Is the UK Balance of Payments Sustainable?

The UK current account deficit John Muellbauer and Anthony Murphy The UK has a large and persistent current account deficit. Policy makers argue that the deficit is easily financed, temporary and therefore not a sign of structural weakness. We examine the conditions in which it is appropriate for a country to overspend its current income with the intention of repaying loans out of future income. These include: an increase in international capital mobility, larger net holdings of foreign assets, and expectations of faster productivity growth. All three apply to the UK, so official reasoning is, in part, correct. Even so, for several decades there has been a trend deterioration of UK trade performance, most markedly in manufacturing, and we detect no underlying improvement in the 1980s. We highlight structural deficiencies in both demand and supply. On the demand side, we show the importance of rising house prices and easier consumer credit in fuelling the consumer boom to an unwarranted extent. This we trace to unjustifiable subsidies to house ownership. On the supply side, we stress vastly inadequate investment in skill formation, education and physical capital. These structural deficiencies lead us to a less optimistic view than official policy. We draw the policy lessons for the UK and consider whether continental Europe will face similar problems as financial markets are liberalized.