The Economist magazine has a piece this week on the role of manufacturing in the UK. While it half-heartedly concludes that a larger, more competitive manufacturing sector may benefit the economy, it suggests that today’s shrunken sector is increasingly employing only highly skilled workers on high wages, producing hi-tech products. The piece argues that the hope that a larger sector would directly benefit those currently left behind by its relative decline over the last few decades is a forlorn one. In other words, jobs which pay more moderate wages and demand fewer skills would not be created, given recent trends.
I disagree. This argument merely extrapolates trends which were at least in part due to the periodic and sustained overvaluation of the pound vis-a-vis our trading partners. I have argued here recently that the serious imbalances in the UK economy could be significantly reduced by an economic strategy which gives a greater priority to a lower exchange rate.
The pound has been trading at a much weaker level since the vote for Brexit back in June. It is imperative that this level is sustained. It would help to reduce the UK’s large current account deficit, currently at 6% of GDP. Exports would grow faster, and imports slower, reducing our trade deficit. At the same time, the value of net flows of investment income from abroad would also change to the good, further reducing the current account deficit.
I would argue, contrary to the Economist, that there is the potential for the creation of jobs in manufacturing which pay more moderate salaries and require fewer skills than those already mentioned. Sustained over a long period, a weaker currency would necessarily create new profit opportunities which were simply not available at the previous overvalued level.
It is of course difficult to make accurate predictions, but the article ignores the impact of a lower currency on the manufacturing sector. It is quite possible that many years of a strong currency have crowded out previously viable firms, which would have either directly exported goods themselves or indirectly provided goods and services to exporters. Some of these might have created high-tech, high-skill, hi-wage jobs, but there would surely have been jobs created that pay wages towards the middle of the income distribution as well.
There are those who argue that the benefits of a weaker pound will be undone by higher import prices. Indeed, some of those firms currently exporting their products have been hit by the higher price of imported inputs. In the short term, they may be forced to raise prices, take lower profits, or some combination of the two. Over a longer period, they might reduce unit costs through improvements in efficiency. In addition, opportunities will arise for domestic firms to supply them at lower costs than firms abroad. This would contribute towards reducing the value of UK imports as part of the ongoing rebalancing.
This potential for change is why it is so vital that a weaker currency is sustained, since firms need time to respond to price changes. In the economics jargon, one would say that the price elasticity of demand for exports and imports will to some extent rise over time. Simply put, a devaluation can take a while to have its full impact.
Thus a weaker currency is essential and sustaining it should be encouraged through government policy. However, while necessary, this may not be sufficient. Some form of industrial and regional policy could be needed to support the creation and growth of firms which have the potential to benefit from the change.
If doubts remain about the potential for changes in the value of real exchange rates to impact foreign trade performance, one need only look at Germany. Since 2000, wage stagnation and more recently a weak euro have made exports more competitive and led to a large current account surplus. I have said before that this is in fact part of the cause of the eurozone crisis and that it represents an imbalance that needs resolving for recovery in the eurozone to be sustained without reducing global demand and growth. I stand by that, but it illustrates the point that changes in the real exchange rate have the potential to improve economic performance. There is no reason why this should not be true for the UK.