Sunday, April 24, 2011
Tricky task of getting Britain back to balance
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

You can think of Britain's imbalances in several ways. There are the twin deficits. So the current account of the balance of payments was in deficit by £36.2 billion last year, an imbalance between exports and imports.

The other twin, public borrowing, came in nearly £5 billion below official projections for 2010-11, at £141.1 billion. This is still a very big number - the imbalance between government spending and tax revenues - which has to be corrected.

The twin deficits are symptoms of wider imbalances. The first is sectoral. Britain has too small a manufacturing sector and too big, proportionately, a service sector. The second is the imbalance in expenditure. Too large a proportion of gross domestic product is driven by consumer and government spending, not enough by net exports (exports minus imports) and investment.

Few doubt rebalancing is needed. The government’s Plan for Growth, one of many over the years, was published last month. It said: “Sustainable growth requires a rebalancing of the UK economy away from a reliance on a narrow range of sectors and regions, to one built on investment and exports, with strong growth more fairly shared .... Economic growth was unbalanced, with regions other than London and the South East increasingly reliant on jobs funded by public spending.”

The Organisation for Economic Co-operation and Development (OECD), in its latest survey of Britain, had a whole chapter on supporting and rebalancing the economy or, as it put it, “getting back to balance”.

So this is the way to go. Britain’s economy was successfully rebalanced after the recession of the early 1990s. After sterling was devalued after parting company with the European exchange rate mechanism (ERM), the economy enjoyed a strong recovery led by investment and exports. Within a few years both the twin deficits - current account and budget - were eliminated. It was a textbook rebalancing.

Why should it be harder this time? For a start the fiscal deficit is bigger, though the current account gap smaller, as a percentage of GDP. The big reason, however, is that manufacturing may have been allowed to shrink too much.

To quote the growth plan again: “Manufacturing’s share of nominal GDP fell from over 22% in 1990 to 11% in 2009. In terms of jobs, the position was equally stark with the number of employed in manufacturing falling from 5m in 1990 to 2.5m in 2010.”

Though manufacturing has been enjoying a strong recovery, it is easy to forget it suffered much worse than services in the recession. First quarter GDP figures will be published this week - it is anybody’s guess what they will show - but the previous numbers showed this very clearly.

At the end of last year manufacturing output was still 9% below pre-recession levels while services were less than 3% down. For industry, even getting back to where it was pre-crisis will take time.

The problem was brought out in three publications last week from the Bank of England. The Bank’s monetary policy committee (MPC) voted, as expected, 6-3 to leave Bank rate at 0.5%, a vote likely to be repeated this month.

For the six on hold, the worry was “whether weakness in the contemporary indicators of household spending heralded a more protracted weakness in consumption growth”. They feared a rate rise would hit confidence and spending further.

As it turned out, the Bank’s misgivings were not backed up by official data. These showed a 0.2% rise in sales volume last month for a rise of 1.3% on a year earlier. Sales value was up 4.5% on a year earlier, in contrast to the very weak picture painted by the British Retail Consortium.

The sales figures belie the squeeze on household incomes. Though the rise is slow, an upward trend is clear. It takes a lot to stop Britons’ spending.

The point is that the MPC majority was sufficiently worried about the weakness of household spending to believe it still needs nurturing with ultra low interest rates. It is not confident enough about rebalancing to allow weakness in consumer spending. Unbalanced growth is better than none.

Item two from the Bank was the regular report from its regional agents around the country on business conditions. The agents’ summaries, which help inform the MPC’s decisions, were this month supplemented by a special survey on imports.

The agents, curious to find out why imports had stayed so strong, dulling the impact on recovery of net export growth, came up with some gloomy findings.

Such is the structure of the economy, and manufacturing’s relative decline, that firms which import components and other so-called intermediates have continued to do so, despite the fact that sterling’s depreciation has made them more expensive.

This was because, even with the help of a competitive pound, “domestic substitutes were still considered uncompetitive”, “or there simply were no domestic substitutes to switch to”. Add in factors such as the procurement practices of multinationals and the agents’ reports suggest we will wait in vain for the import bill to fall. Nor, looking forward, was this situation to change, even over the next three years, “lack of availability of domestic substitutes being the overriding influence”.

Finally, the Bank gave us its latest Trends in Lending. What bank lending picture would you expect in an economy that was rebalancing? Stronger lending to firms and weaker lending to consumers.

In fact, according to the Bank, the opposite is happening. Lending to firms, particular small and medium-sized ones, is shrinking, while both mortgage lending and consumer credit are picking up.

If that’s rebalancing, I’m a Chinaman. And if I were a Chinaman I would be happy Britain’s appetite for imports is unabated. Rebalancing is a desirable, indeed a necessary, aim. But it is far easier said than done.