The UK's problems go far deeper than the cuts agenda. It simply can't produce enough to revive its ailing economy
‘Despite the huge incentive to export created by a devalued pound, Britain is still running trade deficits because it has lost the productive capacity to respond.’ Photograph: Alamy
David Cameron's speech on the economy this week, and the reactions to it, have again confirmed that the British debate on economic policy is getting nowhere. The coalition government keeps repeating that it has to cut spending in order to cut deficits, no matter what. The opposition has been at pains to explain – as a teacher may do to a particularly slow or obstinate child – that trying to cut deficits by cutting spending in a stagnant economy is a largely self-defeating exercise, as it reduces growth and thus tax revenue. And Friday's astonishing letter from Robert Chote, chairman of the non-partisan Office for Budget Responsibility, contradicting the prime minister and reminding him of the ambiguous impact of spending cuts on deficits, has lent further weight to the opposition argument.
In reality, though, the coalition government isn't as stupid or stubborn as it appears. It is sticking to its plan A because spending cuts are not about deficits but about rolling back the welfare state. So no amount of evidence is going to change its position on cuts.
Lost in this cross-wired debate is the issue of the long-term future of the economy. Britain has been finding it difficult to recover from the financial crisis not just because of its austerity policy but also because of its eroding ability to engage in high-productivity activities. This problem is most tellingly manifested in the country's inability to generate a trade surplus despite the huge devaluation of sterling since 2008.
Compared with its height in 2007, the pound has been devalued about 30% against the dollar, 50% against the yen, and 20% against the struggling euro. Yet despite the huge incentive to export created by such devaluation, Britain is still running trade deficits because it has lost the productive capacity to respond.
Despite the devaluation, Britain's service exports have fallen – average annual service exports for 2008-11 were 8% lower than for 2005-07. This may be understandable, given the poor state of its financial sector – rocked by one scandal after another and hemmed in by a slow tightening of global financial regulation.
However, manufacturing exports, which were supposed to make up the shortfall created by the services sector, also fell by 8% after the devaluation. This is highly unusual. For example, back when South Korea had a devaluation of similar scale after its 1997 financial crisis (the won, its currency, was devalued by 35% against the dollar), the country's manufacturing exports were 15% higher (comparing the 1998-2001 average to 1995-97).
The only reason the British balance of payments situation has not been worse is the large increase in primary commodity exports – oil, minerals and food. These were on average 22% higher in 2008-11 than in 2005-07. In other words, since the crisis the British economy has been moving backwards in terms of its sophistication as a producer.
All of this means that, without addressing the underlying decay in productive capabilities, Britain cannot fix its ailing economy. To deal with this problem, it urgently needs to develop a long-term productive strategy through a broad-based public consultation involving not just the government and private sector firms, but trade unions, educational institutions and research institutes.
The strategy should first carefully identify the industries, and the underlying technologies, that will be the future motor of the economy and then provide them with the necessary support. This could be in the form of subsidies for R&D, loan guarantees for small firms, or preferences in government procurement, and should be targeted at "strategic" industries, although they could also be in the form of policies that are apparently not industry-specific.
For example, infrastructural investment needs to be co-ordinated with the broader industrial strategy. Infrastructure is by definition location-specific, so depending on the industries you want to promote, you will have to build different types of it in different places. Similarly with education and skills. Without there being some national strategy, it is difficult for educators to know what kinds of engineers or technicians to produce, and for potential students to know what professions to study for.
John Maynard Keynes once famously said that in the long run we are all dead. But a lot of us have to live for a while yet. A series of short-run policies, whether based on the coalition policy of spending cuts and loose monetary policy or on the opposition policy of increased government spending, isn't going to address the challenges facing the British economy. It is time to think for the long term.
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