The other deficit

I suspect there's a long list of things which are not election issues but which should be. On this list should be: what to make of the fact that the UK's current account deficit last year was 5.5% of GDP, the biggest peacetime deficit since at least 1816*?

First, let's put this into a context. One of the big developments of recent years has been the near-disappearance of the non-financial corporate sector's financial surplus. Since 2011, it has fallen from £69.9bn to £1.1bn, its lowest level for 14 years. This could be tremendously good news. It means that capital spending has risen relative to retained profits - which could be a sign that the dearth of investment opportunities is fading.

However, there's one notable effect this hasn't had. It hasn't led to a big decline in government borrowing.

The point here is simple. Financial balances MUST sum to zero: if one sector is a net lender, another muct be a net borrower. In the past, swings in the corporate sector's surplus have been mirrored by swings in the government's deficit. For example, corporate surpluses in the early 90s and late 00s were accompanied by government borrowing, and corporate deficits in the late 80s and late 90s were accompanied by government surpluses. To put this in more familiar terms, strong capital spending means a strong economy and hence buoyant tax revenues.

However, the fall in the corporate sector's surplus recently hasn't greatly reduced government borrowing. Instead, its counterpart has been an increase in the current account deficit: as the UK domestic sector (which includes households and financial companies as well) has gone from surplus to deficit, foreigners' financial surplus has risen.  

Hence the question I began with: what to make of this?

One possibility is that this shows that the UK lacks capacity in tradeable goods and services. As capital spending and hence economic activity generally has picked up, we've sucked in imports. Our incomes have, in effect, leached overseas rather than to the taxman.

One could therefore argue that we do indeed have a structural government budget deficit, in the sense that there's a big deficit even when the private sector is running a normal financial balance.

This provides a better justification for a tight fiscal policy than the Tories are offering. Such a policy means - given the inflation target - a low path for interest rates which should weaken sterling and so boost competitiveness; think of the standard Mundell-Fleming story. Sadly, this argument is weakened by the Meese-Rogoff puzzle. But one could revive it: to the extent that the external deficit/foreigners' surplus is the counterpart of the government deficit, maybe austerity is needed to reduce the current account deficit and so prevent a disorderly adjustment in which sterling collapses.

There is, though, another interpretation. Maybe the exogenous variable is foreigners' desire to save - due to the Asian savings glut and government and private sector retrenchment in the euro area. If foreigners want to save, someone has to borrow. And that someone has been the UK government.

Financial markets seem to believe its the latter: falling index-linked yields and a strong pound tell us as much.

Which brings me to a hunch. This might be changing. Signs of a recovery in the euro area have been accompanied by a fall in the UK's trade deficit, the biggest part of our current account deficit. This could mean that the foreign sector's surplus is falling. If this happens as the same time as the domestic sector continues to run a deficit, then the government deficit will shrink.

Given that what passes for economic policy debate is often just an application of the post hoc ergo propter hoc fallacy, this might mean that the next government - whoever it is - will be able to claim success in reducing borrowing.

* Based on B.R.Mitchell's British Historical Statistics. Data since 1830 are in this Excel file from the Bank of England.

Comments

[Ericlonners]

You have a high probability of being right! This is why I suspect that labour are happier targeting a path for the deficit, rather than a detailed outline of expenditure cuts. If growth is higher than forecast there will be no need! Worth also pointing out the if the BoE's balance sheet is consolidated, there is no debt problem ... However if QE is reversed that is arguably an increase in the deficit ...

[Pension60]

Deficit or national debt, the poor are not the people to pay it.

Why are the wealthy not buying domestic goods, when their wealth has doubled since 2010?

...the UK domestic sector (which includes households and financial companies as well) has gone from surplus to deficit ...

Wages have stagnated for the bulk of the population, whilst prices ahve not.

Sanctions and benefit cuts impact ability to buy food, so need to borrow not to starve.

Cuts to housing benefit / council tax benefit and the affect of the Bedroom Tax on rent arrears, all mean pay day lenders are having a field day.

From average waged down to zero, more inflation in food prices and energy bills, half of which is tax and VAT.

When Universal Credit and its permanent sanctions on those in work or not just the same and to the over 60s hit by rise in retirement age and denied pension credit,
meet the nil state pension for life (payable if remain in work or not) in 2016, then payday lenders will increase massively, as people for a short while borrow to survive from starvation.

See why nil state pension at end of my petition, in my
WHY IS THIS IMPORTANT section, at:
https://you.38degrees.org.uk/petitions/state-pension-at-60-now

This hits women particularly hard, after business failures of private pensions and opt out from SERPs (that began 6 April 1978)
also hitting the value of works pensions, making them less.

Expenditure cuts have never happened. Austerity is a myth.
The welfare admin bill has risen by the tens of billions each year, whilst the money to the starving has decreased by the billions.

This means the bill has merely transfered over to the NHS by the huge rise in malnutrition hospital admissions and GPs treating more kids for the hunger symptom of Rickets, affecting bone development.

Sanctioned pregnant mothers then suffer premature birth due to starvation and are unable to breastfeed. Again transfer of bill to NHS.

Even early death and suicide caused by 'expenditure cuts' that are nothing more than moving the working poor, poor pensioners and uenmployed to impact budgets of the NHS, ambulance service, Police, HM Coroner and pauper burials / cremations by the council.

As about 75 per cent of the population are poor from just under average wage down to zero, then the nation faces the most severe hung parliament in May, and then a second general election when we get the dictatorship of no party left on the opposition benches and a TORY / LABOUR COALITION.

Will we then see a revolution as has occurred throughout history when the poor are left to starve?

www.anastasia-england.me.uk

[Ralph Musgrave]

What I just love about sectoral balances is this. Assume to keep things simple there is no foreign sector (or if there is, that it’s in balance). When £X leaves the public sector, that’s deficit which is allegedly “bad”. But that £X must necessarily arrive in the private sector whereupon it constitutes private sector “savings” which are allegedly “good”. Indeed we have dozens of schemes which keep thousands of bureaucrats and accountants occupied which are devoted to encouraging private savings.

What can you do but laugh? Incidentally MMTers have been pointing to the above absurdity for years. But it needs repeating ad nausiam till the twits in the Westminster village get it.

[Dave Timoney]

I think its commonly recognised that deficit fetishism has caused the UK media to lose its collective marbles, but I was still surprised by the acceptance of George Osborne's recent claim that "paying your way in the world" means cutting the government deficit rather than balancing the current account.

It says something about the degradation of politics that you have to rely on a hereditary peer (Viscount Hanworth) to point this out. I don't see the quality of debate improving much over the next 5 weeks.

[Metatone]

@FATE - you've found a use for hereditary peers. That's impressive. When are you going to turn lead into gold? ;-)

[Steven Clarke]

A very general question from me, which no doubt has a terribly complicated answer.

Why should we care about the composition of financial balances (at a macro level rather than their distributional consequences)?

Why would a trade deficit be preferred to a government deficit? Or a corporate surplus to a government surplus? Would every sector being exactly balanced be an ideal?

[John]

"pauper burials / cremations by the council"
If they die in hospital and nobody pays for burial, the hospital pays

[Dave Timoney]

@Steven Clarke,

Government debt can be financed indefinitely so long as we can service the interest. In contrast, a trade deficit is an IOU. Over the short term, you expect deficits to be balanced out by surpluses, as trade ebbs and flows. If the imbalance looks semi-permanent, you need to settle up.

The major factor in the worsening balance of payments since 2011 has been the fall in income earned by UK companies on foreign assets relative to income earned by foreigners on UK assets (i.e. more cash is going out than coming in). Chris's chart suggests that UK companies have maintained earnings by drawing down their cash surpluses.

A large government debt plus high interest rates has (depending on fiscal policy) the effect of crowding out public expenditure or prompting compensatory tax rises, both of which depress aggregate demand. A large balance of payments deficit has the effect of draining income out of the country and thus lowering total investment (even if some is recycled as foreign direct investment). If the interest rate on government debt is low, a government deficit is preferable to a balance of payments deficit.