As the dynamics of global trade continue to evolve, the United Kingdom stands at a crossroads. Throughout modern history, the UK has tended to run a current account deficit which is somewhat of an anomaly compared to other Western economies such as Germany and Japan. The reasoning behind this poor trade position is mainly attributed to the fact that UK industrial policy has been less successful in spurring l growth in manufacturing compared to the structured economies across Europe and even Japan. And, while it is true that the UK does house a great financial sector, this trade deficit has grave consequences for monetary and fiscal policy in the long run.
The nature of cross-border capital flows tells us that a current account deficit must always be repaid with a capital account surplus, where an economy is purchasing more from its trading partners than is selling to them. This creates a scenario whereby countries like the UK must sell financial assets such as government bonds to make up the difference in their national accounts.
This effectively means that the more public debt a nation owes in foreign currency, the more unsustainable the debt becomes. In this case, loose monetary policy becomes useless in depressing bond yields (a measure of risk) as this will only make debt repayments to foreign creditors more expensive due to a deterioration in the exchange rate. For Britain, whilst this result is unlikely at the moment, a consistent current account deficit will compound this risk over the long run. The result of this is a nasty feedback loop – more commonly known as a balance of payments crisis – where consistent money creation by central banks only makes the risk of public sector debt worse.
A brief look at Argentina – which is undergoing its own balance of payments crisis – shows that a balanced current account is necessary for long-run monetary and fiscal stability. This sets the stage for a new age of Mercantilism – a perspective which derives economic success from nations’ strong trade balance. For the UK, a comprehensive strategy is needed, which starts with the revival of a highly skilled manufacturing sector through a flexible labour market policy.
Pockets of specialised sectors such as those in the Milton Keynes innovation arc and the green tech surge in the Humber-Estuary signal the potential for a manufacturing revolution. Yet, ironically, this green tech specialisation was born out of labour reallocated from the steel industry, following its contraction due to an influx of cheap Chinese steel. Now economists have long hailed the virtues of free trade, suggesting its inherent infallibility and while it’s true that free trade has the potential to expand markets and improve welfare and efficiency, it does not mean its free lunch. Instead, it has become increasingly clear that the short-term ramifications of free trade can disrupt labour markets, creating winners and losers depending on industry alignment.
The losers of this equation are those hit by frictional unemployment and the burdens associated with transitioning to other industries. Although many trade economists maintain that the long-term impacts of free trade will result in lower unemployment and enhanced welfare, this contention is a topic of heated debate. Current analyses often overlook the distributive impacts of free trade, failing to account for regional discrepancies. Consequently, some communities suffer a disproportionate share of free trade costs in terms of both welfare and employment, even in the long run.
Moreover, free trade absolutists who have reviewed unemployment figures to gauge the impact of free trade shocks are also severely misled as a US case study finds that one in ten workers impacted by the ‘China shock’ ended up on disability benefits, often never rejoining the labour force. Thus, this renders the unemployment data ineffective in supporting the view that free trade has no negative employment impacts in the long run.
However, the answer to these problems isn’t a retreat into protectionism or an overemphasis on industrial policy. Instead, Britain must consider a bottom-up approach, centring on labour market reforms. While it could be argued that state intervention disrupts market equilibrium it is important to understand that this proposal is a comparatively freer and politically viable alternative. Moreover, with labour being quite a ‘sticky’ factor of production – in the sense that people can be irrational and slow to act to market signals – it becomes clear that some level of state intervention is crucial for the efficient reallocation of resources within labour markets.
Britain should focus on robust vocational training and re-skilling programs that facilitate a smooth transition of labour across industries. In the face of persistent uncertainties of a globalised economy – trade shifts, technological advancements, geopolitical issues – this strategy would help the UK become more adaptive and resilient to trade shocks whilst also reaping the full benefits of free trade. Trade reallocation training schemes would be instrumental in providing training and support to those displaced by the pains of trade within an economy. These schemes not only reduce the occupational immobility of labour but also facilitate a flexible economy where resources such as labour can autonomously divert themselves to industries of the future.
Britain must prepare for the new age of mercantilism by focusing on labour market reforms and retraining schemes. This strategy upholds the principles of free-market economists while acknowledging the necessity of state intervention in addressing labour market inflexibility. It offers a promising path forward in the quest for sustainable and adaptive economic growth in an ever-evolving global economy.