Britain Report

Britain has had a consistently growing deficit in trade of goods since 1982. Before then, deficits only existed in times of economic strength that boosted the UK’s marginal propensity to import. Since 1982, economic boom has only served to increase the deficit, which continued to exist even through the recession of 1990 to 1992. This £34bn deficit in 2002, as well as the deficits for years before, can be largely put down to trade in manufactured goods. Of this £34bn, £26bn is due to the net imports of finished manufactured goods. This loss in competitive advantage in these goods is shown by the fact manufactured goods has fallen as a percentage of the UK’s total exports by 9.5% from 17% in 1960 to 7.5% in 1984. Manufactured goods are not the only sector to create the deficit; the second biggest deficit is created by £9bn net imports of tobacco, food and beverages. The deficit in 2002 was the greatest since 1991. There are several reasons of varying importance that could explain the reasons for this deficit.

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Firstly is the issue of low price competitiveness in the UK that will naturally lead to reduced demand abroad for UK goods. When Britain was a strong exporter of manufactured goods, it did not have the expensive labour that it has today. This is partly through an indication of UK growth, and partly through the low levels of unemployment that currently stands at 5% on the claimant count, pushing up labour prices in the UK. By the industry in the UK having to pay more for labour, it looses the ability to compete with countries such as China that have far fewer regulations on employment. Without a minimum wage the average cost of production is far reduced, meaning the goods are much more competitive on the international market. This loss in competitiveness is shown by fig 1.1 below, showing how confidence has been lost in UK manufacturing through dramatically reducing investment.

This lack of competitiveness can also be put down to skill deficits in the UK economy, increasing structural unemployment. Even though the UK fares very well on international rankings for education, we do not have the right skills that are needed to boost manufacturing competitiveness. However, it is not in all goods that the UK has lost competitiveness, as manufactured goods have declined, the exports of high value added ‘knowledge’ goods. These include specialized machinery, pharmaceuticals, telecoms equipment and generating equipment, but the trade surplus in these goods is often overlooked as it is clouded out by the enormous deficits elsewhere. So we do have a comparative advantage in some goods, but this is not enough to make up for our lost competitiveness elsewhere.

Another crucial factor in explaining the trade deficits is the UK’s inability to compete in non-price factors such as marketing, design, and delivery date and product development. All these factors stimulate international demand, but Britain misses out on the opportunity to achieve a surplus by not being efficient enough in these sectors. The issue of delivery dates links in some ways with labour, as workers cannot be exploited to try and make as early a deadline as possible. Britain is also surprisingly poor at product development considering its strong science base that has fared it so well in the value added goods as mentioned above.

A lack of trade structure in the UK has also been blamed for the deficit. Most notably, the deteriorating physical infrastructure of transport, which is increasing the cost as well as slowing the rate at which goods can be moved to trading partners. Trading partners do not want to have to wait for goods they could otherwise get elsewhere.

What I consider to be the most important factor in explaining the deficit is exchange rates. The 48 year low of interest rates at 3.5% would normally indicate a low exchange rate that would stimulate exports by reducing the cost of UK goods abroad. However, This is far outweighed by the currently weak US and weak EU that means the pound has appreciated against both currencies to such an extent that it has reached a five year high against the Dollar. The pound is also strong against the Euro, and considering that in 1999 56% of all UK exports went to the Eurozone, this indicates problems for the UK. There has been a trend since the 1960s to trade with Western Europe while trade has stayed fairly constant with the US at about 15%, while trade with the rest of the world has fallen dramatically, other than some newly industrialised Asian countries.

These growing links with the EU means becoming increasingly reliant on the EU economy, a problem with the economy slows as it has done over the last two years. This means that the marginal propensity to import in both the US and the EU has fallen and the UK deficit grows. However, it is not just these economic superpowers that are creating the deficit. It was imports from powers outside the EU that first created the enormous deficit in 2000. There is also the fact that we continue to maintain strong oil exports, 7.6% of all our imports and as oil is valued in dollars, the strong pound against the dollar is obviously not having sufficient to effect this, as it has not sufficiently reduced our competitiveness in this good. Nor has the strong pound reduced the exports of cars, which was valued at £16.3bn in 2002.

Although it is possible to say that because of the other problems the exchange rate is irrelevant as the UK has little to offer anyway, it is also relevant because if the pound was weaker the UK would have a lower marginal propensity to import, which is as significant in creating the deficit as exports. Together they are reducing the exports minus imports component of aggregate demand.

Firstly, there are many ways in which firms can boost their own individual competitiveness over seas. This will often mean the need to reduce the cost of each unit of output, so it is cheaper to buy abroad. The most obvious way to do this is for a firm to grow, and to take advantage of economies of scale. These only exist in the long run, where all factors of production are variable. They can exist in many different forms: Technical, marketing, transport, increased dimensions, managerial, risk bearing, location, principles of multiples and financial. These all reduce the unit cost of production in different ways, for example increased-dimensions does so as shown below in fig 21. The number of managers required often may not go up if the firm grows, and marketing can be used whether the firm is selling 100, or 100,000 units of the product. This means the cost of advertising per unit falls, hence the average total cost falls as well.

Thus, the unit cost of production goes down and competitiveness goes up. Of all the ways in which firms can achieve competitiveness, this is probably the most important as it is most often the cost of goods as opposed to non-price factors that is affecting the low demand abroad for UK goods. On the other hand it may be through remaining small that a firm can encourage investment because of all the tax breaks available to investors in small business. It is this investment that may be crucial in the factors discussed below.

It is still important for the firms to improve the non-price factors associated with their goods. Global marketing management is needed, but is a complex task. Managers are required to design marketing programs and strategies that will work well across many countries with different economic, political, social, cultural characteristics, or the good is restricted to only certain markets. An equally, if not more important measure that could be taken by firms is investment into research and development. This is crucial in becoming allocatively efficient and producing goods that are desired by consumers all over the world. A firm needs to stay as up to date as possible with technological innovations,

There may well also be the need for restructuring inside the firm to tighten up managerial strategies to ensure that deadlines are met and that employees are working hard for the firm. Encouragement of a stronger work ethic and a portrayal of the firm as a moral company are needed to encourage employees to work harder and more efficiently to boost productivity and consequently international competitiveness.

Equally, firms could become more competitive by acting at a price level where they are making supernormal profits, and both not being allocatively efficient or encouraging sales abroad as much as they could if they just ran at a price level where they made normal profits. This is shown below in fig 2.2

On a much larger scale, the government can do a great deal to try and promote competitiveness abroad. Firstly, in the short run, interest rates can be lowered. Although this will widen the current account deficit by inducing imports, it will also mean hot money leaves the country to go and seek out higher interest rates elsewhere. This will mean that the demand for money goes down and with reduced demand there will be a depreciation of the value of the pound, which will mean it is less strong against foreign currencies. This will encourage foreign consumers to buy UK goods. Reducing the deficit in trade in goods may not actually be such a good move, as the huge deficit at the moment may be having the affect at keeping the RPIX at its current level of 2.8%, and there could be inflationary pressure if this deficit disappears. This will be added to by the increased consumer spending through reducing interest rates.

Reducing interest rates will also have the advantage of inducing investment through the marginal efficiency of capital theory, whereby there will be more investment in firms because it will be less appealing to keep money in the bank. Both of these factors mean a more competitive British good abroad. However, it is quite unlikely that the monetary policy committee will simply follow this move, as competitiveness is normally required to close a trade gap, but a reduced interest rate is going to have the effect on increasing imports as well as increasing exports, possibly by more if the pound remains fairly strong. However, the investment will also be inflationary.

The government could encourage investment in the US and the EU, and any other failing economy, as this would boost their economies and reduced the strength of the pound against the foreign currency, once again increasing price competitiveness abroad. The government could, as a last option subsidise the failing sectors heavily, as it has done for framing in recent years. However, although this will improve competitiveness in this particular area it will increase government spending, possibly resulting in a budget deficit and a growing public sector net cash requirement.

The most likely method to boost competitiveness that the government would use is probably supply side policies. These include trade union reform, education, technological improvement or increasing the geographical mobility of both employees and employers. These policies shift the long run aggregate supply curve to the right, improving the efficiency and hence the competitiveness of the economy. However, there are problems with these long run policies, they take a very long time to work, and have a rather uncertain affect. In addition to this, they may well conflict with other government macroeconomic objectives, as they involve greater government expenditure, producing the problems mentioned above. They also may involve foregoing tax revenue, require the reduction of interest rates and interfere with other social objectives, all of which have significant impacts. Several of the above points are explained below in fig 2.3.

In conclusion, both firms and governments can increase the competitiveness of UK goods abroad, and although the government has the ability to do more, it also has more conflicts of interest, whereas firms often have a good incentive to boost competitiveness as foreign consumers mean increased profits.

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