November 23, 2012 by johnmillsjml
Public opinion in the UK is increasingly resigned to years of austerity, high unemployment, low or negative economic growth, cuts in expenditure and declining national influence. Is this pessimism warranted, or is there an alternative approach to economic policy which would produce far better outcomes? Why should it be the case that we are doing so poorly when much of the world – especially round the Pacific Rim – is doing so much better?
Could it be, contrary to conventional economic wisdom, that our current predicament is the direct result of entirely avoidable policy mistakes which we should never had made and which would not be that difficult to correct? Let me try to persuade you that it is.
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 and we have to borrow to fill the gap.
Why do we have a foreign payments deficit? It is because most of exports are still manufactured goods and we have allowed our country to deindustrialise 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 almost none of the policy makers involved were concerned enough with what happened as a result to the exchange rate. In the UK’s case, it rose by over 60% between the late 1970s and early 1980s.
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 in the East was on average barely half what it was in the West. Because of the continuing obsession among the West’s policy makers on policies needed to keep inflation down, all of which keep the exchange rate too high, 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, 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 it possible to get the exchange rate down? 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 unnecessary and avoidable depression.
23rd November 2012