Economists are part of a fashion industry. Each group of policymakers seems
to have its own priorities, together with certain key statistics or performance
measures that matter more than others. For the first 30 years of the post-war
era, for example, the balance of payments dominated the headlines and worries
about a run on the pound kept the authorities on tenterhooks. Money supply
became the trendy indicator as monetarist theories were tested in the 1980s –
but now, especially since the early 1990s, inflation is the most watched
economic number used to attempt assessment of where interest rates and activity
But like flared trousers and mini-skirts, the old measures are still there,
waiting for their next turn in the spotlight. After years on the back-burner,
while attention focused on the Consumer Price Index, the balance of payments has
deteriorated to the point where some are wondering if the UK can continue
running huge deficits indefinitely. The balance of payments is back en vogue.
In 1997, the year New Labour took office, the UK’s deficit on its trading (or
current) account with the rest of the world was just £840m, one of only two
years since 1980 when the shortfall was less than £1bn. After ten years of New
Labour, and ten years of sustained growth, more jobs and falling unemployment,
the deficit reached a massive £57.8bn in 2007, equivalent to 4.2% of GDP.
In terms of its share of the UK economy, we have been here before – most
recently in 1988, when the sudden jump in the deficit signalled the unravelling
of the Thatcher-Lawson boom.
Are last year’s numbers, therefore, an early warning of a re-run of the early
These data, however, need to be put into the context of today’s economy, which
is very different from the 1960s when the balance of payments was a regular
source of grief for Harold Wilson.
Back then, we lived in an era of fixed exchange rates (the pound was $2.80
when Wilson became Premier in 1964) and there was constant nervousness that a
bad set of trade figures would spark a run on the pound. So our diminishing gold
and dollar reserves had to be used to protect the currency. Edward Heath solved
the problem at a stroke in 1971 by floating sterling, and the balance of
payments moved to the back-burner. Although, today, governments ignore currency
movements at their peril, there is now no specific rate of exchange they are
pledged to defend.
Second, during periods of sustained growth, deficits tend to rise as spending
exceeds our own production. This is more true today than 40 years ago, since
much of our manufacturing capacity has disappeared and we are more dependent on
imported goods. When the economy cools, therefore, the gap between exports and
imports should narrow, both because we spend less on foreign produced goods and
because UK companies become more export focused.
Especially worrying is the £88bn deficit on our trade in goods – a number
that has increased every year since the £12bn shortfall in 1998. This is
partially offset by the robust (£38.5bn last year) surplus the UK consistently
enjoys on its trade in services, primarily financial and business and by
investment income, though this dipped in 2007. Even after the positives have
been added back in, however, the UK still spends nearly £60bn a year more than
it receives from overseas.
Going forward, the issue is how much the surge in the deficit in 2006 and
2007 reflects strong domestic demand (a cyclical trend) or is a structural (more
long-term) problem. If markets were seriously concerned, sterling would take the
strain, as the dollar has with the huge US deficit, but the currency has been
quite resilient. This reflects the ease with which the UK has been able to
finance the deficit, which can be tracked on the capital and financial accounts
of the balance of payments. Investors have looked favourably on Britain’s
business environment and money has come in from a range of sources, and into
various parts of the economy.
But once all the Premier League football clubs and Times 100 companies are in
foreign hands, the UK has to work out how it is going to pay its way in
international trade. We are, after all, dependent on imports for many
essentials. North Sea oil is a diminishing national asset and the manufacturing
base has been shrinking for 40 years. On top of this, the world is changing.
Where previously we looked to our trading partners in Europe and to the US as
our key export markets – this accounted for 70% of all exports in 2007 – the
newer economies such as the BRICs of the world are now driving global growth and
we have been slow off the mark in selling to these markets.
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An excess of consumption as well as borrowing has led to the current slowdown
in activity. If any recovery is to be sustainable, and living standards
maintained, we must rebalance the economy.
This means a bigger contribution to GDP has to come from international trade.
The balance of payments deficit of £57.8bn in 2007 shows the size of the
challenge ahead and makes it clear that this is not going to be easy.