current-account-deficit-1

Every year since 1984 Britain has run a deficit on the current account of her Balance of Payments. What this in effect means is that each year British businesses and consumers have purchased consistently more goods and services from abroad than they have been able to sell. But is this a problem?

In his repudiation of mercantilism, Adam Smith believed that exchange rates and world trade contained a self-correcting mechanism. A trade deficit precipitates an outflow of currency from Britain, which in turn demands a greater supply of sterling, thereby naturally devaluing the currency. This in turn has the effect of making goods and services appear more price competitive, and should readjust the imbalance in trade to equilibrium.

However, since the 2008 recession and despite a 25% fall in the value of sterling, exports have increased by just 5%. Britain was unable to repeat the export-boom of 1992 which fostered a strong recovery from the 1993 recession.

On the one hand, the deficit stands at around 4.4% of GDP, and therefore is hardly an unmanageable anchor on the economy. Moreover, Britain has undergone significant restructuring since the end of the Second World War, away from manufacturing goods, and toward exporting invisibles, such as financial and education services. One effect of this has been that an economic upswing in the domestic economy tends to correlate with a widening trade deficit. British consumers and businesses have a considerable hunger for imports, and as they become wealthier and more prosperous, they buy goods from abroad at a faster rate than they can sell them overseas.

The import hunger is partly encouraged by the UK’s open and liberalised economy. Free trade pushes down the price of imports and provides domestic producers with the added pressure of foreign competition – a strong incentive function to become more efficient. Firms such as Dyson, with a strong Research and Development base in the UK, tend to import manufactures from South East Asia due to the absolute cost advantages these countries offer. Really then, the alternative to the current arrangement would be a return to the 1970s – with inefficient, over-manned industries dominating the landscape – and promoting import substitution. This would make most contemporaries baulk.

Perhaps then a current account balance is merely a reflection of the times we live in. Globalisation and the subsequent fall in transport costs have allowed the free movement of goods across national boundaries. The economy is simply adjusting to David Ricardo’s theory of ‘comparative advantage.’ Indeed, the UK will not return to building battleships or manufacturing textiles because production costs simply won’t permit it. Far better we produce the goods we are competitive at producing – in aerospace and pharmaceuticals – and focus on service exports – financial and legal.

The only caveat, perhaps, concerns the underlying message the persistent trade deficit is transmitting about Britain. A weak export base implies a fundamental lack of competitiveness in the economy. Productivity levels in the UK have been low by European standards for decades now. According to the ONS, in 2011 output per worker in the UK trailed 21% behind the rest of the G7. In effect what this means is that a British worker must work for 21% as much time in order to produce exactly the same amount of goods as his or her equivalent in France or Germany. This is a concern.

The government’s investment in British industry: through cutting corporation tax, encouraging inward investment and developing tight and highly skilled labour markets shows encouraging signs of progress in addressing these deficiencies in the UK’s competitiveness.