Trade deficit in danger of being sidelined in UK’s fight against inflation | Larry Elliott


Britain’s economy has barely grown for 18 months. The level of activity today is pretty much the same as it was when Russia invaded Ukraine in February 2022 and gave an added boost to already strong inflationary pressure.

The sideways drift is noteworthy in itself. Economies don’t very often have prolonged periods when they operate at stall speed; they either bounce back or slip into recession. Not since the late 1950s has the UK experienced anything like its recent torpor.

But everything’s relative. Given what was being predicted for the economy at the end of 2022, the latest official growth figures were surprisingly strong. By this point, Britain was supposed to be halfway through a long recession so, in that context, Rishi Sunak and Jeremy Hunt are entitled to feel relieved. While probably imperceptible to most people, news that the economy grew by 0.2% in the second quarter of 2023 was enough for the prime minister and the chancellor to claim their plan was working.

The inflation figures due out on Wednesday will provide another opportunity for Sunak and Hunt to say that the tide has turned. With last July’s big jump in energy prices not repeated this year, the government’s preferred measure of the cost of living, the consumer prices index, is thought likely to show an annual increase of 6.8%, down from 7.9% in the year to June.

Last month’s rotten weather means there is a chance that inflation might even be lower than expected. The British Retail Consortium reported last week that its members offered big discounts to shift summer stock.

As a result the prime minister now has a decent chance of achieving two of the three economic goals he set at the start of the year: to grow the economy and to halve the inflation rate. To that limited extent, the plan appears to be working.

Yet, for a party that will have been in power for 14 years by the time of the next election, these are not earth-shattering achievements. To make a compelling pitch for a fifth term, the Conservatives need to show they have a plan to tackle the UK’s structural economic problems.

The scale of the challenge is highlighted by the trade figures released alongside Friday’s growth data. In the three months to June, the UK’s deficit in goods stood at more than £51bn, while the deficit for goods and services combined was £19bn. Time was when the trade figures were seen as a critical barometer of the nation’s economic health. Strangely, though, interest in what has been happening to imports and exports has waned even as the UK’s performance has markedly deteriorated.

The Office for National Statistics has detailed figures covering the period since 1997, when a £16bn deficit in goods was more than matched by a £22bn surplus in services.

Things went steadily downhill thereafter. By 2007, a deficit of £32bn was made up of a shortfall of £95bn in goods, partly offset by a £63bn surplus in services. In 2016, the year of the Brexit vote, the deficit was £38bn, with a £101bn surplus in services and a deficit of £139bn in goods. Of the goods deficit, £96bn was with the EU, while the remaining £43bn was with the rest of the world.

The ONS figures reflect the fact that the UK is predominantly a service sector economy, making up about 80% of national output. They also show just how internationally competitive this sector is: exports of services stood at £400bn last year – double the figure for 2010.

But the success in selling services cannot make up for the widening gap between the goods Britain exports and the goods it imports. In part this is due to the fact that the UK is now a net importer of energy, but to a much larger extent it is the result of no longer having a presence in many industrial sectors. The ONS says that since leaving the EU, there has been no real difference in the UK’s export performance: it has been equally bad across the board.

This disparity between trade in goods and services has an impact on Britain’s economic geography, because the high-end services that tend to be exported are concentrated in London and the south-east. Levelling up will require other regions either to build up their strength in sectors such as management consultancy, law, banking and architecture – where the UK has a comparative advantage – or to become more internationally competitive in manufacturing. And that means lots of investment over many years, within the framework of a properly thought-out and comprehensive industrial strategy.

The good news is that there are signs of a pickup in business investment. As the economics team at Berenberg bank noted: “Productivity-enhancing business investment stalled badly after the UK voted to leave the EU, and then collapsed during the first wave of Covid-19 in early 2020. The weakness in investment has hurt productivity, harmed supply potential and contributed to inflation pressures.

“However, the latest data indicate that the post-Covid snapback in investment may be turning into a genuine investment boom. Business investment has surged by 35% from the low in the second quarter of 2020 and is now 6% above its pre-Brexit vote high.”

Rising wage costs may be one reason companies are looking to invest in labour-saving kit. The ONS thinks it is also possible that companies are looking to exploit the opportunities afforded by the drive for net zero.

Even so, Sunak and Hunt would be wise not to get carried away. Weak investment and a massive trade deficit have been features of the UK economy for decades. This is most certainly a case of one swallow not making a summer.



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