By Jeff Ferry, CPA Research Director
Establishment free traders often claim trade policy reform is futile, urging us instead to simply trust the free market. Recent experience in Britain shows that one trade policy—currency devaluation—does work, and pretty quickly too. Despite imports growing more expensive, both consumption and exports increased.
The British trade deficit has, in recent years, been even bigger than America’s as a percentage of GDP. Since the Brexit vote last year, the pound sterling's trade-weighted value fell by 13%. The result has been an astounding 53% reduction in the UK’s current account deficit.
According to figures published last week, the U.K. current account deficit narrowed from 25.7 billion pounds in Q3 to just 12.1 billion pounds in Q4. To put it another way, the current account deficit shrunk from 5.3% of GDP in Q3 to 2.4% of GDP in Q4. Inside those figures lies a substantial (17%) improvement in Britain’s trade balance in goods and services, from negative 39.2 billion pounds in Q3 to negative 32.4 billion pounds in Q4.
The British government’s Office of National Statistics (ONS) confirms that the fall in the value of the pound sterling caused this trade balance improvement. Sterling was in the $1.50-$1.60 range for most of 2015, but following the June 2016 referendum when British voters voted to leave the European Union (Brexit), the pound tumbled rapidly and today sits at about $1.25. As usual, critics and nay-sayers saw only the negative, claiming a lower currency would raise import prices and hurt UK consumption and overall UK economic growth. UK consumption has continued to rise. Exports have risen even more quickly. According to the ONS, sectors that have seen a strong export boost include aerospace, automotive, electrical machinery, and chemicals.
Recent developments in the automotive sector have been particularly noteworthy. After the Brexit vote, there were concerns that large multinationals could leave Britain out of fear that it might lose free access to the large European Union market. There was speculation over Nissan, the Japanese carmaker that operates a large plant employing 7,000 people churning out half a million vehicles a year in Sunderland in the northeast of England. In October, Nissan announced not only that it would stay in Sunderland, but that it is embarking on an expansion plan to enable it to build two additional models at the plant (in addition to the SUVs, sedans, electric vehicles, and Infinitis it already builds there).
Then last month, Toyota announced plans to invest an additional $300 million in its Derbyshire plant in central England. Toyota employs 3,000 people in Britain. Toyota said it is watching the Brexit negotiation carefully and concerned about any tariffs between Britain and its European neighbors. The company is also planning to build more auto parts and components in Britain to take advantage of the cheaper pound and simplify its supply chain. Toyota already makes engines in Wales. Finally, sports car and race car maker McLaren announced in February that it is investing $62 million in a new plant in Sheffield, to design and manufacture lightweight carbon-fiber chassis.
In many ways, the UK economy is analogous to the US economy. The UK has run trade deficits every year since 1998. The UK manufacturing sector was hollowed out. Industrial decline and urban decay in cities and one-industry towns was pervasive in the Midlands, north of England and parts of Scotland and Wales. In the US, we’ve run trade deficits for more than 40 years, with widespread industrial decline and decay throughout the non-metropolitan US.
Political leaders and the mainstream media inexplicably focus on political negotiations on trade deals—the UK media is obsessed with its impending negotiations with the EU bureaucrats while over here all eyes are on President Trump’s meetings with China’s President Xi. But, as business leaders know, the most important factor for business and economic success is to make a good product at a good price and clear out the impediments to honest international competition such as mercantilist practices, trade cheating, and misaligned exchange rates.
The international trade community has forgotten that trade should balance, usually driven by currency values. The pound, like the dollar, has been overvalued for many years. That’s true simply by virtue of the fact that if you run deficits for many years, your currency should come down to put your trade back into balance. By surprise and without any effort, fate has given Britain a more competitive pound, and businesses appear to be responding, and quickly. There’s a lesson in there for the United States.