David Smith discerns distinct shifts that could mean that the old disorder changeth.
Britain's balance of payments has improved dramatically this year. Two years ago, monthly deficits on the current account reached the alarming level of more than £2 billion a month, and the balance of payments had emerged as a constraint on the economy as serious as at any time in the post-war period.
Now, the deficit is, like inflation, no longer on the liabilities side of the economy's balance sheet. This year, Britain will be in the red by the not inconsiderable sum of £5 billion or so. But this is small beer when set against the £20.4 billion deficit of 1989. Back in June, the current account nudged into surplus for the first time since the spring of 1987. lt was a freak occurrence but to go from a £2 billion deficit to a surplus, and all in the space of two years, underlines how times have changed.
The conventional view of Britain's balance of payments position is that this year's improvement owes everything to the depth of the recession and that the underlying deficit - the gap in more normal economic circumstances - remains substantial. In other words the deficit, the Achilles' heel of the British economy, is still a big problem. Thus, North Sea oil no longer props up the trade balance as it did in the early '80s, when it produced annual current account surpluses as high as £7 billion. Industry and services, sadly, have been unable to fill the gap in a sustainable way. Britain's current account improvement in the recession is cyclical, and serious structural problems remain.
It is difficult to argue with the claim that the current account improvement has been mainly due to the collapse it demand in Britain which resulted from the recession. But there are some encouraging signs which suggest that progress is being made towards improving the structural position. Thus, while the deficit is likely to widen as the economy recovers we may not see a re-run of the late '80-balance of payments horror story.
Direct investment in Britain by foreign companies is, to take one example, not showing through in exports, the clearest case being that of the Nissan car plant in Sunderland, Tyne and Wear.
Direct foreign investment in Britain is now running ahead of investment overseas by British firms. Last year inward investment totalled just under £19 billion, compared with outward investment of £11.7 billion. In the first half of this year inward investment was £8.7 billion, against outward investment of £7.9 billion. Such investment is not an unequivocal benefit to the balance of payments. Some 'transplant' production involves little more than screwdriver assembly of imported components, with output designated solely for the British market, so profits are repatriated.
But increasingly, a new breed of foreign-owned plant is emerging. The aim, particularly for the Japanese, is to establish a base for production and export to the rest of the EC. Local content is, or is intended to be, high. Nomura Research estimates that by the mid-1990s, the trade balance could be £4 billion a year better off, partly because it expects Japanese-owned plants in Britain to export an average of 75% of output. Some 15% to 20% of the 1991 improvement in the trade balance is attributed to Japanese transplant production.
The other big change, which divides optimists and pessimists, is Britain's membership of the European Exchange Rate Mechanism (ERM). To pessimists, Britain's entry rate of DM2.95 was too high. Industry, they say, will struggle to compete, increasing balance of payments difficulties. So far, it is not working out like that. Helped by the boom in the German economy, exports to Europe have risen strongly. And, with the recession, inflation and wage settlements have moved into line with German ones. After years of struggle with a volatile exchange rate, exporters appear to have taken to ERM stability like ducks to water.
But why, if British industry can export when it is forced to do so by weakness in the domestic market, and if industry is generally competitive against imports, does Britain still import so much? The answer - which is why we urgently need inward investment flows to continue - is that we have too narrow a product range.
Industrial countries which avoid balance of payments difficulties do so on the basis of a strong domestic market supplied mainly by domestic firms. Export success is based on strength at home. The encouraging sign is that, after the difficulties of the late '80s, when balance of payments problems were initially dismissed as of little consequence by the Government, that lesson may have been learned.
David Smith is Economics Editor of the Sunday Times.
