A Pound of Worry - WSJ

October 14, 2016

Those theories that sterling's fall will help the U.K. economy? Wrong.

Markets have reacted sourly to British Prime Minister Theresa May's Brexit agenda, with the pound on Tuesday hitting a historic low against a basket of currencies. Some of our Keynesian friends are saying that's nothing to worry about, since a falling currency will also boost British exports and gain market share by making them cheaper. Not quite.

It's true that some U.K. merchants-luxury retailers and hotels come to mind-have profited as a weak pound makes Britain more attractive to foreign visitors. A September survey of manufacturers also shows export orders are picking up somewhat, though manufacturers also are starting to worry about the potential for rising import costs.

But those benefits obscure the limits to how much Britain can gain from a cheaper pound. In Japan a 40% yen depreciation between 2012 and 2014 barely budged export volumes. Japanese export growth still trails that of neighbors such as South Korea, against which a weak yen is supposed to offer an advantage.

This happens because demand for exports from economies such as Britain's depends on more than simple price competition. Britain long ago replaced price-sensitive industries such as textiles and cars with pharmaceuticals, precision tools and other ultra-high-tech companies whose customers will buy their products at nearly any price because they can't easily find substitutes.

Meanwhile, the costs of a cheap pound will be considerable for an economy as dependent on imports as Britain is. Roughly 25% of the value of Britain's final exports originated abroad in the form of imported inputs in 2011, the most recent year for which we have data, and that figure has risen steadily. Rising input costs limit any pricing benefits from a cheap pound.

As for households, they rely on imports for more than 40% of the clothes they buy, 30% of their food, half of their shoes and nearly 57% of the spare parts for their cars. Britain also imports much of its fuel, and the weak pound is helping to push gasoline prices to their highest level in a year and rising. That means employers will quickly face demands for higher wages as a weak pound leads to higher prices.

To protect themselves from these effects, U.K. firms have been raising, not cutting, pound-denominated prices. As the pound fell 15% between November 2015 and July, exporters increased pound-denominated prices by 11%, according to Pantheon Macroeconomics. This would be a boon if companies used their additional sterling profits to invest in capital upgrades and additional capacity at home. But British businesses are likely to delay investments while they wait to see what trading relations Britain develops after Brexit and whether Mrs. May will liberalize the economy to stimulate growth. Given these worries, it's especially hard to see how a slumping pound will magically boost exports.

Japan again leads the way: Despite rising profitability for exporters as the yen depreciated, capital expenditure hasn't returned to its pre-2008 level and companies instead are hoarding cash or engaging in financial engineering such as a record level of share buybacks this year.

Rather than pretend that a plunging pound is a disguised blessing, Brexit supporters should treat it as a warning. Global investors, on whom Britain depends to finance its trade deficit, are worried about regulatory, trade and immigration policies that would deter investment and depress growth. Britain can't devalue its way to success. Only an aggressive free-trade, pro-liberalization agenda will work.

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Steven Rich
Sep 17, 2018:
Well done

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