Can exports fill the hole?

By Chris Dillow, 11 August 2010

For anyone is hoping that net exports will grow to offset falling government spending, today's trade figures send a warning. They show that the trade deficit in goods widened in Q2, to £22.9bn, around 6.3 per cent of GDP. But why is the trade gap refusing to close?

Several people blame it on the fact that we export little to the faster-growing economies. Last year, the UK exported less to Brazil, Russia, India and China put together than we did to Ireland alone (£12.5bn vs £15.9bn). We shouldn't blame our exporters too much for this: it's a universal fact that countries export disproportionate amounts to their near-neighbours*.

However, although this might hold back our long-term growth, it hasn't been a huge problem recently, because our neighbours in the euro zone have been booming - though latestdata suggest the boom stopped, hopefully temporarily, in June. And this should have helped our exports.

Indeed, herein lies a small chink of optimism. Our exports to the euro zone have recently done a little better than one might have expected. Between 1999 and 2007 UK exports volumes to the EU** tended to rise 1.3 percentage points for every percentage point growth in euro zone manufacturing output, with a tendency to fall 0.4 per cent a year if euro zone output were flat. This relationship suggests with, with euro zone output having risen 9.6 per cent in the year to May (the latest month for which full data is available), export volumes to the EU should have risen by around 12.2 per cent. In fact, they rose 17.3 per cent. And this above-par performance seems to have continued into June; export volumes to the EU rose 13.8 per cent year-on-year then.

Now, we shouldn't make too much of this. The data is noisy. But it is consistent with the possibility that the benefits of improved competitiveness - even now, sterling is lower against the euro than it was in 2007 - are starting to come through. And perhaps a lack of bank credit is a less biting constraint upon exports.

Which raises the question: if this is so, how come the trade gap is still widening?

Brutal maths, that's why. In Q2, our goods imports were 34.9 per cent higher than our goods exports. This means that our exports have to grow one-third faster than our imports merely to keep the deficit stable. And this is a tough task, given that the globalization of supply chain means that any increase in exports must be accompanied by increased imports of materials and components.

So, even if competitiveness has improved, we should be sceptical of the idea that net exports can increase sufficiently to greatly offset the coming fiscal tightening.

* And it would be churlish to curse geography. Some historians think it was this - in particular our easy access to coal deposits - that was a major factor behind the UK being the home of the industrial revolution. So, on balance, geography has been our friend.

** I've adjusted the figures for carousel fraud, which tested my patience.

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