Commentary: The Balance of Payments and the Savings Gap

The recent national accounts showed the United Kingdom to be running a balance of payments deficit of 5.7 per cent of GDP in the third quarter of 2007, matching the record deficit incurred in 1988/9. In the period up to 1972, when exchange rates were fixed, a balance of payments deficit was a cause for concern, since there was the risk that it would not eventually be possible to meet the gap between imports and exports. The willingness of foreigners to invest in the United Kingdom might be limited and the foreign exchange reserves, which could be used to pay for imports, definitely were. With the change to floating exchange rates the exchange rate adjusts to clear the market. A balance of payments deficit does not then raise the same concerns, and this sometimes leads to the view that it is not very important. What should we make of the current balance of payments situation and what is it telling us about the state of the economy? A balance of payments deficit is no longer a cause for concern per se, but it can be a symptom of economic imbalances indicating something wrong with the economy. These imbalances can be explored by understanding that the balance of payments deficit is equal to the gap between domestic investment and national saving. Thus a deficit arising because saving is low is one thing, while a deficit arising because of an expansion of investment opportunities is a different matter. Examination of the relationship between savings and investment in the United Kingdom allows us to form a preliminary view how far low saving rather than high investment is driving the deficit.

Focusing on the recent past, compared with the period 2003Ð5, investment has risen by about 2 percentage points while saving has fallen by much the same amount. Thus a balance of payments deficit of below 2 per cent of GDP has been transformed into one close to 6 per cent of GDP.

The rise in investment may be explained by the extra capital needs associated with the recent flow of immigrants. There is no obvious reason why this extra capital should be provided by domestic saving; it is perfectly reasonable for the balance of payments deficit to increase in response.

The fall in national saving of 2 percentage points is rather a different matter. If the country were plainly saving too much, one would be pleased by a fall in the savings ratio. But the evidence suggests that saving even in 2004 was a long way below the levels which would be required if each cohort were to pay its own way through its life and the situation has deteriorated since then. There is probably some connection between the decline in saving and the fall in net property income from abroad apparent in recent data. However, even if this does recover as our forecast assumes, the basic savings shortfall remains a problem.

Weaknesses of the Government's macroeconomic framework

The situation highlights the continuing weakness in the Government's macroeconomic framework. Excess private borrowing creates short and long term pressures for public spending and a sensible policymaker would therefore be concerned about it as it happened instead of simply hoping for the best.

Policies to influence saving

We can identify policies which might raise saving or discourage borrowing in the future.

The fact that light-touch regulation of the banking sector has brought about our current problems makes it extremely likely that the reviews of banking regulation currently underway will restrict banks' abilities to lend. This carries with it almost the automatic implication that in future borrowing will be restricted so that private saving is likely to be higher, certainly than it was in the last couple of years. Regulation is likely to add to the cost of banking, perhaps through raising the amounts of capital required or in other ways and this must raise lending rates discouraging borrowing. In the current climate, it is hard to see political obstacles to tighter regulation. Other measures which might raise saving are, however, not so straightforward politically. One mechanism would be to impose a tax on consumer credit and mortgages. A second, rather different route would be for the Government to set its fiscal position with reference to the overall level of borrowing in the economy. In view of low private saving, it would not seem absurd for the Government eventually to run a surplus of 3 per cent of GDP instead of the current deficit of 3 per cent of GDP. Of course the private sector would react to that but in current circumstances it is unlikely that private saving could be reduced much further. In the short term an obstacle to this is that it is a substantial change to the Government's existing position on fiscal policy. In the longer term, unless such an approach can be established with a crossparty consensus, voters are likely to reject governments which impose high taxes to run fiscal surpluses in order to raise saving. If people do not want to save for themselves, they will not rush, on election day, to thank a government which saves for them. A third route might be to subsidise saving. Such a subsidy has to be paid for out of taxation. There would therefore be two effects. One would be an 'income' effect; the Government would be collecting taxes from people to add to their savings. Secondly returns to saving would rise, encouraging saving.

The reality of Britain's savings gap is that all of these policies are probably needed to some extent. A willingness to run a structural surplus on the Government's budget, together with a nonregressive subsidy to saving, should probably be long-term features of the UK's economic landscape. A tightening of the conditions on which mortgages and consumer credit are available, using tools which are capable of short-term fine tuning, is likely to be a useful means of avoiding the sort of consumer boom which caused such large problems in the late 1980s and probably rather smaller problems in the past couple of years. But progress is unlikely to be made until policymakers understand the nature of the problem.