23/07/2014 12:57 BST | Updated 22/09/2014 06:59 BST

The Political Cost of Economic Mismanagement

The extent to which the UK and most of the rest of the Western world are currently mismanaging our economies clearly has a huge financial cost. In the longer term, however, the political cost will be even greater than the economic price - unless we see radical changes in policy.

The failure of so much of the West to run its economies reasonably efficiently compared to many other parts of the world may turn out to be crucial to both world political developments and to perceptions as to how democracy should relate to economic policy.

The problem can be simply stated. Compared with much of the rest of the world, almost all western economies, including our own in the UK, are doing far worse than is the case elsewhere, particularly along the Pacific Rim. It is not just that our rate of growth is so much lower than theirs. It is that the West's economies, including our own, are performing so badly in many other ways as well.

There are two vitally important consequences which flow from the fact that most of the West - including the UK - is managing its economies so very much worse than many other countries in the world. One has to do with our power to influence what happens in the world as a result of our declining relative economic strength. The other is about the ideas influencing how politics and economic policy should be shaped and implemented.

For the whole of the nineteenth and twentieth century it was the West which was the dominant force in the world. This was the case partly because the much higher standards of living in western countries compared to those elsewhere provided the West with overwhelmingly stronger military capacity. More fundamentally, however, the West's high living standard flowed from the intellectual and political climate which made the Industrial Revolution possible. This in turn provided the resources underpinning the social evolution, the development of science, and the investment in industrial capacity which flowed from the potential which industrialisation let loose. The ability of western countries to punch far above their weight in the world in relation to the size of their populations flowed directly from the fact that they had much higher GDP per head than was the case elsewhere in the world.

It is not, however, just that living standards are rising much more rapidly in other parts of the world, and with them the ability to exercise much more military, commercial and political influence. So also are ideas changing about how best to run modern economies. Only a couple of decades ago it still looked as though liberal democracy was the more or less inevitable end game for all modern societies. Not anymore. The failure of the West to deliver a reasonable economic performance - combined with the related problem of widespread inability to get difficult decisions taken - has led an increasingly large number of people across the world to consider whether more authoritarian of running modern diversified economies might work better than those based on liberal democracy.

So far, in most of the West, the moderate centre ground has held its own, but there are ominous signs that the tolerance and consensus which makes western democracy work is breaking down. In both the USA and in much of Europe, the failure of leaders of the centre right and centre left to implement policies which provide growing prosperity for nearly all the voters and citizens for whom they are responsible is leading to more and more widespread disillusionment. This is reflected in turn in the rise of intransigent extremist parties on both the right and left as well as single issue pressure groups with agendas which are hardly compatible with good governance.

Of course, not all the problems faced by western governments would be solved if the economic performance of the West improved substantially compared with the Pacific Rim. It is clear, however, that there would be more practical solutions available to us if our economic growth was higher, unemployment was lower, there was less dependency, less debt was being accumulated, inequalities were less marked and more resources were available to help to deal with the side effects of taking difficult decisions with their inevitable vocal losers.

There is a way to make this happen. Fighting inflation and trying to keep it down to around 2% should not be the over-riding goal of economic policy. Far more important than this, leaders in the West need to ensure that their economies are all able to prosper by being able to compete in the world. To do this, they need to have exchange rates which enable them to avoid balance of payments constraints, so that they can expand demand to make their economies grow and to provide good job prospects for all those capable of working.

The root problem is that much of the West tries to sell its output to the rest of the world at grossly uncompetitive prices. This is why there has been so much deindustrialisation. Since most international trade is in goods and not in services, once the proportion of the economy devoted to producing internationally tradable goods drops below about 15%, it becomes more and more difficult to combine a reasonable rate of growth and full employment with a sustainable balance of payments position.

In the UK, the proportion of GDP coming from manufacturing is now barely above 10%. Hardly surprisingly then that we have not had a foreign trade surplus balance since 1982 - over thirty years ago - while our share of world trade which was 10.7% in 1950 had fallen by 2012 to no more than 2.6%. On this basis, the current improvement in our economic performance, based on buttressing consumer confidence by boosting asset values fuelled by yet more borrowing, is all too unlikely to last. To produce a sustained recovery, we need a much stronger competitive performance, based both on more exports and widespread import substitution. This can only be achieved by more manufacturing, with all the investment in plant and machinery which will be required for this to materialise. This in turn, will never happen until exporting becomes much more profitable and importing much less, which depends almost entirely on how competitive sterling is.

If the fundamental problem with our economy is that the exchange rate is much too high, we may well be in an exceptionally favourable position compared to most of the West to put this right. Much of Europe is locked into the Single Currency, making any of the urgently needed exchange rate adjustments which are required within the Eurozone impossible to achieve at present. The dollar is a reserve currency, which gives the USA some advantages but which also makes it difficult for the USA to achieve the devaluation it needs. The UK, however, has neither of these constraints and our share of world trade is now so small that a big change in the value of sterling - down to perhaps £1.00 = $1.10 or about €0.75 - would invite no more retaliation than did the fall from $2.00 to $1.50 between 2007 and 2009.

The UK is thus in a unique position to show the rest of the West how to start growing again, to provide good jobs for all its workforce - and to show how liberal democracy can be combined with economic efficiency. We very urgently need to demonstrate to the rest of the western world that this can be done.