Lord Flight: How the current account deficit has returned to haunt us

Lord Flight was Shadow Chief Secretary to the Treasury from 2001-2004 and led for the Opposition on the FSMA.  He is now chairman of Flight & Partners Recovery Fund.

Time was when I was much younger that a “Balance of Payments deficit” sank governments in the 1960s.  Harold Wilson was embarrassed to have had to devalue following a £300m Current Account deficit, where the devaluation, arguably, lost him the 1970 General Election.  The Heath Government avoided the embarrassment of a formal devaluation by allowing Sterling to float, but still lost the 1974 General Election.  The ending of capital controls changed all this.  Current Account deficits ceased to matter much, and became easily financeable by capital flows.  It became general practice for the mature economies of the West to borrow the savings of surplus, mostly Asian, emerging economies.

This was in many ways a positive for world growth and world trade as it addressed the imbalances of too much saving in Asia, and China in particular, and too much consumption in the West – led by the USA and UK.  So we all forgot about Current Account deficits and the Savings Rate. In the UK, this supported an artificially prolonged boom between 1992 and 2008, sustained by massive increases in personal debt, financing unsustainable consumption growth; and massive and unaffordable increases in Government spending.  This has now blown up.  Growth in the UK can now only come, for some time, from higher investment and rising exports, rather than just more consumption growth.  Individuals are over-borrowed and are attempting to de-gear.  (Average credit card debt per couple is still around £18,000).

The compound Current Account deficit since 1997 has been approximately £700b, much of which has also been financed by hollowing out ownership within the UK economy.  Many of our best companies have been sold. Our Utilities – particularly Power and Water – are largely foreign- owned, as a result of which we are at the mercy of foreign company boards as regards their policies towards investing in nuclear electricity generation.

From a domestic perspective, saving and investment have been inadequate – saving to the extent of the cumulative Current Account deficit.  This argues for instituting a Savings Policy, anyway needed, domestically, in order to finance the needs of an ageing population, with people being retired much longer. My rough and ready view is that our Savings’ Rate should average around 10% of GDP.  There is clearly an argument not to achieve this quite yet, as it would further reduce consumption in the short term; albeit that with material personal debt reduction now occurring, it is slightly unclear as to what the current Savings’ Rate is.

This should also make sense globally, as China is embarked on switching to consumption to sustain economic growth, where its “excessive” Savings Rate and Current Account Surplus are already starting to decline, and should decline materially over the next decade.  So “the West” will need to have a lower, offsetting, Current Account deficit and higher Savings Rate.

This territory is also an important factor in the breakdown of the Eurozone.  Because the less competitive economies of Southern Europe, as members of the Euro, cannot devalue they, too, have built up a growing and substantial Current Account deficit - mostly with Northern Europe.  For a decade the banks of Northern Europe were happy to lend to the economies of Southern Europe to finance this; but when their credit worthiness was called into question, this all stopped, with banks retiring their loans.  Within their own economies much of this has had to be made up by Central Bank finance.  Ironically, through the Euro, “Target”, Clearing System, the financing of the Central Banks of Southern Europe has ended up, largely, with the Bundesbank, which is now owed of the order of E700b.

The UK is better placed because we have our own currency and can, and have, allowed it to depreciate to restore our competitiveness.  But we face a decade during which any decent growth will need to come from rising exports and increased capital investment.  The financing of some of the latter can reasonably be provided by the various international Sovereign Wealth Funds; but in the interests of financial stability and better long-term growth, we will need to return to an adequate Savings’ Rate, and to reduce our on-going Current Account deficit.