Readers Question: Using the data and your own economic knowledge, evaluate the importance of rising productivity in bringing about an improvement in the UK balance of payment on the current account.
Productivity is defined as output per worker or output per input. Rising productivity implies that the economy is becoming more competitive and will be able to produce goods at a lower cost. If UK firms can produce goods at a lower cost this will make UK exports more competitive and therefore increase exports.
For example, if there is an improvement in labour productivity following better education and training, firms will be help to produce more for the same costs. This will help the UK compete and sell more exports.
Increasing exports will help improve the current account as exports will be rising relative to imports.
However, there are many other factors that influence the current account as well as rising productivity. Firstly the current account deficit is often cyclical. During periods of high economic growth, consumers spend more on imports causing an increase in the size of the deficit. Therefore, even an improvement in productivity may be insufficient to improve the deficit if it occurs during a period of rising consumer spending.
The fortunes of the current account also depend on the exchange rate. If there was an appreciation in the exchange rate then exports would become less competitive and this would offset the improvements from the increased productivity.
Also, it depends on how much UK productivity has increased relative to other countries. If UK productivity increases by 3%, it may still be less than improvements by our main trading partner. For example, China can benefit from rising productivity and low wages and therefore it remains more competitive than the UK.
It appears the UK has an underlying structural deficit caused by a high marginal propensity to consume and declining comparative advantage in many manufacturing export sectors. A rise in productivity will do a little to help improve the situation. However, it is only part of the equation; for a sustained improvement, the UK may need to increase its saving ratio, reduce spending on imports and increase competitiveness even more.
UK productivity post-2008
UK productivity growth slowed post 2008. This period led to a deterioration in the current account.
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