Exchange rate: the ultimate reshoring obstacle?

Posted on 11 Jul 2017 by Jonny Williamson

The value of sterling has a critical effect on the exchange rate and the success of exporting manufacturers, and yet it is rarely debated. Nick Peters sat down with John Mills to discuss the issues.

Spring Budget Reshoring UK Manufacturing Pound Coin Currency Graph Money Brexit Finance - Stock
As a nation, we view a high exchange rate as a virtue, but for manufacturers, it is a millstone around our collective neck.

For all the potential impact on UK manufacturing and our national balance of payments that reshoring might produce, there is a nagging question that might serve to undermine every effort being made to that end.

Indeed, it could undermine the government’s entire industrial strategy, because UK manufacturing will never regain any resilience as long as it remains unaddressed. The question in terms of the exchange rate is: ‘Should sterling be drastically devalued to make domestic manufacturing more competitive?’

As a nation, we view a high exchange rate as a virtue, and for consumers holidaying abroad, or buying imports, it certainly is. But for manufacturers, it is a millstone around our collective neck.

The campaign for devaluation has largely been led by John Mills, chairman of the direct-to-consumer JML Group. Mills is an influential Labour party member and contributor, who also advocated ‘Brexit’. His new book, Britain’s Achilles Heel, sets out the case for a devaluation of the pound almost to parity with the dollar. He believes this would usher in a new golden age for the UK economy.

The Manufacturer spoke to him about the case for devaluation.

This article first appeared in the June issue of The Manufacturer magazine. To subscribe, please click here

I would assume from everything you’ve written in this book that you believe the economy has been hobbled by an inflation strategy that has kept the exchange rate artificially high?

John Mills, chairman, JML Group.
John Mills, chairman, JML Group.

John Mills: Yes, I think we have kept the exchange rate too high for a very long period of time. It goes right back to the 19th century and the fact that we industrialised very early on. We therefore had an economy that became more ‘financialised’ than others, with powerful financial interests who are always inclined to go for strong exchange rates, partly because this gives them more international leverage, and partly because a strong pound tends to be associated with high interest rates and higher returns to capital rather than to labour.

It got worse when the Keynesian consensus collapsed in the early 1970s. Monetarism took over and neoliberalism became the basis for economic policy. People just lost sight of the importance of the exchange rate as an equilibrating influence in our relationship with other countries. The pound shot up in value and the result was that we de-industrialised to a massive extent, down from about a third in 1970 to around 10% now. I think this has left the economy very unbalanced.

If you look at the way the pound is described, when it goes up, it’s a good thing, if it goes down it’s a bad thing. When it’s strong, everybody’s in favour of it. When it’s weak they’re not. The whole terminology is absolutely loaded with value judgments that bear very little relationship to reality – which is, if the pound gets too strong it’s impossible for industry in this country to compete, and we de-industrialise. That’s what’s happened.

If you had your way, what should the new government do?

The problem is that services can operate quite well with a much higher exchange rate than manufacturing can. Our service economy has done well, exports have been very strong in that area, because services aren’t very price sensitive, and because we’ve got huge natural advantages in services. Our geography, our language, our legal system, our universities and so on. None of this applies to manufacturing.

The reality is we need a different exchange rate. It’s so important that we get it right for manufacturing because if you look at our exports, most of our earnings are in goods and not services. If you hobble the goods side of the equation, which is what we’ve done, you finish up with massive balance of payments deficits year after year, which is what we’ve had.

“We’re the odd man out here in thinking that having a very strong currency is a sort of virility symbol”

If you look at what exchange rate is required to make it viable to invest in manufacturing in this country, the exchange rate should be way below where it is, probably not much more than parity with the dollar – $1.05 or something like that.

What about Brexit? The pound took a nosedive after the referendum, and recovered some ground thereafter. If there is a ‘hard’ Brexit, as some ministers are hinting, then you’re going to get what you wanted anyway because the pound will, to use the vernacular, just fall off a cliff.

Well I think that may happen. I mean it’s very interesting that the economy did so much better than all the experts predicted after the June referendum. I think the main reason for this is that the lower pound, going down from $1.45 to about $1.25 provided a boost to exports which will pull the economy through.

If we have a hard Brexit, my guess is that what will happen is the pound will come down again, possibly to the sort of levels which I think it should go down to; in which case I think it then becomes really interesting for people to invest on a much bigger scale than we’ve seen previously in manufacturing facilities in the UK. In which case I think we may well find the economy booming to a much greater extent than most experts would expect.

But by the logic of everything you’ve written about in your book, policy would then veer towards increasing interest rates, to keep inflation down, which will artificially start to raise the exchange rate one more time in the very direction you say is wrong for the economy.

Well, I think there’s a number of issues there which are worth investigating. One is whether devaluation actually does increase inflation? I was always taught that it did, but when I look to the figures I found this simply wasn’t what happened. A very interesting example was when we came out of the exchange rate mechanism in 1992 and everybody said inflation would go up and it didn’t, it went down from about 5-6% in 1991 to just over 1% in 1993, and the economy boomed for 15 years.

“The whole terminology is absolutely loaded with value judgments that bear very little relationship to reality”

I think the idea that you get all the benefits of increased competitiveness washed away by inflation just simply isn’t the case. I think that it’s an illusion. And I don’t see why you should have higher interest rates. Why not keep them down?

But your point surely is that politicians would have to change their mindset and welcome a lower exchange rate, and not try to resist it, which is the way that policy making has pulled them for decades now.

I completely agree. I think that’s exactly what has happened with disastrous results. There has to be a change in mindset. German manufacturing has always has this mindset. So have people in Japan. And in Singapore. We’re the odd man out here in thinking that having a very strong currency is a sort of virility symbol. Everybody else thinks it’s a disaster.

If you look at Singapore, it’s a very interesting example of a very high income, very successful economy which is expanding still at 5-6% per annum. They have a currency board which is intent on making sure that the Singapore dollar doesn’t rise too much in value, so that their manufacturing industry can continue to flourish. Singapore has about 20% of its GDP coming from manufacturing, whereas we have around 10%.

Your philosophy is guided towards preparing the ground for a resurgence of light manufacturing, which you say has been hollowed out over the past 50 years or so. What if there just isn’t enough expertise left – appetite even – for that resurgence to take place?

Well I just don’t believe that. It obviously will take a bit of time for the fruits of re-industrialisation to take place. But my experience of manufacturing – I’ve run a manufacturing operation in this country for 25 years – is that it just simply isn’t that difficult.

If the machinery, technology, raw materials, components are available on world markets, it’s not very difficult to put light manufacturing operations together. The one requirement you have is that they should be profitable, and if they are, then I think people will flood into doing this.

If you look at the world’s history, when South Korea, Taiwan, Singapore and Hong Kong started industrialising, they didn’t have much in the way of skilled labour forces or anything. What they did have was entrepreneurial people who poured in to take advantage of opportunities for making money. Then, as they got more experience, they moved upmarket, and this is exactly what we’re going to have to do.