In the last four years, the deficit on the current account has averaged between 4% and 5%, but during that period we had a six month period when the deficit on goods and services (a key part of the current account) averaged 7% of UK GDP while predictions are that there was a surplus for the last six months of 2019. The last time this happened was over 20 years ago. For 2019 as a whole we might be talking about a deficit averaging 1.5% of GDP. However, there has been a major change in the composition of our balance of payments; our manufacturing sector has declined significantly and its contribution to the balance of payments has been negative. Despite falls in the value of sterling particularly in 2008 and after the Brexit vote, manufacturing failed to thrive as predicted, even after the “J curve effect” which suggests a time-lag between a fall in the value of the currency and an improvement in the balance of payments. Possibly this was because of low UK productivity, poor growth among our main trading partners, limiting their demand for our goods, or because UK producers opted to keep prices the same in foreign currency, therefore increasing their profits. Fortunately, the manufacturing deficit has been partially offset by our service industries where we have a comparative advantage.
Both The Times and Financial Times have printed articles about the decline in the importance of the balance of payments. Their articles refer to the time when newspapers published the balance of payments figures on the front page and the data would be prominent on the television news. Economics students would rank the balance of payments as one of the country’s main economic objectives while today, they struggle to remember what comes after low inflation, low unemployment and high GDP growth. One reason for the decline in the attention given to the balance of payments is that the figures are recognised as sometimes being inaccurate and also likely to be influenced by special factors, such as the way the deficit increased in the run-up to Brexit because businesses built up stocks in case of disruption while, more recently, a partial cause of the improvement in the balance of payments has been the run down in these stocks.
So does a persistent deficit matter? A sustained deficit implies a leakage from the circular flow of income, has implications for living standards and might be a sign that the economy is underperforming since it is selling few exports and buying too many imports. It might also lower the exchange rate with implications for inflation and living standards since imports will become more expensive.
If a deficit is driven by over-consumption, possibly financed by high levels of debt and inadequate savings, then a persistent balance of payments gap is evidence of serious distortions within the economy. (A deficit can be good if a developing country is importing capital and new technology). According to the IMF “When a country runs a current account deficit, it is building up liabilities to the rest of the world that are financed by flows in the financial account. Eventually, these need to be paid back.” Their view comes from the way a current account deficit must be financed which involves a surplus on the financial account. This means that overseas individuals, banks and businesses will be carrying out activities which bring money into the UK. These would include foreign millionaires buying property in London, either to rent or live in, foreigners buying UK company shares or putting money into UK banks or foreign companies building new factories in the UK. The UK is fortunate that it is an attractive place for such transactions. We have a sound legal and financial system, clear property rights and, currently, membership of the EU single market, making us attractive to non-EU businesses so we have been able to finance the deficit without difficulty.
If our attractiveness falls, then the situation could change, with depreciating sterling, since the demand for it from foreigners buying UK exports or depositing money in the UK will be smaller than its supply on the foreign exchange market as we try to buy imports or higher interest rates to attract money from overseas with undesirable consequences for the domestic economy.