In his recent “Build it in Britain” speech, Jeremy Corbyn broke a decades-long taboo by addressing the UK’s international competitiveness problem. Even as the country’s current account deficit – the difference between what we buy from the rest of the world and what we sell to it – has increased over the last 40 years (reaching a peacetime record of 6 per cent of GDP in 2016), we’ve been told that it doesn’t matter. In the short run, a current account deficit would lead to currency depreciation, making our exports more competitive. In the long run, our exports would shift towards areas in which we had a comparative advantage.
Underlying this was the belief that the UK should become a modern, global, service-based economy, with the “invisible trade” of services more than compensating for imports of goods. Labour’s insistence that we need to pay our way in the world was dismissed by neoliberals, who claimed that “making things” was outmoded.
Yet at no point in the last 40 years has invisible trade made up for the UK’s huge deficit in goods. The result has been the emergence of a large and persistent current account deficit. Far from adjusting to this, the UK’s currency has remained overvalued and hindered exports.
Mainstream economists counter that this reflects the high demand for UK assets. This is true, but it is not necessarily welcome. The high demand for our assets has been driven by their rising values. High levels of lending against existing assets, such as housing, led to the unsustainable boom in house prices between the 1980s and 2007. The high returns generated by UK banks pushed up the value of our currency and reduced the competitiveness of our exports.
These processes boosted the profits of financial institutions: financial output grew from 5 to 8 per cent of total output, and 1.5 to 15 per cent of total profits, between 1970 and 2007, while manufacturing shrunk from 32 per cent to 12 per cent. Eventually, financial institutions began turning this debt into complex securities that could also be sold to investors: this attracted yet more international capital, as well as causing the 2008 financial crisis.
When this capital fled the UK that year, the value of sterling fell by 25 per cent. The Brexit vote led to another significant depreciation. Under ordinary circumstances, exporters could have responded to this drop by increasing output.
Yet service exports aren’t very responsive to price increases – a law firm can’t suddenly “produce” ten more lawyers. Meanwhile, our goods exporters, which could have responded to the devaluation, had been ravaged by the preceding 40 years of currency inflation.
Instead, the UK has relied on tax breaks and reduced labour costs to attract investment from abroad. Corporation tax has been reduced from 30 per cent in 2008 to 19 per cent today. Wages, meanwhile, have stagnated: most people are still earning less in real terms than they were before 2007.
The creation of a low-tax, low-wage “bargain basement” Britain has resulted in an influx of foreign direct investment through mergers and acquisitions. Rather than boosting our purchasing power, sterling’s fall has combined with lower taxes and labour costs to make our companies appear a bargain to international investors.
Economic commentators usually speak of “selling off the family silver” in reference to privatisation, but the phrase applies equally to sales of UK assets to fund the current account deficit. Clearly the current account matters. So why have we stopped talking about it? The simple reason we don’t talk about the “other deficit” is that tackling it would require reining in finance.
The dominance of the finance sector has created an economic model based on extraction: that is, extraction from the rest of the world via capital inflows, and from the future via debt. We must rethink the decision made 40 years ago to sacrifice the interests of producers to those of extractive rentiers.
This will require mechanisms to tame the finance sector, including tougher regulation that goes far beyond Basel III (a set of reforms developed by the Basel Committee in response to the 2008 financial crisis) and more and better taxation.
Yet it will also require much greater government investment and an active industrial strategy to boost exporters. Such a rebalancing is the only way to build a sustainable economic model based on productive investment, not financialised extraction.
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This article appears in the 08 Aug 2018 issue of the New Statesman, The rise and fall of Islamic State