All abroad for Britain's recovery

Analysis

THE IDEA of being a rentier - someone who lives on rents, dividends or other investment income rather than income from work - strikes an uneasy chord with most Britons: it feels vaguely unhealthy to depend on the hard labour of others rather than one's own toil. But is it so with nations? One of the most interesting and so far little-noticed features of this economic recovery is the way in which Britain has, over the last couple of years, come to depend more and more on income from overseas investments. We have become a bit more of a rentier economy.

In one sense there is nothing new here, for Britain has a tradition of investing overseas. By the end of the last century, foreign investment income was about one-third of total foreign earnings. We thought of ourselves as the workshop of the world but in fact much of our prosperity depended on the workshops of other countries.

Our investment income now is proportionately smaller than that, but it has been rising very rapidly. Just as important, the surplus on investment account - what we earn from our foreign investments, less what other countries earn from their investments here - is the highest ever recorded. As the graph on the left shows, whereas in 1990 and 1991 we were more or less square on this account, last year the surplus was more than £2bn in each of the first two quarters of the year, and more than £3bn in the third and fourth quarters. It was largely because of this increasing surplus on investment income that the country was in current-account balance last year. (The preliminary figures, published just over a week ago, showed an overall deficit of £200m, but that is as near to balance as to make no difference.)

How have we done it? It is not as though the country has been running large current account surpluses that have been invested abroad. We did run a sizeable surplus in the early 1980s, when oil export revenues were at their peak, but the surplus was blown in the series of deficits associated with the late 1980s boom. Instead, we seem to have used limited resources wisely. We have borrowed money and invested it in buying foreign companies. The improvement in the investment income balance last year came about largely because receipts from the foreign subsidiaries of British companies rose sharply while the interest payments fell.

That improvement will not necessarily be sustained, for interest rates are already rising in most parts of the world, but as a broad strategy it has been a successful one. Just how successful is demonstrated by the graph on the right. This shows the net asset position of the G5 group of rich nations over the 10 years to the end of 1993: the value of all overseas assets minus the value of the foreign-owned assets here. The most dramatic features are, of course, the plunge into the red by the US, the soaring surplus of Japan and the extent to which German unification has cut the surplus there. But the experience of Britain is interesting, for we have pulled back from bare balance at the end of the 1980s to a surplus of some $30bn (£19bn) at the end of 1993.

Figures for the other countries are not yet available, but the Central Statistical Office's first estimates of the UK's net asset position at the end of 1994 show a further rise in the surplus of nearly £16bn, bringing the total to £36.3bn - a little more than $50bn.

To be fair, this achievement is not entirely the result of a brilliant investment strategy. It is also partly a function of the devaluation of the pound. If the pound goes down, that has the mathematical effect of cutting the value of other countries' investments in the UK and increasing the value of our investments abroad.

In theory, the prices of the various investments should eventually rise or fall to adjust to the different inflation rates. In practice, the links are pretty loose. But exchange rate changes are a subsidiary factor in determining the success or otherwise of a country's investment performance. After all, the steadily strengthening yen has not stopped Japan remaining the world's largest creditor nation, while the long-term decline of the dollar has not prevented the US from slipping further and further into debt.

This reliance on overseas investment income is showing up in another way - a divergence between the growth of gross national product (GNP) and gross domestic product (GDP). This distinction might appear a bit arcane, as the two measures of a country's wealth generally give similar figures. But there are a few countries where overseas investment income is a large proportion of the total income - Kuwait before the Gulf War is a good example - in which the distinction does matter. For GDP would only reflect the value of the economic activity going on within the country itself, while GNP shows the total economic activity "belonging" to the country, even if it takes place abroad.

The distinction may start to matter for us. Last year, thanks to this sharp rise in investment income, GNP rose by nearly two percentage points more than GDP: 5.8 per cent as opposed to 3.9 per cent.

This affects the incomes of some of us, albeit indirectly. Anyone depending on income from a job will not notice the benefit of a rise in foreign income. But anyone dependent on income from savings, say a pensioner in a funded pension scheme, will benefit from the rise in the income if it enables higher payouts - though, naturally, this will take a while to filter through. It is perfectly possible to envisage a situation in which, 10 or 15 years from now, it will be much easier for us to sustain reasonable pensions for our growing numbers of retired people if both our direct and our portfolio investments overseas perform well. From the point of view of anyone living on the earnings of their savings, it really does not matter where those savings are lodged; what matters is the return on them.

There are, however, three further issues raised by this success in managing foreign assets. One is that it makes a country vulnerable to any catastrophe in the world economy. You could argue that all developed countries are so interdependent now that this additional element of dependence is insignificant. But it is worth remembering that when the Tsars were overthrown, France, which had invested heavily in Russian imperial bonds, lost more than half its foreign assets. There are dangers, as well as rewards, in foreign investment.

Second, if managing a portfolio of foreign investments leads to neglect of domestic investment, then there are costs in terms of poorer domestic economic performance. This is familiar line of attack mounted against British finance. Even people who reject this argument (and there really is not much evidence that worthwhile projects fail to go ahead because of a lack of funds) should acknowledge that there is a danger here.

And finally, not so much a concern but a comment. Roughly half our physical exports go to the other members of the European Union. But 85 per cent of our foreign investments are outside the EU. If these investments continue to come up trumps, as they did last year, policy will shift towards protecting and fostering those investments. That will inevitably lead to greater emphasis on our economic ties with the rest of the world, rather than with continental Europe. It is an argument for looking to the whole world, not just our near neighbours.