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balance of payment has always been dependant on its most cyclical component – Trade in goods. Trade in goods deficit has been the root cause for the overall UK deficit. Income & current transfers – other components of the current account have been instrumental in ‘cushioning’ the deficit.

 

The increasing deficit on trade in goods was more than offset by increasing surpluses on both trade in services and income.

 

Reasons for Current account deficit

 

De-industrialisation – As mentioned earlier, trade in goods has always been UK’s strength. However, with the onslaught of the deindustrialisation, industries started moving away from manufacturing towards services. Many economists do not regard this as a problem. Every developed country is doing the same now, outsourcing from developing countries to make manufactured goods at a lower cost whilst concentrating on high technology, high skilled industries. In terms of current account, the problem is that whilst most goods can be internationally traded, only 20% of services are considered as internationally tradable. By de-industrialising, UK is declining in a sector, which helps earn foreign currency to pay for imports and expanding in a sector that does not.

 

Tax receipts – The injection of tax receipts can cushion the deficit. It does so by filling in the gaps created by large deficits. However, it is understood that UK’s budget was relatively in a poor shape in the last few years which has allowed for lesser tax receipts than expected by the treasury. A VAT holiday declared by the government further deteriorated matters. Designed to mitigate the effects of the recession, the VAT holiday cost around ￡25bn, or around 1.5% of GDP, much smaller in scale compared to the US. It did not fulfil its intended role, instead affected the tax reserves. This has also contributed the economy being the worst hit by the recession (Larry Elliott, 2010).

 

Recession – The depth and duration of the recent recession has added to the current account deficit in the last 3-4 years. Deficits tend to rise during downturns because tax receipts fall and spending on unemployment and other welfare payments rise. In Britain's case, the economy contracted by more than 6% over six successive quarters from early 2008 to late 2009. By the time growth resumed national output was 10% lower than it would have been had the economy continued to expand at its normal rate of around 2.5% a year. That punched a hole in the public finances (Larry Elliott, 2010).

 

Growth in consumer spending – Over the last few years, growth in consumer spending has also been increasing in the UK. A significant portion of this spending has been on imports (often luxury manufactured goods). As explained earlier, deindustrialisation coupled with increased imports widened the deficit gap.

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