You have a good understanding of the components of the accounts, and have identified several reasons why there might be a deterioration. I have made a small number of changes to your essay. I think it is worth a B rather than an A grade - say 14 marks out of 20. This is because you have neglected to mention a number of factors such as the effect of rapid income growth or the problems arising from the scrapping of a great deal of manufacturing capacity. I have covered these and other points below, and you might like to extract at least some of them and incorporate them into your essay.
The UK’s persistent trade/current account deficit has a number of causes, both short and long term. It should be noted that the scale of the deficit has been reduced since 2007; this is a reflection of six quarters of recession and declining consumer spending on imported goods and services.
A higher growth rate in the UK (before the credit crunch and recession after 2008) than that in our major trading partners (USA, EU, Japan) meant that the growth of imports exceeded the growth of exports (held back by low growth or recession elsewhere). In the UK there is a high propensity to buy imported goods and services, partly reflecting a tendency for consumers to prefer foreign produced output, and when real incomes are growing rapidly and there is an accompanying consumer boom (as seen up to 2008) there is invariably an acceleration of the volume of imports coming into the country. Part of this is caused by a lack of productive capacity of firms, particularly in the manufacturing sector (where the UK deficit is at its greatest) – manufacturing nowadays accounts for only 12% of UK GDP, and so when growth rates are high, if home producers have insufficient capacity to meet demand from consumers then imports will come in to satisfy the excess demand.
In some sectors there is evidence of poor price and non-price competitiveness of firms - cost levels and thus prices relative to international competitors are a measure of competitiveness, while non-price factors are also important. These include quality, design, reliability and after-sales service. The UK has suffered from declining comparative advantage in many areas - the advantages that countries have in producing certain goods and services change over time as technology alters and other countries exploit their economic resources and develop competing industries. UK manufacturing industry has suffered over the years from low cost production in newly Industrialising countries (particularly the BRIC countries) and from southern and eastern member states of the European Union. This trend has been particularly pronounced since the creation of the Single European Market after 1986, and the enlargement of the EU since 2004.
Often the current account deficit increases quite rapidly when the exchange rate is over-valued for a significant period of time - The strength of the pound until 2008 made life difficult for UK exporters in overseas markets. This is because a rise in the value of sterling leads to a rise in the foreign price of UK exported goods and services. When UK prices are higher, foreign consumers are less likely to buy our products. The high exchange rate also makes imported goods cheaper inside the UK. This leads to a rise in the volume of imports and a fall in the share of the UK market taken up by goods and services imported from overseas. This particularly affects the manufacturing sector, both in domestic and export markets
The rising trend UK current account deficit suggests that the UK is continually ‘living beyond its means’. It is, however, seldom regarded as a problem, and this is why it receives remarkably little coverage, either in the press or in parliament. The Balance of Payments automatically ‘balances’ in that credit and debit entries must add up to zero; so any current account deficit will be matched automatically by an equivalent surplus on the financial account. The latter is dominated by direct and portfolio investment and by short term financial flows, and the UK has experienced no difficulty in recent years in attracting capital inflows, though this is nowadays more difficult. In this sense, the current account deficit is not a problem. There are essentially three types of inward investment. Direct investment, including mergers and acquisitions, is in deficit. Portfolio investment (in bonds and equities) is broadly in balance. Hence the key financial mechanism has been 'other investment', which is made up largely of liquid and short term flows, including cash on deposit. This flooded into the UK on account of higher interest rates and booming property and financial markets, and could be seen as gains for UK banks and investment institutions at the expense of UK exporters. Such flows have, however, rather dried up following the credit crunch and the UK’s historically low interest rates.
The enormous trade surpluses and rising savings levels from the fast-growing Far Eastern countries and OPEC nations also have to find a home in the global economy and, until recently, the UK seems to have attracted a disproportionate share of this cash, as overseas investment flooded into London property, UK government bonds and bank accounts which offered a relatively high interest rate. The UK’s ability to attract hot money depended largely on the interest rate differential that kept UK rates at a higher level than those set in the USA, Japan and the eurozone.
The COMPOSITION of the UK’s deficit raises greater concern, because it highlights the relative weakness of the UK manufacturing sector. Uncompetitive manufacturing exports lead to job losses and the rundown of productive capacity, and thus exacerbates regional disparities. In the long run, if imports are increasingly taking over from domestic producers, this threatens economic growth, employment and living standards. The staggering size of the trade deficit in goods is symptomatic of a deeper lack of competitiveness of UK industrial sectors as they face up to the challenges and pressures of globalisation. The UK has undoubtedly built an impressive comparative advantage in many service industries, not least in business and financial services and also in cultural products But manufacturing industry exports the majority of the output it generates and many service jobs depend on maintaining a healthy and successful manufacturing base. It should also be noted that our surplus in oil since the early 1980s is now running at a deficit, while there is a traditional deficit on food, drink and tobacco. The financial services surplus has shrunk on account of international banking turmoil.
I hope this is helpful.