UK Balance of Payments (2): Investment Income and Transfers

The post of 14th March set out the contribution of the UK’s trading account to the Balance of Payments in various economic categories and areas of the world.  This post completes the picture by setting out the two other contributors to the Balance of Payments (i.e. current account): (a) income from portfolio and direct investment and (b) transfers to and by the UK government and the private sector.

1 Income

This is often conflated with the City’s activities and simply added to Financial Services as a measure of Britain’s dependence on the financial sector and the City of London in particular.

In fact, as can be seen in Table 1, the only positive balance in the UK’s Investment Income stream comes from Foreign (Overseas) Direct Investment (FDI) by major corporations like Shell, Vodafone, Rio Tinto, in actual physical facilities such as oil fields, mines, pipe lines, cables, telephone transmitters and networks.  Similarly the debits on FDI come from interest on physical assets in the UK paid for by foreign companies like Tata, Nissan and Toyota.  None of this FDI activity specifically involves the City and its special skills.

The data in Tables 1 and 2 following is taken from the National Statistical Office Pink Book tables 4.1-8. It is customary in the Pink Book to lump short-term bank deposit credits and debits in with actual investment income as most people would understand it.  It is separated out in Table 1 along with an obscure item labelled “employees’ compensation”.

Table 1: UK Income Account 2006 and 2011 in £ billion
2006 2011
Item Credits Debits Balance Credits Debits Balance
Portfolio* 55 (40%) 58 -3 52 (35%) 68 -16
FDI** 84 (60%) 52 +32 97 (65%) 48 +49
Total Investment Income 139 (100%) 110 +29 149 (100%) 116 +33
Bank Deposits & similar*** 98 (41%) 120 -22 39 (20%) 54 -15
Employees’ compensation 1 2 -1 1 1 0
Total “Income” 238 (100%) 231 +7 189 (100%) 171 +18

* Portfolio income results indirectly from investment and unit trust portfolios in the UK investing abroad (credits) and from foreign portfolio investors in the UK (debits). The average yield on UK-owned portfolios invested abroad was around 3% in 2011 (3.8% in 1998).

** Dividends and interest payable on overseas assets owned by UK-based private companies.

*** These are often short-term back to back loans and deposits used in currency transactions predominantly – not actual investments.

Notes on Table 1

(i)         Both the major flows attributable to the Financial sector, the City in particular, show negative balances in 2006 and 2011.  This is not an exceptional situation: previous years show the same pattern right back to 1994[1].  Returns in 2011 at 2.5% were actually lower than returns obtained by foreigners (2.8%) on their UK funds, showing that the City is hardly uniquely expert in these matters (Table 3).

(ii)        By contrast, earnings on direct investments by non-financial companies have shown positive balances at least since 1991, and more than doubled credits since 2000.  Moreover their returns in 2011 (8.7%) and 2006 (11.4%) were over three times the returns on portfolio investment (i) and better than foreign investors obtained from their UK assets (Table 3).

(iii)       The reason for this huge difference between financial and non-financial streams is fundamentally due to the fact that when companies invest in physical assets they deploy engineers and marketeers who know the products they have to make and what prices they are likely to command.  By contrast portfolio investment by fund managers is at best second-hand – through share purchases whose prices are common knowledge in the press and internet, but not necessarily good indicators of likely returns.

2 Current Account Transfers

This is the third and last credit/debit stream which goes to make up the UK current account (post of March 14th 2013).

Table 2: UK Transfers 2006 and 2011 in £ billion
2006 2011
Item Credits Debits Balance Credits Debits Balance
EU institutions“4th resource” and Abatement* 3.6 8.3 -4.7 3.1 10.9 -7.8
Agricultural Fund & import levies 3.2 2.3 +0.9 3.1 2.9 +0.2
Social Fund 1.2 +1.2 0.4 +0.4
VAT-based contributions 2.2 -2.2 2.2 -2.2
Miscellaneous 0.1 0.2 -0.1 0.1 -0.1
Total EU 8.1 13 -4.9 6.6 16.1 -9.5
Social Security** 0.03 1.7 -1.7 0.02 2.3 -2.3
International Aid 2.9 -2.9 5.2 -5.2
(A) Total Government Transfers 8.13 17.6 -9.5 6.6 23.6 -17
Private Sector: Net non-life insurance premiums 11.8 11.7 +0.1 7.6 7.6 0
Household transfers*** 2.7 4.7 -2 2.4 5.7 -3.3
Others 0.8 1.3 -0.5 0.8 2.6 -1.8
(B) Total Private Transfers 15.3 17.7 -2.4 10.8 15.9 -5.1
(A+B) Total Government & Private Transfers 23.43 35.3 -11.9 17.4 39.5 -22

* This is the UK’s direct government contribution to the EU budget and is based on Gross National Product. Abatement is the “Thatcher” refund as later reduced by the Blair government.

** Chiefly pensions to British people resident abroad.

*** Debits mainly by foreign residents in the UK; credits by UK nationals living abroad.

Notes on Table 2

(i)         In 2006 and 2011 the combined Income surplus generated by the private sector at £7 billion and £18 billion (Table 1) is more than wiped out by government transfers for the EU and International Aid (9.5 billion and £17 billion) for the two years.

(ii)        UK government plans to (a) let its payment to the EU budget increase by around £2 billion by 2014/15, and (b) increase its International Aid transfers from about £5.2 billion in 2011 to about £10 billion will make it very likely that the combined “income” and “transfers” account will go negative by 2014/15.  This means that an even bigger load will be placed on the Trade part of the current account.  In fact the UK government is acting as if the balance of payments is of no importance, although all net deficits have to be paid for by borrowing.

Final Comments on the UK Current Account Situation

From 2006 to 2011, i.e. through the recession, the current account deficit actually improved (see 14th March post) by £10 billion.  This was due essentially to an £11 billion reduction in trade deficit, a £17 billion increase in the Direct Investment income, substantially offset by an increase in government spending on overseas agencies – principally the EU (£5 billion) and International Aid (£3 billion).

Overall, one can see from Tables 1 and 2 in this post and Table 1 in the March 14th post that the Financial sector is important to the current account (as it is in Switzerland for instance) but it is not that important.  In particular, export credits are a decreasing part of trading exports and the UK runs a deficit on financial income with the rest of the world, unlike Switzerland which runs a surplus.

While there are some bright spots in the goods part of the trading account as itemised in the 14th March post, the overall picture is of a goods deficit increasing by £24 billion in 2006 to £100 billion in 2011 (6.5% of GDP).  This is due principally to a £9 billion increase in consumer goods (imports) at a time when domestic demand has been suppressed, a worsening of the oil balance by £8 billion and an £18 billion fall in machinery exports at a time when the world beyond the EU and the US is crying out for machines to make things.  These negative features have been offset to a degree by a £10 billion increase in the cars and aircraft account.

Germany exports about £900 billion, about £750 billion as goods; Britain exports about £250 billion for a population which is three quarters of Germany’s.  If Britain were to raise its goods exports by 50% over say a five-year period to about £6,000 per head of population (two thirds of Germany’s £9,000) without a massive imports surge, then the goods trade deficit would be halved to £50 billion – still large but more manageable – with a corresponding elimination of the current account deficit.

But to do this, the measures spelled out in the March 14th post – more factories[2] making a bigger range of consumer products in close cooperation with the retail chains (for import replacement) and a much greater range of machinery (for export expansion) will have to be set as national goals and pursued by industry and government together (see “Produce and Prosper” on this website).

Table 3: UK International Investment Position 2006 & 2011 in £ billion
2006 2011
Item £ billion £ billion
UK Direct Investment Abroad 733 1120
UK Portfolio Investment Abroad 1531 2082
Total UK Investment Abroad 2264 3202
Foreign Direct Investment in the UK 577 775
Foreign Portfolio Investment in the UK 1704 2445
Total Foreign Investment in the UK 2281 3220
UK Net Investment Positions:
Direct +156 +345
Portfolio -173 -363
Direct + Portfolio -17 -18
Returns* on Investment:
UK Direct Abroad 11.4% 8.7%
UK Portfolio Abroad 3.6% 2.5%
Foreign Direct in UK 10.7% 6.2%
Foreign Portfolio in UK 3.4% 2.8%

* Income ÷ Investment x 100. Income is given in Table 1.

Notes on Table 3

1          Returns on Direct Investment by non-financial companies are over three times those of portfolio investment by financial companies.

2          Moreover the returns on UK portfolio investments abroad are only about the same as returns obtained by foreigners on their UK-based portfolios (actually less in 2011).

3          So surely the repeated claims of “special” investment expertise by the Financial sector, especially the City are really not special at all.

4          Given that City portfolio income is in decline and net income negative (see Table 1) and returns are so poor, one wonders what are the objectives of the City.  It is not investment in the British economy which is still in 2012 well below its 2006 levels.

5          The answer has to be transaction fees – on mergers and demergers (thick on the ground lately), commissions on currency sales and purchases mainly divorced from actual commercial requirements, and above all manipulating the famous derivatives – cats cradles of financial transactions almost completely parasitical on the British economy where 99% of our fellow citizens earn their living.

6          Why does the Treasury love the City then?  Because of the domestic taxes it collects n these transaction fees and commissions – which of course are paid for by reduced dividends to shareholders – mainly pension funds who hold equities and commercial bonds.  In effect the whole economy is taxed this way, but nobody notices.


[1]  S F Bush, “The Importance of Manufacture to the Economy”, Transactions of Manchester Statistical Society, 1999/2000, tables 6 and 7, pp 1-46.

[2] S F Bush, “UK Manufacturing’s War for Survival needs more troops”, The Parliamentary Monitor, June 2005.

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