economic policies to reduce a balance of payments deficit
An improvement in trade performance does not necessarily mean that we are seeking to turn a trade deficit into a surplus. Performance might be measured by other criteria - for example:
(a) A rising share of world trade in exports of goods and
(b) A higher trend rate of growth of exports
Short-term improvement in trade performance:
Some of the overall trade deficit is due to the strength of domestic demand for goods and services. If and when the economy enters a slowdown phase, the growth of imports will fall, and this should provide an element of correction for the trade deficit.
Higher Interest Rates - will act to slowdown the growth of consumer demand and therefore lead to cutbacks in the demand for imports.
Fiscal policy (i.e. increases in direct taxes) might also be used to reduce aggregate demand. The risk is that a sharp fall in consumer spending might lead to a steep economic slowdown (slower growth of GDP) or an full-scale recession - as shown in the AD-AS diagram below.
A Lower Exchange Rate
A depreciation in the sterling exchange rate should help to boost the overseas demand for UK exports because British firms will be able to supply more cheaply in international markets.
The extent to which export sales rise following a fall in the exchange rate depends on
(a) whether UK firms actually decide to cut prices and
(b) the price elasticity of demand for UK products from foreign consumers.
A lower exchange rate should also cause imports into the UK to become relatively more expensive - leading to a slowdown in import volumes and "expenditure-switching" towards UK output.
Again the significance of elasticity of demand should be mentioned. In the short run the change in import demand is likely to be fairly small - it takes time for movements in the exchange rate to affect trade flows.
Longer Term Improvements in Trade Performance - focus on the Supply-Side
The key to controlling or reducing a balance of payments deficit in the long term is for the British economy to achieve relatively low inflation with sufficient productive capacity to meet the domestic demand from consumers.
In other words, the ability of the British economy to deliver sustained growth of exports and meet the challenge of imported goods and services depends critically on our supply-side economic performance.
This requires a period of low inflation, low interest rates and a competitive exchange rate matched with sufficient non-price competitiveness in overseas markets.
Often, price is not the deciding factor in winning the demand from buyers. Greater investment in research and development, more effective marketing strategies can have powerful long term effects in winning and maintaining market share in highly competitive global markets.
An outward shift of long run aggregate supply would provide the economy with an increased capacity - permitting a reallocation of resources towards exporting
A sustained improvement in our balance of payments requires
(a) More UK businesses to seek and exploit opportunities in export markets overseas
(b) A greater focus on resources in industries where the UK has a genuine comparative advantage - e.g. increased investment in services (including business finance, tourism) - many services are exportable and have the potential to earn huge sums in foreign currency.
(c) Higher levels of research and development to develop new products in potential high growth markets where the overseas income elasticity of demand is high.
(d) Improve efficiency and productivity in export sectors and those parts of British industry that are exposed to international competition
Does Government have a role to play?
Clearly the answer is yes - but the precise form of government policy is open to debate. Examples might include
(i) Export subsidies - although these are severely constrained by our commitments to the World Trade Organization and membership of the Single European Market
(ii) Investment tax allowances to encourage increased research and development (iii) Sound macroeconomic policies to boost business confidence
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