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Why the UK trade deficit with the EU is woeful and widening

Why the UK trade deficit with the EU is woeful and widening

At the time it was big, big news. Three days before the general election, official figures showed that Britain’s trade had taken a marked turn for the worse. Government claims that the economy was healthy took a knock.

That was June 1970, a time when the size of Britain’s trade gap was front page stuff. Headlines screamed about the UK being back in the red. The TV news bulletins were full of it. Harold Wilson is supposed to have blamed it – along with England’s defeat by West Germany in the World Cup – for his unexpected defeat at the hands of Ted Heath the following Thursday. All this for a trade deficit of just £31m, distorted by the arrival in Britain of a couple of Boeing’s new jumbo jets.

Times have changed and it’s a fair bet that when the latest set of trade figures are released on Wednesday they will not generate nearly so much interest, even though Britain’s performance has grown steadily worse over the subsequent decades. In 1970 as a whole, the trade deficit averaged 0.2% of GDP – a performance that today would be greeted with jubilation rather than despair. Not since the early 1980s has the UK run a surplus on goods, and at the last count the annual deficit was running at £135bn. The deficit in manufactured products alone stood at £95bn.

For the first time in ages, however, there has been a stirring of interest in trade. Donald Trump is obviously one reason for that. The protectionist in the White House has spent the past week ratcheting up the pressure on China. The risk of a trade war between the world’s two biggest economies looms much larger than it did. 

Brexit has also moved trade up the political agenda. Forty-three per cent of the UK’s exports in 2016 went to other EU countries, and business groups are keen to ensure that post-departure impediments to trade are kept to a minimum.

Britain’s trade performance with the rest of the EU has been woeful. According to data produced by the House of Commons library, it has run a trade deficit in goods and services combined in every year since 1999. What’s more, the deficit is getting bigger over time, doubling from £41bn to £82bn between 2012 and 2016. 

The UK’s trading performance with the rest of the world has been better. Exports and imports were broadly in balance from 1999 to 2011 but since 2012 there has been a fivefold increase in the surplus from £8bn to £39bn.

The economist Christopher Smallwood has been looking at what has been happening to the UK’s manufacturing trade deficit since 2005. He finds that almost all sectors are running a bigger deficit. The deficit with Germany has increased by 5% a year, with France by 7% a year and with the rest of the EU by 11% a year. 

Smallwood says the UK’s trade performance has deteriorated because the single market and the customs union are designed to suit other countries, Germany in particular, but not Britain.

“It is not surprising that our trade deficit with the EU continues to grow, because the single market and customs union does not represent a free trade area. It is a free trade area only in goods. Manufactured goods represent Germany’s comparative advantage, whereas ours is in services.

“We have entered into a lop-sided arrangement under which all impediments to trade have been removed from areas where our trading partners are strong but not from areas where we are strong. So obviously our overall trade deficit with them has gone on rising, and will continue to do so.”

This argument is supported by the data. Britain runs a surplus in services with the EU and while it has been growing it has not been doing so nearly fast enough to offset a growing deficit in goods, especially manufactured goods. What’s more, the trend will continue unless EU barriers to trade in services are removed. Inevitably, life will be easier for exporters of EU manufactured goods to the UK than it will be for exporters of UK services to the EU.

Trade deficits have consequences. The need to finance them means there will be upward pressure on interest rates. Productivity growth, which depends on a thriving manufacturing sector, will be lower than it would otherwise would be. Workers who lose their jobs in industry will be decanted into low-wage, low-skill sectors.

Clearly, the UK’s whopping trade deficit is the result of a range of factors. High interest rates, an over-valued currency, a culture of short-termism, poor management and unwillingness to invest in new machinery and skills have all played a part. It would fly in the face of the evidence to suggest that the trade deficit is simply a function of being a member of the single market and the customs union.

Equally, it is hard to deny that other countries are doing rather better out of the current trading arrangements. Britain’s trade deficit for goods and services combined with the EU is 4% of GDP and rising. More than two-thirds of the deficit in goods is with the EU. The surplus in services is around a sixth of the deficit in goods.

Business groups say that leaving the single market and the customs’ union will make matters even worse, but imagine the UK on the outside weighing up the pros and cons of joining a club where the trading rules amplified our weaknesses and nullified our strengths. Would we really be gagging to join? 


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