Osborne’s Legacy: Trouble for Trade & Capital Flows
The end of George Osborne’s ideological mismanagement of UK public finance brings relief. The legacy of that purposeful mismanagement remains a dead-weight drag on the economy, far outweighing the short run impact of Brexit. For no aspect of the economy is this more obvious than the external sector, net trade and financial flows from abroad.
Statistical practice divides country’s external transactions into current and capital balances. The former includes trade in commodities (“goods”) and services, “factor income” (largely from investments, the “primary balance”), and payments not linked to a service or asset (for example, remittances, the “secondary balance”). A current account deficit implies the rise in net debt to foreign creditors and a surplus means declining net debt, most of which is held by private businesses.
Figure 1 shows the overall current account balance over more than three decades, 1980-2016. Early on the Thatcherite version of neoliberalism removed much of the public regulation of trade and financial flows. A decade of deterioration in the current account followed, reaching its nadir in the late 1980s of close to minus five percent of GDP. By accident or design the end of the Thatcher government brought a striking recovery, briefly reaching a small positive balance in 1995.
A reversal of the current account improvement was followed by fluctuation in the range of -2 to -3% of GDP during the Blair-Brown years prior to the Great Financial Crash in 2008. Movements in the current account during 2008-2011 followed a cyclical pattern with the balance growing more negative as GDP contracted and stagnated (2008-2009), then rising toward zero when the economy recovered (2010-2011).
In the second quarter of 2011, marking one year of Coalition government, the current account reached its post-crisis apogee of -0.2% of GDP. This four decade review conveys a clear message: an unprecedented deterioration of the UK current account under the two Cameron-Osborne governments. In the waning years of Thatcher’s rule the current balance declined to its lowest at -4.8% of GDP. In only one other quarter during 1980-2011 did the balance reach minus four percent of GDP (-4.0 in 2009Q1).
During the twelve quarters since 2012Q2 the current account balance failed to reach minus 4% in only four. The balance has been at least minus 4% for all the most recent seven quarters, and minus seven for the last two (-7.2 and -6.9, respectively).
The dramatic deterioration of the current account balance results from two causes. Since the mid-1990s the balance on commodities has declined continuously, from minus one percent of GDP in 1994 to between -6 and -7% now, and net service exports have increased. The shift from commodities to services well predates Osborne’s mismanagement of the UK economy.
The source of the sharp deterioration in the current account lies in the primary balance. As Figure 2 shows over the twelve years 2000-2011 the primary balance was negative in only three of 48 quarters, which occurred consecutively during the financial crisis of 2008-2009. After mid-2011 the primary balance fell continuously, dropping into negative territory in 2012Q3 where it remains.
Net investment income is by far the largest element of the primary balance. During 2000-07 the annual average was £18 billion, reaching a high of 32 billion in 2005. During the economic crisis net investment flows declined but remained positive, averaging £6 billion in 2008 and 5 billion in 2009. For all of 2010 net inflow recovered to £20 billion and almost the same in 2011.
After 2011 came relentless decline in net investment flows, minus 2 billion for 2012, minus 10 billion for 2013, minus billion for 2014 and minus 32 for 2015. The net outflow for the first quarter of 2016 brought the second largest outflow on record (except for the quarter before), suggesting that the total for this year could be in excess of minus 40 billion.
To put is simply, for the last four years foreign investors have to an increasing extent taken then profits out of the UK economy, and UK owners of foreign assets have not compensated for the increased outflow by their profit remittances. We find the same story over in the capital account. In the last 12 quarters net foreign investment flows have been negative in nine.
The impact of Mr Osborne’s ideologically driven austerity on external balances shows itself clearly, short term capital outflow and declining foreign investment. These were easily predicted. Private capital, domestic or foreign does not plough money into a stagnant economy.
This reluctance by business to spend in the UK economy predates any Brexit fears, resulting not from policy mistakes but from the obsessive dedication of the erstwhile chancellor to troglodyte fiscal policies.