https://cpes.org.uk/om/files/original/c599459ed20a62913cddbb749acf6440.pdf e59920e0c43e23940fe06196a180d9b9 Dublin Core The Dublin Core metadata element set is common to all Omeka records, including items, files, and collections. For more information see, http://dublincore.org/documents/dces/. Title A name given to the resource Problems in the Management of the Economy 1971 - 75 Text A resource consisting primarily of words for reading. Examples include books, letters, dissertations, poems, newspapers, articles, archives of mailing lists. Note that facsimiles or images of texts are still of the genre Text. Text Any textual data included in the document Chapter III The Balance of Payments This chapter considers what target for the balance of payments should be adopted in principle and in practice Since, in our approach, the non-trade items in the U.K.'s balance of payments are thought of as being determined largely, if not quite wholly, independently of the pressure of demand in the domestic economy, the achievement of external balance essentially involves the adjustment of the balance of exports and imports (henceforth called the balance of trade). 2. In this chapter, we discuss what is meant by external balance and show that the concept involves some consideration of the UoK.'s external short-term balance sheet. We then examine the flows of non-trade items throughout the period 1960-75 and see what they entail for the par economy in terms of a required or "target" surplus or deficit on its balance of trade. This involves us in making projections which are in some cases unusually hazardous - in that the non-trade flows are heavily influenced by special factors and therefore not on the whole amenable to the sorts of predictive techniques that can be used elsewhere in the exercise. The projections are discussed in some detail in the hope that others interested in the balance of payments field will be stimulated to agree or disagree as they think fit. 3. Briefly, the main results for the balance of payments can be summarised as follows: Par Balance of Payments, 1960-75 (l) (Annual averages; £ million; at 1970 values ) Item 1960-71 1972-5 Long-term capital & trade credit outflows (net) -292 -454 Property income from abroad & transfers (net) 254 133 Par balance of trade 45 190 1960-75 -333 224 81 "Basic balance" 7 -131 -28 (1) For all items, current values are deflated by a single deflator the Blue Book price index for imoorts of goods and services (based at 1970). But see also paragraph 11 below. (2) For present purposes, "basic balance" is defined as the balance on current and long-term capital accounts, including trade credit as part of the latter. III 2. In principle, the par "basic balance" for 1960-75 should average approximately zero; it is shown as being in slight deficit here largely because of some extremely heavy net outflows proJected for the last three years of the period" It is envisaged that the par economy would deal with these by tightening exchange controls, the effects of which are not included here. The meaning of external balance 4. Assuming that 1t starts wlth a satisfactory external balance sheet, the par economy 1s considered to be an external balance if, over a period of years, it earns just sufficient on current account to pay for net t~ng-term investment and net expansion of trade credit overseas" ·If it fails to do this it spends reserves or accumuia~es m~netary (l1quid or near-liquid) liabillties, and if it earns more than th1s us liquidity position improves. 5, There is room for debate as to whether the U K~'s liquidity position at the end of 1959 was indeed satisfactory or not, but it is a debate into which we do not wish to enter here We have simply taken the view that, for the purposes of this exercise, the par economy should not be required to compensate in the period under rev1ew for weaknesses in the U.K net reserve position inherited from the remoter past. Two factors may be cited in justification of this Firstly, no 1nternational agreement has been reached, or seems likely to be reached in the immediate future, on the orderly reduction of the U~K.'s sterling liabilities; and secondly, the U. K. , along with other members of the International Monetary Fund, has received several large allocations of drawing rights which have, taken on their. own, substantially added to its official reserves and available lines of credit. We accordingly regard the reserve target as being met if, between 1959 and 1975, the U.K 's net external liquidity is improved by roughly the extent of these add1tional "paper" and "credit" reserves, 6. Although, in principle at least, the par economy ts imagined as generating current account surpluses on average to finance its "·structural" capital outflows taking one year with another, it is not required to achieve this balance in each individual year. It accommodates fluctuations in the net capital outflow in the first instance partly through movements in its net liquid liabilities, and if these threaten to be very large and persistent it is considered to act to moderate the capital outflows through adjusting its exchange controls and other regulations affect1ng overseas investment. However, the impact of such controls taking the per1od as a whole is determinec by reference to a policy judgment concerning the volume of resources that the par economy should reasonably expect to devote to net long-term investment overseas. (Trade credit is assumed to be determined largely by the growth of exports and imports, and is therefore not so amenable to control as longterm investment,) 7. Implicit in our balance of payments target, set out in paragraph 3 above 1s the view that the par economy could on average devote very roughly £300 million of resources (at 1970 values) to building up net long-term assets and trade credit overseas without undue stra1n on consumers~given past and projected levels of par G.D,P. and net external investment income. Given the reserve objective ment1oned earlier, and after allowing for the net impact on the current account of interest, profit and dividends, public and private sector transfers, and contributions to the E"E.C. budget, this implies a required balance of trade (in goods and services) of just over (1) £80 million per annum (at 1970 values) for the period as a whole. The tendency of the trade target to grow, especially towards 1975, reflects primarily the heavy projected build-up of overseas investment and trade credit (1) For annual figures, see the first column of Appendix Table 5. Ill - 4. flows and the need to pay for membership of the E E C towards the end of the period. The actual £iCture to 1971 8. The starting point for detailed construction of the balance of payments target LS the actual record 0f payments fl0ws since l960 (see Appendrx Table 4) Commencing at end-1959, the cumuiatlve t·jtais of these flows by end-1971 (at cunent price~) .:.an be summansed ci& follows; Current balance Long-term investment overseas (net) Outflow of tcade .: redit (net.) "Basic balance'' New allocat1ons jf reserves, ere Net reserve effect £ mi ll1 ),_, 1042 -1474 -1490 -1922 728 (l) -1194 (1) Increases in the U K s ordinary draw1ng eights at the I M F ; allocations of special drawing r1ghts; and the net impact of revaluations etc affecting the reserves and E E A lvsses on forwards in 1967 and 1968 toliowtng devaluation It can be seen thac the outflows ot long-term investment and trade credit greatly exceeded the actual current balance, creat1ng a "financing problem" of some £1900 million The latter was partially off&et by new allocations of reserves from the I M.F. but, desp1Le these, the U K. 's net liquLdity position at. end-1971 had worsened by nearly £1200 m1llion, with heavy adverse effects in most years before 1969 being only partially compensated for by rapidly increasing favourable effects thereafter (1) (1) These figures are based among other things on the assumption that the "balanc1ng item". wh1ch has been heavily positive s1nce devaluation, represents mainly unrecorded short-term (and highly volatile) capttal inflows. To the best of our knowledge, this interpretation is the correct one .~·: _,.... ...... '· ~·. '' -.·.,,.. Ill - ) 9. Examinat1on of the U K. 's estunated balance sheet of reserves and liqu1.d liabilities at end-1971 suggest!:> that the hnancing problem has been overcome l by a build,up ot l.1qu1d and near-liqul.d external l1ablllttes of nearly £2,500 million, enabling an accumulat1on ot reserves (tncluding unused I.M.F drawing rights) of nearly £1,300 m1.llion to take place. If these figures are broadly correci, the present embarrassingly healthy state of the U K ·s reserves can be attr1buted largely to allJcationE> oi l M F overdraft facilities and to a mass1ve inflow of short·term funds, 1t 15 apparently by no means the case that the improvement 1n reserves as compared W.Lth end-1959 can be traced to trad1ng surpluses followtng devaluat.Lon. Projection of the non-trade flows 10 As stated earlier, the non-trade flows 1n the balance of payments are regarded as being determined largely 1ndependently of the pressure of demand at home,. and are therefore treated in our exercise as exogenous, at least as a first approximation. Future est1mates were obtained for these 1.tems by proJecting them, at constant pr1.ces, on the basis of the best informat1on available to us. 11. Each of the major non-trade itemE> waE> projected separately, on a gross basis and in volume terms Th1s procedure may not be quite consistent with the use of a Single (import price) deflatot in arriv1ng at 1970 values for past flows if 1.ndividual prices of the various items do not move in step w1th U K. import prices, but the resulting d1stortion is likely to be unimportant over the projection period, except 1.n the eventuality of changes in the exchange rate The latter raises a particular kind of problem for the treatment both of the non-trade. flows - especially investment earnings - and asset values which will be dealt with below (see paragraphs 21 to 24 ) 12. Public sector transfers and inter-government loans were projected mainly on f··'·''·'··'-.;. Ill - 6' the bas~s of the aid programme in the Wh~te Paper. Grants and loans by the U K Government are expected to grow steadily by about 8 per cent per annum 1n real terms, loan repayments by the U K are expected to reach about £75 million in 1975, and "other'' long·term offic1al lending, about £50 million. Net private transfers overseas were made to continue the rapid increase in this item in recent yearsr but at a decelerating rate 13. Particular diff1<:ult1es attach to the predict1on ot private overseas investment because of the extreme var1ability of these flows 1n recent years. Special factors that must be taken 1nto account are the effect~ Jf the voluntary restraints on U K.. 1nvestment in the overseas sterling area, and the possib11lty that these may be eased 1f, for instance. the U.K 's net reserve pos~t1on continues to 1mpcove, the encouragement that 1s n~w being given to nationalised 1ndustries to ra1se long-term f1nance overseas; the probability that entry into theE E.C w1ll induce both substantially greater direct 1nvestment by U.K firms on the Cont1nent and, more importantly: by Amencan firms in the U.K ; the possibility that adoption of EEC. rules on free capital movements will result in a heavy outflow of U K portfol1o investment, seek1ng to avo1d the investment dollar premium · wh1ch we th1nk unl1kely in the context of our time period; and, not least. major uncerta1nties surrounding the future levels of inward and outward 1nvesrment by the oil compan1es 14. As regards inward o~l investment, we have taken the v1ew that the mass1ve inflow of some £350 million for "oll and miscellaneous" (at 1970 values) estimated to have occurred in 1971 represents a peak ~n the capital inflow associated with the exploration and development of North Sea oil and gas, and that this figure will fall by about £100 million in real terms by 1975; and foe outward oil investment we expect that the British oil companies will raise the1r present investment overseas of some £150 million p.a .. to about £200 mill1on in 1975 (although this will to some extent be offset by greater . . .'-~· '~...- Ill - 7.. long-term borrowing by the companies from overseas - particularly European-sources) 15. In proJecting direct Investment (other than oil and miscellaneous) we have allowed flows 1n ea.:h direct1.on to increase steadily In real terms to reach about 142 per .::ent of theu 1970 levels in 1975, which 1.mplies average annual growth of about 7~ per cent, Th1.s represents an appreciable acceleration as compared with the trend Ln outwdrd direct Lnvestmenl observed before 1970 (a pertod that witnessed substanti.a1 tightening of restr<tints), and more or less unaltered cont1.nuat1on of the trend 1n inward direct 1nvestment 16 As .:.an b£: seen ttom Appendix Tdble ~; the 1.rnplicat1.on of t>o:5e various proJections 1s a net long·term capital outflow of some £335 m1llton 1n 1975, which amounts to a tutnround of ab.:>ut £460 m1.ll1on from the .excepti.on.J 1 net inflow 1n 1971 i 7 Equai 1f n.:>t gre<tter d1tticulty attaches to the proJection of trade credit The "net" ·:>£ thl.S Hem appears to have grmm w1.th considerable rapidity s1nce abvut 1965 although it 1s eStimated to have fallen back qu1.te appreciably in 1971. In the absence of any d(Lep~dble method of relat1ng trade cred1t to trade flows 1ntecest rates, etc .· and w1thou~ clear I.nformati.on about what to expect 1.n the future- we allowed the n<::t outflow of "unrelated" cred1.t to build up to about £250 mill1.m in 1975 thereby cont1.nu1ng the approximate order of increase in_ real terms obse£ved s1nce lhe mid-l960s It must be admitted that major uncertainty attaches to this estimate, but \-Je would he unable to improve it w1.thout a great deal more research, and the uncertainty iS not crl.tical to the trade target, as Will b£ explained in due course f8. Hav~ng projeLted investment fiows, the est~mat~on of future payments of interest, profit and dividends was a relat~vely straight-forward matter E.:unings and payments on direct investment and "oil and miscellaneous" were projected us1ng s1mple lagged income/net asset ratios that seemed with a little trial and erro[ to fit past data (l) {I) Rattos of 10 per cent with a two-year lag and 12 per cent with a three-year tag were adopted, with some minor modi.fi.cati.ons, for direct investment and "o1.l and miscellaneous" respectively · Ill - 8 U.K interest payments on public sector debt held overseas were projected in line with anticipated actual movements in liabilities outstanding" The net outcome of these proJeCtions was a reduction 1n the net flow of investment income from some E520 mili1on m 1911 (at 1970 values) to some £440 million in 1975 19, The figures for the U,K. contnbution to the E.E.C" budget were obtained from the Government's latest published estlmate contatned in the 1.fuite Paper The Unu.ed Kingdom and the European Communtties (Cmnd 4715) 20 Annual figures for these various items are brought together for the enttre period under Study in Appendix Table 5. The pattern of flow::. ·:an be summarised as follows; Current Non-frade and Capttal Flows 3 1960-75 Pertod (l) Net I.P.D. and tran&fers (2) Long-term capital and trade credit (net) (Annual averages, £ million; at 1970 values (a) } (1) T (2) 1960-63 258 ·223 35 1964· 67 254 ·369 -ll5 t968-7i 251 -284 -33 P£oje~:ted 1972-75 -454 -321 Notes· (a) For 1971 and earlier, current values were divided by the Blue Book prtce index for imports of goods and services, 1970 = lOO (b) Includes contributions to E E.C budget Particularly noteworthy are the heavy outflows of capital in the period preceding devaluation and those proJected for the period 1972-75. The latter, in conjunction with the projected fall-off in net I.P D. and transfers, impltes a combtned adverse balance for all these items in 1972-75 of truly unprecedented proportions ill .. 9. Effect of exchan~e ratt changes and ~nflaticn 21. Both ~n arriv1.ng at par esttmates for the past (l960-71) and in mak~ng projecttons for 1972 5, we have ignored the effect of exchange rate changes and (for 1972-5) ~nfla~ton ~n non-trade flows and asset values. This is not a very ser~ous matter for the par estimates cover~ng 1960-71 since the movement of the par terms of tra.de. over the pen.od as a ~-r.ole ::.s almost ~dent~cal to that of the actual terms. of trade, and the eftects of the actual devaluation at end-196; are c~ntained 1n the esttma.teci past actual f~gures. But r~r 1972-5 we have estimated all flows at constant 1970 values, thus abstracting from world inflatton as reflected LP 1mport pr1ces, and we have not made any provtston for non-trade effects of irnplted sterllng devaluation. 22 In the past .devaluation has cont<:tbuted a sebstanttal !.. rnprovement 1n net property ~ncorne from abroad, and this effect ~s expected t~ apply for any future devaluation. But agaiGst th~s we must set the effect ~f devaluatton on the prtce ot unportt:d l.J.:Jd under the Conrrnon Agricultural Poltcy of t~e LE.C. Rough calculaticn suggests that by 1975 the effect of devaluation on the cost of food tmports w1ll more than offset any tncrease 1n net property income We have not made any allowance fo~ either of these effects, 23. The effects of w0rld 1nflat~on on the net reserve pos1t1on, excluded from our proJect~ons for 1971-5 because flows are expressed in 1970 values, LS to reduce the magnttude of any past net cred~t or deb1t posttion relative to current flows. Thts tends to work in the U.K 's favour since the reserve position, as·we have defined it. always shows an excess of liabilit~es over assets. But our .proJections rr;ake no attempt to quanttfy this advantage, 24,, Exchange rate changes w1ll also, as noted above, result in some asset revaLuation. The estimated gain in the reserve pos1t1on resulting from the 1967 devaluation was a ~220 million reduction 1n net liabilities; but this was more than offset by a large E.E.A. loss on forward transactions, For par Ill - lCL estimates, or the hypothetical future devaluation, one may assume that the balance of these two effects would not be adverse because large losses on forward transactions could probably be avoided, The par balance of trade 25 The dertvatton of Ci batance of trade requirement for the par economy from these flows 1& very muLh a matter for judgment In arr1v1ng at the target of just over £80 mtllton per annum shown 1n paragraph 3 above (and in greater detatl in Appendix Table 5) a number or related objectives anu auditions were borne in mtnd .. Firstly. it was consrdered that the par economy would attempt to improve the balanct of its reserves and short-term llabili.ttes by something approaching the sum ot new I ~ f drawing rtghts received In the entire period, net of gold subscripti~ns (nearly £1000 mtllton). Secondly, the overall Impact of actual exchange controls etc on flows of long-term capital between 1960 and 1971 was taken to be about right for the par economy (although the timtng of changes might have been different) implying that net "structural'' capital outflows averaging slightly under £300 m1ll1on (at 1970 vnlucs) were broadly acceptable for the per1od as a wh~le. Thirdly, while meeting the target deficit on non·trade 1terns of just over £80 rnillton per year for the period as a whole, the par trade balance was made to fullow a sharply r1sing trend in reflection of the need to prov1de for rapid expansion in net inveitrnent overseas and trade credit Furthermore, the balance was made to vary around this trend in response to fluctuations in the net total of other items, the possible improvement in any <Jne year being limited, In line with actual experience, to not more than £40-50 million 26. The stimulus for adJUStment both uf the par trade balance and of par exchange controls, etc." can be concetved of as coming from movements in the net liquidity position. Should large cumulative movements occur in the par Ill · I L economy's net reserves despite the effect of adjustments to the trade balance (say, appreciably 1n excess ot £1,~)0 mtllion from the target liquidity position} 1 these would provide a signal for adjustments in par controls on overseas investment and credit expansion as well as for further trade correction, 1n fact. given the allocat10ns of new reserves and adjustments to these controls that actually took place during the period, the target trade bafance pr0ved JUSt capable of handling swings in rhe non-trade items throughout the pertod. although 1t is clearly under Increasing strain to do so as 1975 approacheso 27, The sertes finally selected for the target balance of traa~ grows steadily from a postulated defictt tn 1960 of £50 mtl1ion (at 1970 values) to a surplus of £100 mi 1tlon in 1969; tt then rematns stationary for thr·ee years in response to the rapid build up ot reserves (hen postulated as taktng place. and increases very sharpiy thereatter at something apprC>achtng the maxtmum permitted rate as the liqutdtty positton detettoraL~s, eventually reaching a surplus of £250 millton in 1975. 28. lt wtll be observed from Appendtx Table 5 that th., t:rade target meets all the requtrements we tmposed uo tt apart from the desired tmprovement in the net ltqutdity positt~n. (The baiance of reserves and tiquid liabi1ittes ts shown as havtng 1mpr0ved by only £443 mil!ton by 1975" as compared with a target at nearly £1.000 million.) Thts f&tlure Is best Lnterpreted as being a stgnal to the par e.·:vn:.~my thdt the CiCtual out£L)W5 of long·term capttal and trade credit pr0Jected tor 1972 75 (partly on the expectation of a relaxation in exchange controls and voluntary 1nvestment restraints) are 10 excess of the targets postulated for 1t. The result can be envisaged as a strengthening rather th~n weakentng of overseas investment and credit restratnts by the par economy as the Loss at reserves in the last three years of the period threatens to go beyond tolerable limits .. The effect of this policy might be to reduce the net cap1tal outfl0w shown in Appendix Table 5 by some £150 million per Ill - 12. annum in 1973-5, thereby adding £450 milliOn t,.J the par economy's closing total of reserves.  Dublin Core The Dublin Core metadata element set is common to all Omeka records, including items, files, and collections. For more information see, http://dublincore.org/documents/dces/. Title A name given to the resource Chapter III The balance of Payments Creator An entity primarily responsible for making the resource Cambridge Economic Policy Group Source A related resource from which the described resource is derived Problems in the management of the economy 1971 - 75 pages III-1 to III-12 Date A point or period of time associated with an event in the lifecycle of the resource 1972