dollar's reserve status has provided a buffer. But that buffer depends on the trust of the rest of the world, and trust can erode.
Figure 6 is a summary of advantages and disadvantages of current account surpluses and deficits.
Figure 6. Advantages and disadvantages of current account surpluses and deficits.
(Credit: Bertelsman Foundation, Gnath, McKeon, and Petersen)
What deeper risks does the balance of payments miss?
What deeper risks does the balance of payments miss?
The balance of payments is a useful tool for recording money flows and spotting some economic vulnerabilities. But it doesn’t show us what is happening to the ecological foundation behind the world's transactions, or whether the money earned or invested actually meets people's needs.
A country that exports timber, fish, or minerals earns foreign currency, which appears as income in the current account. If people extract those resources faster than nature can replace them, the current account still records a gain. But the natural wealth that future production depends on shrinks. The balance of payments can show a country as financially healthy while it depletes its own ecological foundations. This matters especially for countries whose exports depend heavily on natural resources.
The balance of payments also cannot show what a country's productive capacity is actually used for, or who benefits from it. A country can direct its resources and labour toward producing what other countries want to buy, instead of what its own population needs. Export earnings can grow steadily this way, even while many people at home go without enough food, healthcare, or housing. The earlier section on persistent surpluses showed a similar pattern. Exports can grow while the gains flow mainly to firms and the state, and workers and households see little of it. Growing export earnings, or growing productive capacity of any kind, do not by themselves tell you whether an economy is serving the people who live in it.
7.2.4 Activity
7.2.4 Activity
Concept: Systems
Skills: Thinking skills (transfer, critical thinking), Research skills (information literacy)
Time: varies, depending on option
Type: Individual, pairs, or small group
Option 1: Case study of Sri Lanka’s balance of payments
Time: 40 minutes
Figure 7 below shows Sri Lanka's current account balance as a percentage of GDP from 1975 to the present. A negative number means the country spent more abroad than it earned in that year. A positive number means it earned more than it spent.
Look at Figure 7 carefully before answering the questions.
Figure 7. The current account balance of Sri Lanka. (Credit: World Bank)
For most of the past fifty years, Sri Lanka has run a current account deficit. The country imports more than it exports, and the gap has been covered in different ways at different times: foreign investment, borrowing from international lenders, and remittances sent home by Sri Lankans working abroad, particularly in the Gulf states.
From the mid-2000s, the government borrowed heavily to build large infrastructure projects including ports and highways. The borrowing was mostly from foreign governments and commercial lenders. The infrastructure did not generate enough export earnings needed to repay the debt, and the current account deficit continued.
In the early 2020s, several things went wrong at once. The Covid-19 pandemic collapsed Sri Lanka's tourism industry, one of its main sources of foreign currency. Remittance flows also declined. In April 2021, the government banned the import of chemical fertilisers, aiming to shift agriculture to organic methods. The decision was partly driven by the fact that foreign currency reserves were already falling and fertiliser imports had become difficult to afford. The ban was reversed seven months later, but not before rice harvests fell by around a third and tea production dropped significantly, with hundreds of millions of dollars lost in export earnings. The foreign currency flowing into the country was falling from multiple directions at once, while the current account deficit continued.
By 2022, Sri Lanka had run out of foreign currency reserves. It could no longer pay for fuel, medicines, or other essential imports priced in foreign currency. Shortages triggered nationwide protests and the government fell. Sri Lanka formally defaulted on its external debt, the first time in its history.
After 2022, the current account moved toward balance and briefly into surplus. This was partly the result of the currency collapse described in Section 7.2.2. When the rupee lost most of its value, imports became very expensive for Sri Lankan residents, so import spending fell sharply. At the same time, Sri Lankan exports became cheaper for foreign buyers. Both effects pushed the current account toward balance.
Questions
Describe the pattern you see in Sri Lanka's current account balance between 1975 and 2022. What does this pattern tell you about Sri Lanka's economic relationship with the rest of the world during this period?
A current account deficit has to be covered by inflows through the financial account. What were the main sources of financial inflows covering Sri Lanka's deficit in the years before 2022? What happened to those inflows in the early 2020s?
The case mentions that Sri Lanka's infrastructure projects were funded by foreign borrowing, the kind of financial inflow that this section describes as often building productive capacity. Yet the investments did not generate the export earnings needed to repay the debt. What does this suggest about the difference between an investment's type and its likely success?
After 2022, the current account moved toward surplus. Explain the mechanism by which a currency collapse can reduce a current account deficit. Is this the same as an economy becoming stronger? Give reasons for your answer.
Look at the most recent data points on the graph. What do they suggest about Sri Lanka's current position? What further information would you want before concluding that the country's external position is now stable?
Click on the arrow for sample responses, but give it a go yourself or with a partner first!
Sri Lanka's current account balance was negative in almost every year between 1975 and 2022, meaning the country consistently spent more abroad than it earned. The deficit varied in size from year to year but the pattern was persistent. This tells us that Sri Lanka was structurally dependent on the rest of the world to cover the gap, through borrowing, foreign investment, or remittances. The country was not earning enough from its exports of goods and services to pay for what it was importing.
The main sources were foreign borrowing (including loans from foreign governments and commercial lenders for infrastructure), foreign investment, and remittances from Sri Lankans working abroad. In the early 2020s these inflows fell sharply. Tourism collapsed during the Covid-19 pandemic, reducing foreign currency earnings. Remittances declined. The country was left with a continuing deficit but without the inflows needed to cover it, and foreign currency reserves ran out.
Sri Lanka's ports and highways fall into the category this section calls productive: infrastructure, rather than spending on imports or consumption. By type, this kind of inflow should support a country's future ability to earn foreign currency and repay what it owes. But the case shows that belonging to this category is not enough on its own. The specific projects did not attract the traffic, trade, or use that would have been needed to generate returns. This suggests that the type of inflow only indicates the potential for a financial inflow to strengthen a country's position. Whether that potential is realised depends on whether the specific investment is well chosen and viable, not just which broad category it falls into.
When a currency loses value, imports become more expensive in domestic terms, so residents buy fewer of them. At the same time, the country's exports become cheaper for foreign buyers, so demand for them rises. Both effects reduce the current account deficit: less spending on imports, more earning from exports. However, this is not the same as the economy becoming stronger. In Sri Lanka's case, import spending fell largely because people could no longer afford imports, not because domestic production had improved. A fall in the deficit driven by collapsing purchasing power reflects economic distress, not recovery. A genuine strengthening would require export earnings to grow because of improved productivity or new industries, not because the currency has made everything cheaper by becoming worth less.
The most recent data shows the current account moving back toward deficit after the brief post-2022 surplus, suggesting the adjustment effect of the currency collapse may be fading. To assess stability, you would want to know whether export earnings are growing in real terms, what the current level of foreign currency reserves is, whether debt repayments are being met and on what terms, and whether the financial account inflows now arriving are going into productive investment or simply covering consumption. A current account position close to balance is encouraging, but the diagnostic question is what is sustaining it.
Option 2: Data interpretation practice
Time: 30 minutes (more if you do the optional research)
Open the interactive graph titled ‘Current account balance % of GDP’ from the World Bank.
Part 1: General analysis
Use a data interpretation strategy suggested by your teacher or your course to explore the graph.
If you do not have a data interpretation strategy, click on the arrow to see some analysis prompts.
What is the title of the data? What does it measure? Clarify any questions you have about it.
What do the colours represent? Look closely at the legend, and think about why the colour bands are not evenly sized.
Identify one country with a large surplus. Identify one country with a large deficit. Try to give an approximate number for each, using the legend or by hovering over the country if the map allows it.
Is there a regional pattern in the data? Which parts of the world tend to run surpluses? Which tend to run deficits? What story might that pattern tell?
Use the year slider to move back through time. Has the pattern changed much over the years shown, or stayed broadly similar? What might explain what you see?
Are there any countries whose colour surprises you, based on what you already know about their economy? What might explain the surprise?
Part 2: Investigate one country
Choose one country from the map with a large current account surplus or a large current account deficit. Do not choose the United States or Germany, since these are covered elsewhere in this section.
What is your chosen country, and is it running a surplus or a deficit?
Using the ideas from this section, suggest one or two possible reasons for this pattern. Is it more likely to reflect strength, such as a productive export sector, or vulnerability, such as dependence on a narrow range of exports or on foreign borrowing? Explain your reasoning.
What consequences might this pattern have for the country, based on what you have read in this section?
If you have time, do some brief research on your chosen country to check your reasoning. A search for "[country name] current account deficit" or "[country name] current account surplus" is a good starting point. Did your research support your explanation, or suggest something different?
Click on the arrow for guidance on what a strong answer includes.
Guidance (your answer will be specific to your chosen country)
A strong answer names a specific figure or range from the map rather than just ‘big’ or ‘small.’ It connects the data to a plausible mechanism from the text, such as a highly productive export sector, structural features that suppress domestic spending, dependence on a narrow set of exports, or reliance on foreign borrowing, rather than simply restating that the country has a surplus or deficit.
It also considers at least one consequence specific to that mechanism, such as currency pressure, vulnerability to a shift in global demand, or growing foreign ownership of domestic assets. If you did the optional research, a strong answer notes whether the research confirmed your reasoning or revealed a more specific or different explanation.
Ideas for longer activities and projects are listed in Subtopic 7.5
Checking for understanding
Checking for understanding
Sources
Sources
Asia Pacific Foundation of Canada. (2025, November). Sri Lanka's economic recovery in 2025. https://www.asiapacific.ca/publication/sri-lanka-economic-recovery-but-challenges-still-ahead
Econofact. (2025, October). Tariff wars and the United States trade deficit. https://econofact.org/tariff-wars-and-the-united-states-trade-deficit
Gnath, K., McKeon, M., & Petersen, T. (2018). Germany's current account and trade surpluses: A technical debate enters the geopolitical limelight. Bertelsmann Foundation. https://www.bertelsmann-stiftung.de/fileadmin/files/BSt/Publikationen/GrauePublikationen/EZ_BFNA_Germanys_Current_Account_2018_ENG.pdf
International Monetary Fund. (2025, July). Global current account balances widen, reversing narrowing trend. https://www.imf.org/en/blogs/articles/2025/07/22/global-current-account-balances-widen-reversing-narrowing-trend
Kognity. (n.d.). 4.6 Balance of payments. IBDP Economics HL FE2024
U.S. Bureau of Economic Analysis (BEA). (2026). U.S. International Transactions and Investment Position, 4th Quarter and Year 2025 [Data release]. https://www.bea.gov/news/2026/us-international-transactions-and-investment-position-4th-quarter-and-year-2025
World Bank. (2024). Current account balance (% of GDP) -- Germany [Data set]. World Development Indicators. https://data.worldbank.org/indicator/BN.CAB.XOKA.GD.ZS?locations=DE
World Bank. (2024). Current account balance (% of GDP) -- Sri Lanka [Data set]. World Development Indicators. https://data.worldbank.org/indicator/BN.CAB.XOKA.GD.ZS?locations=LK
World Bank. (2024). Current account balance (% of GDP) -- United States [Data set]. World Development Indicators. https://data.worldbank.org/indicator/BN.CAB.XOKA.GD.ZS?locations=US
World Bank. (2025, October 7). Sri Lanka's economic recovery remains incomplete as key challenges remain. https://www.worldbank.org/en/news/press-release/2025/10/07/sri-lanka-s-economic-recovery-remains-incomplete-as-key-challenges-remain
Terminology
Terminology
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