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Over the past quarter of a century there has been a continuing deterioration in Britain’s balance of payments. The current account, which represents the balance of trade in goods and services, has shown an ever widening deficit. The deficit on the current account in the three months to September 2014 reached a value that was equal to 6% of GDP. This is the biggest deficit that has been recorded since modern records began in 1955. Within the current account there has been an increasing deficit in the trade in goods, which has been only partly offset by an increased surplus in the trade in services.
Britain has, in effect, ceased to be a major manufacturing nation. In 1979, manufacturing in the United Kingdom contributed 25% to the gross domestic product and contributed largely to our export earnings. In 2010, manufacturing accounted for only 12% of the country’s national output. Its decline has been greater than in any comparable western country.
When a country runs a current account deficit, it is building up liabilities to the rest of the world that must be financed by flows in the capital account. The inward flows tend to be described, somewhat felicitously, as inward investment. However, in the case of the UK, they have been tied primarily to the sale of existing capital assets to overseas purchasers. A House of Commons Library note from March 2013 shows that the stock of inward investment that has accumulated in the UK over the period from 1970 to 2011 is equivalent to about a half of our gross domestic product. A report of the same year from the Department of Trade and Industry shows that the flows of investments into the UK greatly exceed those into any other country of the European Union.
It is both startling and instructive to explore the implications of this inward investment by taking stock of the current ownership of Britain’s capital assets. Of course, to construct a detailed inventory is next to impossible on account of the complexities of the financial arrangements, which entail joint and partial ownership. However, a good impression can be gathered by taking a few leading examples.
One might start with Britain’s ports, through which most of our trade in goods passes. This month a sale has been finalised that will see 30% of the ownership of Associated British Ports, which is the UK’s largest port operator, pass out of the hands of Goldman Sachs Infrastructure Partners and Infracapital, which is a Prudential subsidiary. The new joint owners will be the Canada Pension Plan Investment Board and the international financial conglomerate Hermes. These partners saw off competition from Malaysia’s sovereign wealth fund, from the Dutch pensions investor APG and from Korea’s national pension service. A third consortium, consisting of Abu Dhabi Investment Authority and 3i Infrastructure, was also vying to take control of the ports in an auction that began last year.
Within the last decade, Ferrovial of Spain has bought British Airports Authority, which is the operator of Heathrow and Stansted airports. The majority of Britain’s energy suppliers have fallen into foreign ownership, as has the supply of our water. The Australian bank Macquarie has recently taken control of our car parks by buying NPC. It would be tedious to continue in this way. Indeed, so complicated and opaque are the majority of such deals that most of us have ceased to pay much attention to them.
It is notable that those deals continue to provide the Government with funds that can be used to defray part of their budget deficit. However, there is an ever diminishing stock of assets for sale that remains in the public portfolio. As the Office for National Statistics informs us, the UK now has a large negative investment position. This means that foreigners own a greater value of British assets than British investors own of foreign assets—indeed, a much greater proportion. At the end of 2012, the balance was £544 billion in favour of foreign owners.
The foreign ownership of our capital assets implies an outward flow of profits, investment payments and dividends. In the past, Britain has been favoured by the fact that its overseas assets have generated a greater rate of return than have the foreign-owned assets in the UK. This favourable circumstance no longer prevails. Indeed, a deficit on the financial account has contributed to our record current account of deficit. This deficit has necessitated even greater adjustments of the capital account, entailing a further sale of our capital assets. A vicious cycle is under way, which will end in our eventual impoverishment and in our inability to pay our way.
“Out of the red and into the black – Britain is back paying its way in the world”.
This ignorant optimism and insouciance contrasts markedly with the anxieties concerning our balance of payments that afflicted his predecessors, both Conservative and Labour, from the early post-war years until 1992 and, probably, beyond that date. In 1992, a Conservative Government were forced to withdraw from the European exchange rate mechanism after it had been unable to keep the pound above its agreed lower limit.
It is difficult to explain how this radical change in perception has come about, but undoubtedly it owes much to the fact that a regime of fixed or controlled exchange rates has been replaced by one that allows exchange rates to float freely. The change in the international arrangements for currency exchanges has been accompanied by a process of economic deregulation and globalisation that has given free rein to the currency markets and asset markets. These developments have been accompanied by a belief in the ability of the markets to achieve favourable economic outcomes in the absence of regulatory interventions.
Perhaps the Chancellor has been unduly influenced by the dogmas of the free-market economists. However, there is real cause for anxiety. On all previous occasions since the Second World War when the current account deficit has been a high proportion of GDP, there has been a booming economy that has sucked in imports. At present, the economy is in recession, yet there is a very substantial deficit. Unless steps can be taken to stimulate the export of manufactured goods from the UK, we will be permanently constrained to maintain the economy in a state of recession, in order to staunch our demand for imports in an attempt to avoid a balance of payments crisis.
A balance of payments crisis will involve a flight of capital from the UK accompanied by a radical loss of the value of sterling vis-à-vis other currencies. Such a loss of value would raise the cost of imports, which, in addition to necessitating a reduction in demand, would give an impetus to domestic inflation. The reduction in the value of sterling might favour a degree of import substitution and it might encourage exports, but the conditions of recession and inflation would not be favourable to either of these tendencies.
The failure over many years of our industries to export their products has been a consequence, in part, of the overvaluation of the pound. It is startling to compare the upward trajectory of the pound to the downward trajectories of the currencies of the countries that have been providing us with cheap imports, namely the currencies of China and of the east Asian countries. In 2007 and 2008, there was a rapid reduction in the value of the pound in consequence of our financial crisis; but, since then, it has been gradually regaining its former heights. Our industries did not respond with alacrity to the enhanced opportunities to sell their goods abroad. For a significant response to have time to get under way, there would have to be a prolonged reduction in the value of sterling. It is clear that export markets can be lost far more easily than they can be regained.
One has to explain why the overvaluation of the pound had persisted for so long and how it might be overcome. The overvaluation owes much to the activities of our inflated financial sector. The sale of our capital assets to foreigners that has been mediated by the financial sector has stimulated a demand for the pound that has sustained its value. These sales have averted a balance of payments crisis, but they have also created the conditions that will exacerbate the eventual crisis. It will take time to amend these conditions. In the process, the financial sector will need to be diminished and its freedom to sell our assets overseas will have to be curtailed.
Our manufacturing industries, which will be required to grow in size and strength, will need to be fostered by a broad range of policies aimed at stimulating investment. The reduction of the value of the pound will need to proceed in a gradual and an orderly manner. This could be achieved with the help of the central bank, which should be instructed to purchase foreign currencies whenever the value of the pound shows signs of increasing. The central bank’s programme of quantitative easing has pumped a large quantity of money into our economy, which is threatening a further inflation of the values of financial assets and of commercial and residential properties. This is liable to stimulate the activities of foreign speculators, which may lead to an even further elevation in the value of the pound.
Quantitative easing has failed to stimulate investment in our native industries. This has to change; the banks have to be encouraged—if not instructed—to lend to businesses. The money that has been pumped into our domestic banks would have been more profitably employed in lowering the value of the pound by purchasing foreign currencies.