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No Long-Term Hope for UK Unemployment Without a Lower Exchange Rate

09/06/2014 17:24 | Updated 09 August 2014

Unemployment in the UK is at a five-year low. This is great news. So why am I still pessimistic about the UK's ability to reducing it further and keep it down? Why do I believe we'll never have sustainable low unemployment without a change in economic policy?

There is no mystery about why unemployment in the UK, and in most of the western world, is so high and so persistent. It is that our currencies, including sterling, are grossly over-valued in relation to those in much of the developing world.

Despite recent reductions, the UK still has a massive unemployment problem. The number of unemployed people in the UK is currently close to 2.2million, giving a jobless rate of about 6.8%. However, this is not the full story. These figures hugely underestimate the true scale of the problem. If, in addition to those registered as unemployed, all those who are not looking for work but who would do so if work was available for a reasonable wage are included, the true number of people out of work is closer to 5m. These 'unemployed' people include those on long-term sickness benefit and others caught in benefit traps which make working uneconomical.

Unemployment is a massive personal tragedy for almost everyone without work. Many people who could work have given up trying to find a job as a hopeless quest. These include a large number of people forced into early retirement. At a time when there is such a huge government deficit, it makes no sense to have large numbers of people dependent on the state for their incomes and paying no taxes on their earnings.

The idea that there are large numbers of unemployable people in the UK is a fallacy. Historical experience shows us that it is completely unnecessary to have close to 5m people in the UK with no jobs. During the latter stages of World War II, for example, there was almost no-one without a job at all in the UK as just about everyone capable of doing any kind of work was mobilised to do so. During the whole of the post-war period from 1945 to about 1970 there was also almost no unemployment in the UK with the average number of people out of work around about 2%. It was only in the 1970s and early 1980s that unemployment started becoming a serious problem. This rise occurred when the introduction of monetarist policies under first the Labour and then the Conservative Government from 1979 caused the exchange rate to go up by more than 60% between the years 1977 and 1982.

Since then, the true scale of unemployment in the UK has steadily increased. While the headline unemployment figures have fluctuated since the 1970s at anything from less than 4% in 1973 to 12% in 1984, the true number of those with no job who would be willing to work if it was worth their while doing so has risen to almost twice the headline figure.

So why does a strong pound create unemployment? First where sterling is too high, as it is right now, all the costs incurred in the UK in the production of goods and services get charged out to the rest of the world at too high a price. High prices mean we're losing out to foreign competitors and losing share of world trade.

When exports are over-priced and imported goods are correspondingly cheaper, the balance of payments on current account - the difference between what we earn from sales of our goods and services abroad and what we pay for all our imports - tends to go into deficit. Small deficits are manageable but large ones are much more problematic. The reaction of governments faced with trade deficits is therefore to damp down the economy in order to reduce the demand for imports and thus the deficit and to raise interest rates to stop sterling depreciating.

Running the economy at less than full throttle means less money being spent and falling demand for all types of labour as businesses across the board find their revenues falling. At the same time, higher interest rates discourage investment, producing another reason why the requirement for labour goes down.

With an over-valued currency, exporting is much less profitable than importing. This has a corrosive effect on manufacturing, especially if the over-valuation is long lasting. Lack of profitability hampers investment and the development of new products. Marketing budgets get reduced. Research and development is cut back. Hardly surprisingly in these circumstances few talented people go into industry rather than other occupations which offer much higher earnings and better prospects.

Manufacturing decline contributes strongly to regional unemployment. Some parts of the country have always been much more dependent on industry than others. If the economy de-industrialises - which is what has happened to the UK as a result of our manufacturers being unable to compete in world markets - this leaves large areas of the country with no way of generating adequate incomes for everyone. The regional imbalances which follow make it much more difficult to stimulate employment in the most disadvantaged areas.

Another way in which very high levels of unemployment feed on themselves is through the education system. Economies with high levels of unemployment tend to have much worse education outcomes than in those where jobs are plentiful. This is hardly surprising. If the job prospects for school leavers - especially for the more disadvantaged - are very poor, the benefits of getting a good education are much less obvious to young people still at school. If the formal economy offers no opportunities for productive work, it is not surprising that a significant proportion of those at school feel alienated and become poor potential employees.

High levels of unemployment also feed on themselves in another way. The Welfare State is there to provide, among other things, income and other forms of support for those who have no job. If unemployment is low, this can be done relatively easily. While close to 7% of people are officially unemployed the difficulties of financing payments becomes progressively greater. Even relatively small levels of taxation on people with low incomes then increases dependency as the extra income from working becomes worth little or nothing more than can be obtained by staying at home and receiving benefits.

We pay a very high price in both social and economic terms for our exchange rate policies which - quite unnecessarily - have consigned so many people to a life of idleness when providing them with work opportunities would be so much better for them and for everyone else.

If we could rebalance our economy so that we could pay our way in the world, removing the constraints which are the cause of the lack of sufficient job opportunities in the UK, there is no reason why we should not be able to get back to around 3% unemployment, reducing the true numbers for those out of work over a period of time from nearly five million to perhaps one million. To get this done, however, we need an exchange rate which will get manufacturing re-established on a much larger scale, so that we have enough to sell to the rest of the world at competitive prices. There is no reason why this could not be done if we were determined to make it happen.