ERC Review of Exchange Rate Alignments (Palgrave Macmillan 2012) by Jim Bourlet

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December 20, 2012 by johnmillsjml

All of two decades ago LSE’s Professor Theo Barker spoke at an ERC dinner under the heading of “Why Economists and Economic Historians should talk to each other”. John Mills at least has answered his call, especially in this new and beautifully polished “Exchange Rate Alignments”. Economists say that, following theory, if you do “A” then “B” will follow. Economic historians say that whenever we have done “A” in the past, “C” rather than “B” has followed. Thus a fall in the exchange rate is supposed by economists to lead to a major rise in inflation but is found by economic historians to have little such effect in the short term and often the opposite effect in the longer term.

Mills clearly has a sound understanding of theoretical economics as shown by his delightful short summaries of Keynesian and of Monetarist theories. But he places that within a context of actual experience using examples from many countries, mostly in recent times, but where useful referring way back – even to 8500 BC!

Drawing together the threads from such a rich background of material inevitably opens an author to the charge of excessive repetition and the reader is certainly left in no doubt that a reduction in the pound sterling exchange rate is called for. Here is a sample quotation from page 210:

“The key requirement for export success is a competitive exchange rate because this has a bigger influence on a country’s relative competitiveness than anything else. There are no supply-side substitutes for the competitive benefits a relatively low parity can provide… Since whether a country’s share grows faster or slower than the world average determines its overall economic growth rate and since whether the share rises or falls is wholly a function of export competitiveness, the exchange rate in turn is the crucial variable in fixing what a diversified economy’s growth rate will be.”

“But,” objected the Adam Smith Institute’s Director, Eamonn Butler, when Mills presented parts of his thesis at an ERC meeting, “the exchange rate is just a price!” As in any other market, there is a demand for pounds and a supply of them and the exchange rate is simply the resulting “price”. As with any other price, he implied, fixing a lower or higher figure would only result in a shortage or a surplus. In the book Mills counters this challenge in great detail. Governments, he says, do have various means to bear down upon (or to strengthen) the exchange rate. These include domestic interest rate policy, discouragement (or encouragement) of sales of securities to foreigners, creating a more (or less) accommodating monetary strategy, ensuring maximum openness (or restrictions) on imports, encouraging (or discouraging) capital exports, and managing public perceptions on expectations.

And we can observe quite obviously that soon after World War 2, when Germany, Japan and Italy were allowed low exchange rates within the Bretton Woods system, their economies grew spectacularly; that currently China has an exceptionally low exchange rate and is doubling in economic size every decade; that Germany today, using a currency which is held low by the misfortunes of the southern EU members, is doing very well; and that Japan which is lumbered with an apparently high exchange rate has stagnated ever since 1990.

“But,” asked the ERC’s Chris Meakin, “since the lower exchange rate thesis for increased economic growth depends on stimulating manufacturing, that may not be the best course for modern Britain. Desperately strong international competition is driving down the prices of manufactured goods eroding the benefits of that activity, and Britain’s relative advantage nowadays is in services – to become the world’s financial capital, the world’s hospital, the world’s educator, the world’s playground and the world’s preferred headquarters for corporate managers’ head offices.” He might have added that if California can prosper simply because energetic and enterprising people want to live there, so Britain can prosper because wealthy and enterprising people want to live here.

All that may be so, Mills argues, but that simply cannot bring full employment back to the northern parts of Britain. It cannot employ the many Britons with manual skills and those at the lower end of the widening income distribution pattern that we now have who are suffering from current policies pursued by the better off elites.

So this book is a powerful plea for a more inclusive “one nation” economy. Inevitably, one can suggest shortcomings – Mills’s account of possible supply-side policies doesn’t mention setting better conditions for start-up entrepreneurs as recently discussed in B&O; his exchange rate model largely ignores links with the movements of surplus savings from such countries as Japan and China, or the reasons for those surpluses; and he talks about “unmanageable competition (from imports)” without quite defining “unmanageable”.

All the same, your sceptical reviewer was impressed and enlightened by the breadth of material supporting Mills’s case, found his complacency unsettled by the strength of the case made and discovered, on balance, a strong sympathy for the policies Mills advocates. This, most definitely, is not a book to ignore.

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