A bad winter
February 11th, 2011
On Wednesday we heard the full figures for the UK’s balance of payments for 2010. They did not make great reading. The deficit on trade in goods came out at £97 billion. The service sector surplus of £51 billion cut the overall deficit back to £46 billion, well up on 2009. December provided a poor end to the year, with a £9.2 billion goods deficit in the month. UK ports were able to bring goods in, at a time when the economy was struggling in the snow to produce and get things out.
It wasn’t just the bad weather that swelled the gap in December. Forthcoming tax changes accelerated imports, including the purchase of some expensive aircraft. The UK is now well into a strong manufacturing upswing, but the economy starts from a position where many goods are imported. The rising prices of commodities, raw materials and components also adds to the upwards pressure on the import bills.
Whilst a trade deficit running at 3% of National Income can be financed, it is further proof of just how out of balance the UK economy became thanks to the decade of debt and higher public spending that it has just lived through. Despite the substantial devaluation of the pound during and after the Credit Crunch, UK consumers have a healthy appetite for imported goods, from both the rest of the EU and from further afield. The deficit in goods with the EU was £42 billion last year, and with the rest of the world £54 billion. The UK no longer has the capacity to make all the consumer goods or capital goods the economy needs. Fortunately the service sector, including financial services, continued to make a healthy contribution to the numbers.
The government’s strategy is to gradually correct these imbalances. The progressive squeeze on spending power as inflation and tax rises bite into wages and salaries should reduce some of the imports of discretionary items. The plan is to promote industrial growth, building on the manufacturing recovery which is well underway. To succeed, the UK will both need to make more things at home that it has been importing, and export more of what it makes. This will require new factories, more plant and equipment, and growing businesses.
To try to secure that the government is negotiating Project Merlin. They seek a deal with the banks to promise a substantial injection of new capital into small businesses, and a useful increase in total lending to business. The banks will probably agree, but they will have to add the caveat that they can only deliver if enough good projects and prospects are forthcoming. They might also add that if the Regulator wants them to raise their capital ratios more in the interests of having stronger banks with greater capital buffers against mistakes, this will impede them from lending more.
It is likely the UK manufacturing revival will continue, as UK industry at its best is now very competitive at the current level of the pound. It is also the case that the UK is still wrestling with a big overhang of past debt and has decided to go for more cautious banking. This will act as brake on the growth rate for some time to come.
