The Blog

The Case for a More Competitive Pound

It is very widely believed that lowering the value of the pound must increase inflation. Monetarists have always claimed that any gains in competitiveness from a lower currency must be offset by rapid price increases. But what might seem obvious needs to be checked against the economic statistics - and they tell a very different story.

The Pound Campaign believes that the main reason why the UK economy is in its current dangerously unbalanced state is that the exchange rate is far too high. If sterling was at a more competitive level, our growth rate could be raised to 4% to 5% per annum on a sustainable basis; unemployment would fall towards 3%; investment as a proportion of GDP would rise from the current pitiful levels - barely 14% - to around the 24% world average.

If the pound was more competitive our economy would be rebalanced towards 15% of GDP coming from manufacturing rather than the current 10%, enabling us to pay our way in the world; neither the balance of payments nor government borrowing would continue to be a problem as we would stop accumulating debt at an unsustainable rate; and both regional and socio-economic levels of inequality would be reduced.

Why, then, are so few people considering getting the exchange rate down to a competitive level? Let's look at each of the arguments against having a more competitive pound.

Devaluation causes Inflation

It is very widely believed that lowering the value of the pound must increase inflation. Monetarists have always claimed that any gains in competitiveness from a lower currency must be offset by rapid price increases. But what might seem obvious needs to be checked against the economic statistics - and they tell a very different story.

Historically, devaluations do sometimes increase inflation - and sometimes they decrease it; but most of the time inflation stays much the same as it would have been anyway. The reason is that a lower exchange rate also brings many costs down as well as putting some up. Tax and interest rates can be lower; investment rises, producing better and cheaper goods; production runs increase giving increased economies of scale; productivity increases, soaking up wage rises; domestic suppliers not affected by higher import prices become competitive. For all these reasons, devaluations do not necessarily increase inflation.

Governments can't change the exchange rate

Many believe that governments cannot change exchange rates. Currency parities are thought to be fixed by market forces, which cannot be bucked. But that view ignores the fact that governments can affect the way in which markets behave, making it unnecessary to fight against them.

A major reason why sterling has been so strong in recent years is that we make it far easier than in any other country for foreign interests to buy UK assets, dramatically increasing the demand for sterling in the process. This could - and should - be changed. We benefit from foreign investment in factories and machinery but selling off portfolio assets such as property, to finance living standards which we cannot really afford, does nothing to improve our economic prospects.

There would be retaliation

Nobody wants a currency war but there is no reason why there should be one. There is so much objective evidence that sterling is grossly overvalued it would be irrational for other countries to retaliate. Our share of world trade is now so low - at barely 2.5% - that what we do does not make much difference to everyone else. The dollar is the world's reserve currency and the Eurozone has so many other problems to contend with. When the pound fell between 2007 and 2009 from its peak of $2.10 to its trough of $1.36, there was no sign of any retaliation. Why should the future be any different?

A lower pound would make us all poorer

If the pound had a much lower foreign value than it does now, it seems at first sight as though we must be making ourselves poorer and lowering our living standards. This is not, however, what actually happens.

Of course, if UK incomes are measured in dollars and sterling is devalued, then our incomes will indeed have gone down. People in the UK, however, do not do their shopping in dollars, except perhaps if they are on holiday. They pay for goods and services in sterling and the volume of goods they buy is almost certain to increase with a lower pound. This is because a more competitive currency tends to increase exports and reduce imports, thus making the economy grow faster.

If GDP is larger and the population stays the same as it was before, as a matter of logic, GDP per head must go up and not down. The problem at the moment is that we are failing to provide jobs for everyone because large sections of the UK labour force are priced out of world markets as sterling is much too high.

We have tried devaluations before and they do not work

On the whole sterling has fallen in value against most other major currencies since World War II. However, these devaluations were forced upon us; they were too little and too late. Inflation in the UK has been substantially higher than in most other developed countries and in these circumstances the five devaluations which took place between 1949 and 2009 were inevitable. Because the parity reductions were kept as low as possible, the result is that for many decades our economy has been uncompetitive; our share of world trade has steadily shrunk; our manufacturing capacity and our ability to pay our way in the world has gone down; and we have not had a balance of payments surplus since 1983 - over 30 years ago.

The UK is incapable of responding to manufacturing opportunities

Finally, it is argued that providing new profitable opportunities in manufacturing, exporting and import substitution in the UK is a waste of time because we would be unable to respond. The British, we are told, are no good at manufacturing and would be unable to take advantage of the highly profitable new opportunities. Perceptions of this sort, however, are surely wrong at every level. We may not be as good at manufacturing as developing economies at the moment, but the main reason for this is that most of it is so unprofitable that fewer highly talented people choose this career path. If there was money to be made, all the evidence suggests that there would be ample entrepreneurial talent in the UK which would be only too happy to take advantage of new money-making opportunities.

We need a more competitive pound

There is nothing to stop us reviving the UK economy nor is there anything to stop us achieving this competitive level if we were seriously minded to do so. Our current problem lies in perceptions about how the economy should be run.

Everyone involved in economic policy knows that we have to have a reasonably well ordered fiscal policy. Everyone also agrees that we need monetary policy to provide the financial stability necessary for our economy to function efficiently. What almost everyone seems to have forgotten, however, is that we also need to have an exchange rate policy which enables our economy to function in a reasonably balanced way with the rest of the world. At the moment we are totally failing to do this - which is why our rate of investment is so low; why our industrial base has withered away; why we cannot pay our way in the world; why we are consequently running up debts on an unsustainable basis to pay for standards of living which we are not earning; and why our economy will be facing years of stagnation once our current upturn dies away - which it will - as a result of a mounting balance of payments crisis and rising interest rates.

As long as this goes on, the future ahead of us in the UK will be one of little or no growth, stagnant living standards, high unemployment, mounting debt, rising inequality and declining national significance. All unnecessary and all avoidable.