15.3 UK trade: the proper definition of "trade"

The word "trade" is often used, carelessly and wrongly, to mean "trade-in-goods" only. The proper definition includes trade in Goods, Services, Income & Transfers.

The last twenty years have seen a massive increase in the amount of Foreign Direct Investment (FDI) worldwide.  The UK is a major factor in global FDI, both as investor overseas and as recipient, usually ranking first or second in the world for both outward & inward transactions. During the same period, the "City", which accounts for around a fifth of the total GDP of the UK,  has increased its share of the world market for financial services, and is currently the world leader.

The economic impact of FDI and the City is reflected as "Income" in the Current Account of the Balance of Payments data. Table 1 shows that the value of UK earnings classified as "Income" now outstrips the earnings from exports of "Services", and is not far behind earnings from exports of "Goods".

Table 1: UK Exports Worldwide by Category: 2005

Source: UK Balance of Payments: The Pink Book 2006, p 122

The proper definition of "trade" (encompassing both exports and imports) is that used internationally in the Current Account of the Balance of Payments. This consists of flows across the national borders of:

Goods + Services + Income + Transfers

The specific reasons for including "Income" in the definition of "trade" are:

• Earnings on Foreign Direct Investment (FDI), a major component of "Income" [Table 2] are conceptually similar to earnings derived from trade in goods and services. FDI, exports of goods and exports of services are different ways of supplying foreign markets - usually complementary: as much as half of all international trade in goods is between fellow-subsidiaries of multinational companies. A pound remitted in the form of dividends or interest (a receipt of income) from, say, a US subsidiary of Rolls-Royce is just as valuable to its British parent company as the proceeds of selling a jet engine to Boeing (an export of goods) or the proceeds of an engine-maintenance contract with an American airline (an export of services).
• At present, the earnings from UK FDI overseas account for around two-fifths (42 % to be exact) of all "Income" on current account [Table 2]. The remaining approximately three-fifths of "Income" on Current Account reflects, broadly speaking, the activities of the City of London and other UK financial centres (notably Edinburgh) [Tables 2 & 3]. Some of that activity is "captured" in the Services category. For example, on a UK bank loan to an overseas customer, the associated arrangement fees would be classified as an export of "services". However, the much larger flows of loan interest would be classified as a receipt (i.e. an export) of "income". A very small proportion of "Income" [Table 4] consists of "compensation of employees", for which the trade justification might be argued to be tenuous: but for the sake of consistency with the UK and international Current Account statistics, it seems appropriate to regard them as "trade".

Table 2: Breakdown of Investment Income by Category: 2005

* of which earnings on banking transactions 60.

Source: UK Balance of Payments: The Pink Book 2006, p 66.

Table 3: Breakdown of Investment Income by Type: 2005: £ bn

Source: UK Balance of Payments: The Pink Book 2006, p 5.

Including  "Transfers" in the definition of "trade" is, on the face of it, more dificult to justify, since in the case of the UK a large part of it consists of the outwards flow (an "import") of UK taxes to Brussels - the UK gross contribution - and the inwards flow from Brussels (an "export") of farming and structural subsidies. However, to the extent that the resulting UK net contribution to Brussels is regarded as an "entrance fee" or "annual subscription" to the Single Market - in other words a cost of doing business with the EU  - it is fair to classify "Transfers" as "trade".  Other transfers consist of UK payments to bodies such as the UN or NATO and of bilateral aid, for which the trade justification is again tenuous: but in view of their small relative size, and for the sake of consistency with the UK and international Current Account statistics, it seems appropriate to regard them as "trade".

Table 4: Breakdown of [Receipts of] "Income": 2005 (£bn)

Source: UK Balance of Payments: The Pink Book 2006, p 58.

IM, January 2007.