Bulletin – November 2013 What is the political cost of the way we and most of the West are mismanaging our economies?1
November 1, 2013 by johnmillsjml
Exchange Rate Reform Group
BULLETIN – November 2013
What is the political cost of the way we and most of the West are mismanaging our economies?
The extent to which we – and most of the rest of the Western world – are currently mismanaging our economies clearly has a huge financial cost attached to it. In the longer term, however, an even bigger political than economic price is likely to have to be paid, unless there are radical changes in policy. The failure of so much of the West to run its economies reasonably efficiently compared to many other parts of the world may turn out to be crucial to both world political developments and to perceptions as to how democracy should relate to economic policy.
The problem can be simply stated. Compared with much of the rest of the world, almost all western economies, including our own in the UK, are doing far worse than is the case elsewhere, particularly along the Pacific Rim. It is not just that our rate of growth is so much lower than theirs. It is that the West’s economies, including our own, are performing so badly in many other ways as well.
They are disfigured by very high levels of unemployment, much of it disguised by the fact that the headline figure – now about 2.4m in the UK – does not include some 3m people who would be able and willing to work if jobs at reasonable wages were available. They have currently dropped out of the labour force because they are in benefit traps or on long term sickness benefit or have given up trying to find a job as hopeless.
There is massive inequality not only between different socio-economic groups but between different regions of the country. Recent figures showed the average Gross Value added per worker in Greater London was £35,638, well over twice the £15,842 comparable figure for the North East. The bottom tenth of income earners in the UK earn 1.3% of all incomes compared to 31% for the top tenth.
UK government debt is now rapidly rising towards 100% of GDP, with little sign that the underlying rate at which it is accumulating is likely to fall. At the same time, the UK as a whole is getting further and further into debt, reflecting our chronic inability to achieve a reasonable foreign payment balance. The last time the UK had a trade surplus in goods was in 1982 and we have not had an overall surplus since 1983. The UK used to have a healthy net investment income from abroad but this has now evaporated. One of the major reasons this has happened is because of the massive sale of UK portfolio assets which took place during the 2000s. Between 2000 and 2010 – excluding direct investment in factory buildings and machines, and including only sales of shares, bonds and property – net portfolio sales totalled a staggering £615bn – equivalent in value to about half the total annual output of the economy at the time.
Investment is almost unbelievably low. In China, well over 40% of GDP is invested for the future every year in factories, plant and machinery, roads, airports, housing, railways ports and much else besides. In the UK, the proportion of GDP devoted to comparable investment was 16.7% in 2008 and had fallen by 2012 to 14.2%, one of the lowest anywhere. The world average in 2012 was 23.8%.
When the economy was growing, it was assumed that there would be sufficient output to enable all the population to be provided with reasonable pensions either by the state or by private pension schemes. Now that there is little or no growth, but in both the public and the private sector there are still large numbers of people with final salary pension contracts, there is a major danger of a massive squeeze on everyone else, providing widespread pension poverty as we head for a major pensions crisis.
As the economy fails to grow, the strains on government expenditure get ever greater. As unemployment rises, more and more expenditure has to be devoted to providing income support. Flagging output leads to lower tax receipts. As government debt increases, more has to be paid in interest charges. Against the background of a failing economy, it becomes increasingly difficult and then impossible at acceptable political cost to reduce expenditure to a level which can be covered by taxation, fees and charges.
As our economic performance fails to match that being achieved in many other parts of the world, with our lack of economic growth being particularly significant, so our influence in the world steadily declines. If we have a decade with no growth at the same time as China maintains an annual growth rate of, say, 8%, in not much more than a decade the Chinese standard of living will have doubled again while ours stagnates or declines.
There are two vitally important consequences which flow from the fact that most of the West – including the UK – is managing its economies so very much worse than many other countries in the world. One has to do with our power to influence what happens in the world as a result of our declining relative economic strength. The other is about the ideas influencing how politics and economic policy should be shaped and implemented.
For the whole of the nineteenth and twentieth century it was the West which was the dominant force in the world. This was the case partly because the much higher standards of living in western countries compared to those elsewhere provided the West with overwhelmingly stronger military capacity. More fundamentally, however, the West’s high living standard flowed from the intellectual and political climate which made the Industrial Revolution possible. This in turn provided the resources underpinning the social evolution, the development of science, and the investment in industrial capacity which flowed from the potential which industrialisation let loose.. The ability of western countries to punch far above their weight in the world in relation to the size of their populations flowed directly from the fact that they had much higher GDP per head than was the case elsewhere in the world. No wonder that the West – including the UK – is now having to adjust to a steadily diminishing role in world affairs as its relatively poor economic performance undermines all the advantages which it used to have.
It is not, however, just that living standards and all that goes with them are rising much more rapidly in other parts of the world, and with them the ability of countries particularly along the Pacific Rim to exercise much more military, commercial and political influence. So also are ideas changing about how best to run modern economies. Only a couple of decades ago it still looked as though liberal democracy was the more or less inevitable end game for all modern societies. Not any more. The failure of the West to deliver a reasonable economic performance – combined with the related problem of widespread inability to get difficult decisions taken – has led an increasingly large number of people across the world to consider whether more authoritarian and less democratic ways of running modern diversified economies might work better than those based on liberal democracy.
So far, in most of the West, the moderate centre ground has held its own, but there are ominous signs that the tolerance and consensus which makes western democracy work is breaking down. In both the USA and in much of Europe, the failure of leaders of the centre right and centre left to implement policies which provide growing prosperity for nearly all the voters and citizens for whom they are responsible is leading to more and more widespread disillusionment. This is reflected in turn in the rise of intransigent extremist parties – or extremist factions within existing parties – on both the right and left as well as single issue pressure groups with agendas which are hardly compatible with good governance.
Of course, not all the problems faced by western governments would be solved if the economic performance of the West improved substantially compared with the Pacific Rim. It is clear, however, that many of the difficulties faced by western governments would become more amenable to solution if the rates of growth of their economies were higher, unemployment was lower, there was less dependency, less debt was being accumulated, inequalities were less marked and more resources were available to help to deal with the side effects of taking difficult decisions with their inevitable vocal losers.
There is a way to make this happen, but it cuts across a huge amount of the conventional wisdom taken to be axiomatic by the vast majority of politicians, civil servants, commentators and academics both in the UK and most of the rest of the West. Fighting inflation and trying to keep it down to around 2% should not be the over-riding goal of economic policy. Far more important than this is to ensure that the West’s economies are all able to prosper by being able to compete in the world. To do this, they need to have exchange rates which enable them to avoid balance of payments constraints, so that they can expand demand to make their economies grow and to provide good job prospects for all those capable of working.
The root problem is that much of the West tries to sell its output to the rest of the world at grossly uncompetitive prices. This is why there has been so much deindustrialisation. Since most international trade is in goods and not in services, once the proportion of the economy devoted to producing internationally tradable goods drops below about 15%, it becomes more and more difficult to combine a reasonable rate of growth and full employment with a containable balance of payments position. In the UK, the proportion of GDP coming from manufacturing is now barely above 10%. Hardly surprisingly, we have not had a foreign trade surplus balance since 1982 – over thirty years ago – while our share of world trade which was 10.7% in 1950 had fallen by 2012 to no more than 2.6%. On this basis, the current improvement in our economic performance, based on buttressing consumer confidence by boosting asset values fuelled by yet more borrowing, is all too unlikely to last. To produce a sustained recovery, we need a much stronger competitive performance, based both on more exports and widespread import substitution. This can only be achieved by more manufacturing, with all the investment in plant and machinery which will be required for this to materialise. This in turn, will never happen until exporting becomes much more profitable and importing much less, which depends almost entirely on how competitive sterling is.
If the fundamental problem with our economy is that the exchange rate is much too high, we may well be in an exceptionally favourable position compared to most of the West to put this right. Much of Europe is locked into the Single Currency, making any of the urgently needed exchange rate adjustments which are required within the Eurozone impossible to achieve at present. The dollar is a reserve currency, which gives the USA some advantages but which also makes it difficult for the USA to achieve the devaluation it needs. The UK, however, has neither of these constraints and our share of world trade is now so small that a big change in the value of sterling – down to perhaps £1.00 = $1.10 or about €0.75 – would invite no more retaliation than did the fall from $2.00 to $1.50 between 2007 and 2009.
The UK is thus in a unique position to show the rest of the West how to start growing again, to provide good jobs for all its workforce – and to show how liberal democracy can be combined with economic efficiency. We very urgently need to demonstrate to the rest of the western world that this can be done.
Published by the Exchange Rate Reform Group
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