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The vanished deficit

The UK is borrowing less from overseas. This is a good thing.
February 2, 2021

One under-appreciated economic effect of Covid-19 is that it has eliminated the UK’s trade deficit. Next Friday’s numbers could show that the UK ran a surplus in trade in goods and services last year for the first time since 1997.

This has not happened because we’ve enjoyed a revival of competitiveness or entrepreneurial spirits. In fact, in the third quarter export volumes were 17.9 per cent down on a year ago. Instead, it’s because Covid has made us spend less. In the second quarter of last year households saved 26.5 per cent of their disposable – by far an all-time record. Although this proportion fell in Q3 it remained far above its long-term average.

It’s not just households who have saved more, though. So have companies. Yes, countless firms have seen revenues slump. But many have also postponed capital spending. The upshot is that, in aggregate, non-financial firms’ retained profits have exceeded their investment – by 1.4 per cent of GDP in the third quarter of last year.

This forced slump in spending has caused a slump in imports and hence a trade surplus.

We can put this another way. Every pound lent must be a pound borrowed. If the private sector is a net lender – with their savings exceeding their investment – somebody else must be a net borrower. For the most part, this somebody else is the government, whose borrowing has soared. But it is also foreigners: their lending to the UK has declined. Latest figures show that in the past six months the UK’s current account deficit (the amount we borrow from overseas) was under 3 per cent of GDP, one of the smallest deficits in the past 10 years.

This might matter. Large, sustained borrowing from overseas – which is rare because financial markets don’t lend as much to countries as you might imagine – can be a warning sign of financial crises.

In the run-up to the eurozone crisis southern Europe countries ran large current account deficits, as did the US before the 2007-08 crisis. There’s a reason for this. If people are investing more than they are saving – that is borrowing from overseas – it might be because they are over-optimistic about future growth. It’s also a sign that banks’ balance sheets are becoming more fragile, as their loans grow faster than their deposits. On both counts, the risk of crisis rises.

In this sense, the dark cloud of the pandemic has a silver lining. It has improved domestic balance sheets and so reduced the chance of a crisis.

There is, of course, a massive caveat here. All this is true in aggregate. It is emphatically not true of everybody. Many workers have suffered redundancy or cuts in hours and have borrowed more: it’s just that they are outnumbered by forced savers. And many companies are teetering on the brink of collapse.

The story of 2021 will be a story of how these very different experiences play out. Will the release of pent-up demand among consumers and firms cause a mini-boom? Or will rising unemployment and corporate failures hold back growth? It is dangerous to bet only on the former. There’s a limit to how much aggregate economic data can tell us.