The UKs BALANCE OF PAYENTS DEFICIT WITH THE EU 27

The UK has a major balance of payments problem. In 2016 we had an overall foreign payments deficit of £114bn – nearly 6% of our GDP. Crucially, however, we had a small surplus with everywhere else but the EU27. More than all of our foreign payment deficit – a total of about £115bn – was with our European partners.

We had a trade deficit with them of £80bn, an income deficit of £24bn and we paid a £11bn net contribution to EU budgets. The trade deficit was made up of a surplus of £17bn on services and a deficit of £97bn on goods... The income deficit consisted of net remittances by migrants and a big difference, going the wrong way, between the amount of profits made on assets owned by the EU27 in the UK compared to those on UK assets owned on the continent. The budget deficit included not only revenue contributions to the main EU operating budget but also all the other net payments made by the UK to other EU organisations.

One thing is for sure. We are not going to go on for ever being able to run a balance of payments deficit so large that we can for ever enjoy a standard of living almost 6% more than we are earning. A crucial question wrapped up in our current Brexit negotiations – although our huge deficit with the EU predates Brexit and would have been a problem even if the 2016 EU referendum had gone the other way - is what to do about this situation. Something is going to have to give. What might this be?

Clearly we have to sell more abroad and to import less. At least in aggregate it does not matter whether our surplus with the rest of the world increases or our deficit with the EU27 decreases, but looking at recent trends shows where action has to be taken. Crucially our trade balance with the rest of the world has remained fairly stable and just in the black in recent years. It is deterioration in our financial relationship with the EU27 which has been the main problem.

Over the past ten years, our trade surplus on services with the EU27 has stayed roughly flat while our deficit on goods has risen from £40bn in 2008 to £97bn in 2016. Over the same period our income balance went from -£3bn to - £24bn while our net contributions to the EU budgets rose from £5bn to £11bn. This is where the big problem lies and there are in principle o0nly two ways of bucking this trend, apart from – eventually - paying less to EU budgets. We can either improve our trade balance in services or we have to do so in goods.

Improving the services balance can only happen if the EU27 really open up their markets to UK services in a major way. Unfortunately, the prospects for this happening do not currently look very promising. The Single Market has never been free of very substantial non-tariff barriers for services, and progress towards liberalisation continues to be slow. Furthermore, even if the EU27 made much more effort to increase UK sales of services to their markets the scale of any realistic improvement does not look likely to be anything like sufficient to make any real difference.

This then leaves us with goods. Understandably, the EU27 does not want to allow the UK to disrupt the Single Market by lowering labour protections, deregulating business operational standards or compromising on the quality of goods. This is one of the major reasons why they are doing their best to hold the UK to all of the acquis communautaire regulatory elements of the Single Market even if formally we are outside it. If, however, this leaves the UK with a mounting deficit, there is only one other way the UK can make itself much more competitive. We would have to have a much lower exchange rate.

When the 2016 EU referendum produced a Leave majority, sterling fell from almost $1.50 to a low of $1.20, a drop of nearly 20%. Since then the pound has risen back to a little over $1.40. At this level, the revival of UK manufacturing we have seen recently is very likely to peter out. As future deficit trends with the EU27 materialise and the Brexit negotiations proceed, whatever their eventual outcome, sooner or later sterling is therefore going to have to fall to a far lower level. The EU27 may be able to protect themselves from what they perceive as lower social standards from the UK but they won’t be able to avoid having to put up with more competitive pricing.