However, Crafts and Kennedy argue that the UK’s economic growth could have been higher with more domestic investment. Contrary to McCloskey’s claim, up to 7% of all workers may have been unemployed, and more domestic investment could have eliminated this unemployment, especially in the building trade according to Clapham. Persistent unemployment reduced maximum potential national income, and therefore reduced the ability of the UK economy to grow as fast as was possible. Furthermore, unemployment may have reduced national welfare if investors’ welfare gain was less than the welfare loss of the unemployed. For the world as a whole though, the flow of UK investment to the most profitable opportunities may have maximised output growth and welfare.
The high level of overseas investment led to an accumulation of assets abroad, which yielded rapidly increasing amounts of income in the form of interest, profits and dividends; overseas income rose from around 2% of GDP to about 7% between 1870 and 1913. Since GDP was rising throughout the period, overseas income therefore rose in absolute terms. Increasing overseas income would have resulted in greater consumption of goods and services. Solomou and Rawthorn argue that consumption of imports increased relative to that of exports, leading to a deterioration in the trade balance (the ‘absorption’ effect); the UK trade balance broadly worsened between 1870 and 1913, with a general movement from 3% of UK GDP in 1870 to –5% in 1900.
According to Matthews, Feinstein and Odling-Smee, the UK’s balance of payments improved (the current account surplus grew) due to increased invisible income from overseas investment, which outweighed the deterioration in the trade balance. They suggest that the increase in investment income therefore resulted (via a strengthening of the balance of payments) in an increase in demand for sterling, the supply of which was effectively fixed due to the Gold Standard, so causing an appreciation in the exchange rate and a fall in competitiveness for manufacturers.
However, the evidence does not fully support this theory, moreover, Matthews, Feinstein and Odling-Smee admit that the balance of payments did not necessarily strengthen due to a rise in investment income so perhaps competitiveness did not fall due to overseas investment. In reality, invisible income may have outweighed the deterioration in the trade balance due to other factors, for example a partial offsetting of the worsening trade balance by a large expansion in coal exports. In general, overseas investment will not necessarily improve the balance of payments since ‘absorption’ effects also due to investment worsen the trade balance.
Edelstein proposes that overseas investment improved the UK’s terms of trade. Edelstein claims that overseas investment reduced foreign producers’ costs. For instance UK investment in railways in Argentina reduced transport costs. Therefore, the price of imports fell, resulting in the terms of trade improving by about 0.1% per year between 1870 and 1913. An improvement in the terms of trade would have enabled the UK to purchase more imports, so enabling greater utility to be gained from a larger level of consumption.
Linked to the macroeconomic effects outlined above, it is argued that overseas investment during the period changed the structure of the UK economy. The possible lack of funds for domestic investment due to overseas investment may have given rise to unemployment, which may have caused the UK economy to under-perform consistently, causing an economic decline relative to competitors such as the USA and Germany. Moreover, the lack of funds for domestic investment may have led to the UK’s failure to develop new sectors such as electrical engineering and chemical industry which perhaps had potential for greater productivity growth and higher incomes.
Similarly, ‘absorption’ effects may have led to discouragement of domestic industry, so that overseas investment further weakened the UK industrial base relative to competitors. The worsening trade balance may have sent the wrong signal to manufacturers. They may have interpreted rising imports as a sign of less demand for their products, when increasing imports were perhaps instead a consequence of rising incomes and insufficient domestic production. Therefore, manufacturers may have (wrongly) felt less incentive to innovate, causing a fall in the long run competitiveness of UK industry.
However, it may not be overseas investment which led to the two structural effects above. The failure to move into new industrial sectors and the declining competitiveness of existing UK industry may instead reflect the increasing development of other countries such as the USA and Germany who competed with the UK for a share in finite emerging industries and export markets. Overseas investment, even if diverted to home, may have been unable to keep domestic industry competitive, given the tariffs and educational systems used by the USA and Germany to protect their industrial sectors.
Moreover, the relative decline of British industry may merely highlight the emergence of a comparative advantage in the service sector, in which the UK specialised increasingly. However, Mathias argues that this shift towards services indicates a failure to develop industry adequately, partly due to complacency based on investment income. A rentier economy is held to have arisen, with a reliance on investment income and an underdeveloped industrial sector.
In conclusion, overseas investment gave rise to various macroeconomic effects. Overseas investment worsened the trade balance via ‘absorption’ effects and improved invisible trade, but did not necessarily improve the UK’s balance of payments or cause the exchange rate to rise. Overseas investment was in the most profitable projects but did not maximise national income and welfare in the short term, due to persistent unemployment. Finally, overseas investment improved the UK’s terms of trade. Linked to these macroeconomic changes, structural effects arose, though their relative importance is less certain. Excessive overseas investment may have led to the UK’s relative economic decline up to today, through an underperformance of the economy due to unemployment, a failure to develop new high-growth industries and a discouragement of improvements in existing industry. The relative decline of industry may have reflected a growing comparative advantage in financial services, but alternatively over-dependence on services may have turned the UK into a rentier economy with an underdeveloped industrial sector.
Points
Possible macroeconomic effects:
Balance of payments – absorption effects – rentier structure
C and I propensities not important over period as a whole
Inflation? – related to BoP, but not a major point – Solomou – only during Edwardian period, rest of time ‘filtered out by other influences’ not inflation, exchange rate!!!
Social return larger than private, welfare increases (Terms of trade improved – EDELSTEIN) Also, industry not lost out because no funds, rather tariffs and education.
Industrialisation overseas so greater competition with UK and less exports eventually…
Possible structural effects:
Britain’s relative decline
Lack of development of new industries
(More conjecture possible this section)
Rentier economy
Discouraged industry (absorption)
