UK: EUROPE CASTS SHADOW OVER UK - OUTLOOK FOR EXPORTS. - Our growth in export trade is threatened by the recession across Europe.

by David Smith.
Last Updated: 31 Aug 2010

Our growth in export trade is threatened by the recession across Europe.

It is a familiar British summer story. You make all the arrangements, organise refreshments and outdoor activities, and then, just as the guests are arriving, the heavens open. The same could apply to the current state of the economy.

The Government has achieved, through a combination of the accident of Britain's departure from the European exchange rate mechanism (ERM) last year, and the design of deliberate post-ERM interest rate cuts, a growth-friendly policy. More importantly, it is an export-friendly policy. The low exchange rate and negligible growth in unit labour costs mean that UK industry is more competitive than at any time since 1976 (when the IMF crisis forced the pound down and the recession had started to bear down on wages). Add the partial completion of the single market at the end of 1992, and it should be all systems go.

But, as luck would have it, Continental Europe is in the middle of an economic downpour, which means that Britain's main markets (more than 50% of the export total) are in decline. Germany is the most dramatic example. The official forecast is 1% decline in gross domestic product this year, but most private forecasters think it will be between 1.5 and 2%. This after a boom which saw GDP rise by 5% in 1990 and 3.6% in 1991.

Had Britain had its current competitive exchange rate during Germany's post-unification boom, then British exports could have offset much of the fall in domestic demand, and limited the recession damage. Had we had something close to the present level of interest rates we might not have had a recession at all. But that is another story.

French GDP is set to show a fall of up to 1% this year, Italy around 1.5%. The smaller economies of the Community will either be flat or show small declines. There is better news from Eastern Europe where, after contracting dramatically, countries such as Poland, Hungary and the Czech Republic are set to return to growth this year. As yet, they are not proving to be lucrative markets for exporters.

History warns us that recession in Britain's export markets does not necessarily preclude economic recovery. The short US-led world recession in l982 did not, for example, prevent Britain's GDP from rising by 1.7% that year, a performance which, if repeated this year, would be regarded by most economists as satisfactory. But in no way was that recovery export-led. Exports rose by just 0.8%, against a 4.9% rise in imports. The main engines of growth were investment and stockbuilding, with net trade (exports less imports) acting as a drag on the economy.

Many forecasters expect history to repeat itself. The chart (left) from Phillips and Drew, is an example. On its forecasts, a rise in domestic demand of 1.5% this year will be converted to a meagre 0.5% GDP rise by the deterioration in Britain's net trade position. In l994 the figures are 3% and 2.3% respectively. The weakness of export markets, in other words, turns a respectable recovery in domestic demand into a feeble overall upturn.

There are three reasons for thinking that it might turn out better than this. The first is the strength of US recovery, coupled with a sterling fall against the dollar that has been more dramatic than its drop against European currencies. The special relationship, expressed in terms of hard trade statistics, should be a compensating factor for the European downturn.

Secondly, one can be encouraged by the view that, having been told repeatedly by the Treasury that devaluation does not work, this might be one that does. The combination of the labour market reforms of the 1980s and the recession of the early 1990s is a powerful one. There are good reasons to believe that, this time, the competitive gains will last. And this, I think, will affect the behaviour of exporters. They can plan their assault on overseas markets on the assumption that they have been priced in to these markets on a lasting basis.

Thirdly, there are good reasons for believing that Continental Europe's recession will not be as protracted as Britain's. For one thing, the country with the most serious problem, Germany, holds the interest rate reins and will loosen them quite dramatically. For another, the economies of the rest of Europe do not have anything like the same build-up of private sector debt to suggest that adjustment to the earlier period of growth will need to be a drawn-out affair.

So, net trade could boost the economy, giving us the holy grail of export-led growth sooner than the current gloomy European outlook suggests - as long, of course, as protectionism and the breakdown of the current General Agreement on Tariffs and Trade (GATT) round does not cast us back into deep gloom.

David Smith is economics editor of The Sunday Times.

Chart not included.

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