Tuesday, 8 April 2014
Investor sentiment is like a scared cat. It is easily spooked and does not care who gets clawed during any frights. It is just such sentiment which is keeping the British economy calm, for now, but can it last much longer? The reason for concern is Britain's alarmingly high Current Account deficits on foreign trade. Unless corrected soon, there will be serious consequences for the nation, and Britain's global supply chain logistics in particular, which should pay more attention to re-shoring outsourced manufacturing back to Britain.
Given, however, that Britain's total earnings from tangible exports (visibles) and intangibles (invisibles), like services income from banking, insurance, shipping and overseas investment income, have not exceeded import costs for decades, why should now be a cause for concern? One reason is the alarmingly high deficit last year of £108 billion on visibles, which reduced to a £27 billion deficit when invisible earnings were included. Last year's awful trade performance, however, was not an aberration. According to Britain's Office of National Statistics (ONS), the combined current and capital account has been in deficit since 1983 and the trend is getting worse. Another is that the capital inflows that have financed these deficits, such as investment in industry and real estate, plus hot money, reflect the scared cat side of the equation. What were once healthy capital inflows could very quickly become unhealthy capital outflows.
For three decades the country has relied on the financial account (direct and portfolio investments) of the Balance of Payments to keep the nation's head above water. This is potentially dangerous because these capital inflows that have come to dominate the Balance of Payments are volatile and intractable and, equally disturbing, such foreign investment in Britain has proved a mixed blessing because of the financial contrivances global corporations use to minimise their taxes and so deprive Britain of billions of pounds in lost corporation and VAT taxes. Such tax avoiders also place indigenous UK corporations, who pay their taxes in full, at an unfair trading disadvantage.
Why manufacturing matters
It has long been touted by purblind political and economic commentators that British manufacturing does not matter much any more because the services side of the economy accounts for the lion's share of Gross Domestic Product. The current deterioration in Britain's invisible exports show just how asinine that view is and the price that Britain must now pay for neglect of its goods-producing sector. The fact is, Britain's investment income for operations abroad showed a £10.3 billion deficit in the final quarter of last year and £17 billion for 2013 as a whole, up from £3.7 billion in 2012. Back in 2008 there was a surplus of £33.2 billion from this source and £22.7 billion as recently as 2011. This has happened because of losses abroad by British banks, at the root of which was British banking's lack of good governance. There has also been a drop in income on overseas investment by British firms. This partly reflects deteriorating returns from British investment in a depressed Euro zone. It was fortunate for Britain that the Euro zone countries with big trade surpluses were prepared to pour money into Britain to fund the country's current account deficit. It is, however, a risky scenario because such financial flows could be vulnerable to political and economic uncertainty.
Britain's long post war history of current account deficits, punctuated by several devaluations and sudden brake slamming on policy, is symptomatic of a serious imbalance in the economy, the cures for which are both short and long term. In the short term, Britain must wean itself off reliance on cheap money which is now stoking up another housing boom that can only end in tears unless the Bank of England acts now to signal careful rises in the base rate. That may not go down well with manufacturers thinking of new investment, which Britain badly needs, but it is far more preferable to huge interest rate spikes down the line forced by soaring inflation rates owing to a de facto devaluation caused by rising import costs and consumer binge spending, financed partly by saving less. Such a scenario partially unfolded in America back in 2007 when for a straight 21 months of negative domestic savings, adopted so that people could pursue their have-it-all-now culture, often based on taking out second mortgages and liar loans, meant that much higher interest rates than three years before (2004), left buyers at the end of their rope. Then, on January 12th, 2007, eight months before Britain's first major retail bank failure in over 100 years, I warned in Warehouse & Logistics News: "The Bank of England's rate policy since being spooked by the dot com crash six years ago, aided by overly eager banks to lend irresponsibly, is a major cause of dangerously high national indebtedness. The banks and credit card companies may well pay a high price for their rapacious stupidity through record numbers of consumers seeking voluntary insolvency deals."*
Another short-term move must be for all British governments to eschew foreign military entanglements because these have a direct bearing on the foreign trade current account. According to one estimate, the Afghanistan war has cost Britain £38 billion so far, with many more years of costs to support the maimed forces personnel and widowed families, with almost nothing to show for it. The Iraq war would have cost much more, again with little to show for it. This is what happens when economically naive governments, egged on by even more benighted military top brass, bestride the saddles.
Moving to solutions of a medium term nature, the British Government, in concert with other governments, must take united action to reform international taxation regimes so that all global corporations pay their righteous taxes, instead of hiding their low-taxed profits in overseas tax havens, and competing unfairly with native companies.
The long-term solution will be harder to achieve but there are signs that desirable moves are already under way. One is the nascent trickle of re-shoring outsourced manufacturing back to Britain for a host of reasons, not least the soaring labour rates in countries like China, where hitherto low labour rates were the main attraction. British companies which have yet to re-shore back to Britain may also like to consider that if Britain's import costs rise owing to a falling Sterling exchange rate then they will be disadvantaged against indigenous producers. Another encouraging sign is that more investment is going into apprenticeships. If Britain is to boost manufacturing it needs a larger pool of suitably qualified labour. In this respect it would be helpful to overhaul a failing education system, which shamefully sees around four in five adults have a low level of numeracy which has been declining since 2003. This has led to the realisation that 17 million adults in England are working at a numeracy level roughly equivalent to that expected at primary school. There could hardly be a more damning indictment of Britain's current educational establishment. There should be more emphasis on occupations like engineering rather than on non productive vocations in the arts. Manufacturers, however, may need more Government incentives to invest so as to counter any adverse impact of rising interest rates that chronic Balance of Payments crises could impose.
On the social front, the Government must bear down even harder on the social security budget to eradicate fraud and waste. Money wasted in this way from undeserving, non contributors to society manifests itself in a deteriorating Balance of Payments. If nothing is done to at least balance Britain's foreign trade accounts then it is the markets that will ultimately decide the issue, and the markets can be merciless. If that happens, then the sparks will fly upwards.
* Google my headline: Good governance must prevail