A trade surplus is not always a sign of strength

A trade surplus is not always a sign of strength

Opinion piece (Financial Times)
04 March 2009

There has been a queue of commentators arguing that the strong economic performance of the US and the UK in the run-up to the financial crisis was an illusion, a product of excessive borrowing and an inflated financial sector. The fact that both countries are running large trade deficits is taken as evidence of economic malaise. They are compared unfavourably with countries such as Germany and Japan that still “make stuff”. These countries’ huge trade surpluses are said to be a sign of their competitiveness.

The financial crisis, it is argued, has revealed the fallacy of the UK’s “excessive dependence” on services. Manufacturing has been allowed to decline too far and as a result the UK has nothing left to sell. The talk has been about the need for “reindustrialisation”. Leaving aside the fact that the UK remains the seventh largest exporter of manufactured goods in the world, this portrayal reveals some lazy thinking.

Britain’s economic prospects are not handicapped by the size of its service sector and in particular its specialisation in internationally traded services. Neither are the long-term economic prospects of Germany and Japan better because of their strengths in export-oriented manufacturing and their external surpluses. If growth in the US and UK has been illusory, it has been no less illusory in Germany and Japan. Had it not been for robust demand for their exports, these two economies would have continued to stagnate.

Ultimately, they owe their short-lived economic recovery in 2005-07 to economic growth in the US and other big deficit countries such as the UK. Even the growth in their exports to emerging markets such as China and Russia was to a large extent a by-product of growth in other developed economies. Chinese growth was heavily dependent on exports (especially to the US), and the Russian economy on high oil prices, themselves a function of the economic boom led by the developed world’s deficit economies.

There is no doubt Britain cannot rely solely on financial services for growth. But its service sector includes a whole range of high-end activities, from business and legal services to intellectual property and the creative industries. These sectors are not going to die, even if their near-term prospects are poor, and are arguably less easy to challenge than many areas of manufacturing.

Of course, manufacturing matters. The UK’s strengths in aerospace, chemicals, pharmaceuticals and measuring devices are sources of prosperity and exports. But it is far from clear that a relatively bigger industrial sector would improve Britain’s economic prospects. The economies hit hardest by the downturn are those with large manufacturing sectors: Germany and Japan. Demand for manufactured goods has imploded faster than that for internationally traded services. It is no coincidence that the hardest-hit sector of the UK economy is manufacturing. Nor is there any reason to expect demand for manufactured goods to bounce back more quickly than demand for internationally traded services.

A trade surplus is not necessarily a sign of strength. In the case of Germany and Japan it reflects weak domestic demand, itself a product of very high savings rates. If savings rates were to fall in these countries, this would stimulate consumption and reduce their dependence on exports. To this extent, it could be argued that Germany and Japan are indeed better placed than the UK and US. However, all the evidence suggests that savings rates in these countries will not fall.

Indeed, the opposite is inevitable, as recession and subsequent stagnation depress employment and wages. The external price competitiveness of German and Japanese manufacturing industries will benefit, but they will find it difficult to boost their sales because of huge overcapacity in many industries and very weak global demand. At the same time, these big surplus economies will remain beset by chronically depressed consumption. With demand for their exports likely to remain weak for years, Germany and Japan arguably face a bleaker outlook than do the US and Britain.

The UK has no shortage of problems, but these have less to do with an excessive dependence on services and more to do with its bloated public sector, poor infrastructure, high levels of household debt and patchy skills. Growth will be stunted by low productivity in the public sector, skills shortages and congestion. However, the relatively small size of its industrial sector is unlikely to be one of the main factors holding back the British economy.