the current account balance
After recording small surpluses in the early 1980s, the UK balance of payments deteriorated badly in the late 1980s following the consumption driven economic boom. Recent years has seen a clear improvement in the figures although 1999 is forecast to see a return to deficit.
Often the root cause of a current account deficit is cyclical. During a boom the demand for imported goods and services rises strongly and if exports cannot keep pace the trade figures move into the red. The economic recession of the early 1990s caused the current account deficit to shrink. Then a boom in exports in 1994-96 lead to small quarterly surpluses in the BOP accounts.
The UK has enjoyed current account surpluses in five of the last seven quarters. This is despite a worsening of the balance of trade in goods. The main reason for the improvement in the figures is the growing surplus in trade in services and very strong net investment income from overseas assets.
If the deficit is symptomatic of a lack of competitiveness in those sectors of the economy exposed to international trade, then specific policy measures may be required to help correct the deficit. In the UK’s case, some economists believe that there is a structural problem in trade in goods - with the economy failing to export enough products to pay for the imports that we require.
If a country has open capital markets where money can flow into and out of an economy with ease, it should not be a problem to attract the capital inflows needed to finance a balance of payments deficit on the current account. However, in the long-term if imports are increasingly taking over from domestic producers, this threatens economic growth, employment and living standards in the deficit country.
CAUSES OF A CURRENT ACCOUNT DEFICIT
For the UK the persistent trade deficit has a number of causes both short and long term.
High propensity to buy imported goods and services - there is a tendency for UK consumers to prefer foreign produced output and in a consumer boom we often see an acceleration in the volume of imports coming into the country
Lack of productive capacity of UK firms - if home producers have insufficient capacity to meet demand from consumers then imports will come in to satisfy the excess demand
Poor price and non-price competitiveness of UK firms -
Cost levels and UK prices relative to international competitors can measure competitiveness, but non-price factors are also important. These include quality, design, reliability and after-sales service
Declining comparative advantage in many areas - the advantages that countries have in producing certain goods and services change over time as technology alters and other countries exploit their economic resources and develop competing industries. UK manufacturing industry has suffered over the years from low cost production in newly Industrialising countries and from other parts of Europe
An over valued exchange rate? - Some economists suggest that trade problems stem from the exchange rate being set at too high a level. This causes UK export prices to be higher in foreign markets whilst imports into the UK become relatively cheaper. This argument was used at times during the UK's short-lived membership of the Exchange Rate Mechanism (ERM).
The strength of the pound over recent years has made life difficult for UK exporters in overseas markets. This is because a rise in the value of sterling leads to a rise in the foreign price of UK exported goods and services. When UK prices are higher, foreign consumers are less likely to buy our products.
A strong exchange rate also makes imported goods cheaper inside the UK. This leads to a rise in the volume of imports and a fall in the share of the UK market taken up by goods and services from overseas.
Falling surplus in the UK's trade in oil - for many years the UK has been a major exporter of oil from the North Sea fields. Production of oil is now well past its peak and the net surplus from oil trade no longer contributes as much as it did to the balance of visible trade
DOES A CURRENT ACCOUNT DEFICIT MATTER?
The answer depends in part on what is causing the net outflow of money from the economy.
A current account deficit has to be financed. This is normally done by attracting inflows of capital from other economies. The UK has found few problems in achieving this in recent years.
If the deficit is due to excessive consumer demand – a recession or slowdown should help to reduce the problem. Consumers cannot go on spending in excess of their income for ever. Eventually they have to control their spending and start saving again to improve their own finances.
But Britain has sustained current account deficits of much larger proportions in the past and this has not provoked a major crisis of confidence in the international financial markets. Britain has one of the most open capital markets in the world. Thus far the country has proved to be a favoured venue for overseas investment - and financing a trade deficit in goods and services has not triggered a sharp collapse in the value of sterling.
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