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For a long time the UK has been spending more than it
earns. Our appetite for spending has created problems which have recently
intensified, and which are now endangering our economic well-being. The UK
has been importing very large volumes of manufactured goods in a spending
boom, which has been financed by the sale of capital assets to foreign
buyers and by consumer borrowing. This process is like selling the family
silver - and much of the family estate - to pay for current consumption ...
and then borrowing to allow further consumption. This seems to have gone
almost unnoticed by both the British people and the political establishment,
but can surely only lead to a slump in the short term and impoverishment in
the long term. At the heart of the
UK’s current worsening trade imbalance there is an important mechanism that
makes the problem worse. With recent sales of UK assets capital has been
flowing into the UK from the buyers of those assets. This inflow of capital
keeps up the exchange rate (the value of the pound) in the short term so
that goods from abroad are kept artificially cheap and levels of imports are
kept artificially high. In other words the asset sales don’t just help to
give us the money to spend on imports but, through this exchange rate
mechanism, they actually make imported goods cheaper. And in the UK we have
been importing on a remarkably large scale. To put it graphically the
“typical” family of four in Britain is, on average, a net importer of over
£4,400 worth of goods each year (2005 figures).
The prices of imported manufactured goods have
also been dropping because of the liberalisation of the world economy and
the emergence of the low-cost BRIC countries (Brazil, Russia, India and,
most importantly, China). Lower prices have fuelled an appetite for imports
and in most product categories the UK could not produce substitutes at
anything like the imported prices, if at all.
In due course this spending and importing binge
must come to an end: the UK will run out of assets to sell. As these
problems become more apparent people’s confidence in the pound will at some
point disappear - leading to a “flight of capital” out of the country and a
recession. Such a recession will be caused by a reduction in demand as
people find they cannot afford so many imported goods and it will very
likely be aggravated by higher interest rates.
A devaluation would lead to higher prices in
sterling terms - inflation. The Monetary Policy Committee of the Bank of
England, which is independent of the government and sets interest rates, may
well then raise interest rates to combat this inflation. Higher interest
rates would aggravate a recession and lead to a slump in house prices. It is
possible that this powerful committee will choose to keep interest rates
low, but that is unlikely as their primary objective of maintaining "price
stability" has been set out by legislation.
What is the current trade balance, in round
numbers?
In 2005 the UK had a deficit in goods traded of
£65 billion while there was a surplus in services of £18 billion. These two
figures give an overall trade deficit of £47 billion. Due to other factors
(government transfers etc.) the actual current account balance wasn’t quite
as bad as this but there was still a very negative overall position – a
deficit of £32 billion (so for our “typical” four-person family there was a
£2,000 deficit in 2005).
The most recent figures, published on 30th June 2006, suggest that the trade
in goods deficit is widening fast and that for the first quarter of 2006 it
was £19.6 billion, which if repeated for the whole year would be 20% higher
than last year.
How many of our assets have already been sold?
Foreign buyers have already bought a large
proportion of those assets that can be sold. Looking at property in the City
of London, a recent report says that 45% of city property is now
foreign-owned, whereas in 1998 it was only 20%. (Source: “Who Owns the City
2006?”). It is being transferred at about 3% per year.
As to the ownership of major companies, figures from the Office for National
Statistics for foreign ownership of UK quoted shares show that by the end of
2004 33% of quoted shares were owned abroad, the largest proportion ever
recorded and this figure is increasing: in 1963 it was only 7%. The Office
for National Statistics states, “the long term trend shows that the
percentage of shares owned by foreign investors continues to increase.”
The true picture is probably even bleaker: when a company is taken over by a
foreign entity it usually loses its quotation so that the quoted shares are
a biased sample – they are only the “survivors” of the original group. This
33% figure is only the percentage of the “surviving” companies owned abroad.
The recent takeover boom, led by foreign investors, has reduced the number
of quoted companies. Many companies are now 100% owned abroad, so that the
percentage of large companies operating in the UK is probably significantly
higher than 33%. One recent example of such a takeover is Abbey which was
bought for £9 billion by a Spanish bank. The result is that Abbey is no
longer in the quoted sector to which these ownership figures relate. That
will also be true for BAA which in June 2006 agreed to be taken over for £10
billion by another Spanish company and for ABP (Associated British Ports)
currently being taken over by an American consortium for £2.5 billion and
for P&O, bought by Dubai’s DP World for £4.4 billion. Many other companies
have been taken over by foreign buyers in the last few months including:
Allied Domecq (to a French company for £7.6bn), Aggregate Industries (to a
Swiss Group for £1.8bn), RMC (to a Mexican company for £2.3bn), Marconi (to
a Swedish company for £1.3bn), British Plasterboard, BPB, (to a French
company for £3.9bn) and Exel (to a German company for £3bn). There are also
several large companies quite likely to be taken over in the next few months
including Aegis, the giant media buyer, and even the London Stock Exchange
itself. The Sunday Times (25.6.06) estimates that in the first three months
of this year, 2006, overseas companies spent about £19.4 billion acquiring
UK companies while the flow in the opposite direction was only £6.8 billion.
An indication of the scale of this selling of assets is shown by the OECD
figures released on 28th June 2006 showing that for 2005 the UK drew in $164
billion of direct investment whereas even the much larger US economy only
drew in $110 of foreign investment. Whilst some of this “inward investment”
into the UK relates specifically to the “Shell” restructuring and some to
greenfield developments and reinvested earnings, a large amount represents
overseas takeovers of UK companies.
A sterling crisis followed by a devaluation of the pound might not stop
foreign buying of UK companies and property: if UK assets are attractive to
overseas buyers at the current exchange rate they will be even more so after
a devaluation.
The long term balance of payments consequence
of these asset sales is a stream of dividends abroad
In the short term each of these sales means an
injection of foreign capital, which is provided by the acquiring company
buying sterling to pay out the former owners, but inevitably the new owners
will want to see a return on their investments. This comes in the form of
cash being sent over future years back to the country of the owning company.
Put another way, each foreign-owned UK company represents a claim by the new
foreign owners on UK assets. Such a claim is paid in the form of dividends
sent abroad – this dividend stream must be paid for an indefinite period - a
“rent” payment. Such payments may be smaller in the first year or two after
acquisition while the newly acquired subsidiary is being reorganised with
associated costs (often including redundancies). However, in future years
these dividends can grow quite rapidly. For example in June 2006 Thames
Water, now owned by a German conglomerate, announced that it is increasing
the dividend to be sent to its parent company by 50% and is sending £200m
back “home”.
There is, too, another downside to foreign ownership for employees: in a
downturn of the world economy a foreign conglomerate may well have to choose
between making people redundant in their foreign subsidiaries or in their
home country. Many of the functions could be carried out either locally or
in the company’s home country. Human nature and domestic politics may well
lead to redundancies in the UK subsidiary companies rather than at home.
Isn’t this just part of globalisation, where
UK companies are buying equivalent assets abroad?
The actual figures do not support this
optimistic view. According to the latest “Pink Book”, which the Office for
National Statistics produces each year, the net change in foreign assets of
UK residents in 2004 was negative to the tune of £141 billion just for that
year: this is a net sale of assets of £9,400 in that year for our “typical”
four person family. Each of the last ten years has shown a deficit on the
assets account so that by the end of 2004 the total net assets position was
minus £683 billion (table 8.1, page 102), which spread over the UK
population proportionately, leaves a net foreign liability of over £45,000
for our “typical” four person family.
But doesn’t the US have a similar problem?
The US does have a serious balance of payments
deficit but its position is very different in that it still has a large
manufacturing base and the dollar is the currency of world trade. It has
many other sources of income from the globalised economy with many of its
companies controlling large and profitable international businesses
(American Express, McDonalds, Morgan Stanley, Google, Microsoft and Coca
Cola to name just a few). It has the further advantage that, issuing
treasury bonds denominated in dollars means that a dollar devaluation would
significantly reduce the real size of both its deficits (government
borrowing and trade) expressed in other currencies.
Have high house prices contributed to the
current boom in UK consumption and imports?
Yes, they have been very important. Higher
house prices have enabled people to borrow more for consumption and to spend
more from properties when they are sold. High property values have also led
to what economists call a “wealth effect” – people feel wealthier so they
spend more and save less. Much of this spending is on imported goods,
including cars and electrical goods.
Borrowing against property for consumption has become a way of life for many
people and is largely made possible by rising house prices. Total mortgage
debt is now over £1 trillion (£1,000 billion). A significant part of the
increase in the level of mortgage borrowing has come from people releasing
equity for consumption. Cash can be taken out of residential property in
various ways: outright sales, remortgaging and by taking a bigger mortgage
than needed when moving to a new home. All this borrowing is called
“mortgage equity withdrawal” (MEW) and is the amount of money people are
taking out of their homes for non-building purposes – mainly for
consumption. For the fourth quarter of 2005 the figure was £11.8 billion
according to the Bank of England’s latest release on the subject. This is
just part of a surge in such new borrowing which began rising in 2001.
Assuming this level of borrowing for a whole year and putting it in terms of
our “typical” four-person family they are borrowing an extra £3,150 against
their home each year for spending. Of course if this is the average amount
it means that very many people must be borrowing a lot more.
How has the credit boom made things worse?
The figure above, being an injection for
consumption of almost £12 billion per quarter from non-building related
mortgage borrowing, only affects those with a home to borrow against. Those
who do not own property have also been borrowing in a big way. Unsecured
lending has increased dramatically in the last few years. For the first four
months of 2006 it increased by £1 billion per month and is now in total at
£191 billion. This means the average person has an outstanding unsecured
debt of about £3,000, so that our family of four has, on average, unsecured
debt of over £12,000. The increase in this sort of debt has meant a large
boost to consumption and imports. Should the economy turn down sharply, much
of the population will find it very painful or impossible to service this
debt.
All this extra income coming into the economy creates a “multiplier effect”
– consumers spend money and some of this goes to other consumers who in turn
spend it, so that a large injection of new money has an even larger impact
on overall consumption than one might expect. Added to this is the
confidence factor – people see most people around them spending freely and
talking optimistically of the future. Together these effects create a boom
in spending.
Will our invisible exports surplus (trade in
services) compensate for our lack of manufacturing?
Unfortunately our “invisible exports” are not
big enough and this surplus from trade in services is not growing
significantly. The surplus on invisibles comes mainly from banking and
insurance and is a bit erratic and subject to shocks - such as that recently
suffered from hurricane Katrina and periodic crises in the financial sector.
To put this services contribution into perspective and taking the monthly
figures for April 2006, the trade in goods deficit was £5.8 billion whilst
the surplus in the trade in services was £1.8 billion so the resulting
monthly deficit is reduced, but was still £4 billion in one month.
Won’t our North Sea oil help us?
No, we are now net importers of oil and other
fuels. In 2005, although we exported £22 billion worth of these we imported
almost £24 billion – a deficit in oil and fuels of about £2 billion. In 2005
the UK became a net importer of oil for the first time since 1979. .
What about all the investments held abroad by
UK residents? Can’t those be used to fill the gap?
In principle it does make sense to set total
national liabilities off against total national assets, but there is an
important difference that makes “off-setting” these amounts unwise: the
repatriation of earnings is out of the UK government’s control. If a foreign
company buys an asset, such as a water company, then the foreign company
will take dividends back to its home country. By contrast a UK company or
individual owning assets abroad, does not need to bring these dividends back
to the UK. The UK owner cannot be compelled to repatriate foreign earnings.
Indeed, a sterling crisis, with the inevitable talk of further devaluation
and talk of exchange controls, may well discourage holders of foreign assets
from bringing money back to the UK. Fundamentally, however, the problem is
that the foreign-owned UK assets now significantly exceed the net assets
owned abroad by UK residents (by £683 billion, as above).
Are other factors making things better or
worse? What about all the new workers coming into Britain?
In May 2004 the EU was expanded to 25 countries
including as new members Poland, Hungary, Slovak Republic, Slovenia, the
Czech Republic and the three Baltic states of Estonia, Latvia and Lithuania.
The result has been a large inflow of new Eastern European workers. The UK
has received a particularly large number because, whilst France, Italy and
Germany have limited the rights of foreigners to work in their countries,
Britain has allowed free access to its labour market. The result has been an
influx of new workers who have overwhelmingly gone into the service and
construction industries. Anecdotal evidence suggests that very many of these
workers are sending significant amounts of money back to their home
countries. This flow of money out of sterling from foreign remittances looks
likely to increase.
The UK's problem has fundamentally been low productivity – we do not need
more foreign workers but a more productive use of the indigenous workforce.
Won’t a modest devaluation correct the
position?
Unfortunately the nature of the imbalance is
not one that will be easily corrected by a small change in the exchange
rate. The problem is that a modest adjustment may not be enough to improve
the trade position significantly. A larger devaluation will probably be
needed.
Whilst a modest devaluation would help exports it may do very little for the
cheap imports to which we have become addicted. Although it would lead to a
higher price for these imported goods, it is hardly likely to lead to
widespread manufacturing in the UK. The UK minimum wage is around £40/day,
whereas we are competing with countries where the daily wage is a small
fraction of this (“dollar-a-day countries”). The most relevant question in
most product groups is, “how much would the pound have to be devalued in
order to choke off demand so that less sterling was being spent on those
goods?” The fear is that to reduce demand for foreign goods the pound may
have to be devalued a great deal.
How do the prospects look? - aren’t things
getting better?
In general the economy is becoming more open -
driven by both government policies and technical changes such as the
increasing use of the Internet. This openness seems to be harming British
businesses in relation to foreign ones. Indicative of this is the dominance
of the Internet by US corporations. Looking at the top 10 sites visited by
the British on the internet, nine of them are American and the tenth is
French (Wanadoo), according to the researchers Hitwise, quoted in Marketing
Week on 25th May 2006. In addition, business is now massively dependent on
“search and search-driven advertising” – both the main agencies in this
field, Google and Yahoo!, are US owned. The logic of this seems to be that
as Internet usage grows, and rapid online growth is projected for almost all
parts of the economy, American companies will become increasingly dominant
and will be making larger profits which they will take back to the US,
putting further pressure on the pound.
As has been said, “Globalisation is good for lions, but not for rabbits.”
So, why should a balance of payments crisis
matter?
A severe devaluation would quickly reduce
overall demand in the economy as so many of our businesses depend on cheap
imports - which would suddenly not be so cheap. Spending throughout the
economy would be reduced. As the pound reduces in value, most manufactured
goods will go up sharply in price and both foreign goods and holidays will
become increasingly expensive.
The difference between pay rates in the UK and abroad may come to be seen to
be too high for an economy which is so open and whose manufacturing base so
shrunken. A significant devaluation will at least be effective as a way to
reduce real wages.
A devaluation also matters because the people of the UK rely on a strong
economy – people need to be paid, they need to eat, they want to buy things
to use and they need the economy to be sustainable so that they and their
children can face a prosperous future. A downturn of the sort envisaged
would be particularly damaging to a nation which is now so highly borrowed:
higher interest rates and higher unemployment together may provoke a sharp
reduction in both real wages and house prices.
Couldn’t we stop the imports by imposing
import taxes?
No: the EC wouldn’t allow it and even if they
did it probably wouldn’t help. Other countries would respond in a similar
manner and we would find those exports which we do have would be equally
hit. Protectionism may be a realistic route for a country which has a large
manufacturing base, but the UK has lost that base – it may lead to
widespread pain as prices of large numbers of products go up sharply. This
will be inflation in goods, but skewed towards imported goods. Real wages
may fall significantly both from a devaluation itself and from higher
unemployment.
Why hasn’t this been brought to our attention
by the politicians?
It seems that most politicians simply don’t
realise what is happening and have little concern for the UK's balance of
payments position. They will only react either in the event of a crisis or
when they are put under pressure. If a crisis is indeed inevitable, it will
be better for the problems to be generally recognised sooner rather than
later – as has been said, “the better the party the worse the hangover”.
Perhaps it is time to stop the party.
What do our politicians feel about the sale of
British assets to foreigners?
Mostly they have welcomed it! What many
countries would regard as undesirable foreign purchases our politicians
refer to in celebratory tones as “inward investment”. In contrast the
Italians and French have been very protective of sales of their assets.
Although some foreign investments are genuinely new investments in new
production facilities, our government appears to make no distinction between
these “real” investments and purchases of existing UK assets. The UK
government has welcomed the sale of most of the utility businesses to
foreign companies – for example, to take just a few, Innogy, Npower,
Yorkshire Power and Thames Water are all owned by the German firm RWE.
Implications for individuals
For individuals who own assets the sensible
course of action is clear: sell sterling assets and buy
foreign-currency-denominated assets. Investors should not feel guilty about
this - stockpiling before a famine is in the public interest: it is trying
to stockpile once the famine has started that is anti-social.
For those without assets, they should, as far as possible, be prepared for a
downturn in the economy and perhaps not assume that their jobs are secure –
reducing debt would be desirable and as far as possible one should build a
lifestyle less dependent on imported goods.
Conclusion
If the arguments presented above are correct
then the UK economy is drifting towards a sterling devaluation and a
recession at some point. Such a recession would be characterised by
increased prices of goods, falling wages and probably higher interest rates.
The government might still be able to avoid this by acting to make UK
companies less attractive to foreign buyers and by adopting policies to make
foreign goods less attractive to UK consumers.
Author’s note: I am indebted to my friend and colleague Karl
Grossfield for many ideas and discussions on these issues and to my American
friend George Kegler for his constructive and challenging comments. Note on
trade figures: there were some relatively small revisions made immediately
after this article was written but as these do not affect the argument I
have left in the figures based on the ONS original estimates.
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