With only December's trade figures still to come for 1992, it seems unlikely that the current account deficit will be less than pounds 11bn or around 1.75 per cent of national income. This is worrying. The collapse of spending during the recession should have led to a collapse of imports and a mammoth shift into payments surplus. Instead, the recession has merely cut the record deficit of 4 per cent of GDP in 1989.
Something seems to have snapped over the last year, since the relationship between imports and domestic spending is far worse than economic models based on past history would have suggested. For example, the Treasury predicted in the autumn of 1991 that domestic spending would grow by 3 per cent in 1992, that imports would rise by 7.5 per cent, and that the current account deficit would be pounds 9.5bn.
Instead, the Treasury projected in the autumn of this year that there will be no increase at all in domestic demand in 1992, that imports will be 6.5 per cent higher, and that the deficit will be pounds 12bn. Spending is down 3 per cent, but imports look about the same.
The trend looks like this: imports took 32.5 per cent of domestic spending in 1991. The Treasury thinks they took around 34 per cent in 1992 and that they will take 35.5 per cent in 1993. Moreover, this rising share is part of a pot of domestic demand that is predicted to rise by only 1.5 per cent over the period.
The implications are alarming because, traditionally, recovery from recession depends in large part on rising domestic demand. And if domestic demand rises, so will imports. And if imports rise, the payments deficit will worsen. Will foreigners continue to finance the deficit on conditions we will find comfortable?
A current account deficit has to be matched by an equivalent capital account surplus: an inflow of foreign funds. In effect, we are asking foreigners either to buy our assets or to accept our IOUs. They are likely to become progressively less inclined to hold either. Either our assets and IOUs will have to become so much cheaper that they will be expected to rise in price, or we will have to pay much higher interest rates to attract cash.
The first scenario implies a sharp further fall of sterling, raising import prices, stoking inflation, cutting the real value of wages, and hence spending and imports. The second scenario arrives at the same destination by a different route and with lower inflation: it implies tight policy and a prolonged squeeze on consumers' spending and hence on imports.
Either way, spending growth must be more moderate than for a long time. There cannot be any recurrence of the 1980s boom during the 1990s. Some simple arithmetic shows how serious the problem could be.
Imagine that we maintain the improved export performance that occurred during the 1980s, and hold on to our share of world markets. Despite a loss of share this year, this seems plausible, particularly since there will be short-term gains from the recent currency devaluation. Our exports could grow in line with the 5 1/2 per cent annual growth of world trade, giving us an extra pounds 22bn (in 1985 prices) of foreign exchange in 1995.
Suppose, too, that we merely have to stop the deficit from deteriorating, so that it would gradually shrink as a share of the whole economy. We could therefore spend all the extra export earnings on imports.
The key to our performance then becomes our ability to perform in the home market. If import penetration continues to rise at the rate now predicted by the Treasury, about 38.5 per cent of all domestic demand will be spent on imports in 1995, and we will have to limit the growth of spending to a little more than 2 per cent over the entire three years.
Since domestic demand growth determines the growth of output in the two-thirds of the economy which does not trade (hairdressers, grocery stores, transport and so on), this stagnation in home demand would condemn us to a tiny rise in output. The growth of the economy would be less than 1 per cent a year, and unemployment would rise remorselessly.
But if the devaluation buys a real and sustained improvement in competitiveness because wage claims and inflation stay low, we might hold on to more of our domestic market. If imports take just 36.5 per cent of domestic demand in 1995, we could afford an increase in spending of about 2 1/2 per cent each year without the balance of payments spinning out of control. Allowing for high export growth, we might enjoy annual output growth of 3 per cent.
But the economy is now about 7 per cent short of its potential. Since 3 per cent growth exceeds likely potential output growth by only half a percentage point a year, the economy will still be below trend even in 1995.
Is the optimistic or the pessimistic case more likely? The balance of payments figures are notoriously fickle, and all the world's balances add up to a deficit, which means we are probably underestimating our exports. Japanese car production in Britain is building up quickly, and we will become net car exporters again in 1994.
Moreover, there is an oddity in our trade performance. We have creditably maintained our share of world markets despite the challenge of the Asian 'dragons', while we have been less successful in holding our share of the domestic market. One possible explanation is that the success of Japanese exporters based in Britain - not just car makers but companies like Sony - is flattering exports but also sucking in imported components.
A more hopeful explanation of our contrasting fortunes in home and export markets is that our businesses have suffered more than those of other European countries due to the increased competitiveness of American rivals as the dollar fell. After all, we buy more goods from the US than Continental countries. We may therefore benefit more as the dollar now rises.
Another explanation is that the pattern of the recession, which has hit manufacturing less hard than the 1979-81 recession, may explain why imports have not sagged as much. The import content of manufactures is far greater than, say, estate agencies. There may be room for a greater increase in domestic demand without deficit problems.
But the notion that we can resume rapid spending or that the balance of payments does not matter, always a Lawsonian conceit, now looks merely absurd. Our tradeable sectors - particularly manufacturing - are crucial to the performance of the whole economy. We desperately need a strategy for research, training and competitiveness which puts tradeables first.
True, the problems of high debt are likely to imply exceptionally slow growth in spending in any case. But if consumer confidence does recover sharply, the balance of payments may stop us in our tracks instead. Britain's economy is caught between the devil of debt and the deep blue sea of payments deficits.Reuse content