There is no shortage of concern about the UK’s large balance of payments deficit. Many in the government are trying to solve it by cajoling British companies to export more with lots of new fancy schemes and initiatives. Speaking before the opening of the Commonwealth Games this week, for example, David Cameron said this should be a golden era for UK exports, with his government “unashamedly activist” in helping British firms sell abroad. But it is unlikely that a structural trade deficit is caused by our companies somehow being unable to export as well as Chinese companies or German companies. Why should British companies be unusually bad at exporting?
Others suggest that Britain’s high exchange rate is the key problem. John Mills, who has founded the Exchange Rate Reform Group, is one of many advocates of a weaker pound.
But would a depreciation of sterling make any difference? The argument seems enticing. A lower exchange rate would raise the prices of imports and lower the prices of exports. It would reduce our standard of living, but it may help us import less and export more, thus helping to close the trade deficit.
However, depreciation is not the magic bullet some believe. Whether a fall in the value of sterling would help reduce our trade deficit depends, among other things, on the cause of the high exchange rate.
It is possible that speculation is driving up the value of the pound. This might be short-term speculation or it may involve rational, medium-term portfolio decisions based on the view that sterling is a safe bet compared with the euro. The Bank of England could try to reduce the value of sterling in these circumstances by loosening monetary policy. However, this is likely to give rise to an unsustainable boom in asset prices and/or inflation, and to nullify the benefits of any devaluation pretty quickly. Alternatively, Bank governor Mark Carney could try to “talk down” the value of sterling: after all, he seems to have opinions on almost everything else, so why not on the value of the pound?
The effect of talking down the pound will probably be short term unless it is also backed by action on the monetary policy front – for example, some sort of target to lower sterling which is pursued by more QE. But this, as noted, would be a dangerous policy.
Perhaps we should stop treating symptoms and look more carefully for causes. Consider Miss Profligate. Miss Profligate spends 105 per cent of her income on consumption, and borrows 5 per cent of her income from the bank. In effect, she has a trade deficit – she buys a greater value of goods than people buy from her (or more than they pay her to make). Now consider Miss Prudent. She has the same income, spends 95 per cent on consumption and saves 5 per cent. She has a trade surplus equal to Miss Profligate’s deficit. She earns more than she spends, and people are willing to pay her, to make goods and services, an amount of money that is greater than the amount she spends on other people’s goods.
In short, Britain is Miss Profligate and Germany is Miss Prudent. Our government is borrowing about 6 per cent of national income and Germany’s government is borrowing nothing. The British private sector is saving about 4 per cent of national income and the Germans 10 per cent – though there are definitional differences in the savings data. There are also differences in investment levels between the two countries but, very basically, these figures explain our balance of payments position. We are spending more than we are earning and the Germans are earning more than they are spending. The superior efficiency of our investment probably means that we could get away with lower private saving than Germany if only our government were not, literally, consuming the equivalent of every penny that our citizens save (and more).
How does this translate into a higher exchange rate? Borrowing by British consumers and by the government leads to an inflow of capital to finance that borrowing: 40 per cent of UK government bonds are owned by overseas investors. This pushes up the exchange rate. This is inevitable and it helps – along with other forces – to create the conditions that lead to the balance of payments deficit which is the counterpart to the UK being a net borrower.
Of course, there are other factors involved as well. But we cannot ignore the fact that, if our government is going to borrow on its current scale then, without huge levels of private saving, we will run a balance of payments deficit. Reducing the budget deficit will not necessarily eliminate the balance of payments deficit – the private sector might just borrow more instead. However, it is up to the private sector to look after itself. For the present, the government is doing our exporters no favours by not getting its borrowing under control.