The Coalition insists the government deficit is the UK's biggest economic problem, but it's our current account deficit they should be concerned about argues James Meadway
Latest official figures for the UK show the chronic trade deficit narrowed from September to November last year, with the gap between what we import and export, closing from £2.8bn to £1.4bn.
That looks like a pretty substantial improvement. The UK has imported more than it has exported every year since 1983. Even with the trade in services included, we’ve run a deficit for decades. A major part of the Coalition’s original economic plan was to close the UK’s international trade deficit – so this might look like substantial progress.
But the government’s “march of the makers” remains a distant prospect. Manufacturing production is still lower than its pre-crash level, and the recent shrinking of the deficit has been due to us buying less – not selling more overseas.
In particular, we’ve been buying less, by value, of oil. From October to November, the value of oil imports fell from £4.2bn to £2.9bn, bringing the deficit in oil trade down from £1.5bn to £0.5bn. But critically, the fall in oil prices is due entirely to international factors, including the shale oil boom in the US, faltering demand for oil globally, and OPEC’s successive decisions not to restrict output and force prices up – rather than as a direct result of government policy or improvements in the economy at home.
Worse, trade in goods and services aren’t the only relationship the UK economy has with the rest of the world. There are additional flows of income from the rest of the world to here, and vice versa.
Putting the balance of these flows together with the balance of trade gives us the current account: a complete summary of the payments made and received between all of us in the UK and those in the rest of the world.
The current account balance is getting worse
The most recent figures released just before Christmas show that the UK’s current account deficit grew from £24bn over May to June last year, to £27bn over July to September. This is despite an improvement in the trade deficit over the same time. At 6% of GDP, this is one of the worst deficits on record.
As the graph below shows, the UK’s net income from the rest of the world is now negative (shown here in red). We used to earn more from investments in the rest of the world than we, collectively paid out to the rest of the world for their investments here. But that situation no longer applies: we’re now paying more out to the rest of the world than we are getting back.
Firstly, incomes from investments in the rest of the world have fallen from £311bn in 2007, to £162bn in 2013, reflecting a weak global economy. But the other factor at play is more troubling.
A current account deficit implies that the rest of the world is financing your economy. This financing can happen either by borrowing from the rest of the world, or selling assets to those abroad. The scale of this borrowing has been astronomical: the UK’s external debt (debt owed abroad) is now around 400% of GDP.
But loans demand interest payments. And assets produce an income, which, if they are owned abroad, now flows elsewhere. By borrowing and selling off so much, we have created enormous flows of income out to the rest of the world. At £175bn in 2013, these flows are now bigger than the flow of income back into the UK from the rest of the world, resulting in this growing imbalance.
If the global economy remains weak, returns from investments elsewhere will remain low. With slowing growth in China, deflation in Europe, and assorted geopolitical flashpoints, that’s a reasonable bet. However, if, the UK’s economic growth remains strong, (relative to the rest of the world), the implication is that larger and larger amounts will continue to flow abroad.
This situation is not sustainable
It’s not generally possible for a country to run a current account deficit that reaches 6% of GDP – that continues to worsen – for an extended period of time. Something has to give. One option is for the pound to fall in value, reducing the price of exports and so, in theory, boosting sales abroad. But if the rest of the world – and in particular the Eurozone – remains weak, that’s a tough call. The pound has devalued about 20% since 2008, and our trade deficit has widened since then. Devaluation, in the first instance, is more likely to simply ramp up the cost of imports, and squeeze consumers here.
More effective, would be a reduction in returns from investments in the UK that would reduce the outflow of incomes. Short terms rates are already low while further quantitative easing could reduce long-term interest rates (although the effectiveness of QE for this is increasingly questioned). And QE has boosted asset prices –precisely one of the things encouraging the inflow of capital.
If returns are to be reduced, then, the implication is a fall in GDP. A steady slowdown in investment, from either domestic or foreign sources, could (in theory) bring this about quite neatly. Reduced spending from in London property from foreign investors could go part of the way, although there’s little sign of that happening yet. Moreover, if London property maintains its status as a “safe haven”, investment from abroad is likely to continue or even accelerate. There is a good case here for placing controls on the inflow of capital – like taxes on property investments made from abroad.
The alternative is a sudden stop, most likely brought about by a significant number of the UK’s debtors who are unable to meet their commitments. And the larger the debt pile when the stop comes, the worse the juddering halt will be. A further, sharp recession is one possible outcome. The Coalition has spent almost five years insisting the government deficit was the biggest economic problem facing the UK, threatening Greece-style ruin if it wasn’t dealt with. And despite missing their deficit targets, no crisis has occurred. That's because it's the deficit on our current account that they should be concerned about addressing
Radical economist James Meadway has been an important critic of austerity economics and at the forefront of efforts to promulgate an alternative. James is co-author of Crisis in the Eurozone (2012) and Marx for Today (2014).