There it goes again. Sterling has been dropping sharply this year against the U.S. dollar and especially the euro, as Britain turns to a tried and trusted remedy for its economic problems: devaluation. Even with its slight uptick on Wednesday, sterling is down more than 6 percent against the euro since the beginning of 2013 and has slid 10 percent over the past six months.
This is not something the British government is boasting about, especially at a time when there’s concern over -- and sometimes a high-level condemnation of -- countries such as Japan that allegedly seek to manipulate their currencies. But it’s also not something the British government or the Bank of England is trying to hide – or stop.
The big question is: Does devaluation still work? It’s an old tool aimed at restoring competitiveness that has been used countless times by Britain in the past. In the 1960s and 1970s, the Labour government devalued sterling sharply against the dollar (and gold). And over the past 60 years the pound has lost more than 80 percent of its value against the German currency – first the mark and now the euro. In that time, the two countries’ economic fortunes have fluctuated, with Germany showing very robust growth in the postwar years and Britain performing relatively better from the early 1990s, when it crashed out of Europe’s system (at the time) of semi-fixed exchange rates, just as Germany was struggling to digest the economic impact of reunification.
Devaluation hasn’t always helped: In 1976, Britain famously had to go to the International Monetary Fund to ask for a loan to end a damaging run on sterling. It can also be a risky strategy if inflation gets out of control, which is why Germany, for one, is so skeptical about devaluation as a policy tool. But there’s a new concern surfacing: Can it even work? In the era after the financial crisis of 2007-08, there is mounting evidence that devaluation may not be able to help kick-start a stalled economy as readily as it may once have done.
In a recent speech, Martin Weale, a senior member of the Bank of England’s monetary policy committee, openly discussed the desirability of a continued fall in sterling’s value against other currencies. Yet he prefaced his remarks with a critique of British trade performance since 2007-08, when the pound dropped by 25 percent. Despite that depreciation, Britain’s balance-of-payments deficit is no smaller today than it was beforehand. His conclusion: “The United Kingdom seems to have made no progress with rebalancing.”
The latest trade figures released this week underscore that judgment. The UK’s deficit on trade in goods fell sharply in January, and both import and export prices rose. And the overall economic outlook remains bleak, one of the reasons why Moody’s last month downgraded the U.K.’s credit rating from the prized AAA to aa1.
Gabriel Felbermayr, an international trade expert at the Ifo Institute in Germany, says that while currency devaluations can give a short-term boost to exports, “they are a much less effective policy tool” than they once were.
He cites two principle reasons. The first is that advanced countries such as Britain are producing many more goods that aren’t particularly price-sensitive. As a result, a modest cut in price won’t lead to consumers in other countries flocking to buy them. The other reason, Felbermayr says, is that advanced economies are increasingly interrelated. For example, a British company such as Rolls Royce uses a substantial number of components from Germany that it needs to import, so the gains to its competitiveness from having a weaker sterling are limited, because those components become more expensive.
For his part, the Bank of England’s Weale blames psychological factors as holding back British exports even with the weaker pound. “High levels of uncertainty and a reluctance to take new risks have stood in the way of exporters seeking new markets and domestic producers doing what is needed to displace imports,” he said.
There’s another element in this equation that also may explain why the British economy hasn’t responded as well as expected to the post-crisis devaluation: Labor productivity, after years of quite robust growth, is “lousy,” in the words of John Van Reenen, director of the Centre for Economic Performance at the London School of Economics. Output per hour was 16 percentage points below the average for the rest of the G7 countries in 2011, the most recent year for which there are complete statistics. That’s the widest productivity gap since 1993, according to the Office of National Statistics. If people aren’t working as productively as their contemporaries elsewhere, it’ll take more than a weaker currency to right the economy.
