Chapter 9 The Balance of Payments

Peter Sinclair

What is the balance of payments and how do we measure it?

Why is the balance of payments of interest to economists and policymakers?

Is the UK borrowing from or lending to the rest of the world and how is this position financed?

Is the UK’s external financing position sustainable?

How does Brexit and other international trade policy affect the UK’s relationship with the rest of the world?

In 1695, William III of England appointed a new committee of the Privy Council “for promoting the Trade of our Kingdom, and for inspecting and improving our Plantations in America and elsewhere”.

Read the records of the Board of Trade in the National Archives.

The first priority of the “lords of trade” was the American Colonies but, from 1749, they also began to focus on trade with colonies in Africa, becoming the Board of Trade in 1786, a title which survives to this day.

We think of national statistics as something that were conceived and developed in the twentieth century. But data on the international trade of England, then Britain, and finally the United Kingdom has been measured for more than three centuries.

Today, the UK economy is one of the most open economies in the world, as trade and investment flows are particularly important for the UK. International trade comprises around three-fifths of its GDP, while the UK plays a major role as a financial centre for global financial flows. Production processes have become more international, such that the UK economy now reflects a complex set of inter-relationships in the world economy. For example, the manufacturing of motor vehicles in the UK no longer reflects a domestic industry that only serves UK consumers. Instead, it is an industry that reflects the UK’s participation in global value chains. It includes inputs into the production process that are imported from elsewhere, while value added is also reflected in the exports of other countries.

balance of payments (BOP)
Summarises transactions between residents and non-residents during a period; consists of the current account, the capital account, and the financial account.

The United Kingdom is the world’s fifth-largest exporter of goods and services. One worker in three is employed in producing exports or retailing imports at home. So no study of the UK’s economic statistics can be complete without studying these large flows of international trade, and the balance of payments (BOP) in which they play a major role. At the same time, the City of London constitutes one of the largest financial centres in the world—indeed, on many measures, the largest of all. Many of the flows associated with globalisation are channelled through the London financial markets, another reason why the UK needs to be closely concerned with the issues posed by globalisation.

International trade occupies a leading role in economic and political discussion. During the four or more years of Brexit discussions, one of the most prominent strands was the UK’s future trading relationships with the European Union. Globally, one of the most significant events of recent decades has been the re-emergence of China into a major role in the world economy, greatly increasing its exports to the rest of the world. Was this a good development? Probably the majority of economists agreed that it was, enabling the world to enjoy the benefits of increased specialisation. But not everybody thought so. In 2019, the United States threatened barriers against Chinese (and Mexican and Canadian) exports. This led to counter threats against US exports—the beginnings of a global trade war. What cannot be doubted is that, for many decades now, trade has grown much faster than national incomes.

It is not just trade, though, that is of interest. In fact, international flows between countries relate not only to trade, but also to the purchase and ownership of assets. These might be UK residents’ acquisitions of overseas assets—whole companies, for example—or of financial assets. In the opposite direction, foreign residents acquire UK businesses or invest in bank deposits or securities traded on the Stock Exchange. The ratio of such transactions to countries national incomes, just as with trade, has increased vastly in recent decades.

What we are talking about with both trade and financial transactions is the phenomenon known as globalisation. In production terms, the world is much more interconnected. The design—of a car, for example—may originate in one country, parts then manufactured in another country—or perhaps several countries—and then assembled in yet a different part of the world. Such global value chains are no longer a curiosity but an everyday feature of much of the productive process. Imports and exports are involved at each stage.

Similarly, the ownership of assets is much more internationally oriented. Increased ownership of domestic assets by foreign residents is not only evident in the UK but is a general trend around the world.

9.1 What does the UK export and import?

Trade is, of course, much older than the earliest statistics.

9.1.1 Four millennia of imports and exports

Great Orme, a coastal hill near Llandudno in North Wales, was an important copper mining centre 4,000 years ago, when Britain exported copper to Phoenician cities in the Mediterranean. Cornwall was rich in tin. Cornish tin mines operated for four millennia, until the last one closed in March 1998.

Well before the arrival of the Romans in AD 43, however, Britain had diversified. In his ‘Geographica’, Strabo reports that Britain exported corn, cattle, hunting dogs and animal hides, as well as other metals such as gold, silver and iron. Slaves were also exported, he notes. Labour was presumably much cheaper there then, than in the tighter labour markets of the Roman Empire.

It was partly the shortage and high price of precious metals that led the Romans to occupy Britain. They mined lead for export in Somerset, and gold in Dolaucothi, in Carmarthenshire. Emperors owned substantial agriculture estates in fertile parts of England, where, among other goods, wool was produced and exported. English wool and cloth were sent to Gaul from the eighth century, at this time along with cheese (which Strabo complains British farmers never produced, despite ample supplies of milk). Later, exports of East Anglian wool, together with woollen textiles and apparel, formed the basis of much of later medieval England’s economy. In return, some pottery items and wine continued to be imported, sometimes irregularly, from the Roman period onwards.

9.1.2 Imports and exports: Goods

ONS Resource

In the UK, the prime source for these accounts is given by the annually published Pink Book or, more prosaically, The UK Balance of Payments, the Pink Book: 2019.

Let us look first at the types of goods that the UK imports and exports today. Figure 9.1 breaks these down into types of goods.

Figure 9.1 Exports and imports of goods

Exports and imports of goods

UK, 2018

Office for National Statistics – Pink Book

Figure 9.1 shows present-day patterns in UK trade very clearly. Certainly, the UK is still a major exporter of goods—the £345 billion total in 2018 is equivalent to around one-sixth of GDP. But in almost all categories, the corresponding imports are greater.

This a change from the picture that characterised the UK up to approximately the first half of the last century. Historically, the UK imported food—and still does—but it was also a major net exporter of manufactures to the rest of the world. That is clearly no longer the case.

9.1.3 Imports and exports: Services

Figure 9.2 gives a similar breakdown by type of service. Prominent among the services the UK now exports are finance, insurance, and other business services. Early in the last century, Britain’s major net exporting sectors were coal, iron, steel and metal manufactures, ships, and textiles. Now the lawyers, financiers and insurers in the City of London are to be found among its leading net exporters. A common theme is that many of these services are relatively complex and command a high price.

The UK attracts many tourists; London is in fact the most visited city in Europe. However, the £36 billion of receipts from tourists visiting Britain in 2018 were outweighed by the near £52 billion spent by UK residents on holidays overseas.

Figure 9.2 Exports and imports of services

Exports and imports of services

UK, 2018

Office for National Statistics – Pink Book

Educational services exports are not separately identified in the Pink Book, but a report by Oxford Economics states that there were 437,000 overseas students attending British universities in 2014 to 2015, making up almost one-fifth of the total student population. Its authors calculated that this increased the UK’s gross value added by nearly £14 billion, and export earnings by nearly £11 billion. It is not only tertiary education services that the UK exports. Some 51,500 non-British pupils, many the children of non-resident parents, attended fee-charging schools in the UK in 2019, according to the Independent Schools Council Annual Census for that year.

9.1.4 Where does the UK send its exports and where does it source its imports?

The Pink Book gives an additional breakdown of UK trade showing the countries and regions to which the UK exports and from where it receives its imports. A great deal of detail is available, but Figure 9.3 indicates the main features of trade in 2018.

ONS Resource

The ONS has an impressive range of interactive tools which allow trade flows between the UK and other regions and countries of the world to be seen easily.

The annually published World Trade Explorer contains tools for both goods and services. In addition, tools are available to explore trade flows in goods in greater detail.

They can be accessed through the monthly UK trade bulletins, for example the bulletin for March 2020.

Figure 9.3 Exports and imports by country or region

Exports and imports by country or region

UK, 2018

Office for National Statistics – Pink Book

For both exports and imports, the European Union was much the largest trading partner of the UK in 2018. It was the market for 45% of UK exports and the source of 52% of its imports.

The next largest trading partner was the United States, accounting for 19% of exports and 11% of imports.

China and Japan both represented significant trading partners, though on a lesser scale than the EU or the United States. However, collectively the rest of Asia was of more importance, representing the markets for 13 per cent of exports and the source of 11% of imports. Digging beneath this grouping, the most significant trading relations were with India, Korea and the Hong Kong Special Administrative region (counted separately from the rest of China for this purpose).

One other feature shown up by Figure 9.3 is that the UK imports more than it exports from some regions, and the opposite from other regions. For example, the UK imported £66 billion more from the EU than it exported, but this was partly offset by a surplus on its trade with the United States.

9.2 The balance of payments accounts

To start to pin these matters down, we need an accounting framework. This is the balance of payments accounts. Like the national accounts discussed in earlier chapters, these accounts have been developed over several decades and are formulated within international guidance—in this case, the Balance of Payments Manual (BPM).

The latest version of the Balance of Payments Manual, Manual 6, is currently being revised, alongside the System of National Accounts, to which it is closely related.

visible trade balance
The visible trade balance is that part of the Balance of Payments that refers to international trade in goods. This includes all tangible goods which add to, or subtract from, the stock of material resources of a country by entering its economic territory (imports) or leaving it (exports).

9.2.1 The current account balance

We can build the account up in stages. To start with, we can define the visible trade balance as the difference between the UK’s exports of goods and its imports of goods This is useful information, because much trade does indeed consist of imports and exports of physical goods, such as foodstuffs or cars and other machinery. But imports and exports of services are also substantial; in fact, these have grown in relative importance. Such transactions might take the form, say, of sales of banking, legal and accounting services. They also include, for example, tourism and education. Foreign students paying for a university education in the UK are buying a UK export and UK residents studying overseas are importing educational services.

invisible trade balance
The invisible trade balance is that part of the Balance of Payments that refers to international trade in services. This includes all intangible services which add to, or subtract from, the stock of material resources of a country by entering its economic territory (imports) or leaving it (exports), including services provided through foreign affiliates established abroad.

These trade transactions in services form one category of invisibles—invisible in the sense that, unlike goods, services cannot be physically observed. However, there are also other similar flows that are relevant—essentially income that UK residents receive from foreigners or pay out to them. They can be categorised under two rather unimaginatively named items: primary and secondary income.

primary income
Comprising compensation of employees, investment income, earnings from rent and taxes, and subsidies on production and on the import of goods.

Primary income is the flow of interest, profits and dividends that UK residents—companies and individuals—receive from assets they own overseas, On the opposite side of the account is the corresponding income that foreign residents obtain as return on their assets in the UK. Primary income also includes remittances of UK workers overseas back to the UK , and, in parallel, remittances of non-resident workers in the UK back to the countries of which they are residents. Compensation of employees presents remuneration in return for the labour input into the production process contributed by an individual. In the international accounts, compensation of employees is recorded when the employer (the producing unit) and the employee are resident in different economies. Investment income covers earnings (for example, profits, dividends and interest payments and receipts) arising from foreign investment in financial assets and liabilities. Credits are the earnings of UK residents from their investments abroad and other foreign assets. Debits are the earnings of foreign residents from their investments in the UK and other UK liabilities. The flow of investment in the financial account is recorded separately from earnings, although reinvested earnings of companies with foreign affiliates are a component of both. The total value of UK assets and liabilities held at any time is also recorded separately under the international investment position. Other primary income covers earnings from rent and taxes, and subsidies on production and on the import of goods. Under the Balance of Payments Manual fifth edition, taxes and subsidies on production and on the import of goods were classified to secondary income (previously titled current transfers). The recording of rent was previously classified to other investment income.

secondary income
The provision (or receipt) of an economic value by one party without directly receiving (or providing) a counterpart item of economic value.

Secondary income covers other transfers, not directly related to economic transactions. The main items here are overseas aid and UK contributions to international bodies, such as the UN and— pre-Brexit—to the European Union.

Adding together the visible trade balance (goods), the invisible trade balance (services) and primary and secondary income gives the current account balance. To put some numbers on this framework, we can look at the UK’s overall current account balance for 2018.

Figure 9.4 Current account balance

Current account balance

UK, 2018

Office for National Statistics – Pink Book (2019)

The UK economy characteristically has a negative balance on visible trade (look at the bar for goods) but offset by a substantial surplus on invisibles (look at services). Secondly, primary income and (to a lesser extent) secondary income flows have an important bearing on the overall picture. We will look at this account in more detail later.

9.2.2 The financial account

The current account is important. But it gives only a partial picture of the flows of international payments described earlier.

capital account
Consists of two components: capital transfers and the acquisition (purchase) or disposal (sale) of non-produced, non-financial assets.

One relatively minor addition are the items in the capital account. This covers, for example, capital transfers—payments mainly made by governments to contribute to the financing of projects overseas. The account also covers purchases of non-produced, non-financial assets,—items such as purchases of patent rights, goodwill, trademarks, and so on. Also included under this heading are transactions in rights to natural assets, such as land or water. Such transactions need to be included for completeness but are usually quite small in relation to other items in the accounts.

Capital transfers are those involving transfers of ownership of fixed assets, transfers of funds associated with the acquisition or disposal of fixed assets, and cancellation of liabilities by creditors without any counterparts being received in return.

financial account
Transactions that result in a change of ownership of financial assets and liabilities between UK residents and non-residents, for example, the acquisitions and disposals of foreign shares by UK residents.

Much more important are the transactions covered by the financial account. This relates to the voluminous transactions in financial assets and liabilities. The accounts are presented by the functional categories of direct investment, portfolio investment, other investment, financial derivatives and reserve assets. These can be broken down into several broad categories:

Just to give some feel for the size of the numbers involved, Figure 9.5 shows the relevant flows in 2017.

Figure 9.5 Financial account flows

Financial account flows

UK, 2018, £ billion

Office for National Statistics – Pink Book (2019)

The financial flows are almost as large as trade flows. Compare the annual Inflows and outflows respectively of £177 billion and £101 billion to the trade flows shown in Figure 9.4.

The current account deficit of £92 billion in Figure 9.4 is close to the net inflow of investment into the UK shown, of £77 billion in Figure 9.5. This is not a coincidence, as we will explain. The sum of the current account balance and the (small) capital account balance indicates the extent to which the UK is improving its position against the rest of the world. If it is in surplus, it is receiving more income from overseas than it is paying out. In deficit, the reverse is true. But it must be doing something with these proceeds. In surplus, the UK collectively must be either acquiring more foreign assets or paying down liabilities. In deficit, the UK must be running down overseas assets to finance the deficit or be increasing its borrowing. It is precisely such movements that the financial account captures.

If there were no errors and omissions resulting from the practical procedures used to compile the accounts, the current and capital account balance would be exactly matched by the net investment financial account inflow or outflow.

Putting it another way, the current and capital account balance show whether the UK is a net lender or a net borrower in each period to the rest of the world. The financial account shows how it is financing that lending or borrowing.

For example, the 2019 Pink Book records that in 2018:

Financial account
Current account deficit –£92 billion
Capital account deficit –£3 billion
Total deficits –£95 billion
Net investment inflow +£77 billion
Errors & omissions +£18 billion
Balance £0

The key point here is that the sum of these items is zero, and always is. This is exactly why the balance of payments is so called—these accounts must always balance.

We will turn shortly to how these current and financial account flows are measured.

9.2.3 International Investment Position (IIP)

There is one final segment of the accounts that needs to be considered. So far, we have been talking mainly in flow terms —the value of trade or of financial transactions in a particular period. But for many purposes, what is happening to stocks is at least as important; what are the levels of the UK’s assets and liabilities outstanding at a particular point in time and how do those compare to each other.

International Investment Position (IIP)
A statement that shows at the end of the period the value and composition of UK external assets (foreign assets owned by UK residents) and identified UK external liabilities (UK assets owned by foreign residents).

In terms of simple personal budgeting, if I spend more in a month than my income, that may not be necessarily a problem. I can probably borrow to cover the deficit, or to run down my bank deposit. But if I go on spending more than I earn, there may be more problems. My bank balance may run down and/or my borrowing rise to levels that are unsustainable. At national level, it is the International Investment Position (IIP) that can throw light on such issues. The framework of international accounts sets out that the IIP is also presented by functional category, consistent with primary income and the financial account.

Figure 9.6 shows the gross stock of assets and liabilities that make up the International Investment Position (IIPs) as it appeared at end 2017.

2017 2018
Assets Liabilities Net Assets Liabilities Net
Direct Investment 1697 1720 −23 1706 1796 −90
Portfolio Investment 2671 3374 −703 2450 3303 −853
Other Investment 4305 3944 361 4628 4100 528
Financial Options 2028 1982 46 2078 2023 55
Reserves 112 0 112 135 0 135

Figure 9.6 UK international investment position (IIP)

UK international investment position (IIP)

End year 2017, £ billion

Office for National Statistics – Pink Book

Figure 9.6a IIP composition

Gross stock of assets and liabilities that make up the International Investment Position (IIPs).

Gross stock of assets and liabilities that make up the International Investment Position (IIPs).

Office for National Statistics – Pink Book

2017 2018
Assets Liabilities Net Assets Liabilities Net
Direct Investment 1697 1720 −23 1706 1796 −90
Portfolio Investment 2671 3374 −703 2450 3303 −853
Other Investment 4305 3944 361 4628 4100 528
Financial Options 2028 1982 46 2078 2023 55
Reserves 112 0 112 135 0 135

Figure 9.6b The data

Gross stock of assets and liabilities that make up the International Investment Position (IIPs).

Gross stock of assets and liabilities that make up the International Investment Position (IIPs).

Office for National Statistics – Pink Book

This shows that at the end of 2017, UK assets and liabilities each stood at near £11 trillion. But we also want to know the net figure.

UK assets fell short of UK liabilities by £208 billion. In other words, the UK was a net debtor to the rest of the world by this amount. A year later, there had been a further deterioration.

UK liabilities now exceeded assets by some £224 billion, a worsening of £16 billion. What was behind this?

One of the factors was that the UK had a combined current and capital account deficit of some £95 billion in 2018, as we saw above. So it was selling assets to finance this. But assets such as equities vary in price over time; so do many debt instruments, such as bonds.

If the price of the UK’s existing assets or liabilities falls, so too will the aggregate value of the corresponding assets and liabilities, even without a current deficit to finance. Foreign residents’ holding of assets in the UK will also be subject to revaluations. Some assets and liabilities—bank deposits, for example—do not have a varying price. But they can still be subject to revaluations in their sterling value originating in movements in the exchange rate.

If sterling fell in value against foreign currencies, the sterling value of assets and liabilities denominated in foreign currency would increase. The reverse would be the case if sterling appreciated.

The pattern of asset price movements and exchange rate revaluation effects worked in favour of the UK position in 2018; therefore, the deterioration in the IIP was less than the combined current and capital account deficits.

This is an example from one year only. In other years, the change in the IIP was worse from the UK’s perspective than the current and capital account position alone would have indicated. Again, it was the pattern of revaluations that made the difference.

9.3 Compiling trade statistics

ONS Resource

These sources are supplemented by information from surveys, such as International Trade in Services survey (ITIS) and the International Passenger Survey (IPS). Further details are given at the ONS publication ‘UK Trade’.

The interlinked accounts set out above provide a powerful tool for describing and analysing the international position of the UK. But an obvious first question is how we can measure the various items that appear in these accounts. This is done using a similar set of surveys and administrative sources as the basis for other economic statistics.

ONS Resource

The Foreign Direct Investment survey is used to provide annual information about (unsurprisingly) movements in the stocks and flows of direct investment.

For the trade account, trade is measured for both exports and imports, and for goods and for services in each case. Some thirty different sources are used to assemble this data, the main one being returns from Her Majesty’s Revenue and Customs, based on import and export documentation.

A similar wide and varied set of information sources is used to provide the basis for estimates in the other accounts. Some of these are from administrative sources: government’s estimates of own overseas spending and receipts are one example, information collected by the Bank of England regarding financial transactions and market positions in financial options is another. Various surveys are also conducted.

9.4 Statistical challenges

Notwithstanding the multiplicity of data sources available to estimate the trade and balance of payments accounts, they are beset by a number of knotty issues and it is important to be aware of these. This section outlines some of the main issues that arise. We can break down the statistical challenges into those that are:

9.4.1 Conceptual challenges: Goods

The most common-sense way of looking at trade would be to count goods moving across borders. That would seem to chime with how we define exports and imports, and statistics using the concept of physical movement of goods are called overseas trade statistics in the UK.

There are, however, problems with this approach. First, it is not consistent with the rest of the National Accounts that use the concept of economic ownership. Transactions in the National Accounts are recorded when there is a change of economic ownership, not when goods are physically moved.

The second issue is that the physical movement of goods might lead you to some misleading conclusions. Take the example of a German supermarket buying wine from a French vineyard. Say this wine is transported by road and passes through a warehouse in Belgium on the way to Germany. If we simply measured the physical flows, we would count a French export to Belgium and then a German import from Belgium: we would not see a French export to Germany.

If, instead, we looked at economic ownership we would likely see this recorded as trade between France and Germany. In the UK, this approach to measuring trade is called the balance of payments approach.

While this economic ownership approach gets us closer to the economic reality than simply looking at physical movements, it is still not foolproof. Take a further example of a car, worth £20,000, produced in the UK and sold overseas. We would record this as an export of £20,000. But say £8,000 of imported components were used in its production. In that case, is the export really £20,000 or the value added of £12,000, i.e. the value of the car less the value of the imported inputs?

trade in value added (TiVA)
The goods and services we buy are composed of inputs from various countries around the world. However, the flows of goods and services within these global production chains are not always reflected in conventional measures of international trade.

There is growing interest in looking at the concept of trade in value added often known by its acronym TIVA, and this approach, however, requires much more data than other approaches for measuring trade. In effect, one needs international versions of the supply–use tables discussed in Chapter 4.

The development of trade in value added (TiVA) addresses this issue by considering the value added by each country in the production of goods and services that are consumed worldwide. TiVA indicators are designed to better inform policy makers by providing new insights into the commercial relations between nations.

The OECD have a project to develop these measures.

When publishing trade statistics, most countries do so on the economic ownership or balance of payment basis. Nonetheless, it is worth bearing mind that there are other ways—such as TIVA—of counting trade.

9.4.2 Conceptual challenges: Services

trade in services
A record of the value of services exchanged between residents and non-residents of an economy, including services provided through foreign affiliates established abroad.

As there is no physical movement of goods, we do not have to worry about whether there has been a change in economic ownership. Rather, the problem with trade in services is spotting it in the first place. Services include transport, travel, communications services, construction services, insurance and financial services, computer and information services, royalties and license fees, other business services (merchanting, operational leasing, technical and professional services, etc.), cultural and recreational services, and government services not included in the list above.

trade in goods
A record of physical, produced items that add to, or subtract from, the stock of material resources of a country by entering its economic territory (imports) or leaving it (exports).

Cross-border transactions in services are of an order of magnitude harder than trade in goods to identify, track and value. If a UK citizen pays cash for a tattoo in Austria, let us say, or for someone shining his shoes in France, there will be no trail of the transaction, electronic or on paper. Unless the provider or purchaser of the service happens to be surveyed, and to recall it, it will simply get omitted. A very large number of high value financial transactions occur almost continuously between banks and non-financial companies, as well as between different banks and between different subsidiaries or branches of a single large bank; many such transactions involve parties resident in different countries. This form of international service trade may be opaque and very hard to quantify with any precision.

There are three main ways in which trade in services happens, which are known as modes of supply. They help explain some of the challenges in measurement:

There are two points to draw from this. First, trade in services can often involve the movement of people. Secondly, it will often be only the businesses themselves who can observe this trade, as there will be no administrative record equivalent, for example a customs document in the case of trade in goods. Trade in services is therefore not difficult conceptually difficult, but may be challenging, in practice.

9.4.3 Practical challenges: Measurement

Not all trade that takes place across national borders is recorded. Shippers might make errors in recording the exact quantity or size of any product they send. Estimates of value might be entered incorrectly. Values that should be expressed in one currency might get expressed by mistake in another, or the numbers in any price statement could be wrong. Some categories of goods may take many different forms, with quite a range of prices, but the customs form may not deal in adequate detail with these differences.

There are also issues in recording cross border flows. Some borders are open, especially within the European Union’s Schengen Area, with few if any formal checks. Until Brexit, goods crossing the border between Northern Ireland and the Republic of Ireland, or British ports or rail heads on both sides of the English Channel, have had minimal customs inspections or formalities for decades. Some goods are sent by post, perhaps with a brief statement about value and nature, which may not be fully accurate Other statements go electronically as email attachments, with no scrutiny by border authorities. In the EU, there are no customs checks on trade between Member States. So specific surveys of businesses are needed to estimate trade flows.

9.4.4 Practical challenges: Smuggling

Certain commodities bear very high rates of tax. Alcoholic spirits and cigarettes are examples. About 80% of the retail price of cigarettes sold in the UK is tax, mostly in the form of a specific duty, but topped up by standard rate VAT.

A BBC report lodged by Angus Crawford in 2016 describes a cigarette factory run by a company called Neman, in the town of Grodno, in Belarus. This plant produces some 20 billion cigarettes each year, commanding a local retail price of barely one sixth of the average price of cigarettes sold legally in Britain. Neman’s production is enough to meet the annual requirements of some 4 million regular smokers. Not all of them appear to live in Belarus, which has a total population of only some 9 million. Crawford states that about one third of the factory’s output is estimated to be sold within the European Union (of which, of course, Belarus is not a member).

Some cigarette smugglers do get caught. HMRC’s website provides numerous details of criminal convictions. But the detection rate is unknown and might be quite modest.

610 million cigarettes which are estimated to have been sold illegally in the UK in 2015, a loss of revenue to Her Majesty’s Revenue and Customs of some £200 million. Smuggled goods will not normally get included in official records of trade.

carousel fraud
A type of VAT fraud detected in many EU Member States; it relies on VAT-free movement of goods between Member States.

According to a European Parliament’s TAX3 Committee meeting in October 2016, carousel fraud and other related types of crime are estimated to have cost EU governments as much as €50 billion in 2006. In essence, fraudsters obtain VAT registration to acquire goods VAT-free from other Member States. They then make a domestic sale of the goods at VAT inclusive prices and disappear without paying over to the tax authorities the VAT paid by their customers. This deceit occurs, for instance, when products which are bought with a zero rate of VAT in one EU country, and then sold in another with a standard rate of VAT added (at a rate of 20% or so). There is no justification for this, and the supposed “tax” proceeds are withheld by the seller, and not passed to the importing country’s fiscal authority. The buyer may go on to repeat the same trick. At the least, such nefarious activities are liable to distort figures for recorded trade.

9.4.6 Errors and omissions

Some countries’ customs authorities might be more assiduous than others. Not every country is equally good at estimating values and volumes of trade, in services or goods. Some 200 territories in the world engage in international trade; most attempt to record it officially. Economists have recently examined and compared all available distinct bilateral pairs—of which there will be nearly 40,000—to see which countries’ data seem better correlated with others’, and which exhibit greater discrepancies. Some countries’ statistics raise concerns about accuracy for other reasons. The World Trade Organization’s Statistical Review 2018 reports particular doubts about the accuracy of Russia’s import data in this connection: registration with that country’s customs authorities is incomplete.

As we saw in the previous section, the accounts published annually by the Office for National Statistics include a series for errors and omissions. Such entries reconcile other elements in the accounts. At £18 billion or so in 2018, this might at first sight seem substantial. On the other hand, it is small relative to the size of the underlying flows in these accounts, representing less than 1% of the UK’s GDP. No time trend or systematic bias is detectable in the errors and omissions in previous years. In fact, in the two previous years, they had the opposite sign to that in 2018.

9.4.7 Trade data asymmetries

International trade statistics provide estimates of the value of imports and exports of trade in goods and services between countries. In theory, the estimate of the trade flows by each country should match. For example, France’s estimate of its imports from the UK should match the UK’s estimate of its exports to France. However, in practice, there are differences that are known as trade data asymmetries.

There have always been discrepancies in the reporting of trade flows, and the existence of trade data asymmetries has been well documented by international organisations such as the Organisation for Economic Cooperation and Development (OECD), the International Monetary Fund (IMF) and the statistical office of the EU, Eurostat. As a share of global trade transactions, asymmetries are very small, and have been estimated by these organisations as between 0.1% and 1.0% of the global current account. However, it is important to understand and reconcile asymmetries to better inform policy and decision making on international trade.

Asymmetries can be caused by a range of conceptual and measurement variations between the estimation practices of different countries. Statistical agencies are likely to have different source data, estimation methods, and methodological and definitional differences. It should also be noted that the “true” value for a given statistic is unknown and could lie between the two countries’ estimates or outside that range.

While it will never be possible to eliminate trade asymmetries, the international community is collaborating to better understand the reasons for asymmetries and to reduce them, for example through the use of models to reconcile trade flows, such as that developed by the OECD. The UK is proactively engaged in this international work, and has published several articles which document this, most recently in 2020.

The UK’s largest bilateral trade asymmetries are in its trade in services statistics, rather than its trade in goods statistics. It is commonly agreed that services transactions are more difficult to estimate than goods transactions, which can be physically observed; when estimates are based on business surveys, it is easier to identify firms that export services than those that import services.

Figure 9.7 and Figure 9.8 indicate the UK’s largest trade in goods and trade in services data asymmetries, using international sources for Figure 9.7, and ONS data for Figure 9.8.

Partner country UK export data [ED] Mirror (import) data [EP] Export absolute asymmetry (EA=
UK import data [ID] Mirror (export) data [IP] Import absolute asymmetry (IA=
Total asymmetry (TA=EA+IA)
Netherlands 25.9 21.6 4.3 41.9 33.6 8.2 12.5
China 20.8 17.9 2.9 47.5 42.7 4.8 7.6
Germany 35.6 32.6 3.0 69.0 72.4 3.4 6.4
USA 49.4 46.3 3.2 47.4 49.7 2.2 5.4
Ireland 21.2 17.6 3.6 13.7 14.3 0.6 4.2

Figure 9.7 Top five export and import trade in goods asymmetries by trading partner country

Top five export and import trade in goods asymmetries by trading partner country

UK, 2018, £ billion

United Nations Comtrade

Partner country UK export data [ED] Mirror (import) data [EP] Export absolute asymmetry (EA=
UK import data [ID] Mirror (export) data [IP] Import absolute asymmetry (IA=
Total asymmetry (TA=EA+IA)
USA 69.0 45.5 23.5 35.6 55.5 19.9 43.4
Ireland 14.2 15.8 1.6 8.0 25.0 17.0 18.6
Netherlands 17.8 18.3 0.5 7.4 22.3 14.8 15.3
Germany 20.4 22.8 2.5 11.3 23.5 12.2 14.7
France 17.6 20.8 3.2 15.7 24.5 8.9 12.1

Figure 9.8 Top five export and import trade in services asymmetries by trading partner country

Top five export and import trade in services asymmetries by trading partner country

UK, 2018, £ billion

Office for National Statistics

Few economic statistics can be taken as 100% accurate; the trade and payments statistics are not alone in this. The trade statistics provide important information, albeit necessarily with margins of error.

9.5 Brexit and trade

Having looked at the trade and balance of payments accounts for the UK and what they indicate about its trading position and behaviour, what implications do they have for policy issues? The Brexit debate has certainly qualified as a prominent policy debate. It is undoubtedly a complex issue with many dimensions: political and cultural, as well as economic. But the question of trade has featured prominently in the debate.

9.5.1 How large is UK–EU trade?

Some proponents of strong links with the EU point to the importance of trade for the UK and of the importance of the EU in that context. They have force in these points. As we have seen, by international standards, the UK has a high ratio of trade to GDP. It is dependent on overseas sources for much of what it consumes, and on overseas markets to sell much of what it produces. In that context, the EU is much the most important trading partner. So, the argument goes, it would be unwise to put such arrangements at risk without the utmost consideration.

One of the key reasons for the strength of this relationship was the relative absence of barriers to trade between members of the EU. EU partners enjoyed tariff-free access to the UK market while the UK was itself a member, as did the UK in its exports to them. It remains unclear what arrangements will replace those in future, now that the UK has left the EU. But the danger is that they will be less conducive.

In a careful study of Canadian provinces and US states, Behrens and others allow distance elasticities to vary by region.1 All but seven are above unity (defined as positive). They range from 0.674 for New York state to 2.6 for the most remote province, Newfoundland-Labrador. Redding and Weinstein illuminate further, with a valuable short paper discussing gravity as a factor in trade.2

Trade barriers, or their absence, are part of the story–but only part. Distance matters, too. Shipping costs vary with sea miles and flight times. Evidence from tests of the gravity model of trade predicts that the value and volume of trade almost halves on average as distance doubles.

Bloom and others set out the details of the potential risk to the UK’s trading position.3

Obviously, the EU has the advantage of proximity to the UK, beginning only 23 miles away. Distances from other trading partners are generally much greater. The argument is that this factor together with the point about increased trade barriers would have a seriously detrimental effect on the trade on which the UK is very dependent. So Brexit would be challenging, for the UK as well as for its erstwhile EU partners, especially for a disorderly departure.

9.5.2 How important is UK–EU trade?

Other commentators, of course, take a different view and there are features of the UK’s trade accounts that are relevant to their arguments. First, notwithstanding the fact that the EU remains the UK’s largest trading partner, the proportion of trade it represents has fallen significantly over time. Figure 9.9 is extracted from successive Pink Books and shows exports of goods to the EU as a percentage of total UK trade in goods.

Figure 9.9 Share of total UK exports of goods and services to the European Union

Share of total UK exports of goods and services to the European Union

1999 to 2018

Office for National Statistics – Pink Book

Thus, over the last two decades, the EU share has fallen by 10 percentage points, notwithstanding the tariff and distance advantages that UK trade with the EU enjoyed. Over the period as a whole, economies and markets outside the EU have grown more rapidly than those within it. That has perhaps been less true after the “Great Moderation” ended, following the financial crisis. The fall in the EU share since then has been less steep. That might change if growth in the Asian and South American markets, for example, resumes at previous rates, in which case the EU share could fall further. It has to be said, however, that the immediate indications of this are, at best, mixed.

As is clear from Figure 9.9, the UK has a major trade deficit with the EU—equivalent to more than 3% of GDP —whereas it has surpluses with, for example, the United States, central and South America and with Asia outside China. If the concern for the UK economy is the size and persistence of the trade deficit, then it would not be obvious that focusing mainly on the EU would be the best way forward.

In the context of Brexit, none of the above points are, or could be, decisive. The issue is much more complex. However, what the balance of payments accounts show about trading patterns clearly represents important information.

9.6 Can the UK pay its way in the world?

The underlying concern, whether in the context of the Brexit debate or more widely, is about the persistence of the UK’s current account deficits.

Amongst others, the Bank of England’s Financial Policy Committee has noted this as one of several risk factors for financial stability.4

9.6.1 The UK’s current account deficit

We saw earlier that the UK has a deficit on trade in goods offset by a smaller surplus on services, resulting in a current account deficit. This has been a feature for many years. In fact, the UK has been running current account deficits every year since 1984. By contrast, in earlier post-war years, current account surpluses were more frequent than deficits, especially before 1972. Does this represent a serious longer-term threat to the economy?

The argument that it does is a straightforward one:

So the question is whether the UK is indeed on such a doomsday path. There is no doubt about the existence of the substantial current deficit, as Figure 9.10 shows.

Figure 9.10 Current account surplus and deficit as a percentage of GDP

Current account surplus and deficit as a percentage of GDP

UK, 1970 to 2018

Office for National Statistics – Pink Book and Blue Book

Figure 9.10a The UK has historically run a current account deficit

If the vertical axis is positive, it represents a current account surplus. A negative figure is a deficit.

If the vertical axis is positive, it represents a current account surplus. A negative figure is a deficit.

Office for National Statistics – Pink Book and Blue Book

Figure 9.10b There was much volatility in how much the UK borrowed from and lent to the rest of the world through the 1970s and 1980s

Up until the 1980s, the pattern was of a mixture of annual surpluses and deficits.

Up until the 1980s, the pattern was of a mixture of annual surpluses and deficits.

Office for National Statistics – Pink Book and Blue Book

Figure 9.10c The Lawson Boom of the late 1980s helped lead to an increase in current account deficit, followed by a sharp correction in the recession of the early 1990s

The UK has experienced deficits in every year since 1984.

The UK has experienced deficits in every year since 1984.

Office for National Statistics – Pink Book and Blue Book

Figure 9.10d There was a widening in the current account deficit up until the financial crisis

They became larger from around 2000 onwards.

They became larger from around 2000 onwards.

Office for National Statistics – Pink Book and Blue Book

Figure 9.10e A decline in its net investment income led to the UK current account deficit widening to historically high levels in the mid-2010s

From 2008 onwards, only in one year was the deficit less than the equivalent of 3% of GDP.

From 2008 onwards, only in one year was the deficit less than the equivalent of 3% of GDP.

Office for National Statistics – Pink Book and Blue Book

Figure 9.10f The UK has historically run a current account deficit

Since 1984, the cumulative deficit up to 2018 comes to £1,512 billion, a massive amount by any standard.

Since 1984, the cumulative deficit up to 2018 comes to £1,512 billion, a massive amount by any standard.

Office for National Statistics – Pink Book and Blue Book

9.6.2 International comparisons

The international evidence also supports the idea that there may be a matter of concern here. Figure 9.11 shows the current account deficit as experienced by other developed economies in 2018.

Figure 9.11 Comparison of current balances in major economies

Comparison of current balances in major economies

2018, percentage of GDP

International Monetary Fund, International Financial Statistics

Most of these countries enjoyed surpluses on their current accounts. But of those that had a deficit, the UK had the largest in relation to the size of the economy. In fact, that has now been the case for several years.

9.6.3 The UK’s international investment position (IIP)

But does this mean that the UK position is unsustainable and well on the way to the doomsday outcome described above? The evidence about the current balance above is sufficient for the “entry on the charge sheet”. But, to continue the analogy, the court’s judgement is what has been happening to the international investment position and its behaviour over time, as shown in Figure 9.12. Think of it as a companion to Figure 9.10. Figure 9.12 sets us a puzzle: step through it to find what it is.

Figure 9.12 International Investment Position

International Investment Position

UK, percentage of GDP, 2000 to 2018

Office for National Statistics – Pink Book

Figure 9.12a 2000–2007

There was a steady deterioration in the net IIP as the UK continued to borrow more from the rest of the world.

There was a steady deterioration in the net IIP as the UK continued to borrow more from the rest of the world.

Office for National Statistics – Pink Book

Figure 9.12b 2008–2015

The sterling depreciation following the financial crisis led to a positive revaluation of the net IIP.

The sterling depreciation following the financial crisis led to a positive revaluation of the net IIP.

Office for National Statistics – Pink Book

Figure 9.12c 2016–2018

The 2016 fall in sterling following the result of the EU referendum, led to an improvement in the value of the net IIP.

The 2016 fall in sterling following the result of the EU referendum, led to an improvement in the value of the net IIP.

Office for National Statistics – Pink Book

We should not expect that 2016 surplus. And while the cumulative current account deficits over this time were £1,012 billion, the deterioration in the IIP in this period was less than a quarter of the cumulative deficits. So what was going on?

The answer: the main reason for the more favourable outturn looks to have been the weakness in sterling. The UK’s overseas assets denominated in foreign currency became more valuable in sterling terms, while the sterling value of overseas residents’ sterling assets was, of course, unaltered in sterling terms. The fall in sterling in 2016 was particularly large, following the result of the Brexit referendum; sufficiently large, in fact, to give the small positive net asset position that we see in Figure 9.12.

Should we be concerned by the UK’s overseas assets falling short of its liabilities to this extent? Some clue is given by looking at the IIPs of other developed economies, as in Figure 9.13.

Figure 9.13 Comparison of international investment positions in major economies

Comparison of international investment positions in major economies


International Monetary Fund, International Financial Statistics

Standardised against each country’s GDP, there is a wide range of experience.

The UK can be broadly seen as in a group with France and Italy, all having relatively small net liabilities.

Japan and Germany have large net assets relative to the size of their economies, as—to a lesser extent—do Canada and China.

In the opposite direction, the outlier is the United States, which has net liabilities equivalent to nearly half the size of its economy.

Is this reassuring or worrying from a UK perspective? Perhaps not of grave concern yet. On the other hand, not completely reassuring either. Both France and Italy—with similar starting points to the UK—are running current account surpluses, while the UK has continued with heavy deficits since the end of 2018. Further, the position may not be bailed out by further sterling weakness, as it was in 2016. If anything, the pound has been strengthening over the subsequent period. Admittedly, the United States has a much larger excess of international liabilities over its assets than does the UK. But that country has a special position in the world financial system. What is possible for the United states may not be possible for the UK.

Interestingly, while trade issues generally have been much discussed in recent years, the question of the UK’s net debt has been much in the spotlight. But, depending on developments going forward, it may become a more central policy issue in future. Certainly, it is a situation that should be carefully monitored.

9.7 Summary

Imports and exports of goods and services have always been a major part of the UK economy, and that importance has only increased in a globalised world. Flows relating to cross-border purchases of assets or liabilities are no less important, whether UK residents’ transactions in overseas assets or liabilities, or foreign residents’ dealing in UK assets or liabilities.

The system of statistics and accounts available in the UK monitors what is happening in regard to these transactions. Imports and exports of goods and services give us the trade balance. Other flows that had a bearing on the current surplus deficit.

The balance of financial transactions in assets and liabilities is by definition the way in which the UK as a nation financed its current surplus or deficit. The previous accounts related to the UK’s international investment position, essentially its balance sheet of assets and liabilities with the rest of the world.

These accounts tell a story about the kinds of goods and services that the UK imported or exported and about the geographical pattern of the UK’s trading partners. The EU has remained the UK’s most important trading partner but that the proportion of UK trade with EU partners has declined appreciably in the last decades.

While the series of current account deficits has led to an emerging excess of liabilities over assets, this imbalance to date is not an undue cause for concern. On the other hand, if the position should worsen further—because, for example, of continuing current account deficits— the situation could become more problematic.

9.8 Further reading


  1. Behrens and others (2014), ’Trade, Wages and Productivity’, International Economic Review 

  2. Redding and Weinstein (2019), ‘Aggregation and the Gravity Equation’, American Economic Review Papers and Proceedings 109 

  3. Bloom and others (2019), ‘Brexit Uncertainties’, National Bureau of Economic Research 

  4. ‘Financial Stability Report, Financial Policy Committee. Record and stress testing results – December 2019’