Mills' plan is not the answer

Logo-There is an alternative

John Mills plan is a peculiar mixture of fact, acute observation, misconception and fantasy.

Gerald Holtham
5 August 2014

Flickr/D W S. Some rights reserved.

He paints a picture of a UK economy growing rapidly – 4 to 5 per cent, a rate never sustained in the whole of our peacetime history – with higher levels of investment going into reviving manufacturing industry in relatively deprived areas of the country.  This is all to be launched, if not achieved, within one parliamentary term.

How is this miracle to be achieved? By somehow getting the exchange rate to fall to £1= $1.10.  And how is that to be achieved?  Mills writes as if we still lived in the Bretton Woods era of adjustable-peg exchange rates, backed up by exchange controls.  Somehow he has not noticed that we have lived with floating exchange rates since 1973 and exchange controls were abolished during the first Thatcher administration. Exchange rates are now driven by relative monetary policy, the expected return on assets in different currencies and the expectation of the markets about those things. This year the pound has risen from around $1.50 to $1.70, the opposite of what he wants. But that is not government policy; it is the result of the current pick-up in the UK economy and the foreign exchange market reaction to it.

The usual way to lower an exchange rate is to slash interest rates. But official rates are already close to zero. I suppose the government could put a scare into the financial community so it fled the pound – perhaps by threatening  to tax financial transactions and by extending higher taxes to offshore investors. But wait a minute. The devaluation was supposed to lead to a large, nay vast, increase in investment, from 14 per cent to over 20 per cent of GDP. Presumably much of that investment is supposed to come from the private sector. Yet it is hard to imagine private business being so gung-ho when the government is busily trying to scare the wits out of foreign exchange dealers and foreign investors.

So John Mills depicts a scenario remote from the present situation and he has no means of getting there. Monetary policy could not be easier than it is. A determined effort to force the exchange rate down by printing yet more money or terrorising the markets would undermine the confidence he needs to raise investment to rates that have not been seen in the whole of British economic history outside the war economy. A dirigiste war economy is a logical possibility: draconian exchange controls, forced investment under threat of expropriation etc. But, to be fair, Mills does not suggest that, and the precedents for running a modern economy that way are very far from good.

So there will not be a 4-5 per cent growth rate and the problems of the British economy will not be tackled in one parliamentary term. So much for the fantasy; let us turn to the misconception.

Mills’ desire to restore British manufacturing is quite widely shared. It is uncomfortable to be running a deficit in trade (visible and invisible) which is financed by borrowing or selling assets to foreign residents. I share the unfashionable view that ownership matters in many industries. Scotch whisky can be made only in Scotland but that is not true of most commodities or services. So we should not be indifferent as British registered companies are sold off. Companies that have roots, that will stick and compete where they are rather than decamp to where inputs are cheaper, are of great benefit to a country – as the German Mittelstand has shown. But the key is that these are successful companies making and selling marketed products. It is irrelevant whether they are selling motor cars or software, computers or code for computer games. To fetishise “manufacturing” is to miss the point.

Mills laments the decline of manufacturing from 30-odd per cent of GDP in the 1970s to some 10 per cent now.  But reader, ask yourself this: how much of your own discretionary expenditure is on manufactured goods now, compared with 30 years ago (if you are old enough for the question to make sense)? Manufacturing as a proportion of output is down world-wide because it is down as a proportion of consumption. If you won the lottery, you might buy a new house (not a traded good) and a smarter car. But after that you would consume services: get the garden landscaped, dine at the best restaurants, send the kids to expensive schools, perhaps employ a trainer. You would not need to fill your house with more tat; even if you are a member of the “squeezed middle” it is probably full of tat already. You might get it wired up so you can draw the curtains while you are away on an expensive holiday. But the cost of doing that is largely the consultant know-how and the installation, not the kit.

Manufacturing should play its part in a revival of the productive British economy but Mills shows he is really living in the past when he says:  “... manufacturing provides a much better spread of high quality, skilled and well-paid blue collar jobs than is the case with the service sector.”

Now a manufacturing revival may help the country balance the trade books and be of other benefits but it will never be a large-scale employer. Manufacturing employment has been falling for decades in all developed countries, including Germany, and will continue to do so. If anyone chooses to locate a manufacturing plant in the UK rather than China or Vietnam it will be because productivity is high enough to offset higher wage costs. That generally means automation, lots of it. Those well-paid blue collar jobs are a feature of economic history, not the present day. 

That is also why, contrary to Mills’ assertion, the existence of unemployment does not in itself provide the fuel for rapid growth of 4-5 per cent. With the ending of capital controls, the IT revolution and the liberalization of China, India and other formerly autarkic economies, there is a global surplus of untrained, ill-educated workers – especially ones who require the UK’s minimum wage.

So fantasy and misconception apart we get to Mills’ acute observation and to the crux of the issue.  Globalisation has led to the re-siting of many relatively unskilled activities to countries where labour is cheap. There has always been such a product cycle of industries moving to low-wage locations as their technology ceases to be cutting-edge and becomes widespread. But the scale and speed has gone up enormously. That has changed the balance of industrial power in developed countries, not just the UK with evident effects on the distribution of income.

So much, so well known. But there is a corollary less often acknowledged. With wages not keeping up with output as profits rise, there is a shortage of effective demand world-wide. In that situation everyone, like John Mills, wants a competitive exchange rate so they can export the problem to someone else – but that does not work when everyone tries it. The only solution found so far is to encourage the workers to accumulate debt to buy the things their wages won’t cover. And the way that is done is to provide super-lax credit that leads to asset price bubbles, notably in house prices. If your house makes more money than you do, you can increase your liabilities in line with your assets and borrow to spend.

Mills is quite right that the current recovery has not departed from this pattern. He is also right that it is unsustainable, that eventually the asset bubble bursts and households have to rein in their spending sharply. Another recession then looms. As a solution it also leaves out the young who have not had time to acquire assets to borrow against and who cannot afford to get on the housing ladder with their inadequate wages.

So he is perfectly right that the economic future has troubling features. It is also perfectly true that in many parts of the country our education and training systems do not equip our young people to deal with this difficult reality. The political and academic classes have largely failed to grapple with these intractable problems and have peddled bromides of one sort or another.

Unfortunately, John Mills’ proposal belongs in that category.


See the rest of the series here.

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