Article for the Labour finance & Industry Group

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June 30, 2012 by johnmillsjml

Are all the austerity, high unemployment, cuts in expenditure and nil or negative growth which are currently in store for us  inevitable? No, they are not. On the contrary, our present economic predicament is directly as a result of entirely avoidable policy mistakes which we should never had made and which would not be that difficult to correct.

Our basic problem is that we cannot pay our way in the world, so we have a payments deficit every year which sucks money out of the economy. The gap then gets filled by more and more borrowing by the government and by private consumers. There is a simple reason why there is too much debt. It is because we do not export enough to pay for our imports.

Why do we have a payments deficit like this? Because most of exports are still manufactured goods and we have allowed our country to deindistrialise to a point where we do not have enough manufactures to sell to the rest of the world to pay for everything we want to buy from them..

An            d why is our manufacturing base so weak? Because it is far more expensive to produce almost everything here than it is elsewhere in the world, especially in the Far East. And why has this happened? It is because the exchange rate in the UK – and indeed in many other western countries – is far too high compared to what it needs to be to make our exports competitive in world markets.

How did we – and most of the West – ever get into this predicament?  In the 1970s and 1980s, when there was a problem with rapidly rising prices, economic policy makers fixated on inflation as economic enemy number one. As a result, to get inflation down, interest rates were raised, the money supply was tightened dramatically, unemployment went up – and price rises did come down. But none of the policy makers involved bothered with what happened as a result to the exchange rate, which shot up as a result of high interest rates and tight money.

Unfortunately, this happened just as South Korea, Hong Kong, Taiwan and Singapore – the so called Tiger Economies – were getting into their stride and also just when China was entering   the trading world. The result was that the cost base for manufacturing from the 1980s onwards has been on average about half most of the East compared to what it is in the West. Because of the continuing obsession among the West’s policy makers on all the policies needed to keep inflation down, it still is. The result is that we have deindustrialised while the East now has far more than it fair share of manufacturing.

What can we do about this? We have to get the value of the pound down – right down – until we can get the UK cost base sufficiently low to enable us to compete. How much devaluation would be required? Probably about 25% from where we are now. A devaluation of this size is needed to generate enough additional exports to eliminate our payments deficit, to allow the economy to grow at 3% or 4% per annum, to reduce unemployment to perhaps 3% and to provide the funding we need for public services.

Is this possible? Yes. If the government was determined to get this done, they could do it relatively easily. Could other countries retaliate? They might try but there is very little they could do to stop us. Will this happen? Probably not – at least for now – because for decades practically every politician, civil servant, political commentator and academic has supported policies which kept the pound far too high. This is the catastrophic mistake we have made.

Eventually, however, the pound will come down. This is because with no growth and mounting debts, sooner or later we will become insolvent, a bit like Greece. When we reach this point, sterling will  crash, after wasted years as we persevere with the wrong policies. When this happens, however, our economy will recover, just as it did after the all too temporary devaluations of 31% in 1931 and 19%,  in  1992. In both cases inflation went down and everyone’s standard of living went up.

Now is the time to do it again – not to waste years in a completely unnecesary and avoidable depression.

John Mills

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