https://cpes.org.uk/om/files/original/96e0ea0285764ba8ae698c308fa36715.pdf 89de0774b70113f0b08653e375e2c5ba 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 Prospects for Economic Management 1973 - 77 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 7 Balance of trade on goods and services by Roger Tarling 1. The balance of trade on goods and services deteriorated sharply over the period 1972-73 by £1,600 million. The Government has claimed that there have been significant elements of bad 'luck' which no policy review could have foreseen and which largely account for th~s deterioration. Implicit in that is the belief that the underlying posit~on is acceptable and that, at least before the oil price increases, future prospects were favourable. Here we shall see that bad 'luck' contributed about ~ of the deterioration of the balance of trade on goods and services in 1972-73 and that very large deficits must be expected ~n the future. Method 2. Changes in the balance of trade can be considered to have three components. FLrstly, there are short-term variations in exports, imports and the terms of trade which ar~se from domestic and world cycles Ln demand and short-run changes in our costs of production relatLve to compeL~tors. These short-term variations have been examined in great detail by many people and are fairly well understood; various studies we have carried ouL conf~rm conventioned estimates of the import content of domestic output and the effects on the balance of trade of relative ~nflation as well as fluctuations in world demand, Secondly, each component in the balance of trade is presumed to have a smooth longer-term trend; and finally there are unexplained deviations from the underlying trend which we call 'abnormal' movements.. Thus we have Actual =. short-term variation + trend -+ abnormal variat~on 3. The effects of short-term influences are removed from actual series, using relationships described in detail in the appendix, to obtain adjusted levels (actual- short-term variation), We then estimate underlying trends in the volume of exports and imports and in the terms of trade by taking logarithmic trends through the series of adjusted levels; these trends are used to project the underlying position into the future, adJusted to incorporate expected new developments such as the rapid rise in oil prices. After removing the, longterm trends, we are left with unexplained deviations from trend; it is these abnormal elements which could be called good or bad 'luck'. - 7-2 The exogenous factors a) Domestic demand and output 4. Increases in domestic output lead to marked increases in the volume of imports., The most disturbing feature is the apparently high elasticity of imports of finished manufactures with respect to changes in domestic demand, This means that an expansion of domestic demand carries with it the threat of a substantial trade deficit,. 5. We have estimated that changes in domestic output have a marginal import content of over 40%, roughly two-thirds of this being in the form of finished manufacturers, The estimated elasticity of the latter with respect to domestic demand is no·less than 4; this surprisingly high elasticity is of the order of magnitude required to explain recent changes in the volume of imports in this category, b) World demand 6. It is not at all clear that increases in the volume of world trade are necessarily favourable to our ba,lance of trade on goods and services. There are two adverse effects which may lead to a deterioration in the balance when world trade expands. Our estimates of the response of U.K, exports to changes in world trade imply that the U.K. share in total trade declines during a world boom. The other unfavourable aspect is the response of import prices to changes in worid trade; the response of the aggregate deflator for all imports of goods and services can be estimated quite firmly but the allocation of the overall response to various component deflators is less well attested. We estimate an elasticity with respect to changes in the volume of world trade which is slightly more than 1 for the import deflators of food, basic materials and semi-finished manufactures. This certainly is consistent with events in 1963-64 and 1972-73 when prices on world commodity markets were very high. 7. At best the numerical elasticities can only represent average experience over a given historical period. The effect on import prices and export volumes of a boom in world trade in any one year will depend on a variety of factors which are hard to predict in advance. The price of primary commodities is very sensitive to the world stock position and to the short-term accidents o~ weather and political developments which can affect supply. The effect of a world boom on our exports may also be quite sensitive to the particular timing and pattern of the upswing in each of the other industrial countries. All these unpredictable factors have to be regarded, in our analysis, as sources of 'abnormal' variation. This does not mean to say that they are entirely fortuitous ot incapable of rational explanation. 7-3 8. We assume that on average a 1% rise in world trade increases our volume of exports by slightly less than ~%, but that th~s ~s offset by the feedback through import prices which also rise by ~%. Given the level of domestic output, the net effect of changes in the volume of world trade on the external balance for all goods and services is therefore almost exactly zero. c) Kelat1ve costs 9. Changes in relative costs arise either through differential rates of domestic and foreign inflation or through exchange rate movements. Our relationships allow for direct and lagged effects on import and export prices and on the volume of exports, The latter is estimated to be very responsive to changes in relative costs, with a long-run elasticity of about 2, but with lengthy lags which take some considerable time to work through. Thus the recent improvement in our relative cost posit~on has not yet by any means been fully reflected in the actual export performance. Against this however is the fact that devaluation has generally been followed by fast domestic 1nflation which ser1ously reduces its value as a cure for balance of payments d~fficulties. The longer-run effects of shifts in relative costs on the terms of trade are small. 10. Because of the long lag of the response of expor~to changes ~n relative unit costs, it 1s important to note that different methods of altering relative costs, such as incomes policy, export subsidies, devaluation and depreciation, may well have different effects on the time path of the trade deficit. Policies aimed at achieving an immediate and susta1ned improvement in relative unit costs will give a more favourable time path of the trade deficit than a policy, such as steady depreciatio~ of the exchange rate, designed to achieve the same terminal relative cost position. Balance on goods and services, 1972-73 11. The El,600 million deterioration 1n the balance on goods and services between 1972 and 1973 was the outcome of a 9.4% rise in the volume of imports, an 8.6% rise in the volume of exports, and an 8.1% deterioration ~n the terms of trade. Underlying trends account for much of the increase 1n volumes, but almost none of the actual fall in the terms of trade. - 7-4 12. The expansion of domestic output by 5~% would have been expected to '/ produce a 6% rise ~n basic materials, a 15% rise in imports of semi-finished manufactures and an increase of nJ, less than 35% in imports of finished manufactures. The actual growth of imports therefore looks rather modest - but this is mainly because the 1972 level seems to have been considerably above trend. 13. Given the boom in world trade and depreciation of sterling, the growth of exports was a little disappointing. But of course the main 'abnormal' element in last year's balance was the huge deterioration in the terms of trade. On the basis of earlier experience of world boom and sterling devaluation, the predicted fall in the terms of trade would have been only 2~%. The element of 'bad luck' is therefore estimated at 5!7. on the terms of trade, worth about £950 million (of which some £110 million is the cost of the abnormal increase ~n oil prices). 14. The table below gives an analysis of the balance on goods and services ~n 1973, broken down into its short-term, trend and 'abnormal' components. It will be seen that the volume of both exports and imports were both abnormally low, perhaps because of capacity limitations both in the U.K. and in the other industrial countries. The abnormally high price of Table 1 Analysis of the balance on goods and services in 1973 Volume of goods and services (at 1970 prices) Exports Imports Trend level Effect of short-term influences Predicted level Abnormal factors Actual level 13405 +103 13508 -13 13495 13478 +405 13883 -153 13730 £ million Terms of trade (1970 = lOO) Balance on goods and :services at current prices 96.9 -0.2 96.7 -4.6 92.1 -643 -437 -1080 -641 -1721 imports relative to exports added about £800 million to the deficit in 1973. But the combined effect of all abnormal factors taken together is estimated to have been only £640 million. The conclusion of our analysis is that, even in the absence of 'bad luck', the 1973 deficit on goods and services would have been £1,100 million, implying a deficit on current account of about £800 million. 7.5 Future trends 15. The trend position in 1973 (which assumes a par 2!% level of unemployment already yields a deficit in the balance of trade on goods and services. Simple extrapolation of past trends suggests that there would be some small continued deterioration in this deficit. The volume of exports would have a trend growth of about 6.9% p.a. whereas the volume of imports would have a slightly faster 0 trend growth rate of 7.7% p.a. The trend terms of trade would remain almost constant. 16. But there are factors in the future which make the position slightly worse than this. On the favourable side, the volume of oil imports should be reduced after 1975 when North Sea oil production reaches significant levels, particularly if coal production can be maintained at last year 1 s level. On the other side, there is the very substantial rise in the price of oil imports and also the fact that the growth of the vqlume of imports is accelerating· because of composition effects. Imports of basic materials have a rather slow trend growth rate, but this conceals a switch to importing basic materials at a more processed stage which shows up in the 10% p.a. trend growth rate of semifinished manufactures. 'What gives the most cause for concern, and is the main cause of the acceleration in the growth of total imports, is the 18% p.a. trend. growth in the volume of imports of finished manufactures, which already accounted for 27% of all imports of goods and services in 1973. 17 In appendix table 8, the past and future trend position is shown inclusive of 1 abnormal 1 factors. We have to assume that the effects of high commodity p~ices on the import bill will persist into 1974 and only die away in 1975. Indeed, food prices .will never-fall back to their earlier trend level because of the new floor imposed by the Common Agricultural Policy of the E.E.C. There is also an offset in trend exports to the rise in oil prices. It must be assumed that the revenues accruing to oil-exporting countries will increasingly be spent on additional exports from the industrial countries. Agreements for special purchases from the ·u.K. have already been announced in recent weeks. We assume additional U.K. exports on this account to be worth £90 million in 1974, rising to £240 million in 1977. 18. The futu~e trend position has a 7~7% p.a. growth of total imports compared with par growth of output of 3% p.a., implying a 4.7% p.a. rise in the ratio of imports to G.D.P. This is in fact about the same rate of change in the ratio as actually _experienced by the U.K. over the past 6 years, and is quite modest by comparison with changes in other industrial economies over the same recent period (see table 2 below-). But it is markedly faster than the growth in the ratio of t [ ! - 76 imports to G.D.P. experienced by any country ;>efore 1967. Table 2 Volume of trade in industr.tal countries, 1961-73 1961-67 Growth (%p.a.) of Export Volumes Import Volumes Ratio of imports to G.D.P. Japan 15.7 Italy 11 8 Canada 8.9 Germany 8.8 Netherlands 8'7 I France u.s 6 .'.l. 5.8 U.K. ?.9 10.8 9.1 9.0 7.6 7. 8 9.2 9.1 4.6 1.4 4.1 3. 2 3.9 2.8 3,7 4.0 1.8 1967-73 Growth (%p.a.) of Export Volumes Import Volumes Ratio of imports to G.D.P. Japan Netherlands France Germany Italy Canada u.s U.K. 13.8 13. '3 12.3 11.0 10.0 8.6 8. 3 8.0 13.3 10.5 12.5 12. 1 10.0 8.9 9.2 7' 7 3.3 5.1 5.8 6.7 5.6 3.7 5.6 5.0 19 After allowing for all spec.ta1 and abnormal factors, the trend position (appendix table 8) shows an average growth between 1973 and 1977 of 7.1% per year in the volume of imports. The terms of trade, having dipped sharply in 1974, recover by 1977 to the same level as in 1973. Overall the trend deficit on goods and services is £3,100 million in 1974, falling to £2,600 million in 1975 and remaining at about the same level thereafter. Projections with different rates of growth of G. D. P, 20. We have made projections for G.D.P. growth at 1%, 2% and 3% per year between 1973 and 1977. In each case we assume that world trade returns to its trend level in 1974 and grows on trend thereafter; and that U.K. relative costs remain at their level at end -1973, thus showing some improvement from their average level in 1973. These assumptions imply that the volume of exports would grow at an average rate of 8.4% per year between 1973 and 1977. The three projections are summarised in Tab le 3. X Actual 1973 13495 Pro.:;ected G D P. growth a) at 2% per year 19 74 19 75 1977 14805 16118 18644 GrCMth rate l9 73' 7 84 b) at 3% per year 19 7'+ 19 75 1977 .L4805 16118 18644 Table 3 Summary of proiect:1ons M TT RC BT 13730 0.921 il028l 0 965 -1721 14812 15524 17231 58 i5058 16083 18574 0.848 0 877 0 918 -0 z. 0 849 0 879 0 921 lt9034 129950 154877 0,915 .0. 915 00 915 -3612 -2328 - 210 89 li9(J34 129950 154877 0.915 0.915 0 915 -3976 -3210 -2621 84 / 8 c 8. 9 c) at 1% per year 19 74 19 75 197 7 14805 16118 18644 145 71 15014 16058 0 847 0.875 0 916 119034 129950 154877 0. 915 0 915 0 91.5 -3255 -1521 1903 Grcu;th rar.e l973-7 8-.4 4 0 -0 l -l 3 Variat1ons 1n assumptions, \·li th G, D. P .- growth at 2% per year a) world trade recession 1974 1975 1977 14384 15189 17572 14812 15524 17231 0. 874 0,931 0.973 113082 116955 139388 0.915 0-915 0,915 -3482 -2194 - 226 GrouJth rate l9 73-; ) 5. 8 l.4 60 b) 2% faster relative domest1c inflation 1974 1975 1977 14684 15759 17480 14812 15524 17231 0, 851 0 882 0 927 119034 129950 154877 0,933 0.952 0,990 -3739 -2761 -1952 GrCMth rate l-973-7 6.? 5 .. 8 0 2 0-.6 c) 3% p.,a" faster growth of export volumes 1974 1975 1977 15216 17023 20790 14812 15524 17231 0-848 0877 0,918 119034 129950 154877 0,915 0,915 0,915 -3053 - 996 3469 GrOUJth rate '\ l-973-7 U. 4 5.8 -0 l 8 .. 9 -l 3 ----------------------- - 7.8 21. Growth of G.D.P. at 3% p.a., which is approximately the growth of productive potential, would hold the level of unemployment at its current level of under 500,000. The implications for the balance of trade on goods and services are however serious. The deficit in 1974 would be £4000 million falling back to the trend level of £2,600 million in 1976 and 1977. The fast rate of growth \ of export volumes, at 8.4% p.a., includes the beneficial effects of additional exports to oil-exporting countries and the lagged effects of the recent improvements in relative costs. 22. Slower growth of domestic demand at 2% per year (the growth of exports being as above) reduces the average growth of imports over the period 1973-77 to 5.8% p.a., largely through a 4i% p.a. reduction in the growth of imports of finished manufactures. This slower growth path, whilst reducing the deficit in 1974 by only £350 million, does lead to a very small deficit in 1977 of only £200 million. In fact the deficits in 1976 and 1977 are almost entirely accounted for by the higher prices of oil imports. 23. If G.D.P. were to grow at only 1% per year between 1973 and 1977, the growth of import volumes would then be only 4% per year and the balance of trade on goods and services in 1977 would be in surplus by nearly £2000 million. This shows the sensitivity of the balance to the expansion of domestic demand, the range in 1977 varying from -£2,600 million if output grows at 3% per year to +£2000 million if output grows at only 1% per year. Sensitivity to other assumptions 24. Each of the three projections discussed above has different assumptions about the growth of G.D.P. but the same assumptions about the growth of world trade and movement of relative costs. They are subject to considerable uncertainty; world trade may grow more slowly because of the fuel situation and fiscal policies adopted by other countries, there may be a rise in relative costs because of domestic inflation in the U.K., and we may have good or bad 'luck' on the growth of export volumes. Taking the projection with 2% per year growth of G.D.P., table 3 also shows the sensitivity of the balance of trade on goods and services to each of these possibilities in turn. 25. As explained in paragraphs 6-8, changes in world trade have very small effects on the U.K. balance of trade on goods and services. If world trade is projected to groV at only 2i% per year for the next two years before returning to its trend rate of growth of 9% per year, there would be only a modest imr provement in the deficit in each year; export volumes would grow more slowly -..7 (j at an average rate of 6. 8% per year but ·slower growth of import prices would improve the terms of trade at an average rate of 1. 4% per year. 26. The assumption for competitiveness incorporated in the projections ~s shown in appendix table 10. Also shmvn in that table is t.he par series for relative costs. This series for par relative costs does not provide a current target for relative costs; it shows the movement of relative costs, past and future, which would have been necessary to meet balance of t-"-ayments targets o.ver the years. It is nevertheless instructive to compare actual and projected relative costs with this par series. The average par level of rela~ive costs through the period 1973 to 1977 ·.vould be nearly the same as the projected actual series. The most important difference between actual and par relative costs, which give rise to large projected deficits, is that from 1970 to 1973 actual relative costs have been on average 8~% above the par level. 27 If, instead of constant relative costs at the end-1973 level, we assume faster domestic inflation, so that U.K. relative costs rise at 2% per year, the growth of export volumes betvTeen 1973 and 1977 is reduced from 8.4% per year to 6. 7% per year. Because of the hig~1 long-run elasticity of export volumes to relative costs, the deficit on goods and servi· es is increased by £1700 million in 1977, although the effects in 1974 and 1975 are racher small. Thus, with an extra 2% per year domestic inflation, the tra·'e deficit in 1976 and 1977 is still £2000 million and even slow growth of G.D.P. at 2% per year fails to meet any reasonable target on the balance of trade on goods and services. 28. If exports grew 3% p.a. faster than expected between 1973 and 1977 (at 11.4% p.a. rather than 8.4% p.a.), the annual rate of improvement in the balance on goods and services bet~veen 19 74 and 1977 would be £2000 million a year, turning a deficit of £3000 million in 1974 into a massive surplus of £3500 miJlion by 1977. A 3% p.a. slower growth of exports has an equally large adverse effect on the balance; in that case, the deficit would average about £3,900 million a year between 1974 and 1977. 29. If export volumes actually grow considerably faster than expected, the stronger balance of payments would permit faster growth of G.D.P. The converse is that slower growth of export volumes would be disastrous. If, in fact, do~stic inflation is not contained and sterling does not depreciate so as to maintain relative costs at their present level, there would be a progressive deterioration in the balanc· of payments, continuing beyond 1977, because of the lengthy lags in the response of export volumes to changes in relative costs. 7.10 Conclusions 30. The conclusions to be drawn from this analysis are rather depressing. After allowing for all special and abnormal factors, G.D.P. growth at 2% per year between 1973 and 1977 does not get to a balanced position quickly; indeed the cumulative deficit on the current balance of payments for the years 1974 to 1977 would be £8,000 million adthe U.K. would not have covered any of the £7,500m. cost of abnormally high prices of primary commodities and oil imports. The pro~ jections show that the balance of payments is very sensitive to the rate of expansion of demand; it also appears that the deficits projected for 1974 to 1977 if G.D.P. grows at 2% per year could comfortably be financed given the conclusions in chapter 6 about the ability of the U.K. to finance balance of payments deficits over the next few years. 31. The analysis suggests that we cannot rely on world trade to solve the balance of payments difficulties; world trade booms or slumps, in the absence of any 'abnormal' movements, have no significant effect on the U.K. balance of payments. The variations in import prices associated with variation in world trade could however have important consequences for changes in relative costs; which, as table 3 shows, have marked effects on the balance of trade on goods and services in the long run. 32. The expansion of world trade in recent years has affected most industrial economies (see table 2, para 18), leading to increases in the rate of growth of import and export volumes in nearly all countries shown in the table. A move to autarkic protection, involving import controls, is likely therefore to be met with strong retaliation; it may also prejudice gains in productivity from specialisation. The response to balance of payments difficulties should therefore be to seek a faster growth of export volumes. Given the high long-run elasticity of exports, this could be achieved by a sustained improvement in relative costs.  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 7 Balance of trade on goods and services Creator An entity primarily responsible for making the resource Roger Tarling Source A related resource from which the described resource is derived Prospects for Economic Management 1973 - 77, pages 7-1 to 7-10 Date A point or period of time associated with an event in the lifecycle of the resource 1974