The current account, together with the capital account (non-produced, non-financial assets-such as copyrights) and the financial account (transactions associated with changes in ownership of financial assets and liabilities) make up the UK’s balance of payment.

While the concept of trade in goods and services is relatively self-explanatory, other items on the current account are less clear.

Investment income balance

Put simply, the investment income balance is the difference between earnings from UK-owned investments in overseas countries and that paid out to foreign owned investments in the UK.

This includes direct investments (e.g. setting up a car plant) as well as portfolio investment (e.g. equity shares in the company which owns the car plant).

Employee salaries

The category ‘employee salaries’ covers mostly payments earned by individuals for work done in a country in which they are not resident.

Current transfers

Finally, current transfers are payments made and received within twelve months by general government and other sectors such as EU institutions.

The profile of the current account usually follows broadly that of trade in goods, which is its biggest component.

After hitting almost £26bn, or 4.9% of GDP, at the height of the late 1980s boom, the current account deficit narrowed sharply during the early 1990s; the gap closed further in subsequent years, and in 1997 the deficit came within a whisker of disappearing, shrinking to a mere £962 million.

Source: ONS

From 1998, however, the current account deficit started widening again and, after stabilising in 2001-2003, the gap widened sharply again, reaching a record £44 billion in 2006 before shrinking back to £25 billion in 2008.

The deficit as a share of GDP has also widened, although the 2006 peak figure of 3.3% is some way below the record 4.9% reached in 1989.

Equally significant, though, is the fact that the way in which this country pays its way in the world has changed. In particular, goods trade, which in the 1970s represented some 60% of the value of current account transactions (total debits and credits), has declined in relative importance and now accounts for less than half of all current account transactions. This suggests that widening goods trade deficit is a less certain predictor of a marked deterioration in the overall current balance.

Meanwhile, the surplus generated by trade in services has been growing strongly, rising from under £7 billion in 1990 to nearly £54 billion in 2008; not surprisingly, this strong growth has also seen the sector taking an increased significance for the current account, its share of transactions rising from 13% in 1990 to 20% in 2008.

There has also been a very rapid growth in another key element of the current account, namely investment income.

For most of the 1990s, investment income represented a little under 30% of current account transactions by value. Between 2000 and 2007, however, investment flows rose strongly before falling back slightly in 2008 when the total value (both inward and outward) stood at £500 billion, nearly double the 2000 flow and 35% of current account transactions.

Source: ONS

The good news is that this has translated into much stronger surpluses on the investment income element of the current account.

During the 1990s, the annual surplus on investment averaged £1.7 billion but then over the period 2001-2008, it surged to nearly £20 billion a year.

In general, the flow of net investment income is sensitive to changes in the exchange rate: a stronger pound reduces the value of overseas profits by UK companies, while a weaker pound means that overseas earnings are boosted by the conversion into sterling.

TABLE 17.5: THE UK's CURRENT ACCOUNT, 2008 (£ million)

In 2008, the current account deficit was £25.1 billion, the major contribution to which was the deficit on trade on goods.

Although the deficit seems large, it is important to bear in mind the relative size of trade flows. In 2008, the UK exported goods worth £251 billion compared to imports of nearly £344 billion, yielding a goods trade deficit of nearly £93 billion.

This is not unusual, for there have been only six years since 1945 when Britain managed a surplus on its trade in goods.

In the past, especially when the UK had to defend a fixed exchange rate, big deficits on goods trade have been major headaches for governments. It was once the case that a sizeable trade deficit was liable to precipitate a run on the pound, thereby necessitating urgent action by the Government to curb the demand for imports.

This was once a common feature of Britain’s post-war “stop-go” cycles.

Now, however, because of the growth of other sources of overseas earnings (trade in services, and investment income) the record trade gap does not mean that the economy is coming off the rails.

Rather it is an indication of how tough life has become for the manufacturing sector. And it reflects structural changes in the domestic economy.

Given that some 40% of manufacturing output is exported (compared to about a tenth of services), it is almost inevitable that the manufacturing sector will bear the brunt of any downturn in the global economy.

This was very much the case following the global downturn of 2001 and 2007-08, both periods seeing a sharp fall in UK manufacturing output.

Source: ONS

The current account gives a fuller picture of Britain’s transactions with the rest of the world.

In 2008, for example, a surplus of £54.5 billion in services and a further £27.6 billion from overseas investments partly offset the shortfall on trade in goods.

Adding the £13.6 billion deficit on transfers left the overall current in the red to the tune of £25.1 billion, equivalent to 1.7% of GDP.

The growing trade deficit is a warning sign that GDP growth in the UK is too unbalanced between domestic demand and the external position.

The growth which the UK has enjoyed over the last decade and a half has been overly dependent on consumer debt and, more latterly, government debt with net trade and investment making too little a contribution.

It is important, therefore, that when recession is replaced by recovery the UK finds a new path for sustainable growth based on improving the international trade.