15 November 2012

By John Mills

By focusing on keeping inflation at a minimum, the government is selling out Britain's workers.

Since the financial crisis, the question of how to improve the resilience of our economy has been raised again and again. According to the government, the answer lies in drastic cuts that harm the poorest in society, and a more "flexible" workforce - that is, one with fewer employment rights.

When workers at Ellesmere Port's Vauxhall plant were forced to be more "flexible" to keep owner General Motors - a company which last year reported record profit - in the country, they agreed to compromise on pay and conditions. The deal struck by Unite to retain its members' employment at the site was a success in that it saved thousands of jobs, but it also highlighted the fact that workers are now positioned at the mercy of international companies, and thus in competition with their counterparts abroad. This time, the Vauxhall plant stayed in England instead of relocating to Germany as proposed. But next time such a situation arises, will there be further pressure on German workers to accept even lower pay and conditions in order to win out in a race to the bottom?

Rebuilding our manufacturing base and strengthening our exporting industry would not only lead to growth, but could also improve the resilience of our economy. But why should the burden of the recession fall on the shoulders of vulnerable workers when there are other ways to make our nation attractive to businesses again?

By far the largest reason why the British economy is in the catastrophic state in which we now find it is that we have been chasing the wrong economic policy objective. Since the 1970s, the government has focused on keeping inflation low at around 2%, rather than opting for the far more critical objective of maintaining the exchange rate at a level which would enable us to compete in the world.

It is extraordinary that one of the most potent economic policy levers is now barely ever mentioned. When we had a fixed exchange rate between the end of World War II and 1971, the strength of the pound was a constant pre-occupation. Since sterling began to float, however, using the exchange rate as an economic policy instrument has dropped almost completely out of sight.

Ignoring the exchange rate and just leaving it to market forces in this way is a huge mistake. The rate at which the UK cost base is charged out to the rest of the world makes a massive difference to the way our economy performs. If the rate is too high, manufacturing and exporting becomes unprofitable and declines. Manifestly, this has been what has happened to the UK.

The resulting balance of payments deficit - £100bn a year on goods nowadays - means we cannot expand the economy as we would like. Furthermore, the trading deficit sucks demand out of the economy, causing governments to make up the lost purchasing power with excessive borrowing. Because it is much easier to achieve productivity gains in manufacturing (through technological advancements for instance) than in services, the UK growth rate is much lower than it needs to be, and has been elsewhere.

How did we ever get into this situation? Much of the blame goes back to the battle against inflation in the 1970s. Monetarism swept the board and squeezing price rises out of the system became the over-riding priority. Interest rates were raised; money was tightened – and as a result sterling became about 60% stronger against all other currencies between 1977 and 1982. With some oscillations, this is where it has stayed every since.

The main reason why sterling has stayed so strong is that keeping inflation down has become the main economic policy objective, around which all others revolve. The problem is that keeping inflation at the British target of 2% – which is also the goal in the USA, while the Eurozone attempts to lower it even further – involves almost exactly the same economic policy responses as one designed to keep the pound much too strong.

As a result, growth has ground to a halt. Unemployment – if all those who would be willing to work if they could do so for a reasonable wage are included – is about 5m – far higher than the headline figure. Living standards are stagnant and we are facing years of austerity, cuts in public services and national decline. None of this is necessary. If we got the exchange rate right, so that we could pay our way in the world, this dismal outlook could all be avoided.

The effectiveness of such a move has been proven before, with two recent examples from UK history. After the devaluation of the pound in 1931, the economy grew faster than it ever has done before or since, while a similar boost was seen in 1992 after we came out of the Exchange Rate Mechanism.

Could the government get the exchange rate down if it was determined to do so? Of course it could. Just increasing government expenditure and reducing taxes such as VAT and national insurance would soon produce a much lower pound and there are many other steps which would achieve the same goal. But first of all politicians, policy makers, academics and public opinion formers, who have wrongly assumed that keeping inflation low is the most important economic target, need to realise that this is a huge mistake. Instead they need to recognise that getting the exchange rate to the right level and keeping it there is a far more important goal.

Until they do, we will have nothing but austerity and decline. Once we start aiming at the right target, however, all the evidence suggests that, with the right complementary policies, everything would move in the right direction, as it did in the 1930s and the 1990s. So why don’t we do it?

This article is based on ideas expanded on by John Mills in the journal Federation Viewpoint, in which nine experts detail their proposals for alternatives against austerity.

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