Plaid Cymru’s economic adviser replies to John Mills’ proposals on how to re-industrialise the British economy.
John Mills’s analysis of the state of the UK economy provides a sobering antidote to those who are proclaiming an end to the UK’s economic problems, that growth has returned for the foreseeable future and that we are, or soon will be, back to ‘business as usual’. Many of Mills’s comments echo the concerns that Plaid Cymru has expressed over the years regarding the imbalances in the UK economy both in terms of sectors and geography.
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This week on Click on Wales
This week on Click on Wales we are publishing part of the series run by OurKingdom recently. In the first piece John Mills wrote a sobering analysis of the state of the UK economy. In the following pieces of this series Gerald Holtham and Eurfyl ap Gwilym respond to John Mills’ article.
Tuesday: John Mills outlined his plan for the British economy after 2015.
Yesterday: Gerald Holtham argued about Mills’ economic plan for the UK.
Today: Eurfyl ap Gwilym replies to John Mills’ proposal on how to re-industrialise British economy.
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By 2015 the UK’s public sector debt is forecast to be approaching 100 per cent of GDP which will place an ever increasing burden on the tax payer. At the same time the cuts in public expenditure will continue to put additional pressure both on employment in the public sector and on public services. It is true that in the past, usually after wars, public debt reached comparable levels but rapid economic growth helped turn the position around with growth in GDP outstripping growth in debt. Mills’s central thesis is that given the current policy mix the UK cannot look to growth to resolve the debt problem unless the economic balance is altered radically with strong growth in exports driven by a resurgent manufacturing sector. Growth alone will not fit the bill because it will lead to a rapid increase in imports of manufactured goods which will exacerbate an already unsustainable deficit in such goods: in 2012 the manufacturing deficit for the UK as a whole was £107bn compared with a £74bn surplus on services. In his summing up Mills calls for the current approach of seeking to steer the economy by fiscal and monetary means to be broadened to include exchange rate policy.
Manufacturing in the UK now accounts for approximately 10 per cent of GDP compared with 32 per cent in 1970. In Wales it has declined from 30 per cent in 1989 to 16.8 per cent in 2011. Mills identifies a number of factors that have driven the long term decline. The discovery and exploitation of North Sea oil and gas in the 1970s was allowed artificially to drive up the value of sterling to the detriment of manufacturing. Following the deregulation of financial services in the mid 1980s (Big Bang) there has been the explosive growth in this sector.
In the case of the UK as a whole financial services as a proportion of total GVA grew from 7.6 per cent in 1997 to 10.3 per cent in 2009. In the case of London financial services grew over the same period from 14.4 per cent to 21.6 per cent of GVA: in Wales the proportion grew from 3.4 per cent to 5.2 per cent. Mills’s analysis echoes the arguments advanced by Plaid Cymru that not only has the growth in financial services been overwhelmingly concentrated in south east England but it has other malign consequences. It has sucked in too many of our most talented people attracted by the high levels of pay for performing services many of which were described by the former chairman of the FSA, Adair Turner, as ‘socially useless’.
Another effect of the growth of financial services has been the sector’s increased influence on UK political parties with not only the Conservatives but Labour falling over themselves to create through ‘light touch regulation’, together with fiscal and monetary policy, the conditions for the sector to grow ever stronger at the expense both of other sectors and other countries and regions of the UK (the disparity in GVA per capita across the countries and regions of the UK is one of the highest in the EU). Indeed it was Labour who were the instigators of regulatory arbitrage to ensure that London stole a lead over New York.
Labour was so successful that according to the IMF by 2010 the banking assets in the UK were 550 per cent of GDP compared with 100 per cent in the case of the US and 150 per cent in Germany. This ratio is not an indicator of success as was claimed by Labour but a measure of dependence on financial services and even more crucially a measure of the vulnerability of the UK economy to the periodic implosions of the financial sector. Little wonder that when the banking crisis erupted in 2008 the UK caught an almighty cold – but, ironically, it was the countries and regions away from London and the South East that paid the heaviest price and it is now London that once again is showing the strongest growth in employment and GVA.
Thus far Mills’s analysis adds little to what is already well understood. More interesting is his ten point agenda where he calls for setting a target for faster economic growth, 4 to 5 per cent per year, and for such growth to be generated by a resurgent manufacturing sector. How could such a resurgence be achieved? His answer lies in calling for a major devaluation of sterling from $1.60 (in July 2014 it stands at $1.71) to $1.10 and a comparable fall in terms of other major currencies.
Such a fall would not only stimulate exports but also lead to significant import substitution. At the same time there would need to be vigorous implementation of supply side polices in such areas as planning, infrastructure and skills training. Of course such a switch could not be achieved overnight and in my view Mills’s timetable of ‘being fully implemented in five years’ seems far too optimistic. The loss of manufacturing capacity over recent decades cannot be recovered easily or quickly. Such a resurgence will not only need the rebuilding of manufacturing capacity in terms of plant and machinery but also in terms of education and skills. Many of those who worked in manufacturing have drifted off into other industries, have retired or simply given up.
It will also, as Mills points out, need a redirecting of investment away from housing and other property to investment in manufacturing and related infrastructure. A rebalancing of the economy away from financial services and into manufacturing should lead to a more geographically balanced economy but this is by no means assured. Many of the traditional manufacturing regions have taken a beating and it will require major and sustained action by successive governments to reverse the decline. In fairness the current UK Government is talking increasingly of rebalancing the UK economy but the steps so far announced do not measure up to the challenge.
Another challenge to rapid growth in exports of tradable goods is the uncertain outlook for many of the UK’s traditional export markets. The Eurozone continues to be fragile with the fear either of fragmentation or deflation never far away. China is moving from low value added production to higher value products and ‘moving up the value chain’ will not be a panacea for UK industry. However there may be reasons for optimism elsewhere. The US offers hope with the rapid exploitation of indigenous energy sources poised to give that economy comparative competitive advantage both at home and abroad.
Paradoxically the strengthening of the US economy will pose both a threat to UK exporters but also offer a buoyant market. The Far East and other emerging markets may provide a good market for the export of high value, capital goods: this is the strategy adopted by Germany with considerable success. Another positive factor is that there are clear signs that some manufacturing which had been off-shored is now been repatriated. This is due to the rapid increase in costs in emerging markets, issues with intellectual property rights in certain countries and the recognition that physical proximity to markets can often be important.
Mills’s analysis is strong and is supported by extensive quantitative analysis and modelling but as is so often the case in economics, witness Marx and Picketty, it is not so clear how such an analysis can lead to the formulation and implementation of policies that lead to a radical transformation of the economy. Is the highly centralised UK state with its London-centric political establishment prepared to drive such change? London and South East England are showing the strongest post recession bounce-back but at the same time identifiable public expenditure in London is the highest of any of the English regions and that is before non-identifiable expenditure with its strong bias to London is taken into account. London is booming and many in the Westminster-City nexus may think that the weak performance of the rest of the UK is a price worth paying.
As noted a novel ingredient in Mills’s proposals is to use exchange rate as a third arm of macroeconomic policy. One of the great puzzles under both Labour and the Conservatives is that while they opted to keep the UK out of the Eurozone they have not sought to take advantage of that freedom to use the exchange rate to rebalance the UK economy in the way that Mills advocates. How would devaluation of sterling be accomplished? Would the UK be able to devalue without retaliation?
It is true the Eurozone’s neighbours appear to be devaluing in response to the ECB’s monetary easing: in June Norway signalled that it would not raise interest rates before the end of 2015 and in July Sweden’s Riksbank slashed its key interest rate to 0.25 per cent. Switzerland and the Czech Republic already manage their exchange rates against the Euro. In July the Financial Times reported that pressure was ‘mounting on the ECB to take action against a persistently strong euro’. It quoted Fabrice Bregier, chief executive of the Airbus passenger jet business, as saying ‘[Europe] cannot be the only economic zone that doesn’t consider its currency as a weapon…as a key asset to promote its economy’. Mills also concedes that there would be a price to pay for higher economic growth: he foresees inflation as measured by CPI of 3 to 4 per cent. This could, of course, be a price worth paying but will the UK political parties see it that way or will they continue to be swayed by the interests of the City of London?
Central to the UK government’s strategy is that if inflation is kept low then growth will come about ‘naturally’ but little attention is paid to the nature, in terms of sectors or geography, of such growth. Plaid Cymru has long advocated a radical change in the balance of the UK economy with a renewed emphasis on manufacturing and a much greater attention being paid to economic renewal in the countries and regions of the UK. Unfortunately in the run-up to the UK General Election in 2015 I do not expect to see any of the UK parties advocating a strategy such as that proposed by John Mills. In the cases of Scotland and Wales it will be up to their governments to seek their own salvation using the limited economic levers at their disposal.
While Dr ap Gwilym is right to point out that our economy still faces some potentially very dangerous long-term weaknesses, the fashionable ‘City bashing’ is not helpful. On this occasion the Adviser to Plaid has trumped the past Deputy Chairman of the Principality. If we are to progress we need to get out of the blame culture, and understand that Wales is not poor because the South East is rich nor did the rise of the banks cause the decline of manufacturing. Although the banks have done many reprehensible things, the long post-War suicide of British manufacturing was the result of bad government, bad management, and politicised trade unions, probably in that order. The hope for the future is that there is now understanding of that and none of those three factors is as bad as they were before 1979, but government in particular still has a lot to learn.
That said, all three contributors to this series should be congratulated on their stimulating and well-researched articles which together provide a lot of nutritious food for thought. This is the sort of thing the Institute does well.
I understand the description of the problem but it`s the prescription i have difficulty with. How do we manage devaluation? If a devalued currency is in our best interest who are we and does that we include the richest and most populous parts of the UK? If as I suspect the second part of that question is no then its tempting to think that Welsh independence is an answer.Presumably with our own (cheap) currency. Now why doesn’t Mr Salmon think that`s a good idea.
I concur with Eurfyl ab Gwilym that no UK party will adopt John Mills’ proposal because the principal suggestion John Mills makes is to stimulate net export growth by a massive sustained devaluation. But the British government does not have the power to engineer such a sustained devaluation. If the pound did fall and the UK did start growing at 4 per cent, that fact alone would lead to a sharp rise in the pound, as we have seen sterling rise just on the prospect of the current rather anaemic recovery. Eurfyl makes the point that the devolved territories must seek their own salvation with the instruments at hand. Indeed. I think all the Welsh parties owe the Welsh public a programme for how they aim to improve the Welsh economy. No one in their senses expects a Big Bang quick fix. But over 30 years we have become the poorest part of the UK. What about sensible proposals to reverse that over the next ten to 30 years? Come on, Welsh politicians, let’s be hearing from you.
‘But over 30 years we have become the poorest part of the UK. What about sensible proposals to reverse that over the next ten to 30 years?’.
For starters let’s try and isolate those things that have led to our decline. Things that are particular to Wales rather than the UK as a whole.
I submit the following for consideration:
i) fascination with the Welsh language
ii) greater public sector employment opportunities for Welsh speakers
iii) a ‘Welsh’ orientated school and university education system
iv) subsidising students attending Welsh universities
v) the Welsh Assembly
I don’t think we need to leave it to the politicians to tell us what is wrong in Wales.
Jonti,
I do not think these things are at the root of our problems. An area with relative decline as fast as Wales’ (though not to such a low level,because it started more prosperous) is the West Midlands. Welsh was not a factor. And small prosperous European countries like Finland support an indigenous language that no-one else speaks. Welsh is not a requirement for the vast majority of public posts in Wales but Irish civil servants do require a qualification in Gaelic, which almost no-one speaks. That has not been blamed for either the rise or fall of the Celtic tiger. People get very emotional about the language, both for and against. Economically, it is not a significant factor so far as I can tell.
Finland can support it’s language because it is prosperous. And I would query the comment about Welsh not being a requirement for the vast majority of public jobs. In economic terms it can be ‘the straw that breaks the camels back’ both in terms of money, time and recruitment of the best individuals, and probably a factor in driving the best away from Wales. Unfortunately, emotions and political correctness get in the way of proper, comprehensive analysis. I doubt that we will ever get that in the foreseeable future.
Colin, Wales was prosperous when most of the population spoke Welsh. Our decline is parallel to Anglisiation beeng forced on us by our ruling neibour who wants to see one nation (i.e. not ours)
So, are you agreeing that English has been, and still is, bad for Wales?
Gwyn – English is ‘bad’ for most languages, not just the small ones. Look at Germany, France, etc. But this fact doesn’t ‘help’ the Welsh economy. As for the decline being parallel to Anglisiation, I would suggest that it was far more to do with the decline of heavy industry.
Colin Miles, why would you query that Welsh is not a requirement for the vast majority of public sector jobs? That is a statement of plain fact. The civil service is a UK one and most senior civil servants in Cardiff are English. The vice chancellors of our universities are mostly not Welsh, never mind Welsh-speaking. Chief executives of local authorities are mainly not Welsh speaking. Only Gwynedd has a Welsh language policy. Adverts may say “Welsh an advantage” but outside Gwynedd and parts of the BBC, no-one takes any notice. If anything holds Wales back it is not the language but the fact that members of both language groups maintain a persecution complex about the other group. Speaking as one with roots in the English language group, I think the Welsh speakers have a stronger claim to persecution than we do but I do not expect to overcome the paranoia of my co-linguists.
I’m inspired to post my first IWA comment, in challenge to Jonti’s implied assertion that all would be well if we all just spoke English.
Wales is in a currency union with the rest of the UK. Hence, if external conditions have a different impact on the Welsh economy compared with other areas (this is called an asymmetric shock), the safety valve which would be provided by currency realignment doesn’t exist. As an example: if North Sea oil is booming, or financial services exports from the City are significant, and if monetary policy is set with reference to conditions in Scotland or London respectively, then sterling could be overvalued from the perspective of other parts of the economy, with a detrimental impact on the trading sectors’ ability to export. This is the old “crowding out” argument we used to hear in the 1980s and is the point Eurfyl ap Gwilym is making in his critique of the City’s impact. I expect that Greeks and Italians have got familiar with the concept too.
In a currency union, such economic tensions are compensated for in three key ways: relative wage adjustments, fiscal transfers, and labour mobility. I suspect that a significant proportion of Welsh salaries are tied to, or set with reference to, UK pay settlements. The fiscal transfer is reflected in the large gap between Welsh public expenditure and tax receipts. And labour is highly mobile, which, for those of us who can cope with the idea of people speaking more than one language, is problematic – it means a lot of our young Welsh speakers, as well as labour talent generally, move out.
Debate on the Union is, it seems to me, focused on constitutional issues to the detriment of economics. On both sides we need more thoughtful analysis. Advocates of an independent currency (and hence devaluation) need to consider whether we have the skills and capacity to take advantage of the initial boost to cost competitiveness, rather than see any advantage frittered away in wage inflation. And Unionists need to ask themselves whether the currency union as currently configured represents an economic straitjacket from which we have little chance of escaping.
What could our politicians in Wales do in the short term? As Eurfyl points out, the available levers are limited. Here are some suggestions: argue for a new Barnett formula, i.e. a greater fiscal transfer. More usefully, push for a form of fiscal transfer which is conducive to economic development (e.g. lower relative corporation tax, NI and VAT rates – I doubt that differential income tax rates would have as much benefit, yet this is the focus of all the politics.) Abandon UK-wide public sector wage deals. Stop introducing rules which add to commercial costs (e.g. gold-plated construction standards.) Avoid subsidising unproductive forms of investment (e.g. schemes such as “right to buy”) and prioritise economic development spending on those areas which will deliver the largest productivity gains (cheap energy from fracking, perhaps?).
Gerald – ‘Adverts may say “Welsh an advantage” but outside Gwynedd and parts of the BBC, no-one takes any notice.’ Unfortunately the very fact that the adverts say that can put off well-qualified non-Welsh speakers from even applying – so people do take notice, whatever the end result. And I know of an example where as soon as the Welsh qualification was dropped the quality of the applicants immediately rose – and others say the same. This is not about any persecution complex, real or imagined, just a rather sad fact of life.