Sunday, March 14, 2010
Our exports may be cheap but Europe isn't buying
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


A few days ago, something odd happened. A bad set of trade figures came out and they resulted in sterling coming under pressure. Why odd? Because it is a long time since the markets took any notice of the monthly trade figures.

In the distant past, they were regarded as the single most important barometer of the country's health. We will never know for sure whether a bad set of trade figures cost Harold Wilson the June 1970 election, but they certainly did not help.

Later, capital flows took over from trade as the driver of currency movements. Sterling was strong from 1996 to 2007 because of this, despite a deteriorating trade picture that nobody took much notice of. Now, it seems, trade is important again.

So are the markets right to focus on the trade figures again? No and yes. No, because there are certain figures some analysts should not get their hands on.

The trade deficit on goods and services in January, 3.8 billion, looked dreadful compared with the December figure of 2.6 billion. But a month ago the December figure was 3.3 billion. Without wanting to sound like a broken record, these figures are prone to revision, even leaving aside January weather effects, and the markets should have been more aware of that.

Part of the problem for sterling at the moment is the political uncertainty discussed last week. The other is the London effect. London is the world's biggest foreign-exchange centre, turning over a scarcely believable $1.7 trillion (1.1 trillion) a day, and traders always have some data to latch on to, in a way that does not happen for other European countries. There are plenty of rent-a-quote currency analysts ready to talk down the pound.

But yes, markets are right to regard trade as more important now. One reason sterling was strong before the crisis was flows into the UK banking system from abroad to meet the banks' funding gap. Those flows have been greatly reduced and will remain so, which helps to explain sterling's fall.

Britain's trade has improved somewhat. The trade deficit in goods and services narrowed from 45 billion in 2007 to 38 billion in 2008 and 33 billion last year. The current account deficit seems to have been only about 1% of gross domestic product last year, from nearly 4% in late 2006.

That said, there are two problems for Britain when it comes to exporting, despite the huge advantage of a competitive exchange rate. We don't make enough of the right things and we don't sell them to the right places. That is particularly true of goods, in which UK exports last year, 228 billion, were less than three-quarters of the value of imports, 309 billion.

On the first, a report last week, Ingenious Britain: Making the UK the leading high-tech exporter, offered some useful pointers. It was commissioned by the Conservatives and written by Sir James Dyson, the entrepreneur. Britain does a lot better in high-tech exports than is usually thought. The Engineering Employers' Federation reports a strong revival for high-tech sectors, particularly electronics.

There is a lot more that can be done. In 2007, before the financial crisis, Britain registered 17,000 international patents, according to the World Intellectual Property Organisation, compared with 240,000 by America and 330,000 by Japan.

Dyson argues that the problem starts in schools, where only 4% of teenage girls want to be engineers compared with 32% who want to be models, and he blames the bias against science and technology in education. Paying science, maths and technology teachers a lot more might help. Universities are too constrained, especially by the drive to produce peer-reviewed academic research, which limits their ability to collaborate with business.

Financing high-tech start-ups is risky and should be rewarded with more generous tax relief. Government support, particularly the research and development tax credit, should be refocused on small, high-tech businesses. By their nature, however, these changes will take time.

What about shifting the geographical bias of our exports? That well-known economist Gordon Brown put his finger on the problem a few days ago. "It's pretty obvious what's happening," he said. "The European economy, which is our major source of growth, is not growing fast enough."

He is right. Retail sales in the EU are doggedly failing to recover. In January they were 1.6% lower than a year earlier. Without demand on the Continent, sterling's undervaluation against the euro is wasted.

Last year nearly 55% of Britain's goods exports went to the rest of the EU. There is little evidence that patterns of trade are shifting. Indeed, because many foreign firms use Britain as a base to export to the Continent, that is easier said than done.

The good news is that exports to China are rising. In the latest three months, despite those disappointing January numbers, UK exports to China were up by an impressive 48.4% compared with a year earlier. Exports to South Korea rose by 22%.

The bad news is that we start from a very low base. Though the share is rising, only just over 2% of UK exports of goods go to China. Exports to the four Bric countries (Brazil, Russia, India and China) added up to 5.2% of UK exports of goods last year.

The picture for trade in services is different, though not hugely so. International Financial Services London, which produces data on the sector, said 33% of the UK's trade in financial services in 2008 was with the EU, followed by America, 26%, and Japan and Switzerland, 4% each. China and India combined accounted for less than 1%.

Building new export markets is hard work. It will take time to shift the bias of Britain's trade away from Europe. Sooner or later, however, it has to happen. Otherwise Britain will be left in the slow lane.

PS: March 24 may or may not be Alistair Darling's last budget outing but he can do the country a huge favour by clearing up some of the mess he has created for Britain's pensions system. Last week I attended the National Association of Pension Funds (NAPF) investment conference, where I discovered two things.

One was that pension funds have plenty of appetite for UK government bonds (gilts) as long as the Debt Management Office, headed by Robert Stheeman, who was also at the conference, issues more long-dated and index-linked stock (linkers). He said that while the proportion of long-dated bonds and linkers issued looks low, the absolute amount has risen enormously, from 10 billion early in the last decade to 80 billion this fiscal year.

The other discovery was deep concern about recent tax changes. Removing higher-rate tax relief for top earners probably sounded sensible at the Treasury to prevent the very well-off from avoiding the new 50% tax rate by increasing their pension contributions.

When these changes take effect in April next year, however, the incentive for anybody earning above 130,000 a year to be in a company pension is sharply reduced. Worse, as the NAPF has demonstrated, there are circumstances in which people earning well below 130,000 can be hit. Most insidious of all, for the first time people will be taxed on employer contributions to their pension.

This is the thin end of a nasty wedge, which could kill company pensions. Once senior people lose the incentive to participate, schemes risk falling by the wayside. Far better, if the concern is avoidance, to slash the absurdly generous 245,000 annual allowance for contributions. This government started damaging pensions in 1997 with Gordon Brown's 5 billion annual tax raid. It is not too late for the chancellor to make sure it does not end by wrecking them entirely.

From The Sunday Times, March 14 2010