A Falling Pound will Lower the Living Standards Of Workers and the Poor

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First posted on Thursday, 28 February 2013

Socialist Economic Bulletin

A falling pound will lower the living standards of workers and the poor

By Michael Burke 

The British pound has begun to fall once more on the international currency markets.  It may be further helped on its way by the loss of the AAA credit rating.  This will have important domestic economic consequences.The currency is also being talked down by a number of officials, effectively including both the current governor of the Bank of England and his appointed successor.  Their hope is that a weaker pound will boost Britain’s woeful export performance, and perhaps lead to a revival of business investment in the export-oriented sectors of the economy.

A policy of failure

One key problem in pursuing this policy is that it has already happened in the recent past and failed. Between 2008 and 2009 the pound fell by approximately 30% against the US Dollar. Against a basket of currencies (represented by the Sterling Trade-Weighted Index) it fell by over 25%.

Chart 1

13 02 28 Chart 1

This was effectively a significant devaluation of the pound. Yet even in nominal Sterling terms, exports barely grew. Britain’s share of world export markets actually fell, from 3.5% in 2008 to 3.2% in 2012, continuing a long-term trend.

Chart 2
13 02 28 Chart 2

The effect of the devaluation was to push up the Sterling value of imports. This, combined with Coalition measures such as the increase in VAT and higher charges for transport and domestic fuel bills, pushed inflation higher.

Britain was the only major industrialised economy that experienced ‘stagflation’ during the crisis – that is a simultaneous economic decline or stagnation along with accelerating inflation.  Using a common measure such as US Dollars for international comparison, the UK became an incredible shrinking economy, the biggest absolute decline of any major economy.  Real wages and incomes also shrank dramatically, as the effect of wage freezes and welfare cuts were magnified by sharply rising prices.

This ought to be a lesson for all those who argue that a simple exit from the Euro and large devaluation is the remedy for the crisis-hit countries of the EU.  Britain is outside the EU and experienced a large devaluation.  The sole consequence was higher inflation and lower real incomes.

One of the reasons why membership of the Euro remains so popular even in the crisis-hit countries is that repeated devaluations punctuated the preceding decades of those economies – and failed to raise relative living standards.

Currencies and competitiveness 



Currency exchange rates are simply relative prices so that devaluation can reduce the relative price of the same or similar good.  But the effects of global competition mean that an improvement in relative price competitiveness will not last if investment levels fail to match competitors.

This relative underinvestment is the key structural failing of the British economy.  According to recent data from the Office for National Statistics productivity is 16% below the rest of the G7 and has fallen relatively by 10% during the crisis.

This has resulted in a structural deficit on the external accounts.  The deficit on the current account, which is equivalent to the British economy’s borrowing from the rest of the world, has widened to 3.7% of GDP in the first three quarters of 2012, compared to zero in the depth of the recession.

Borrowing is either conducted for consumption or for investment.  But as SEB has repeatedly argued, British investment has slumped.  It is now just 14% of GDP.  This is the cause of the slump in relative productivity, even compared to the rest of the G7, all of which have lower investment now than before the crisis in 2008.

As investment has already fallen therefore the current account deficit can only be corrected by a relative decline in consumption.  This runs entirely contrary to the argument for increased consumption to resolve the crisis.  But we have already seen that real wages have fallen during the crisis.  This has reduced the consumption of most workers and the poor.

Who will pay for investment? 



Fortunately, there is an alternative method of reducing aggregate consumption in order to boost investment.  Alongside workers’ wages and investment Marx argued that consumption was divided into necessary consumption and the consumption of luxuries.  In this category may be included all items not essential to sustaining well-being, but also all items which have no production capacity.  The most important of these is expenditure on armaments.

At £777bn the accumulated stock of profits held in cash at British banks is already a multiple of the funds required to restore all the output lost in the recession.  At the same time dividend payouts to shareholders are at a record high approaching £79bn in 2012.  Managerial and other bonuses (including in the City) are climbing once more.  Economically, the renewal of Trident is a huge waste of resources, up to £100bn, as are increased military interventions, with lethal consequences.

From these multiple sources, there is more than sufficient capital to increase investment and reduce consumption without in any way hurting the real incomes of workers and the poor.  On the contrary, improving their living standards is both essential to and the ultimate purpose of socialist economic policy.
The obstacles to this solution are political and social.  The purpose of capitalism is to preserve and expand capital, hence its name.  Any policy which infringes on, let alone overturns the absolute prerogatives of capital will be resisted fiercely.

Instead what is currently on offer is a continuation of the long relative decline of the British economy.  To alter fundamentally that path of decline would require a redirection of wasteful spending and idling capital towards investment.  Instead, what is planned is a further erosion of the real incomes and consumption of workers and the poor. From that, there may eventually be some modest increase in investment. The decline of Sterling, and the inflationary effect it will produce is part of that project.

Other Michael Burke posts on Think Left:

BRIBING THE PRIVATE SECTOR TO INVEST ISN’T WORKING

GDP DATA SHOWS BRITAIN IS THE WEAKEST OF ALL THE LARGE ECONOMIES

PRODUCTIVITY CRISIS IN THE BRITISH ECONOMY

20 YEARS OF LOST OUTPUT

The Autumn Statement and long-term Austerity

Investment Slump Greater Than Whole Loss of British GDP

BRITAIN’S EXPORT PERFORMANCE IS WOEFUL

The new recession is directly made in Downing Street

WHY MORE ‘AUSTERITY’ IS ON THE WAY

THE UK’S BUDGET DEFICIT IS RISING NOT FALLING

BRITAIN’S EXPORT PERFORMANCE IS WOEFUL

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BRITAIN’S EXPORT PERFORMANCE IS WOEFUL

By Michael Burke

 

A number of commentators have recently called for a currency devaluation as a way to revive the British economy and outgoing bank of England Governor Mervyn King has described a recent very modest rise in the value of Sterling as ‘unwelcome’.These calls tend to ignore the fact that Britain has already had very substantial devaluation. As the Bank of England chart shown in Fig. 1 below shows the decline in the pound’s exchange rate index (ERI) from 2008 onwards. The ERI fall was nearly 30%, with a slightly larger fall against the US Dollar and a less pronounced fall versus the Euro. The recovery in the currency’s exchange rate has only been a partial one.

Figure 1
12 11 29 Chart 1

There are usually two main effects arsing from a sharp currency devaluation. One is to increase the price of all imported goods which cause inflation. This is what happened and the British economy was the only major economy to experience both a sharp economic downturn and a rapid rise in inflation during the crisis. The other usual effect of currency depreciation is to cheapen the price of exports in foreign currency terms, and so provide a boost to exports and the growth and jobs that depend on them. But following that devaluation exports have barely grown in volume terms.

Figure 2
12 11 29 Chart 2

From their pre-recession peak exports fell by 11.3% to their low-point. They have since recovered but were still 0.8% below that peak in the 2nd quarter of 2012. Since George Osborne announced the ‘march of the makers’ as the theme of his first budget in 2010 export volumes have actually fallen by 0.4%. This is possibly the only time in British history where there has been a very substantial currency depreciation and no recorded improvement in export performance.

This is a remarkably bad performance given that world trade has expanded since the recession of 2008 to 2009, according to the World Trade Organisation, by 13.8% in 2010 and by 5% in 2011. It is also a remarkably poor performance even compared to sluggish major trading partners. Fig. 3 below shows export volumes compared to both the US and the Euro Area. Euro Area export volumes are now 3.6% above their pre-recession peak while US exports have increased by 8.3%.

Figure 3
12 11 29 Chart 3

Of course, these are not the strongest performers. As a group, Newly Industrialising Countries’ exports have risen by approximately 50% over the same period according to WTO data.

There are numerous reasons for the exceptionally poor export performance of the British exports over the recent period. Patterns of trade are highly dependent on the weak export markets of the industrialised countries, financial services played a disproportionate part in the exports of services during the upturn, exporters responded to the devaluation by raising prices rather than winning market share, and so on. But all of these can be essentially reduced to the current problem of not producing enough goods or services that the rest of the world needs to buy. To correct that requires investment.

Given that the private sector remains on an investment strike, the government could respond as a minimum by investing in high-speed rail links, improved port facilities, super-fast broadband and through investing in education by scrapping fees and bringing back EMA. It could also remove the restrictions on visas including student visas so as to increase trade and educational ‘exports’. A government committed to creating hi-tech jobs would invest directly in carbon-reduction and renewable technologies for which there are very large and growing export markets. But that would all require a very different type of government.

Addendum:

Michael Meacher MP wrote in July 2012:

The UK trading performance is much more serious than most people realise.   The last time Britain had a current account surplus was in 1983, 29 years ago.   In the last 55 years Britain has only had a surplus on its traded goods in 6 years.   Initially in the 1970s the surplus in services (insurance, shipping, etc. as well as banking) covered the deficit in goods, but from 1987 the deficit in goods rose much more sharply and a large net deficit between goods and services grew ever wider.   By 2010 the deficit in traded goods had reached the staggering level of £99bn and the surplus on services at £49bn could cover only half of this.   A yawning deficit of this magnitude cannot continue for long without the creditors (like any bank manager) calling time.

Why has this happened, and how can it be reversed?   Our manufacturing capability has been allowed to decline long-term following Thatcher’s elevation of the City after Big Bang 1986 and the converse privatisation and selling-off of so much of the industrial landscape.   The neo-liberal market made the manufacturing decline all the sharper by the preference for mergers and acquisitions over long-term investment, the sale of key British firms to foreign interests, the damaging break-up of crucial supply chains, the relentless emphasis on short-term profiteering over long-term market share, and the neglect of apprenticeships and quality training which along with the decline of R&D stunted UK productivity.

Britain heads for biggest trade deficit ever

Yet in his 2012 budget, Osborne had the ‘nerve’ to trumpet the ‘march of the makers’ – the renaissance of manufacturing industry.

In the event the UK deficit in traded goods hit an all-time high at £100bn in 2010, a level nearly reached again even against a background of fading growth.   There has been no rebalancing of the economy towards industry, no restructuring of finance, no spurt of entrepreneurship – just austerity and rising inequality.

*Definition of ‘Trade Deficit’

An economic measure of a negative balance of trade in which a country’s imports exceeds its exports. A trade deficit represents an outflow of domestic currency to foreign markets.