Case Study Analysis - UK Imports and the Recovery of the UK Economy
This report is based on United Kingdom (UK) imports and the recovery of the economy following the 2007-08 financial and economic crises. The 2008-2009 recession resulted in an increase in the rate of unemployment, inflation, budget deficit, and investment. The report applies concepts and models of macroeconomics to explain how the value of imports into the UK is affected by (i) a fall in British pound value, and (ii) a decline in UK labor productivity. Also, the report explains possible benefits to the UK linked to the weak British pound and evaluates the effects of increased taxation and public spending on the trade deficit. Lastly, reasons for the failure of the depreciation of the pound to improve the UK’s balance of trade (BOT) are examined.
Definition of Recovery
Recovery is the process whereby an activity that has declined starts to grow back to normal. Investopedia (2015) has defined economic recovery as the period in a business cycle that results in increased business activity indicating the end of a recession. An economic recovery may be hard to recognize during the first few months after it has started. During this period, the economy regains its normal growth and surpasses peak output levels and employment rates achieved before the economic downturn. According to Ohanian, Taylor, and Wright (2012), a recovery period is characterized by high levels of growth in employment and real gross domestic product (GDP). The indicators of recovery as provided by economists are such as growth in GDP, decline in unemployment, decrease in inflation, improved financial markets, and improved business performance.
Value of Imports
Imports and Exports are central to international trade. For example, when the value of imports entering the UK is higher in comparison to the value of exports, then the country's BOT is affected negatively (Peng, 2010). When exports are less compared to the exports, then a trade deficit is achieved. The value of imports can be influenced by a fall in the value of the British Pound and a reduction in the UK Labor Productivity.
a. A Fall in the Value of British Pound
In 2015, the UK imported over $625bn (£474bn) of goods and services from the U.S., Germany, China, and the Netherlands (Office for National Statistics, ONS 2016). A fall in the value of a pound is expected to have negative effects on import value. For example, a weak pound will result in increased prices on products such as clothing and electronics which are mostly imported from abroad. Subsequently, imports will be more expensive compared to exports, hence the high value of imports. The fall in the pound has resulted in an increase in costs for businesses; especially those importing their production inputs compared to the export sales (ONS, 2016).
b. A Reduction in the UK Labor Productivity
Labor productivity is a determinant of the productive potential of an economy. For instance, weak labor productivity growth is related to low rates of growth, high inflation, and weak export demand (ONS, 2015). A reduction in the UK labor productivity will result in low exports and increased import value. The formula is:
The decline in labor productivity during the recession period was affected by the competitiveness of goods produced at home. This is because the UK imports most of its raw materials from EU and non-EU countries. For example, in 2009, imports increased by 7%, while labor productivity remained flat since 2007 as illustrated in Figure 1 below
Figure 1: Labour Productivity and GDP per Head. (Source: Harari., 2017).
Economic growth in the 2008/2009 recession was relatively weak as well as the labor productivity. A high labor productivity results in improved competitiveness of exports in international markets. Reduced labor productivity as it is in the case of the UK reduced the competitiveness of UK exports, hence boosting import value.
Benefits to the UK Economy of a Weak British Pound
a) Improve the UK’s Trade Balance
Typically, a fall in the Pound’s value is more likely to assist improve the UK’s BOT. This is because exports will be more attractive compared to imports. In the fourth quarter of 2015, the BOT deficit was 7.2% of GDP (Hamroush, Taylor, Luff, Wales & Hardie, 2015). A weaker Pound has the potential to help decrease the BOT deficit because exports will be more competitive, thus decreasing demand for imports. Figure 2 below shows how trade exports have been increasing since 2013 against the decline in the sterling exchange rate.
