Time for an alternative to the pro-austerity consensus

5th March, 2015 4:06 pm

The conventional assessment is that the UK economy is in reasonable shape. Indeed, there has been some growth in GDP over the last year or two and unemployment has fallen.

A harsher view – developed in detail in a book being published in March 2015 by Random House called Call to Action, written by myself and former Labour shadow minister Bryan Gould – is to note that average living standards are still well below what they were in 2007. The proportion of GDP which we invest is so low that productivity growth has ground to an almost total halt. We have deindustrialised to a point where we have not been able to pay our way in the world since 1985. Our balance of payments deficit – now at 6% of GDP the highest in the developed world – is getting unsustainably high.  

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We have a population which is expanding at about 500,000 per annum, diluting down our growth rate and our social capital because we are not investing nearly enough to stop this happening. The government deficit is stuck at about £100bn a year, adding about 3% of GDP to the national debt every year; and that what growth we have had has largely been based on consumer spending driven by unsustainable asset inflation.

Against this background, it is hard to believe that the growth we have had over the last couple of years is going to be sustained – and even less likely that living standards are going to rise. Instead, it seems much more probable that increases in GDP will be shared out among a population which is rising every year by the number of people living in Nottingham, leaving them below the 2007 level all the way through to at least 2020.  Can we really not do better than this?

We can. But to do so we need to adopt a radically different economic policy. The key problem in the UK at present is net of depreciation; there is virtually no investment taking place in the section of our economy – light industry – which is best capable of producing high returns and rapid increases in productivity. The reason is that the UK cost base – all the costs incurred in sterling which are associated with manufacturing – is way above what it is in other parts of the world, particularly in the Pacific Rim. This is entirely an exchange rate issue. Sterling is far too strong for most medium or low tech industries to survive.

Does this matter? Yes, it does. It means not only that we forego the best opportunities for productivity increases, and all the good blue collar jobs that go with them, but we also finish up with too little to sell to the rest of the world to pay for our imports. The consequent balance of payments difficulties force us into deflationary policies, low growth and unemployment at much higher levels than it needs to be.

If we want to get out of this bind, some careful calculations – all set out in our book Call to Action – show that we would need to bring the exchange rate down by about 30% from where it is now – to around £1.00 = $1.10 or €1.00. The consequent export and import substitution led growth would then see manufacturing as a percentage of GDP rising from 10% to 15%, the UK economy expanding on a sustainable basis by 4% to 5% per annum, unemployment falling to about 3%, investment as a percentage of GDP rising from 14% to somewhere close to the world average of 24%, while living standard rise significantly every year.

Why don’t we do it? Because a lot of people believe a whole range of things about the exchange rate which are not true. They believe that devaluation causes inflation, but history shows that it doesn’t; they think that governments cannot change the exchange rate but there is plenty of evidence that they can; they think there would be retaliation, which actually is very unlikely but manageable even if it occurred; they think that lowering the exchange rate must make us poorer, but the reverse is true; they claim that we have tried devaluations in the past and they don’t work whereas the reality is that we have always devalued to little and too late, never making the economy competitive enough; finally they believe – against every shred of evidence that is available – that people in Britain would not respond to new profitable opportunities if they were available.

Of course going for growth based on a manufacturing revival presents some challenges. No policy is completely risk free. But there are also huge risks with staying as we are. What are the prospects for Labour going to be like in the future if a Labour led government between 2015 and 2020 presides over another five years of static or declining living standards, relentless cuts in expenditure, rising inequality and relative if not absolute economic decline?

‘Call to Action’ will be launched at the Royal Society of Arts at 6.30pm on Monday 16th March. Admission is free, you can register here: http://call-to-action.org.uk

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  • MrSauce

    There is no magic money wand to wave that makes everything lovely.
    Better idea: make stuff that people want.

    • Dave Postles

      That requires investment, but once again there is an investment strike by the corporations, sitting on their cash piles, as is pointed out above. When there is investment which must be applauded (e.g. JLR at the Wolverhampton engine plant), millions of people deny their nationality and buy German Audis, VWs, Mercs. We cause our own downfall.

      • treborc1

        Who’s fault is that we do not have a British car any more, if we were to stop buying vehicles built here they just move them to another country. I bought an Astra last year thinking it would be built here it’s not the model I bought is made in Germany

        • Dave Postles

          http://www.theaa.com/motoring_advice/car-buyers-guide/cbg-cars-made-in-britain.html

          All Astras should now be made in Britain, I believe. It’s not easy, of course. I was mainly referring to the high-end, expensive products, where customers have more latitude. Why buy an Audi, Merc, VW when you can have a Jag or baby Jag?

          • treborc1

            Mine is made in Germany.

          • MrSauce

            Ooo, is the Jag coupe out now?
            It might be time to say goodbye to the Merc…

          • Dave Postles

            Stick with the push-bike – it suits you, sir.

        • It doesn’t really matter where the car is made. We’ve got to ask ourselves if running a surplus of exports is always good thing.

          That, by definition, means we always swap more goods and services for fewer goods and services and accumulate a collection of IOUs issued by others to make up the difference.

          Would we as individuals want to do that indefinitely?

    • Dave

      people are not going to want stuff until they have the jobs and wages to pay for that stuff.

      • MrSauce

        There is no shortage of wants.

        • Dave

          if there was no shortage of demand, you wouldn’t have low core inflation, unemployment, underemployment, weak growth etc.

        • That’s true. But there’s a difference between “wants” and economic demand. We can all want whatever we like to wish for, but to provide economic demand we need to have money which we are prepared to spend.
          Income = Spending.
          Always has. Always will.

          • Dave Postles

            Partly so, but current demand which is maintaining the services sector is still partly funded on credit/debt.

          • It doesn’t matter. Its still spending. If the private sector is borrowing more and spending more then Government can spend less. When that changes, say we have a credit crunch, Govt has to spend more.

            Govt creates money when it spends. It can just edit numbers in bank accounts. It destroys money when it taxes.

          • Dave Postles

            I’m referring to personal and household debt – which is created by the retail banks – although some of it is created by the central bank supplying cheap credit to the retail banks.

    • Mr Sauce,

      You need to ask yourself where money comes from in the real world. Do you think it comes from God? And it’s a sin to create more than He intended we should have? I’d agree it isn’t magic, or supernatural. We mere mortals have total control over the amount of money which government creates and spends into the economy.

      We need to take note of how Goldilocks liked things. They had to be just right. Not too big. Not too small. Not too hot and not too cold. Government needs to get it just right too!

      • MrSauce

        Money is merely the means of exchange.
        The thing that matters is value: the value of the goods and services being traded.
        Playing about with the units of money does nothing to affect the fundamental value of what is being exchanged.

        • That’s true fundamentally. The real value of the UK , for example, is in the wealth of the real things that the workers produce and the natural resources that nature provides.

          But does that mean that we can ignore things like the amount of money in the economy, the level of taxes, the amount that government spends? No it doesn’t.

          If we get it wrong, as governments often have, (and usually do!) we have the absurd situation where workers want jobs, say growing food, but because they don’t have jobs they can’t afford the food that is produced so therefore they go hungry. Or they want somewhere to live, they’d be happy to take a building job but because there are no building jobs ….

          Get the idea? If not, take a look at the Greek economy.

          • MrSauce

            Yes, you can ignore the volume of ‘money’ in the economy.
            Just add a nought to the numbers on all bank notes (and accounts) and see if that changes anything.
            No you can’t ignore the level of taxes.
            Money is the means of exchange of value. The more of it goes to the state then the worker sees less of the value of his labour.

          • Dave Postles

            If we address labour theory of value, then it’s your employer who is taking your surplus value. From the state, you receive value in return. We are the state. The state just exchanges the money for other goods and services; it doesn’t salt it away in tax havens, removing it from the domestic economy. In spending the money on goods and services, it has a multiplier effect. Through redistribution, it increases aggregate demand, because the poorest, through necessary expenditure, pass more into the economy and than the rich, who have discretionary expenditure, a propensity to save and to save in tax havens.

          • “…..The more of it goes to the state then the worker sees less of the value of his labour.”

            What about when he is unemployed?

            There’s no point arguing about who takes what if there is nothing there to take in the first place. Unemployment arises because there is insufficient spending in the economy to provide jobs for everyone who wishes to work.

            That deficiency in aggregate demand can only be rectified by the State spending more into the economy than it receives back in taxation.

  • bikerboy

    This will not affect the pound in your pocket…..

    Even GB couldn’t manage parity with the euro and Lord knows he tried hard enough.

    • Dave Postles

      That, of course, reminds us of the gnomes of Zurich and their recent inability to stabilize the Swiss franc against the Euro.

  • Dave Postles

    What we need is a bloody great big investment bank which supports SMEs. It needs billions of pounds. It needs to lend on reasonable terms. We know that the commercial banks are not lending or are lending on unfavourable terms. We know that SMEs are drawing on their own resources rather than the commercial banks. We know that RBS Global Restructuring Group has probably been naughty. We know that the commercial banks have tricked SMEs with interest swaps. Let’s be unequivocal: the state will establish a massive investment bank with substantial capital.

    • ebc12

      That is exactly what we need.

    • This, albeit in a more leftish format, is still supply side economics. In other words it’s accepting Say’s law which is that “supply creates its own demand”. Keynes turned that right around and said it was “demand that creates its own supply”.

      It could well be that the truth is somewhere in-between. Nevertheless, its quite clear at the moment that it is lack of demand and not lack of supply which is the problem in the UK and, more generally, in the other EU economies too.

      • Dave Postles

        On the other hand, you are always behind the curve when demand picks up. In the meantime, there is a private-sector moratorium on investment. We could be investing for: (a) infrastructure and energy security with funding to SMEs who will receive some of the contracts from the big contractors; and (b) assisting SMEs to enter other markets (which they hardly do). Otherwise our skills base will also wither away. It’s not a panacea on its own, but it is a strategic response to long-term issues.

  • ebc12

    Dallying with exchange rates is for the old days.

    In our low interest times we should be borrowing to build and borrowing to invest.

  • Dave

    I agree that we need an alternative to austerity. Productivity and industrial finance are serious issues in the UK, and a public investment bank is a good idea. But the fundamental problem is lack of demand. Even if finance is available, businesses simply won’t invest until they can expect to have more and more buyers for their goods and services in the foreseeable future.

    Every major economy from the Japan to the Eurozone countries is trying to export their way to recovery, but there is a real limitation to this strategy on an international scale: who is going to grow fast enough to buy everyone’s exports?

  • “they think that lowering the exchange rate must make us poorer”

    And “they” are right to think that! A lower exchange rate will indeed boost exports and reduce imports.

    Why? Because a poorer population cannot afford those imports. Companies making stuff in the Uk will be less able to sell it in the UK because the population will be less affluent so they’ll look to export it instead.

    You have to ask yourself if its really a good idea to want to run an economy like Germany’s. Is it a good idea to ALWAYS swap more goods and services for fewer goods and services and take an IOU (which you can never cash in) to make up the difference?

    • MrSauce

      They are right in more ways than one.
      Mr JML’s exchange rate ‘solution’ increases the price of energy (which is fundamentally priced in $US) by 40%.
      The same goes for any globally commoditised raw materials.
      Mr JML may think he has waved a magic money wand and made exports competitive, but the increased cost of production has cancelled that out.

      • Not completely cancelled out. The price of imported commodities is only one factor in the price of domestic finished produce. There are other factors like the level of wages and the price of rents which don’t vary with the exchange rate.

        Lowering the value of its currency is a necessary condition for any currency wishing to artificially support its export industry.The big net exporters like Denmark and Switzerland ( but to a lesser extent since they revalued their franc) do this by creating, printing if you like, lots of extra currency to suppress its value. Germany used to do this with the DM but now relies on the weaker EZ economies to reduce the value of the Euro.

  • treborc1

    I would say yes to that although I would not know what is the best way forward, I mean with rates so low for borrowing surely this is the time to get those houses build the young trained and do what labour did in 1945. Sadly for labour Miliband Ball although slightly to the left I think Blair and Progress have way to much power.

  • Dave Postles

    Psychological costs of ‘austerity’ report

    • MrSauce

      Somebody should tell them that public spending has been increasing.

  • There used to be a Northern Irish Labour Party which closed down in 1987. It was essentially a Unionist Party of the centre left. The polarisation of politics around partition in Ireland will always deprive the party of a critical mass. Any NILP would have to have a position on the question of the border. That’s the problem.

    Whatever the shortcomings of the SDLP , its unlikely that Catholic voters will be shifted away from them unless the NILP agreed with them on the question of partition. In which case they’d lose Unionist support.

    It’s best for the Labour Party to keep out of NI politics!

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