Bulletin November 2012 – Far the most important reason why unemployment is so high is our grossly over-valued pound

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November 15, 2012 by johnmillsjml

There is no mystery about why unemployment in the UK – and in most of the western world – is so high and so persistent. It is that sterling – and indeed most western countries’ currencies – are grossly over-valued in relation to those in much of the developing world. This Bulletin explains why, as a result, the exchange rate plays such a critical role in creating an environment where so many people in the UK cannot find a job or have dropped out of the labour force altogether, and what has to be done if unemployment is to be brought down to much more acceptable levels.

The Scale of the Problem The number of people in the UK meeting the internationally agreed definition of unemployment is currently close to 2.5m – about 8% of the potential labour force – of whom a disproportionately large percentage – over a million people altogether – are aged between 16 and 24. Despite the fact that the total number of people in work is nearly 30m – the highest it has ever been – these figures hugely underestimate the true scale of the problem of lack of unemployment among those in the potential labour force as a whole. If, in addition to those registered as unemployed, all those who are not looking for work but who would do so if work was available for a reasonable wage are included, the true number of people out of work is closer to 5m. A recent TUC survey showed that about 4.9m people in total who would be able and willing to work if jobs were available at reasonable wages were out of work. Some are on long term sickness benefit. Others are caught in benefit traps which make working uneconomical. Many people who could work have given up trying to find a job as a hopeless quest. These include a large number of people forced into early retirement.

Especially at a time when the population is aging and the ratio between those of working age and those who are over retirement age is steadily rising, it makes no sense whatsoever to have such a huge proportion of those who would be willing to work, if the opportunity to do so was there, left with no prospects of a job. It is also clear that unemployment is a massive personal tragedy for almost everyone without work. Furthermore, especially at a time when there is such a massive government deficit, it makes no sense to have huge numbers of people dependent on the state for their incomes and paying no taxes on their earnings, because they are making no contribution to the national income.

History Historical experience shows that it is completely unnecessary to have anything up to almost five million people in the UK with no jobs. The idea that there are large numbers of unemployable people bears no relationship to what has actually been the experience in the past. During the latter stages of World War II, for example, there was almost no-one without a job at all in the UK as just about everyone capable of doing any kind of work was mobilised to do so. During the whole of the post–war period from 1945 to about 1970 there was also almost no unemployment in the UK either as the average number of people out of work oscillated round about 2%. It was only in the 1970s and early 1980s – when the introduction of monetarist policies under first the Labour and then the Conservative Government from 1979 caused the exchange rate to go up by over 60% between the years 1977 and 1982 – that unemployment started becoming a serious problem.

Since then, the true scale of unemployment in the UK has steadily increased. While the headline unemployment figures have fluctuated since the 1970s at anything from less than 4% in 1973 to 12% in 1984, the true number of those with no job at least in the formal economy who would be willing to work if it was worth their while doing so has risen to almost twice the headline figure. The UK has a massive unemployment problem.

Why over-valuation produces unemployment The process whereby the over-strong pound has caused such high levels of unemployment is not difficult to understand. It happens for the following sequence of reasons:

1.A Uncompetitive Exports If sterling is too strong, all the costs incurred in the UK in the production of goods and services get charged out to the rest of the world at too high a price. This is particularly a problem in manufacturing where a large proportion of the goods produced by any advanced and diversified economy such as that of the UK are very price sensitive. Since most foreign earnings in an economy like the UK’s are still manufactures, high prices mean losing out to foreign competitors and losing share of world trade. This is exactly what has happened to the UK. In 1950 Britain produced 25% of the world’s exports. We now achieve about 2.3% – less than a tenth of the ratio 60 years ago.

1.B Balance of Payments When exports are over-priced and imported goods are correspondingly competitively priced, the balance of payments on current account – the difference between what we earn from sales of our goods and services abroad and what we pay for all our imports – tends to go into deficit, even allowing for other factors such as net income from abroad and transfers to and from other countries. Small deficits are manageable but large ones are much more problematic, not least because all deficits have to be financed by borrowing. The reaction of governments faced with trade deficits is therefore to damp down the economy in order to reduce the demand for imports and thus the deficit and to raise interest rates to stop sterling depreciating.

1.C Lack of Demand Both cutting back demand and increasing interest rates then feed through to increasing unemployment. Running the economy at less than full throttle means less money being spent and falling demand for labour of all sorts as businesses across the board find their revenues falling. At the same time, higher interest rates discourage investment, producing another reason why the requirement for labour goes down.

1.D A Vicious Circle The fact that exporting, with an over-valued currency, is much less profitable than importing has a corrosive effect on manufacturing, especially if the over-valuation is long lasting. Lack of profitability hampers investment and the development of new products. Marketing budgets get reduced. Research and development is cut back. Hardly surprisingly in these circumstances few talented people go into industry rather than other occupations which offer much higher earnings and better prospects.

1.E Productivity Lack of demand does not, however, stop productivity among the employed labour force slowly increasing – typically by about 2% per annum – as new techniques and management practices diffuse through the economy. Rising productivity should normally be welcomed because this is what raises living standards. If, however, overall demand is only increasing slowly – or perhaps not at all – rising productivity does not produce more output, it simply increases the number of people out of work.

The Pathology of Unemployment As unemployment creeps up, the economy becomes less and less able to be efficiently run, exacerbating other problems linked directly to high levels of unemployment. In particular:

2.A Regional Problems Manufacturing decline contributes strongly to regional unemployment. Some parts of the country have always been much more dependent on industry than others. If the economy de-industrialises – which is what has happened to the UK as a result of our manufacturers being unable to compete in world markets – this leaves large areas of the country with no way of generating adequate incomes for everyone. The regional imbalances which follow then make it much more difficult for any stimulus provided to the economy to reduce unemployment in the most disadvantaged areas to become effective before those better placed start over-heating.

2.B Educational Deficiencies Another way in which very high levels of unemployment feed on themselves is through the education system. Economies with high levels of unemployment tend to have much worse education outcomes than in those where jobs are plentiful. This is hardly surprising. If the job prospects for school leavers – especially for the more disadvantaged – are very poor, the benefits from education are much less obvious to those at school. If the formal economy offers no opportunities for productive work, it is not surprising that a significant proportion of those at school feel alienated and become poor potential employees.

2.C The Welfare State High levels of unemployment also feed on themselves in another way. The Welfare State is there to provide, among other things, income and other forms of support for those who have no job. If unemployment is low, this can be done relatively easily. As the proportion of the potential labour force which is out of work gets larger and larger, however, the difficulties of financing payments to more and more people who are claimants but paying no income tax becomes progressively greater. High levels of taxation on people with relatively low incomes then increases dependency as the extra income from working becomes worth little or nothing more than what can be obtained by staying at home and receiving benefits.

The UK’s over-valued currency is thus not only the major reason why we have such high and persistent levels of unemployment. It is also doubly unfortunate that having so many people out of work makes all other policies needed to make the economy perform well much more difficult to implement successfully. We pay a very high price in both social and economic terms for our exchange rate policies which – quite unnecessarily – have consigned so many people to a life of idleness when providing them with work opportunities would be so much better for them and for everyone else.

If we could rebalance our economy so that we could pay our way in the world, thus removing the constraints which are the cause of the lack of sufficient job opportunities in the UK both in terms of quantity and quality, there is no reason why we should not be able to get back to around 3% unemployment, reducing the true numbers for those out of work over a period of time from nearly 5m to perhaps 1m. To get this done, however, we need an exchange rate which will get manufacturing re-established on a much larger scale, so that we have enough to sell to the rest of the world. There is no reason why this could not be done if we were determined to make it happen.

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