The Current Account as a Political & Foreign Policy Issue

Today’s Times leads with a Chinese threat to the future of up to £100bn of investment in the UK economy.

The new UK government’s review of the Hinkley Point nuclear power station — and implicitly of the role China plays in the project -is already having serious repercussions. The newly installed Downing Street Co-Chief of Staff is notably less keen on the previous government’s policy towards China. Hinkley Point may just be the first manifestation of this new official attitude.

One prominent Treasury minister (Jim, now Lord, O’Neill — coiner of the term BRICs) is already apparently threatening to resign. And now the Chinese, understandably enough, are reportedly threatening to pull other investments in the UK.

The outgoing Government’s policy towards China was certainly accommodative (I’m using a lot of willpower here to avoid the term kowtowing). The UK has made a push for closer economic and financial links — the first Western state to back the AIIB, luring overseas RMB bonds to London, promising a stock market tie up, showing an at times cavalier attitude to Chinese human rights issues and risking the displeasure of the State Department in the pursuit of monetary advantages. That might all be changing.

But it’s worth stepping back and asking what exactly drove what was in reality a major foreign policy shift. On one level it was the UK’s large current account deficit.

The balance of payments, as it says on the tin, balances. The UK has an historically persistent deficit on the current account (the sum of the trade balance of goods & services plus net investment income from abroad (payments coming in from overseas UK holdings minus payments sent back by foreign entities in the UK) and some other, smaller, transfers). In recent years that deficit has widened as the income account has moved from a surplus to a deficit. In effect the UK is receiving considerably more money from the rest of the world than it sends aboard.

The counterpart to the current account deficit (the thing that makes the balance of payments actually balance) is a large surplus on the financial (or capital) account. That’s foreign lending to the UK and foreign acquisitions of UK assets.

Simply put the UK economy is reliant on large flows of foreign capital to keep it functioning in its current state.

The Governor of the Bank of England has commented that we are dependent on the “kindness of strangers”. Well, as Martin Weale has noted, it’s not really kindness — they do demand a return.

As I’ve argued repeatedly — I think this deficit is both an indication of a domestic economy that is seriously out of balance and a potential source of economic vulnerability.

But leave aside for a moment the raw economics — it’s increasingly clear that the large and persistent current account deficit is also a potential political and foreign policy problem.

A country dependent on foreign capital inflows (and we are unique amongst the major economies in the extent of our deficit) finds itself having to take action to attract such flows.

The Chinese threat is only really a threat because we have a deficit to finance. Whilst I’m not arguing that UK policy is East Asia is driven by a current account deficit — I certainly am saying it’s a factor that influences our behavior.

We moved on from Suez - when a threat to a weak current account position could shift policy dramatically — but perhaps not as far as we may think.

But the implications of our foreign capital reliance go beyond foreign policy.

One of the first tests of the May government’s new business policy was the Japanese takeover of ARM — Britain’s leading technology company. A takeover that came days after May signaled a new attitude to industrial policy and overseas acquisitions.

That takeover was nodded through with some (unenforceable?) guarantees on UK jobs, despite some hand-wringing in the tech sector.

As long as we run a persistent current account deficit these sorts of situations (ARM, Astrazenca, Cadburys) will keep emerging.

We tend, as short hand, to say the UK is “borrowing record amounts from the rest of the world” when discussing the current account. A more accurate statement would be “borrowing record amounts and selling record amounts of assets of UK assets to the rest of the world”.

Equally — complaints about foreign buying of UK property (especially in London) pricing locals out of the market come up with alarming regularity. What do we think is behind this?

Foreign capital is sometimes very useful to the UK economy — in the car industry a combination of foreign capital investment and better management have turned the industry around.

But it also comes with costs — costs in terms of selling successful British companies, large parts of the housing market leaving British hands and potentially pressure on our foreign policy. It’s hard to “take back control” when you are as reliant on foreign money as you’ve ever been.