In my previous post, I suggested that for UK public (and private) debt to fall sustainably would require a dramatic shift in the current account from deficit to surplus, which would need to be maintained for a number of years. I also suggested that this seemed an unlikely scenario in the medium term. The UK current account deficit hit 6% of GDP in the third quarter of 2014 and has averaged over 5% for more than a year. As already mentioned, economic stagnation in the Eurozone represents a significant constraint on the expansion of UK net exports. Without sufficient demand for UK exports from its largest trading partner, the prospects of achieving even a small surplus seem bleak.
There are two channels through which a recovery in the Eurozone would help the UK to rebalance its economy. Such a recovery could be associated with a rise in consumption, and of imports from the UK which could improve the current account balance. This would be a boost to demand in itself. However a sustained recovery in the Eurozone would also be likely to lead to a rise in the euro exchange rate against the pound, as investors become more confident in economic prospects on the continent. A relatively lower pound sterling vis-a-vis the euro would provide a further boost to UK trade, as UK exports become cheaper for consumers in the Eurozone, and imports from the latter become more expensive for UK firms and consumers. This would lead to a further improvement in the current account towards a surplus.
Whether this would be enough to produce a current account surplus for the UK remains to be seen. The Eurozone economy is showing few signs of dynamism which will continue to be a drag on UK growth. The largest economy on the continent is Germany, which also has the largest current account surplus. What really needs to happen is for German consumption and imports to rise, shrinking the surplus and providing a source of demand to exporters across the continent including the UK. If German profits are not to fall and prices to rise excessively, damaging investment and competitiveness prospects as a result, then productivity and wages need to rise to stimulate consumption spending. This in turn would require a significant rise in public and private investment. This would represent a reversal of economic trends in Germany over the last decade, but is vital for a Europe-wide recovery. It would help the UK, as well as Spain, Portugal and Greece particularly, to recover by boosting net exports in countries such as these. German unemployment may be low, but overall economic performance has, contrary to popular belief, been quite poor in recent years, aside from an export boom, and has not benefited the majority of the population with wage increases. Indeed, wages in Germany have stagnated, keeping the prices of exports competitive and contributing to the export boom and consequent large current account surplus. The counterpart to this was large current account deficits in countries such as Spain, but also in the UK. The credit booms and increasingly uncompetitive export sectors that were reflected in these current account deficits led to the Eurozone crisis, which is ongoing. For Spain and other countries involved in the crisis to rebalance requires Germany to rebalance. Such a rebalancing would benefit the UK as well. If this is happening at all at present, it is doing so in an extremely painful way, producing mass unemployment and rising poverty across the continent.
Returning to our original thesis, the UK needs to rebalance its economy towards running a current account surplus to begin to pay off its large public and private sector debts. This requires a resolution of the Eurozone crisis and a continental recovery, led by Germany. If the latter does not happen over the next few years, UK exporters will need to seek new and faster growing markets in countries outside the Eurozone where growth prospects are much more positive. That they are not doing so at the moment is partly reflected in the large and persistent current account deficit. But until the world economy produces faster overall growth in demand, either of these alternative scenarios for rebalancing and recovery remains a distant goal.