All the austerity, high unemployment, low or negative growth in prospect for us are unnecessary and avoidable. All are caused by the UK having far too high an exchange rate. This is why we have de-industrialised, why we cannot pay our way in the world and why we have excessive borrowing.
SUMMARY OF THE CASE FOR A LOWER EXCHANGE RATE
1. Britain’s root problem is that for many years we have been unable to pay our way in the world. We do not have enough exports available at competitive prices to sell to the rest of the world to pay for our imports.
2. The consequent current account balance of payments deficits suck demand out of the economy which then gets replaced by expenditure financed by excessive consumer and government borrowing. It is our weak balance of payments position which has caused both government and consumer borrowing to rise to unsustainable levels, because all current deficits have to be matched pound for pound by increasing debt.
3. Neither the Coalition nor Labour policies for reducing the government deficit will work. Cutting government expenditure will deflate the economy but the consequent falling tax revenue and the mounting cost of unemployment will make the public expenditure gap impossible to close. Reflating the economy with the exchange rate where it is at the moment would be equally self defeating. It would destabilise the markets and put our credit rating at risk, thus almost certainly raising interest rates and borrowing costs.
4. The major reason why we have such a large current account balance of payments deficit every year is that we have a huge trade deficit, especially for manufactured goods. Two thirds of our exports and three quarters of our imports are goods rather than services. The only way, therefore, for us to be able to avoid trade deficits is for us to sell more manufactured goods to the rest of the world. Services will never be able to fill the gap.
5. The reason why we have a £100bn a year deficit on manufactured goods is that it costs much more to manufacture almost anything here than in many other parts of the world, especially the Far East. Huge swathes of the world’s manufacturing capacity have therefore migrated from the UK and other western countries to the Pacific Rim. We thus have far too small a share of the world’s manufacturing capacity in the UK to be able to generate enough income from abroad to pay for all our imports.
6. The reason why manufacturing in the UK is so expensive compared to elsewhere is that the cost base in the UK is so high. The cost base encompasses all the locally based costs – mostly but not all labour costs – which businesses in the UK have to pay, and that are in turn charged out to the rest of the world in export prices. By far the biggest influence on what the cost base is charged out at to the rest of the world is the exchange rate.
7. There is no reason why the cost base in the UK should be charged out a higher rate than is done by other countries. This is entirely an exchange rate issue and the very high UK charge out rate is the direct result of hugely expensive mistaken policies pursued here for many decades, which have kept the exchange rate much too high. These were greatly exacerbated by the monetarist policies pursued from the 1970s onwards to combat inflation, which included tight control over the money supply and high interest rates, all of which forced up the exchange rate by over 60% between 1977 and 1982. It is the anti-inflationary monetarist policies which have been pursued with such vigour in the UK which have kept sterling much too strong. It is the excessively high prices at which UK manufactured goods get charged to the rest of the world, which have caused us to deindustrialise.
8. Deindustrialising also has other very major costs. Productivity increases are much easier to secure in manufacturing than in services, so countries with weak manufacturing bases grow more slowly than those with strong ones. Manufacturing also provides large numbers of high quality blue collar jobs which services cannot offer to the same extent. In addition, these good jobs tend to be more widely dispersed geographically. Deindustrialisation is thus a major cause of the rising inequality seen across the western world, but especially in countries such as the UK and the USA with the weakest manufacturing bases.
9. Balance of payments deficits year after year also entail a very heavy constraint on expanding the economy and thus making it possible for us to use all our resources to full effect. This is the main reason why we have such appalling unemployment problems. Not only do we have over a million young people out of work, but we now also have a total of nearly 5m people who are not working in the UK but who would do so if there were opportunities to do so at a reasonable rate of pay. This is an incredible and inexcusable waste, especially at a time when the population is aging.
10. The only policy which will remedy these problems is to get the UK cost base down to a level which will make it possible for us to re-establish enough manufacturing capacity to enable us to compete in the world. To do this, some fairly simple calcuations show that we need to get the pound down by about 25% from where it is now – to around $1.20 or €0.85.
11. None of the reasons which the conventional economic wisdom uses to claim that this approach would not work are correct. In particular:
11.A It is not true that devaluation usually produces more inflation than would have occurred anyway. It often reduces rather than increases average price rises.
11.B It is not true that devaluation reduces living standards. On the contrary they will increase. If the growth rate increases, the average standard of living must go up.
11.C It is not true that governments cannot change the exchange rate if they want to do so. There are many examples showing that this can be done.
11.D It is very unlikely that other countries either would or could retaliate against us.
11.E It is not true that we have tried devaluation before and found that it does not work.
12. It is, however, true that if the pound went down by 25% imports and foreign holidays would be more expensive. It is also true that all the politicians, civil servants, commentators and academics who have supported policies to keep inflation down as top priority would have to change their mind-set to understanding that getting the exchange rate right is much more important. Changing accepted orthodoxy is likely to be much the biggest obstacle to getting policies for the UK back on track.
13. There are two other compelling reasons why the policies advocated above should be adopted. These are:
13.A They are a necessary but not sufficient condition for any recovery to our economic prospects. While many complementary policies are going to be needed, unless we deal with the problem of our hugely uncompetitive cost base, no other mix of policies will work.
13.B If we continue as we are, this will not stop the pound eventually being devalued by market pressures. This will inevitably happen sooner or later as we get trapped into more and more borrowing with an economy which is not growing, a condition which is simply unsustainable. If we are going to have to devalue at some stage, we would be much better to do it earlier rather than later, thus avoiding a long and wholly unnecessary period of austerity, high unemployment and little or no growth, as our position in the world steadily declines.