Those people who had hoped that sterling’s fall would reduce the UK’s trade deficit were wrong. Figures next week could show that the gap in the third quarter was close to a record high, at around £39bn, or over 7 per cent of GDP. This means that the UK’s economic growth in the third quarter was entirely due to domestic demand, and that net exports actually subtracted from growth.
This isn’t because of any problem with exports. Taking July and August together, non-oil export volumes have risen 8.7 per cent in the past 12 months. That’s better than the 5.1 per cent growth in world trade, as estimated by the CPB. Given that export growth has lagged behind world trade growth since 2000, this is a decent performance.
Instead, the deficit has risen because import volumes have also grown strongly – and because imports are bigger than exports, similar growth rates in the two lead to ever-higher deficits.
Such growth is inevitable. Supply chains are globalised, which means that if companies are to export more they must import more. This means it is very difficult to export our way out of a trade deficit.
What we have here is an example of economic forecasts being correct. Economists pointed out last year that a fall in the pound wouldn’t much reduce the trade gap, partly because importers and exporters price to market and so respond to exchange fluctuations by changing profit margins, and partly because of globalised supply chains.
It’s these chains that explain why most economists are so keen on remaining in the EU’s single market. Non-tariff barriers to trade such as customs checks and extra paperwork don’t just mean that imports take longer to arrive in the shops. They mean that important parts and materials get delayed, which requires firms to re-jig their production plans to ensure that such delays don’t slow down output. That distracts management from other jobs, such as increasing efficiency.
All this raises the question. If a fall in sterling and increased exports do little to narrow the trade deficit, what will do so? The answer lies in a simple national accounts identity. The trade deficit is the largest part of the current account deficit on the balance of payments. And that deficit is – by definition – equal to the excess of domestic investment over domestic savings. This tells us that the trade deficit will shrink significantly if and only if savings rise relative to investment.
Maths tells us this could happen if government borrowing continues to fall. History, however, tells us this isn’t the case, because falls in government borrowing have been offset by falls in private sector saving; the households’ savings ratio has halved since 2010.
More likely, then, the UK’s external deficit will decline only when households save significantly more. As this would mean weaker domestic demand growth – which is why import growth would slow – the cure to the UK’s longstanding trade deficit might well be worse than the problem.
