THE PROSPECTS FOR BRITISH EXPORTS*

By DAVID LAW

1. Introduction'The forecasting of exports, because it depends on trends and policies in all

the rest of the world, is likely to remain the most intractable problem in economicforecasting. Since changes in exports have repercussions elsewhere, this limitsthe success one can hope for in forecasting demand as a whole.'1 The NationalInstitute's record of forecasting bears out this judgement: their annual forecastsof the change in exports from 1962 to 1966 were wrong by over 50 per cent.2 InFebruary 1967 they expected exports to rise in 1967 by 5.5 per cent over the1966 level: in fact they fell for the first time in ten years. But such a comparisonof forecast and actual values is not the best way of assessing forecasts becauseeconomic policy changes may be inspired by the forecast itself, with the object ofpreventing the forecast from becoming reality.

In the particular case of export forecasting, as the above quotation suggests,exports are to a large extent outside the control of the Governmentthoughexport prices, and the level of domestic demand can be influencedand to thatextent the rough comparison of forecast and actual value is valid. Ideally oneshould compare the forecast with what would have happened in the absence ofpolicy changes, but this hypothetical situation is elusive since it requires an es-timate of the magnitude and speed of the effects of the policy measures themselves.

At the present time export forecasting is much more difficult than usual. Inaddition to the normal uncertainty about world economic events, exports thisyear will be influenced by the (still uncertain) responses, both at home andabroad, to devaluationnobody yet knows for certain what export price changeswill result from devaluation, or what the price-elasticity of demand for Britishexports is likely to be. Other complicating factors include the postponement ofexports due to last year's docks strikes, measures taken to improve the USbalance of payments and budget deficits, and the degree of stability in the worldmonetary situationto name but a few of the most important.

Not only is short-term forecasting more difficult this year. At the presenttime the basic question is one whose rarity makes it unlikely that the ordinarytechniques of short-term forecasting are perfectly apposite. The usual questionin short-term forecasting is what deviations can be expected this year (or thisquarter) from the basic trends of the past. Econometric models, for example, arebased on relationships estimated from past trends, and provide short-termforecasts when values are independently given to exogenous variables. Short-term forecasting techniques may be inadequate in present circumstances for two

*An earlier draft of this paper was read at the first annual Colloquium held by the EconomicsDepartments of the University of Wales, April 1968 Thanks are due to the members attendingthe Colloquium, and to Professor E. T. Nevin, Mr. D. I. Bateman and Mr. K. Richards forvaluable advice, but any remaining faults are mine alone.

1 R. R. Nield and E. A. Shirley, 'An Assessment of Forecasts, 1959-1960', National InstituteEconomic Review, May 1961.

NIER, November 1967, p. 32.D 315

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reasons. First, the object of the devaluation measures was precisely to breakaway from past trendsto reverse the weakening balance of payments, to raisethe proportion of output exported and the proportion of income invested, and toraise the trend rate of growth of the economy. Secondly, devaluation hassuddenly changed the ratio of British costs and prices to those of our competitorsby an amount which is far outside the normal year-to-year variations in inter-national competitiveness. Available estimates of demand elasticity are generallybased on these smaller variations in relative prices, and it is not known yetwhether demand will respond to the same extent to the large changes in relativeprices brought about by devaluation.

British post-war economic history has been dominated by balance of pay-ments problems and continued failure on the part of the Government to bringabout a more than temporary solution. This failure is all the more remarkableconsidering the variety of weapons used: devaluation (in 1949), exchangecontrols, deflation and 'stop-go'; the import surcharge, export rebates; plans forimport-substitution, export credit facilities; the income policy, knighthoods forchairmen of exporting companies, the Queen's Award to industry; the SelectiveEmployment Tax, the 'piggy-back' expedition; restrictions on overseas invest-ment, continued resort to overseas borrowing; £50 limit for tourists abroad, etc.,etc.

In spite of these and other measures (admittedly not applied simultaneously)Britain continued to experience balance of payments problems throughout the1950's and 1960's. Indeed if one takes four-year moving averages to indicate thelong-run trends, as shown by lines AAl and BB1 in Fig. 1, it can be seen thatboth current and basic balances have been steadily deteriorating since 1958.Then, at last, in November 1967, after unsuccessfully trying to make good thelargest ever basic deficit of £731 million in 1964 the Government was forced todevalue, and early this year to cut back public and private spending at home withthe stated objective of achieving and maintaining a £500 million basic surplus bymid-1969shown as line CC1 in Fig. 1.

Three noteworthy points about these trends are:Although the imbalance has been worsening it is still pretty marginal inrelation to the gross flows, e.g. the 1967 basic deficit of £320 million was only3.5 per cent of gross inflows on current and capital accounts.On the other hand they represent what happened given that governmentpolicy was continually trying to improve the positioni.e. the trend wasconstrained by policyin its absence the trend would have been moreunfavourable.Measures taken to strengthen the balance of payments have had undesirableside-effects in increasing the level of unemployment and reducing the rate ofeconomic growth.

In the present situation the fundamental question seems to be whether thedevaluation measures will succeed, where others have so conspicuously failed, tobreak away from the trends shown in Fig. 1, and to remove the balance of pay-ments constraint on the achievement of fast economic growth with full employ-ment. This is the long-run question, as to whether the trend BB1 in Fig. 1 can be

replaced by the new trend CC1, accompanied by a faster rate of economic growth.The short-run question, with which this paper is concerned, is whether therequired surplus can be achieved by mid-1969. This is a relatively unusual type

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318 BULLETIN

of short-run target, since what is required in the movement from point B2 topoint C in Fig. 1 is not simply a short-term variation around a trend, but rathera traverse from one trend-line to another.

2. Short-term ProspectsShort-term prospects obviously depend on many things beside exportssuch

as the growth of imports, capital flows, the growth of capacity, and the rate ofinflation. But we can arrive at a preliminary export target for mid-1969 by

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assuming that the National Institute of Economic and Social Research is rightin its forecasts of all the other items on the balance of payments.1 As it happens,they envisage a balance in long-term capital (plus balancing item) so the targetof a £500 million basic surplus is also the current balance target. Reckoningeverything on current account other than exports of goods and services, thedeficit amounts to an annual rate of £8,500 million. Add £500 million for therequired surplus, and the export target is £9,000 million (exports defined asexports of goods and services).

Forecasts for exports of goods and services have already been made by threegroups: (a) the Treasury,2 (b) Professor R. J. Ball and Mr. T Burns,3 and (c) theNIESR.4though (a) and (b) are at 1958 prices. All are shown (including bothTreasury forecasts) in Table 1 and in Fig. 2 at current prices (by multiplying the1958 prices' forecast by 1.25the ratio chosen by NIESR).

TABLE 1Export Forecasts for the first lullf 1969, Annual Rates

1958 Prices Current Prices

NIESR ... ... .. ... ... 7,1101 8,9002Treasury: Low ... 6,960 8,700

High ... ... 7,140 8,925R. J. Ball ... ... 7,164 8,956

1 NIESR Feb. 1968, Table 2, p. 12.2 op. cit., Table 3, p. 15.Bearing in mind the highly uncertain factors which will influence British

exports in the next eighteen months it seems astonishing that the forecasts are soclose to each other, and to the target. The forecasts of the increase in exportsdiffer by less than 15 per cent, whereas in less unusual years the NIESR waswrong by more than 50 per cent. If we reckon that the NIESR may be only 50per cent wrong in the change in exports from 1967 (approximately £7,200 million)to mid-1969 this immediately widens the range to £8,050-9,750 million As inmost other examples of economic forecasting, none of these forecasts give anyindication of the likely margin of error. It can however be roughly estimatedin a relatively simple fashion by taking optimistic and pessimistic assumptionsabout each factor which is supposed to be important, combining the optimisticassumptions to estimate the upper limit, and combining the pessimistic assump-tions to estimate the lower limit

First, on the demand side, visible exports would have increased even withoutdevaluation because of the growth of world production and trade. The dollarvalue of world exports increased from 24.65 billion in 1959 to 46.25 billion in1967an annual (compound) growth of 8.1 per cent. Last year it was 5 per cent;this year the NIESR expect 7 per cent, and OECD expects its imports to growby 7 per cent.5

Let us take 4 per cent and 8 per cent as alternative estimates. Over 18 monthsto mid-1969 world exports would then be be $49.5 billion and $52.5 billion

NIER February 1968, Table 3, p. 15.'Financial Statement 1968-69,' March 19th, 1968.The Sunday Times, March 31st, 1968.

4NIER, February 1968.OECD, Economic Outlook, 1967.

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respectively. What does this imply for British exports if devaluation had nottaken place? The UK share of world exports has been falling by 0.23 percentagepoints a year from 9.44 per cent in 1959 to 7.82 per cent in 1966. Suppose thiswould have continued to 1969. Then UK visible exports would have increased by£128 million and £447 million (at old parity) to £5,151 million and £5,470 million.(As a comparison the equivalent estimate for 1968, made by NIESR was £5,260million (in the February 1968 Review) and £5,500 million (in the November 1967Review).

The second factor on the demand side is the effect of devaluation. Demandwill depend on (a) how much UK export prices are reduced and (b) what theprice-elasticity of demand is. Export prices are bound to rise in terms of sterlingbetween 1967 and 1969. The NIESR estimated rises of 2 per cent to abolitionof the export rebate, per cent due to abolition of SET premium and 2f-3 percent due to rising import costs. Allow 2 per cent for increased wage costs and thetotal is about 7 per cent. So firms could cut dollar prices by 7 per cent but somewill choose not to. Let us take 5 per cent and 8 per cent dollar price cuts as thelikely limits.

For a rough calculation all we now need to know is the 'average' price-elasticity of demand for British exports. The result will be an under-estimate ofthe effects of devaluation because it ignores the changing structure of exports, asthe following hypothetical example shows. Assume that there are three com-modities A, B and C, for which demand elasticities are respectively 1.0, 2.0and 3.0. It is reasonable to expect that manufacturers will reduce prices less,as a result of devaluation, of those goods for which demand is relatively inelastic.Suppose that the prices of goods A, B and C are reduced in terms of foreigncurrency by 5 per cent, 10 per cent and 15 per cent respectively. If A, B and Ceach accounted for one-third of the pre-devaluation value of exports, the averageprice fall would be 10 per cent, and the average price-elasticity of demand wouldbe 2. Taking these averages, the value of exports would increase by 8 per cent.But if we calculate the change in export value for each commodity separatelyand then add together, as in Table 2, the value of export increases by 10.33 percent.

TABLE 2Change in Value of Exports following Hypothetical Devaluation

An accurate calculation of the effect of devaluation would clearly require adetailed disaggregation of exportables according to demand-elasticity andproportionate price change, if that were at all possible. In this paper, andindeed in the NIESR estimate,2 only the rough method of taking averages is

UN, Monthly Bulletin of Statistics, March 1968, p. 99.2 NIER November 1967, p. 6.

Commodity Value of exports Percentage Price- Value ofbefore price elasticity of Exports after

devaluation change demand devaluation

A loo 5 1.0 99.75B 100 10 2.0 108.00C 100 15 3.0 123.25

Total 300 331.00

THE PROSPECTS FOR BRITISH EXPORTS 321

used. It must, however, be borne in mind that even apart from the furthercomplication of the relative importance in exports of goods for which demand iselastic or inelastic, the estimate is biased downwards. This is equivalent tosaying that, for example, the elasticity estimate of 2 used by the NIESR waseffectively smaller than 2, to an extent determined by the (uncertain) range ofelasticities for the various British goods exported. The greater the range ofelasticities the greater the underestimate.

Various investigations have been carried out, both cross-section and time-series analyses, and both long-term and short-term, to estimate price-elasticitiesof demand, and two points in particular stand out.' First of all, most concludethat the price-elasticity of demand increases for several years after the initialprice change (or more accurately that there is a distributed lag in the response ofdemand and supply). Secondly, the estimates differ greatly, ranging from plus0.1 (Renton) to 5.5 (Junz and Rhomberg). Let us take 1.5 and 4 asreasonable alternatives.

If we combine the 5 per cent price reduction with 1.5 elasticity, the dollarvalue of exports increases by 21 per cent and combining the 8 per cent pricereduction with 4 elasticity produces a 21 per cent increase in dollar value.Convert the dollar value growth into sterling by multiplying by 116.7 per cent,and the result is a range of 19 per cent to 41 per cent increase in sterling exportsdue to devaluation.

We arrive at a range of export values for mid-1969 by taking the lowerestimate (5,151 million) without devaluation and multiplying by the lowerestimate of devaluation effect (119 per cent) to provide the lower limit, and bymultiplying the higher estimate by 141 per cent to provide the upper limit. Thenet result is shown in Table 3.

Finally, on the demand side, let us make the heroic assumption that serviceswill be increased in exactly the same proportion as goods. The result is thatexports of goods and services would total £8,615 in the pessimistic forecast and£10,822 in the optimistic forecast. The range is shown by the vertical lines PQ(goods and services) and RS (visible exports) in Fig. 2. Briefly, it means thatthe likely range of export demand would result in a current (and basic) balanceof from +f115 million to +2,311 million. The export target of £9,000 millionand the other forecasts are clustered together about one-quarter of the way upfrom the pessimistic level.

Now the question on the supply side is whether there will be enough room leftto enable the export demand to be satisfied, and to answer this we need toconvert the forecasts into real terms (for the sake of convenience, into 1958prices). The lower limit represents an inçrease of £616 million over the actuallevel of exports of goods and services in 1967 (6,276 million) at 1958 prices, andthe upper limit an increase of £2,382 million. This would absorb an extra 2.3per cent to 9 per cent of 1967 GDP over a period of 18 months, and if capacitygrows only at 3 per cent a year even the lower limit would take 50 per cent of the

1 E.g. G. A. Renton, Forecasting British Exports of Manufactures to industrial countries',NIER November 1967; H. B. Junz and R. R. Rhomberg, 'Prices and Export Performances ofIndustrial Countries, 1953-63', IMF Staff Papers, July 1965; A. C. Harberger, 'Some Evidenceon the International Price Mechanism', Journal of Political Economy, December 1957.

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TABLE 3Demand for Exports in the first Half 1969

growth. By the first half of 1969 the Treasury estimate that, taking the effectsof the budget into acount, items other than exports will absorb 2 per centgrowth, so adding the upper forecast for exports would show a total increase indemand of 11 per cent. If we added 2 per cent to include multiplier consequencesof these exports the rise in demand would be 13 per cent of GDP and obviouslyimpossible to supply. Even then the extra investment required to produce thisextra output has been ignored.

In terms of the strain on resources the pessimistic forecast leaves 50 per centof the growth over eighteen months from 1967 to mid-1969, or approximately2.5 per cent of GDP, available for all other uses besides exports. Clearly eventhis pessimistic forecast leaves little room for increases in domestic expenditureif the inflationary conditions of the past are to be avoided. As pointed out above,the optimistic forecast of an increase in demand equal to more than thirteen percent of GDP would be impossible to supply, but in straining the resources of theeconomy would certainly accelerate inflation with potentially serious long-termconsequences.1 Two years' inflation at a rate three per cent faster than ourcompetitors would erode much of the cost advantage gained in devaluation.

It may be objected that the range of values taken for key variables in thispaper is too wide; and certainly where assumptions have to be based on roughjudgements of uncertain facts there is room for disagreement. Two points mightbe made here. First, it seems useful to provide, on explicit assumptions whichmay be checked and amended, a range of possible values as well as the usualsingle-valued forecast. If exception is taken to the specific assumptions usedit is possible to calculate different ranges using what seem to be more likelyassumptions. Second, it should be possible, with more work, to attach astatistical probability to the range chosen for each key variable, and hence tothe range of values for the forecast variable. One means of doing this would beto fit a regression equation to past values of the key variable and to obtainconfidence limits for the regression co-efficients at, say, the 95 per cent level.These limits could then be used to define the range within which one would be95 per cent certain of finding the future value of the variable.

It should be remembered that both optimistic and pessimistic forecasts are based on theassumption that the estimates of all items in the Balance of Payments other than exports madeby the NIESR in February 1968 turn out to b correct.University College of Wales,Aberystwyth A ugust, 1968.

million

Pessimisticforecast

Optimisticforecast

Growth of world trade ... ... ... 4% p.a. 8% p.a.Value of exports, if no devaluation... ... ... 5,151 5,470Change in $ export prices due to devaluation 5% - 8%Demand elasticity ... ... ... ... 1.5 4Export value growth due to devaluation ... ... 19% 41 %

Value of visible exports 6,140 7,713

Exports of goods and services 8,615 10,822