Even with its large service-trade surplus, and additional income flows from overseas investment, travel services and tourism, the UK spends more money abroad each year than it receives from abroad. This gap shows up in its Current Account, which showed a deficit of £81.6bn in 2018 and £30bn (5.6% of GDP) in the first quarter of 2019 .
The UK might seem to be living beyond its means, by consistently buying more from other countries than it can sell to them. But over 30 years of current-account deficits have not stopped the economy growing, or undermined the strength of the pound. The UK is unusually successful in selling assets to pay for current purchases, so that other countries keep transferring us the funds with which to buy their goods.
This is shown on the UK’s Financial and Capital Account, the counterpart to the Current Account, which has been consistently in surplus since the 1980s. There have been consistent net inflows of foreign direct investment (FDI) and foreign portfolio investment (into shares, bonds and other financial instruments), along with capital gains on the stock of foreign assets (real and financial) held by UK-based investors.
In 2017 (the latest year for which detailed data is available), the UK received inward direct and portfolio investment equivalent to 23.5% of its GDP, while its outward investment reached only 19.7% of GDP . This net inflow financed the current-account deficit, which had narrowed to 3.9% of GDP (from a record 5.2% in 2016).
If the rest of the world keeps investing more in the UK than the UK invests abroad, there could eventually be a net outflow of interest and profit, adding to the strains on the current account. Foreign ownership of UK assets moved into line with UK ownership of foreign assets in 2016 , ending a long phase in which assets abroad comfortably exceeded liabilities. In 2017 the UK’s £1.31 trillion stock of outward FDI was slightly below the £1.33 trillion that had flowed into it .
The UK can still use this to pay for its excess of imports over exports, however, provided it generates enough income from its still sizeable foreign assets. When the current-account deficit narrowed sharply in 2017, it was mainly due to a strong rise in net earnings on the UK’s foreign direct and portfolio investments . Financing the current-account deficit with capital inflows is substantially more comfortable than closing it, which would require a weaker pound to boost our exports and a slowdown in growth to curb our appetite for imports.