The sharp fall in the pound in the wake of the 2016 Brexit referendum would help “rebalance the UK economy”, in the words of Mervyn King, former governor of the Bank of England. But since then, the UK has struggled to improve its trade position and has certainly not seen any boost to GDP growth.
The idea was that a fall in sterling would rejuvenate British industry: exports would become cheaper to overseas buyers, leading to higher demand and sales. Faster growth in exports would boost the economy, along with job creation and wages.
The pound is once again under pressure, with a further depreciation expected if the UK leaves the EU without a deal. But while some commentators continue to argue that a weaker currency can help to stimulate the economy, the data suggest a different narrative is playing out.
Between the end of 2015 and the end of the first quarter of 2019, trade-weighted sterling fell 12.1 per cent. Meanwhile, the manufacturing sector as a share of the total value added of the economy rose from 10.02 per cent to 10.07 per cent. And as a share of total employment, manufacturing increased from 7.69 per cent to 7.7 per cent — hardly the rebalancing some had hoped for.
The trade data are even worse. In the first quarter of 2019, net trade reduced GDP growth by 3.4 percentage points compared with a year earlier. This is the most negative quarterly year-on-year contribution from trade since records began in 1955.
Granted, pinning this on sterling is unfair as the stockpiling of goods in the run-up to the March Brexit deadline played a large role, but there is plenty of other evidence of the lack of improvement in the UK’s external performance.
Currency is just one of several key drivers that a standard trade model would rely on to explain the volume of exports. Taking a simple weighted average of GDP growth using the UK’s export shares tends to be three to five times more powerful in explaining growth in exports than currency. When examining a nation’s export performance we should also take global trade into account — the question is, has the UK managed to take a bigger slice of the world trade cake?
Since 2000, the volume of global exports has almost doubled, while the UK’s has risen by almost two-thirds, according to Schroders’ calculations. Britain’s share of global exports has therefore fallen, despite trade-weighted sterling falling 29 per cent over the same period.
Alongside currency moves, there are two additional factors to consider when explaining the UK’s dismal performance.
The first is the competitiveness of the labour market. The UK has long been known for having one of the most flexible labour markets in the world. Yet it has not been able to keep up in terms of productivity growth, and has therefore allowed the cost of labour per unit of output to rise versus that of its competitors.
The trade-weighted euro has risen 23 per cent since January 2000, for example, while the sterling equivalent has fallen 29 per cent. Despite this wide gulf, the performance of Germany’s and the UK’s real effective exchange rates — that is, the nominal trade-weighted exchange rate adjusted for unit labour costs — has almost been the same over this period. So the advantage of a depreciated sterling has largely been lost (against Germany) due to poor labour market performance.
The second factor to consider is whether exporters have pricing power in foreign markets. Most of the value of the UK’s total exports is generated by a small proportion of companies, often large multinationals that are protected by patents and intellectual property. A good example is GlaxoSmithKline, a global top 10 pharmaceutical company that has the ability to price its drugs in foreign markets.
But as sterling has depreciated, many British exporters have simply left their prices unchanged and become more profitable in sterling terms. This is great for investors, but less so for the economy in real terms — without the increase in exports, part of the expected benefit from the currency depreciation is lost.
If sterling falls far enough, companies will choose to export rather than serve the domestic economy and the UK will be able to compete. But in order to not erode the competitive advantage, a much larger depreciation than what we have seen would be needed and labour costs would have to remain at current levels.
The cost of such a currency fall in terms of higher inflation, lower purchasing power and the destruction of the value of savings would be devastating.
This article was first published in the Financial Times: Why weaker pound has failed to turbocharge the economy
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