A vast number of shipping containers come in to UK ports each year carrying goods, but a sizeable proportion of them leave again empty, transporting nothing but fresh air.
This sounds bad but, in itself, might not be a problem.
It could simply be that UK exports have a high price per unit volume, such that the value of its exports could match its imports, even if they take up less space. Or it could be that the UK exports enough services to make up for its deficit in goods.
Sadly, neither of these theories is true.
The reality is that, except for a brief spell in the mid 1990s, the UK has run a sizeable deficit in its current account – the part of its international balance of payments that includes goods and services but not financial or capital flows – in every year since 1985 (Figure 1). What is more, in the years where there was no significant deficit, the UK merely balanced the books rather than running any substantial surplus.
Fig. 1 The UK Current Account Balance
It is not that the UK has nothing to export. Annual UK exports are $480bn, making it the tenth largest exporter on Earth – only slightly worse than one would expect for the seventh largest economy. The UK is arguably the leading exporter of financial and professional services, and it is a major supplier of high-end manufactured goods, such as in the aerospace and defence sectors.
It just imports even more than its exports.
A natural counterpart of a current account deficit is a capital account surplus – a net inflow of capital into the UK. A current account deficit tends to be associated with a capital account surplus simply because, if a country is importing more than it exports, it must either be running down foreign exchange reserves or borrowing from abroad to pay for the difference. The UK currently has net external debt equal to 30% of GDP – reflecting past borrowing to finance current account deficits.
One cause of all this is simply the fact that British people have enjoyed high-levels of debt financed consumption, racking up huge credit card bills in the process.
Part of this has been financed from abroad and has paid for imported goods – leading to a current account deficit and capital inflows. This behaviour has been facilitated by the highly-developed UK financial system, which has funnelled foreign savings to UK consumers with relative ease.
Over-valuation of sterling must also be part of the explanation.
An excess of imports over exports means there must be more demand to convert domestic currency into foreign currency for the purpose of trade in goods and services than the other way around. This should cause the currency to fall, making imports more expensive so that fewer of them are bought, making exports cheaper so that more of them are sold, and eventually restoring current account balance.
That this has not happened for so long tells us that sterling must be persistently over-valued relative to what trade alone would dictate.
Over-valuation occurs because of demand for investments denominated in sterling. Sterling is a reserve currency and sterling-denominated assets are used by investors and central banks around the world as a relatively safe store of wealth (making the pound effectively a mini version of the dollar).
The stock of various kinds of assets denominated in sterling has grown: consumer debt taken on partly to finance imports, UK government bonds issued to finance budget deficits, securities issued by firms which have listed in London because of its role as a major financial centre and money market accounts at major UK banks. Investors must purchase sterling to invest in these assets, and doing so has propped-up the pound.
The external debt of the UK is not catastrophic – Australia has net external debt near 60% of GDP and New Zealand is close to 100% without suffering calamity. But, if current trends continue, a point will eventually be reached where Britain struggles to pay external debts, sterling-denominated assets become unattractive and the pound crashes.
In the meantime, an over-valued pound makes life hard for British manufacturers.
Britain must re-balance so that its exports are more competitive and debt-financed imports are proportionately lower. Deliberately trying to weaken sterling is not the solution as it could trigger retaliatory devaluations from foreign governments and a ‘currency war’ (although the currency is falling anyway as a side-effect of quantitative easing).
Instead Britain should reduce incentives for debt-financed consumption, in part through higher capital charges on banks for such lending, and directly support the competitiveness of exporters by every means allowed under EU competition rules.
Fostering research and development collaborations between industry and academia, encouraging immigration of skilled workers and targeted tax breaks for innovators would be a good start.
Sean Harkin is a risk manager working in Edinburgh and the author of The 21st-Century Case for a Managed Economy.