Mills replies to Skidelski: without more devaluation nothing will turn round the UK economy

In this thoughtful reply to Robert Skideslky, John Mills examines the UK's trade performance post-crash and argues that, though requiring a more rounded industrial policy as a whole, any measures taken without further devaluation will fail to turn the economy around. 

I would like to firstly thank Robert Skidelski most warmly for his comments on my Civitas pamphlet as they help draw out some of the critical points of the devaluation debate. Before providing some responses to that critique I think it worthwhile to provide some background as to how my views have developed, from both the intellectual perspective and also the practical experience of running a multinational business.

My academic background in economics comes from reading PPE at Oxford, where I specialised in Economic History and Statistics. Many of the perceptions I have about economic policy, however, stem from the 50 years I have spent in the commercial world selling high volume consumer products. For the first 25 of these I ran various manufacturing companies in the UK which produced the products I then sold. This period of my career came to an end in the early 1980s when the pound was so strong that we could barely buy the raw materials for a better price than we could buy the finished goods from China. As a result, the company I was then running went to the wall, leaving me with debts which it took me half my income for ten years to pay off.

Aged 46, I then started again from scratch and I am now the Chairman and majority shareholder of a company with a turnover of £100m a year with operations in about a dozen countries, while we also sell our products to about another eighty. Nowadays we have no manufacturing facilities. Everything is subcontracted, mostly to China where we can still get almost everything we sell manufactured for barely half the price it would cost to make in the UK. My experience is not, therefore, only academic. I have seen from very close up how economic incentives work. 

I simply do not understand how economic policy makers can believe that we have any chance of reviving manufacturing and rebalancing our economy if it is far easier to make money out of importing than exporting, and where any sort of manufacturing starts with costs which are far above the world average. This makes competing extremely difficult and generally unprofitable. Human beings, from my experience, are good at working out what is and what is not in their best financial interests. If they live in conditions where manufacturing is difficult and loss making, while importing is relatively easy and much more profitable, it is hardly surprising that countries with over-valued exchange rates deindustrialise and are left with a massive balance of payments problem. Unless they are in a niche business, they are protected by intellectual property rights or they operate in the sort of business in which it takes decades to accumulate the necessary experience to compete, this is the situation facing British manufacturing. This is exactly the problem we must address.

Tuning now to Skidelsky’s analysis:

It is suggested that I have perhaps concentrated on only one aspect of a complex problem. I agree, wholeheartedly, that there is much else that needs to be done for the UK economy beyond just getting the exchange rate down. I do, however, believe that without this being done all the other policy prescriptions on hand will not work effectively. In particular, I do not believe that keeping the rate of inflation at about 2% as the main macro policy goal, while promoting supply side policies on the other, has the slightest chance of being successful, as is becoming increasingly apparent. The policies needed to keep inflation at 2% are more or less exactly the same as those needed to keep the exchange rate much too strong while supply side policies are never going to make the economy competitive enough to cope with international competition with the exchange rate where it is now.

Skidelsky points to the apparent lack of progress on the trade balance since the fall in the pound from 2007 to 2009. I am not sure that the figures bear that out. The latest ONS Balance of Payments Statistical Bulletin shows that the value of our manufactured and semi-manufactured exports rose by nearly 21% between Q3/2009 and Q1/2011, which I think is quite impressive. Admittedly, imports over this period rose slightly faster and recent experience has been worse, partly because of the travails in the Eurozone and partly because sterling has recently strengthened. I think there are two major comments to make on these sorts of figures, these being:

Firstly, there is a “J” curve effect which means that any devaluation will take a bit of time to show that it is working successfully.

Secondly, figures like the recent ones for the UK always tend to be distorted by influences other than the exchange rate. It is better, therefore, to rely on long run elasticities of demand (price sensitivity) for imports and exports as an indication of whether a devaluation strategy is likely to work in the medium to long term. All the figures I have been able to find – some of which are cited in the Civitas pamphlet but there are also others - show that this condition for the UK is amply fulfilled. 

That devaluation on its own needs to be accompanied by an active industrial strategy is again a point on which I agree, up to a point. I think we will need initiatives such as training programmes and probably some relaxation of planning and regulation constraints but I also think that many other components of the sort of industrial strategies which are generally favoured which are unlikely to be very helpful. Let me give some examples:

I am extremely sceptical as to whether it makes any sense for the UK to try to achieve an economic revival based largely on “high tech” industries. Of course it is true that we do relatively well with cars, aero-engines, arms, and pharmaceuticals, all of which are relatively high tech. In my view, however, the reason why these industries are still with us, whereas simpler manufacturing processes have disappeared, has a lot to do with the fact that high tech industries are complicated and difficult businesses to run. It therefore takes longer for countries such as  China to catch up and compete with them than with the simpler sorts of processes with which I was concerned when I was running manufacturing companies, such as injection moulding, metal pressing, assembly and fabrication.

Sooner or later, however, these high tech businesses will face more and more effective competition with the exchange rate as it stands, and their advantages will get eroded away. Incidentally, high tech industries are not necessarily ones with particularly high productivity. Consequently, the idea that high tech equals exceptional increases in output per head, and hence stronger economic growth, does not work either. 

If we then need to rebalance the economy with new manufacturing processes, I think we would be far better to concentrate on low tech. Entry is much easier and quicker. The problem with low tech, however, is that ability to compete on world markets depends entirely on the cost base and the exchange rate. But so, in the end, does high tech. The notion, however, that if the exchange rate is very strong then the only way to survive is by concentrating on high tech industries - while ignoring low tech - is in my view absolutely guaranteed to fail.

At the company level, I am also very sceptical about anything the government can do to help other than to keep out of the way and to provide opportunities for profitable trading. I do not believe that the success of the Tiger economies or Japan in its heyday or China now had much – if anything – to do with whatever industrial strategies they had. What worked for them, in my view, very largely was that they had competitive exchange rates. Everything else then fell into place.

On financial structures Skidelsky makes an important point, in particular the need for an industrial bank and easier access to finance for manufacturing industry. I think that the record of the British banking industry is appalling and I dare say that we share much common ground here. I am not, however, convinced that lack of finance is nearly such an important constraint on export performance as lack of profitability. My own telling experience is that, although the business I run is extremely difficult to finance, we have never actually been stopped from doing anything we wanted to do by lack of cash. Provided we kept profitable we could always find the money we needed somehow (with no help at all from UK high street banks). If manufacturing was profitable enough it would find the money it needed – probably from ploughed back profits which, in my view, is always the best sort of finance to have. 

Moving on, clearly we do not want to get into a world where there are unending competitive devaluations but surely this cannot possibly be an argument for keeping our exchange rate far too high, and running our economy into the ground as a result. It seems to me that what the world needs is to get an exchange rate regime in place which enables every country, broadly speaking, to keep its foreign payments in balance. I think this needs to be done by having exchange rates which enable all diversified economies such as ours to have enough manufacturing capacity to pay their way in the world. 

This seems to me to be a powerful argument for us to put to the rest of the world. If our exchange rate is too high and, as a result, we cannot avoid big current account deficits and  all the borrowing that entails, combined with no growth, then we are heading for default. This is in no-one’s interest. This is a completely different matter from surplus countries trying to build up even larger surpluses – completely pointlessly in my view - by manipulating their currencies downwards.

If, however, we could not persuade other countries that what we were proposing in terms of a major devaluation was in their interest, I doubt if there would be much retaliation, if any. Our share of world trade now is less than 3%. The USA still has the dollar as the world’s major reserve country, making it much more difficult for them to devalue than it would be for us to do so. The Eurozone countries have their own pre-occupations, although their travails may very well soon lead to massive exchange rate changes which the world will have to live with, on the back of which we might well be able to ride. In the end, I don’t think that we should crucify ourselves because of fears of retaliation. There may be some risks, but ultimately we need to do what is right for our economy.

 

 

About the author

John Mills is a businessman and economist. He is chairman of direct to consumer retailer, JML, and has published widely as an economist. His most recent book is Exchange Rate Allignments.