The UK needs to reform its trade policies to combat a consumption slowdown

Christian Stensrud, 3 February 2017

The UK economy finished strongly in 2016, with the ONS estimating growth of 2.0% in 2016, higher than any other G7 country. Because of the UK’s resilience after the Brexit vote, yesterday the Bank of England increased its forecast for UK economic growth in 2017 from 1.4% to 2.0%.

The resilience of the UK economy post-referendum has been largely supported by expansions in consumer spending. This continues a long-term trend where consumer spending has contributed the lion’s share to UK GDP; household consumption accounted for 62% of total expenditure in the UK economy in 2015.

However, the next few years do not look good for UK consumers. Inflation is already rising strongly due to the sharp depreciation of sterling pushing up import prices. The Consumer Price Index hit 1.6% in December, the highest since July 2014, and the Bank of England predicts inflation to rise above its 2% target for the next three years, peaking at 2.8% during the beginning of next year.

Higher prices and a slowdown in employment growth will start to weigh on people’s incomes, potentially reducing household’s purchasing power in the coming years. Thus, consumer spending is set to grow at a slower pace compared to last year, declining from 2.8% in 2016 to 1.7% in 2017 and 0.4% in 2018.

A lower rate of consumer spending will drag on the UK’s GDP growth, especially because it accounts for such a large proportion. To help nullify this, the UK needs to rebalance its economy away from domestic consumption and towards foreign markets by boosting exports.

Part of this rebalancing will happen naturally via the depreciation in sterling. The depreciation should make exports cheaper and therefore more appealing to overseas markets.

However, the timing and size of the depreciation’s impact on exports, if any, is uncertain. Firstly, it will depend on how companies anticipate and respond to Brexit, and this is extremely hard to gauge, especially before the UK/EU exit negotiations begin. Secondly, the last time sterling devalued to any significant extent, between 2007 and 2009, the balance of trade in goods and services remained broadly unchanged. The reasons for this are unclear. However, a lack of global demand, oil prices and the nature of the UK’s exports have all been cited.

The uncertainty means the government should do everything in its power to maximise the benefits a depreciated currency can have on the UK’s export performance. The question is how can the government achieve this?

Much of the economic research conducted shows that export promotion programmes can have a significant positive impact on a country’s export performance. The UK already has an export strategy. However, the recent select committee inquiry into that strategy highlighted that the UK’s export growth has been the slowest in the G7 since 2008. In fact, UK exports as a percentage of GDP have remained stagnant since the 1970s and below the world average since 1999. This points to a failure in the UK’s export strategy.

The select committee inquiry highlighted numerous areas of the UK’s export strategy that need improving, including more assistance for small and medium-sized enterprises, especially sourcing export opportunities; a lack of collaboration between national and local government and trade bodies, leading to a poor overall service for businesses; and the level of export finance offered by UK Export Finance seems low compared to counterparts in other countries. These factors are hindering exporters as well as companies looking to start exporting.

If the government wants the UK to be ‘one of the great trading nations in the world’, then it must find a way of fixing these issues and offer a genuinely effective trade strategy that helps businesses to start exporting or to increase their global reach. If this is achieved then the UK’s trade balance will become stronger and help guarantee the strength of the UK economy in the face of a slowdown in domestic consumption and the biggest shake up to UK trading relations in over 40 years.