Britain's balance of payments deficit is undesirable, says David Smith, but manageable.
Many of the topics that compete for attention on our economic and financial pages would mystify an audience from 30 or 40 years ago. They would have some difficulty with financial futures and other derivatives; and privatisation would be an odd term, if logical enough. The newly transparent relationship between the Treasury and Bank of England, with minutes published of meetings that were never previously admitted to have taken place, would have them scratching their heads. But one topic would make them feel immediately at home: worries about Britain's balance of payments.
The belief that balance of payments performance will ultimately act as a constraint on the economy has its origins in the stop-go period of the 1950s and 1960s, even though the real current account horrors did not emerge until the 1970s (mainly as a result of the first OPEC oil-price hike), returning with a vengeance in the late 1980s (when an unsustainable consumer boom sucked in imports with the force of a powerful vacuum cleaner). Now it is back again. As soon as the economy started emerging from recession, over two years ago, the Cassandras started looking for the problems recovery would bring. The first was inflation. The second, identified largely because the situation of rising demand in Britain alongside a sluggish world scene appeared to have but one possible result, was the balance of payments.
Neither, however, has so far proved justified. Inflation I shall leave for another time, but the current account of the balance of payments, while remaining in deficit, has failed to deteriorate in line with the predictions of the pessimists. Thus, the current account was in deficit by £10.5 billion in 1992, but this only widened marginally, to £10.9 billion in 1993. The figures for this year do not indicate any dramatic worsening.
Even the normal J-curve effects that could have been expected to follow sterling's post-ERM devaluation in the autumn of 1992, did not occur. (The J-curve arises because the initial impact of a lower pound is to push up the cost of imports. Only in time do the beneficial effects, in theory, help exporters improve their performance. The movement of the trade balance - and initial deterioration followed by a later improvement - gives the text book J-curve).
Nor, according to the Treasury and the independent, if semi-official forecasters at the Organisation for Economic Co-operation and Development (OECD), will the balance of payments be a problem for the foreseeable future. The OECD's recent assessment of Britain, in the twice-yearly Economic Outlook, concluded: 'Sustained output growth, low inflation, modestly declining unemployment and a small current account deficit are projected for the coming two years.' Nevertheless,the Cassandras maintain a pessimistic position on the balance of payments. Their first line of attack is that, if the official figures are not showing a sharply deteriorating trade position, then the official figures must be wrong. And this is no mere clutching at straws. The introduction of the European single market at the beginning of last year posed a problem for the trade statisticians. With trade data no longer automatically available from customs information, a new EU-wide system of data collection, Intrastat, based on returns from exporters and importers had to be developed. The suspicion, partly based on the fact that other EU countries are showing a better trade position vis-a-vis Britain than our own figures would suggest, is that Intrastat must be understating UK imports from the rest of Europe.
This is potentially a serious problem, given that the new system came in at the beginning of 1993, which is precisely when, on past experience, Britain's trade position might have been expected to have embarked on a cyclical deterioration, exacerbated by the J-curve effects described above.
This is not the only possible difficulty. Some economists also doubt the figures for trade in invisibles (services, interest, profit and dividends). According to UBS, the combination of under-recorded imports and an overstated surplus on invisibles means that the true current account deficit last year was £20 billion, nearly double the official figure. UBS also argues that the current account deficit should be taken more seriously now than in the late 1980s, because the stock of net overseas assets built up during the North Sea oil years has declined. They estimate net overseas liabilities of £20 billion, compared with net assets of £100 billion at the end of the '80s.
The second line of attack is that, even if it is accepted that the balance of payments has not yet deteriorated, it is bound to do so. Britain's manufacturing base is too small in relation to the level of demand in the economy. Investment has failed to revive sufficiently in the recovery to alleviate worries that industry will soon run up against serious capacity constraints. And exporters (according to those same official figures) have not used the advantage of a lower pound to increase international market share. Rather, they have simply put up prices, partly to compensate for the continued squeeze on margins in home markets.
So, should we throw up our hands in horror at Britain's external position, and conclude that the recovery will run up against the buffers of a deteriorating trade position? As a long-term balance of payments bear, I rather surprise myself to conclude that the answer to this question is no.
No one knows whether the data is understating or overstating Britain's deficit. It was a common argument in the 1980s that the deficit was overstated because, in sum, the world's current account positions did not sum to zero, as they should have done. The world, it appears, is in surplus with itself. It is fair, if part of this worldwide item is apportioned to Britain, to argue that the deficit is between £4 billion and £5 billion below what the official figures say it is. In any case, the figures do not show the position deteriorating as the recovery has proceeded.
Nor should it. Britain has a competitive exchange rate, The European economy is now recovering. In Britain, consumption will be held back by the large tax increases coming through in 1994-5 and in 1995-6. If there was going to be a current account problem, it would have emerged at the time when the adverse J-curve effects coincided with a period when recovery was out of step with the rest of Europe. We have now moved beyond that point.
And there is an additional argument. The Lawson-Burns doctrine of the 1980s, after Nigel (now Lord) Lawson and Sir Terence Burns, the Treasury Permanent Secretary, was that current account deficits are only problematical if they are difficult to finance or if they are a symptom of suppressed inflationary pressure in the economy. Neither of these conditions applies to the UK economy at present.
It would be better if Britain did not run a deficit on her external trade, not least because it would demonstrate greater underlying strength and competitiveness for the economy. But we should not work ourselves up into a lather over something that, at present, is perfectly manageable.
David Smith is economics editor of the Sunday Times.