A2 Economics Revision - The US and the UK Economy

This revision note covers some of the macroeconomic connections between the UK and the USA economy.

The United States is the largest economy in the world and macroeconomic developments in her economy inevitably have a significant impact on the global economy and prospects for the British economy. This revision notes flags up a few of these:

Data from Timetric.

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United States Real GDP Change from Previous Year from Timetric

The sheer size of the US economy means that what happens there has important feedback effects on the wider global system which then affect us. Ex Prime Minister Gordon Brown repeated ad nausea that the recent recession in the UK “started in America” with the bursting of the sub-prime crisis. Whilst there is something in this argument, the reality is that events in the USA were not the dominant cause of the financial crisis in the UK in 2008-09.

1/ Trade
Around 16% of the UK’s trade in goods and services is with the United States, indeed, save for the European Union, the USA is the largest single export market for the UK. So changes in the economic cycle in the USA may affect the size and growth of export markets for many UK businesses and also the prices of products imported into the UK from the USA. The UK runs a sizeable trade surplus with the United States - it grew above £25bn in 2009 with exports to the USA just below £70bn last year.

2/ Investment
The UK has many large-scale investments in the United States - data for 2009 shows that the USA is the leading overseas destination for British investment. When the US economy is strong, successful external investments from UK companies and individuals will generate a rising flow of interest, profits and dividends back into the UK - adding to our GNP and helping to improve the current account of the balance of payments. US companies and institutions are major investors in the UK.

3/ Exchange rates and commodity prices
The US dollar ($) - sterling exchange rate is one of the most heavily traded currencies in the international financial system. The external value of the dollar (which is a floating currency) is determined by factors such as relative interest rates, expected rates of return on overseas investments, the strength of the domestic US economy, growth and inflation expectations and world demand for the US dollar as a reserve currency.

Consider a situation where the US dollar weakens against a basket of international currencies. This is likely to cause an appreciation in the value of sterling against the dollar. Because many internationally-traded commodities are priced in dollars, then a rising $/£ exchange rate will make it cheaper for the UK to import commodities and raw materials.

Trade, investment and currency effects are important for the UK economy but it would be wrong to attach too much weighting to the consequences of developments in the USA for Britain. We now live in a multi-polar world - the global economy has more than one engine of growth as the balance of economic power shifts away from developed countries (e.g. the G7) towards emerging market countries. Growths in nations such as the BRIC nations and a growing number of other developing nations are key in understanding the prospects for Britain as it looks to emerge from the recent recession.