Stephen King: The UK economy won't rebalance until we recognise the world has changed
Outlook: The UK didn't go into recession alone, and exports therefore were unable to make any headway even as imports collapsed
Monday 13 September 2010
There's a rather nice page to be found in the monthly press release on UK trade which, perhaps unwittingly, offers a value judgement on our balance of payments position with the rest of the world. It tells you how good or bad the latest month's – or latest three months' – numbers are in historical context. As the balance of payments is merely an accounting identity, this is a slightly odd state of affairs. Apparently, deficits are bad and surpluses are good. At the global level, this is rather unfortunate because, for every nation which runs a current account surplus, others must, by definition, be running deficits.
By now, I'm sure you're waiting on tenterhooks to know how the UK's trade position stacks up at present. For goods and services in total, the July deficit, at $4.9bn (£3.20bn), was the worst since August 2005, when the trade data were distorted by the global effects of Hurricane Katrina. Taking the total over the last three months (and hence reducing the Katrina effect), the deficit stood at £13.2bn, the worst since, well, the worse ever, in fact.
To be fair, as we become richer and our incomes rise, so we should be able to cope with a larger deficit. Adjusted for the size of the economy, the largest deficits were recorded in the late-1980s during the Lawson boom. Today's numbers are nothing like as big. But the UK's trade deficit has been steadily deteriorating over the past couple of years (yes, I have made the same mistake as the Office for National Statistics. I should say "steadily widening" rather than "steadily deteriorating").
This is surprising for one notable reason. Britain's exchange rate collapsed in 2008 and that collapse, in turn, was supposed to mark the beginnings of a major "rebalancing" of the UK economy. No longer were we going to rely on the debt-fuelled consumption of old. Instead, we were about to embark on an export-led recovery, supported by a newly competitive exchange rate.
A year ago, in remarks made to The Journal, of Newcastle, Mervyn King, the Governor of the Bank of England, reinforced this view by observing that the "rebalancing of the UK economy that I have been talking about for about 10 years is very necessary. I think the fall in the exchange rate that we have seen will be helpful to that process but there's no doubt that what we need to see now is a shift of resources into net exports, whether directly or in producing things that compete with imports that help to reduce the trade deficit."
With a newly widening deficit, it increasingly appears that the fall in the exchange rate has not achieved quite as much as Mr King was hoping for. Of course, the deterioration in the trade position might have been even worse in the absence of a major sterling decline, but that's hardly an encouraging conclusion. The bottom line is this: with a major decline in sterling and with an economy which, having collapsed in 2008 and 2009, has barely recovered subsequently, the trade position should have improved.
So, why hasn't it? The most obvious explanation is that the UK didn't go into recession alone. With other Western nations also succumbing to a financial crisis, UK exports were unable to make any real headway even as imports collapsed. It would have been far better to have gone into recession alone because, that way, imports would probably have fallen faster than exports.
But this argument can be taken only so far. No one is suggesting that the cure for the UK's trade deficit is entry into perma- recession even as nations elsewhere in the world continue to enjoy economic growth. That would be too costly. Rebalancing is not a story about persistent slump. Rather, the idea is to do more of one thing (exports) and less of something else (consumption) so that we can pay our way instead of being dependent, year-in, year-out, on borrowing from the rest of the world which, as we discovered in 2008 and 2009, can be switched off with remarkable speed.
This is where the exchange rate comes in. A fall in sterling adjusts relative trade prices. In sterling terms, imports become more expensive while, in foreign currency terms, British exports end up cheaper. We end up consuming less of what's made abroad and foreigners end up consuming more of what's made in Britain. That, at least, is the theory. Yet it appears not to have worked.
Part of the reason relates to British business's lack of ability to determine global prices. In a competitive international market, the price of British exports is likely to be set in dollars or euros, not sterling. If sterling declines, the foreign price remains unchanged but the sterling price goes up. British exporters are more profitable as a result. Economically, what then matters is how the higher profits are used. Are they invested in expansion plans or used to pay down debt? Are they frittered away in higher wages or do managers take it easy and choose to use Friday afternoons for a round of golf rather than a solid few hours of work?
Other factors are also important. Although a decline in sterling may help relative price competitiveness, sterling is not the only determinant of relative prices. Over the past year or so, oil prices have risen dramatically. Our oil import bill has risen as a result. Partly, this reflects the enduring success of emerging nations such as China, which have weathered the economic storm far better than western nations and which have continued to increase their demand for the world's scarce resources at a rate of knots.
But if emerging nations are growing so quickly, their success surely creates opportunities for British exporters. What we lose on the oil price swings we should gain on the export roundabouts. If only that were true.
While other nations have increased their connections with the emerging world over the past 25 ears, Britain has seriously lagged behind. The economic and financial crisis seriously upset trade patterns around the world but, pre-crisis, it's clear that Britain had been heading in the wrong direction. Exports to emerging nations fell from 4 per cent of UK GDP in 1985 to 3.5 per cent in 2008 (and to just 2.6 per cent in 2009, as the collapse in world trade reached its nadir). US exports to emerging nations went up marginally, from 1.5 per cent of US GDP to 3.7 per cent.
The really big changes happened elsewhere. Germany's share went up from 5.3 per cent to 11.6 per cent, Japan's from 3.7 per cent to 6.7 per cent, Australia's from 3.5 per cent to 7.1 per cent and Switzerland's from 5.3 per cent to 8.2 per cent. And emerging nations have continued to expand trade with each other: China's exports to other emerging nations rose from 2 per cent of GDP to 9.5 per cent over the same period.
So part of Britain's problem is its ongoing habit of exporting the wrong kinds of things to the wrong parts of the world. Focusing on the exchange rate as a source of "rebalancing" gives completely the wrong message. Our economy won't rebalance until we recognise that the world has changed.
It's as if British industry has been asleep for the past quarter of a century, seemingly unaware of the emergence of economic superpowers which already are promising to become the biggest markets for western products. It's about time we woke up.
Stephen King is managing director of economics at HSBC
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