Balance of Payments Deficit Could Unravel Budget Calculations
5% hole in the UK current account predicted
A new report from the independent think tank Civitas predicts a further deterioration of the UK current account balance. The UK deficit is likely to more than double from the 2009 rate of 2% of GDP to almost 5% in 2020. A current account deficit of that size would make untenable the plans of all political parties to reduce our huge national debt.
In Prospects for the UK Balance of Payments, Cambridge University economists Robert Rowthorn and Ken Coutts present a previously uncalculated projection for the UK balance of payments.
The ‘gloomy’ forecast
Resolving a deficit of the predicted magnitude would be very painful involving lost output and higher unemployment. The problematic deficit has been buried by the euphoria of a prolonged economic boom. Today, however, the urgency of the problem has been brought home by the credit crisis and ensuing recession.
Undermining the Budget
All predictions of future economic trends are fraught with uncertainty, but Professor Rowthorn and Ken Coutts have had a solid record in the past. In the short run deficits are not necessarily significant, but most economists accept that sooner or later the current account should balance. Moreover, larger deficits take longer to adjust and are associated with significantly slower output growth during the current-account recovery. (p. 15)
Ultimately, therefore the reality of a 5% chasm in the UK current account could undermine Alistair Darling’s Budget forecasts. Rowthorn and Coutts assume that:
- UK domestic spending will increase by 1.5% p.a. in 2010, 2.5% p.a. in 2011 and 3% thereafter;
- The real price of imported food will increase at 2% p.a. from 2010;
- UK energy imports will rise as the volume of UK North Sea oil production falls by 7% p.a. from 2010.
What can the Government do?
Coutts and Rowthorn argue that the Government should do whatever it can to help the City, the manufacturing sector and other knowledge-based services:
- Future reform of the financial sector should be designed to contribute to the export potential of this sector.
- In the case of manufacturing and knowledge-intensive services, there is scope for an ‘industrial policy’. Such a policy is now coming back into fashion.
They also argue for a weak pound:
‘The big devaluation that occurred in 2007-08 has given UK exporters an advantage and the government should aim to preserve this advantage by pursuing appropriate monetary and fiscal policies. Indeed, to the extent that it is feasible, there is a case for engineering a further sterling devaluation.’ (p. 15)
The authors think the City is vital to our future prosperity but argue that too much faith has been put in financial services in the past, forfeiting the benefits of other activities, such as manufacturing: ‘it is likely that global finance will become more regulated, more conservative, and on average less profitable than in the past.’ (p. 6)
We will need to assign a central role to manufacturing
‘The scale of UK trade in manufactures is, and will remain for years to come, larger than the exports of the City of London and all knowledge-intensive services put together. Safeguarding the City and increasing knowledge-intensive exports are both important objectives, but success in these areas would not remove the need to improve the trade performance of the manufacturing sector.’ (p. 15)
In 2008 manufacturing exports were worth £193.6 billion and exports of financial services plus knowledge-intensive services were worth £127.8 billion.
When the oil runs out
In a commentary Bill Martin argues that the UK will have to undergo a large structural adjustment when the oil runs out:
‘We are rightly concerned that the banking sector may not fill the gap; we know that the UK appears to suffer from a disparity in trade elasticities – with the import elasticity higher than the export elasticity – and we also know that there are asymmetric adjustment pressures. Capital market pressures placed on deficit countries to adjust can be much greater than the pressure applied to surplus countries. This means the costs of being over-concerned about the UK’s balance of payments position may well be less than the costs of being under-concerned.’
For more information contact:
Robert Rowthorn on: 01223 368 235
Civitas on: 020 7799 6677
Notes for Editors
i. Civitas is an independent social policy think tank. It receives no state funding either directly or indirectly and has no links to any political party.
ii. Robert Rowthorn is Emeritus Professor of Economics and Fellow of King’s College, Cambridge. He is the author of a number of academic articles on economic growth, structural change and the balance of payments.
iii. Ken Coutts is Assistant Director of Research in the Faculty of Economics, Cambridge and Fellow in Economics at Selwyn College, Cambridge. He has published a number of articles on developments in Britain’s balance of payments.
iv.Prospects for the UK balance of payments by Robert Rowthorn and Ken Coutts can be downloaded below.