On October 16, the House of Lords Select Committee on Overseas Trade published its report on the UK balance of trade deficit in manufactures. Alasdair Smith, Co-Director of CEPR's research programme in International Trade, discussed the report at a lunchtime meeting organized by CEPR that same day. Smith praised the report for its excellent, clear analysis of the long-run problems facing the British economy, but he argued that its advocacy of increased protectionism was both unhelpful to British industry in the long run and dangerous for the world economic system when protectionist forces in the US are so strong. Smith's talk was one of a series in which CEPR Research Fellows discuss research relevant to economic policy; the opinions expressed are their own and not those of CEPR, which does not itself take institutional policy positions.

Smith stressed that the balance of trade deficit in manufactures is a poor indicator of the performance of 'the manufacturing sector' of the economy, and undue attention to it can lead good analysis towards bad policies. Emphasis should be placed on policies designed to increase productivity and to boost real incomes; policies which concentrated exclusively on the manufacturing sector might actually reduce real incomes.

It was important, Smith maintained, to distinguish long-run concerns about the performance of the UK economy as a whole from other issues, such as: (i) macroeconomic management, especially the effect of monetary policy on the exchange rate; (ii) the inevitable impact of North Sea oil and of the successful overseas performance of the services sector; (iii) the question whether the government should discriminate in favour of manufacturing as such.

In his comments on the Report, Smith called attention to the fallacy that manufacturing production is uniquely 'wealth creating'. The brewing of beer, for example, is not an intrinsically more worthwhile or valuable activity than the writing of computer software.

The Select Committee, according to Smith, had done an excellent job in identifying the problems that will inevitably arise toward the end of the century, when the flow of oil from the North Sea diminishes and the balance of trade in oil moves from surplus to deficit. The view of the Treasury seemed to be that adjustment to this change would occur automatically. The Select Committee report argued that this adjustment though necessary would not be painless. Smith agreed with the report that much of the burden of adjustment will fall on the manufacturing sector, just as it had when the flow of oil built up. It was nevertheless important in this context to focus attention on resource allocation and not merely on the behaviour of the exchange rate. Increased production for export or lower domestic consumption would be needed as the flow of oil diminished. Increased productivity would allow the adjustment to occur with less pressure on real wages and incomes, Smith argued.

Smith described as 'laudable' many of the policy prescriptions of the Committee. It is widely agreed, for example, that changes in national attitudes to productive activity, changes in the education system and more attention to price and non-price competitiveness would bring economic benefits. Smith noted, however, that such changes are desirable quite independently of the country's balance of trade position, and they will benefit sectors other than manufacturing. If all these changes were introduced, the UK would enjoy higher real incomes, with or without North Sea oil. The UK might still have a balance of trade deficit in manufactures even with such higher incomes; this suggested that the manufactures balance was not in itself a useful focus for policy. Smith agreed with the Committee's view that the government should pay more attention to the microeconomic effects of real exchange rate fluctuations which result from macroeconomic policy changes.

Smith found it harder, however, to defend the Committee's proposals to aid manufacturing industry per se. It was true that as the flow of oil diminished, more exports would be needed to fill the gap; this would require greater manufacturing production and certainly higher productivity. Smith did not agree that this justified special treatment for manufacturing. Aid for manufacturing meant a transfer of resources away from other sectors, and this needed justification. In particular, he criticized as oversimplified the report's case for increased export promotion.

Smith described the report's advocacy of increased protectionism as 'both unhelpful to UK industry in the long run and very dangerous for the world economic system, at a time when protectionist forces in the US are so strong'. It was hypocritical, he argued, for the Committee to advocate 'Buy British' policies in paragraphs 210 - 220 of its Report, and then in paragraph 227 to attack the effects of US 'Buy American' policies! This would strike directly at the developing countries, Smith argued. Their ability to expand output and production, and thus to increase their prosperity, were the result of freer world trade. This was the outstanding success of the post-war economic system, now threatened by protectionism.

The discussion which followed ranged over a variety of issues. Concern with the balance of trade really reflected an underlying concern with employment, one participant argued. Smith agreed that employment was an important issue but stressed that this was a question of macroeconomic and exchange rate policy, as the Committee had noted; the remedy did not lie in manipulation of the trade balance. Policies should be designed to increase real incomes and productivity; in this respect Smith believed that studies of specific industries and the problems they faced might have been enlightening.