Friday, 24 March 2017

Fall in wages has much further to run

By Tom O’Leary

The latest consumer price inflation (CPI) data showed a sharp acceleration in prices increases. This will have a negative effect on real wages and real incomes, once inflation is taken into account. Most workers are facing flat wages and the poor, who rely on social welfare and are seeing freezes or cuts, will all be poorer as a result. Even worse, economic trends suggest that this problem will deepen.

Chart 1 below shows the medium-term trend in real wages. It uses single month data rather than the more customary rolling 3-month average data highlighted by the Office for National Statistics (ONS) to smooth out monthly fluctuations. However, the single month data can be superior in identifying key turning-points. As the chart shows, it seems likely we have entered a key turning-point, with a sharp downturn.

Chart 1. Real Average Weekly Earnings, January 2008 to January 2017

This is even more apparent in a ‘close-up’ of the same data focusing in the more recent period since the beginning of 2016 in Chart 2. This shows that real average weekly earnings fell by 0.2% in January compared to a year ago.

Chart 2. Real Average Weekly Earnings, January 2016 to January 2017

In the immediate period ahead the fall in real average weekly earnings is set to become more pronounced. In February, the acceleration in inflation saw the CPI jump from 1.8% from a year ago to 2.3%. There was zero inflation as recently as 18 months ago. It is extremely unlikely that wages will have kept pace with the recent jump in prices. So real wages are set to fall more sharply in the next few months.

Over the medium-term, these negative trends are likely to worsen. The complacency about inflation following the slump in the exchange rate value of the pound is misplaced. Devaluation effects take their time to work their way through the economy.

The pound slumped by 31% in the period from end 2008 to early 2009. But CPI inflation only peaked at 5.2% around 2½ years later in later 2011. This time around the devaluation is a little more than half the previous fall, which should limit the scope of price rises. But there is no reason to believe the period of rising prices will not be similarly prolonged.

This means that the fall in real incomes will also be similarly prolonged. The real wage slump will be deep and long.

Thursday, 16 March 2017

Wages are falling


By Tom O’Leary


Real wages are falling once more. In addition, nominal wages have fallen in the last 2 months which is highly unusual. Both of these developments are Brexit effects and the situation is likely to get worse as Brexit unfolds.

The trends in both real (inflation-adjusted) and nominal wages are shown in Chart 1 below. Real wages peaked in April 2008. A very large gap then opened up between real and nominal wages following the crisis, as nominal wage growth slowed and inflation subtracted from real wage growth.  But as the chart shows, it is rare for nominal wages to fall, and this has contributed to a marked recent drop in real wages.

Chart 1. Trends in UK Nominal and Real Wages, January 2000 to January 2017

Source: ONS

In the two months since November 2016 real wages have fallen by 1%. In nominal terms they fell by 0.2%. Compared to a year ago, nominal wages have risen by just 1.9% and in real terms the rise is zero. All such data are subject to revision. But these changes are so marked that any revision is unlikely to alter the fundamental points.

These are Brexit effects. Just as the substantial devaluation of the pound in the 2007-2008 crisis led to a sharp rise inflation, so the renewed significant fall in the pound since the Brexit referendum is pushing up inflation once more. In both cases, flat or slow nominal wage growth meant that inflation pushed real wages lower.
The current rise in inflation has much further to run. Even if the pound had stabilised after its fall, most importers ‘hedge’ (or insure against) the risk of a currency fall. But those hedges are time-limited, usually after 6, 12 or even 24 months.  A recent article in the Financial Times argued that the hedges are only now beginning to expire. Import costs will rise sharply, and push consumer prices higher. But the pound has recently begun to fall once more, close to just 1.20 versus the US Dollar, so the extent of import price inflation will continue for some time.

The recent fall in nominal wage growth is more modest than the decline in real wages. But because it is so rare it is alarming.  There is a widespread and mistaken idea that investment leads to job losses and low wages. The opposite is the case. Investment leads to increased production and productivity. Of course, all employers would like to claim all the rewards of increased output themselves as profits. Workers try to claim those rewards as wages and benefits. The outcome is the result primarily of industrial bargaining and struggle.

But investment has been falling. It was lower at the end of 2016 than in mid-2015. Without investment it is extremely difficult to create new highly-paid jobs. The new jobs that are being created tend to be lower paid, and push down average wages, even in nominal terms.

The fall in investment is itself a Brexit effect. As SEB has argued, the biggest negative impact from Brexit is likely to be felt in investment, much worse even than trade. This is because investment is made for a return. Investment returns will necessarily be lower in the UK economy outside the EU Single Market, the world’s largest market, rather than inside it.

The link noted above between investment and jobs, and especially between investment and wages means that lower investment will place further downward pressure on wages. It is clear that significant negative Brexit effects are accumulating.

Monday, 13 March 2017

Workers and the poor hammered as Hammond gets UK ‘match-fit’ for Brexit

By Tom O’Leary

The economic policy outlined by Chancellor Philip Hammond in the Budget is so extreme that it represents a new fierce attack on living standards for the overwhelming majority. This is despite the fact that there is in total a modest giveaway, or fiscal loosening. This is because it is based on narrow class interests, a very large giveaway for big business and an almost equal series of taxes on workers and cuts in social security. 

The character of this Tory attack, and the narrowness of the beneficiaries of the Budget opens a wide political and then economic opportunity for Labour. As a result, it is extremely important to be clear on the fundamental economics behind the Budget. 

Hammond’s gamble

Hammond has effectively signalled a rise in taxes (National Insurance Contributions, NICs) on the self-employed, to widespread criticism. The self-employed now includes a wide array of social categories, from extremely well-paid professionals, through to what are actually small businesses, to a surge in fake self-employment, where workers are forced off payrolls so that employers can avoid employers’ NICs, statutory sick and maternity pay and other protections. Numerically, it is the latter category which is the largest.

According to the Resolution Foundation, the median average income of the self-employed will rise to £13,200 next year. If so, it will still be less than half the average wage. The Foundation’s support for the change in NICs is entirely misplaced. Those on average wages will be at least £200 a year worse off. Any change to workers’ NICs should focus entirely on the very high paid, or on employers’ NICs.

The reason for this political gamble should be clear. Hammond expects much more fake self-employment over the next period in response to Brexit and his own response of ‘making the UK competitive’. This strategy means turning Britain into a low-tax, low-investment, non-union and low-pay economy and Hammond cannot afford to lose the tax revenues from this growing army of ‘self-employed’. This gamble illustrates the high stakes for the labour movement, for the whole economy and all political actors over the next period.

McDonnell’s correct framework

Hammond and this Tory Government share the main tenets of the reactionary and illogical framework of their predecessors. Hammond aims for a zero public sector deficit. As Government expenditure is comprised of two quite separate categories, public current spending and public investment, so aiming for a balance on the entire budget effectively means refusing to borrow for investment. For a Government fond of individual analogies, it is equivalent to refusing to borrow for a mortgage to buy a house because you have confused it with your credit card bill. Perhaps a closer analogy would be a business that refuses to borrow to grow. 

Current Government spending includes all such items as the NHS, the police, all public services, including public sector pay and pensions, and so on. If there is a deficit on current spending it can be brought into balance not by cuts but either by increasing tax or by increasing economic activity which generates tax revenue. As only the latter can sustainable be repeated, the way to raise revenue is by increasing investment. Permanent current budget deficits mean borrowing for consumption when it could be used for investment. As borrowing for consumption cannot sustain growth it simply leads to greater government debt and to a bloated class of ‘investors’, and a finance sector that subsists on the interest payments from that Government borrowing.

By contrast, government investment includes every type of public sector investment, in rail, roads, housing, infrastructure, broadband, and so on. Arguably, spending on education is more appropriate to this category, although not officially classified as such. Investing in these raises output over the long run.

John McDonnell has correctly elaborated a fiscal framework which makes the distinction between current spending balances and borrowing for investment. This is completely different to the Tories, who pursue a deeply reactionary policy of transferring incomes and wealth from workers to business and from poor to rich. This is cloaked in the economic illiteracy of balanced budgets, fixing roofs and gas in the tank.

Labour’s policy is to balance the current spending budget over the business cycle and to increase borrowing for investment. It is based on economic logic not reactionary sound bites, so it has very few serious critics, even from the economic mainstream. This is because the greater the borrowing for, and returns from, public investment, the greater the funds that can subsequently be directed to public services.

The maintenance of the current leadership of the Labour Party is also the only hope of ending austerity, so these questions are of the utmost seriousness.

OBR forecasts surpluses 

The Office for Budget Responsibility (OBR) has a poor record on forecasting GDP growth and its components and their effect on the fiscal aggregates. So its forecasts must be treated with caution. However, the startling fact is that the OBR is forecasting a surplus on the current budget well before the end of this Parliament. 

In the Tory framework, this is of no account because they aim for a balance on the entire budget, including investment. This has nothing to do with fiscal sustainability. Falling investment (and total investment fell in 2016) increases instability, a propensity to crisis and fiscal receipts based on other factors such as unsustainable consumer spending.

The purpose of the current Tory plan and its predecessors should be clear from the fact that, as taxes have risen for workers and the poor, there have been a series of deep tax cuts for businesses and the rich. The Corporation Tax rate was 28% in 2010 and is set to fall to 17%. This is precisely done to transfer incomes to capital. The claim is that this boosts ‘entrepreneurship’ and business investment. The entrepreneurship is the surge in fake self-employment and as noted business investment fell in 2016.

But a surplus on the current budget matters a great deal in the Labour framework, even if it is only a forecast. The full table from the OBR budget document Economic and Fiscal Outlook is reproduced below. The balance on the public sector current spending is highlighted both in terms of proportion of GDP and in cash terms. 

According to the OBR the current budget will be in surplus in the Financial Year prior to the next legally mandated election in 2020. In GDP terms the surplus will by then be 1% of GDP or £21.3 billion. In the following two years it will be 1.3% and 1.6% of GDP respectively, or £29.6 billion and £37.1 billion respectively.

Table1. OBR Fiscal Forecasts Spring Budget 2017
 
For Labour this surplus would mean that there will be significant additional funds to immediately alleviate and begin to reverse austerity, in addition to its own planned borrowing for investment. Realistically, even with an emergency Budget that would surely be necessary early in the new Parliament in 2020, the following year is when a Labour Government could have a much more significant impact on the direction of the economy and the allocation of public expenditure. In those years the current budget surpluses are forecast to be in the order of £30 billion to £37 billion. 

Calculating the effect of policy

The McDonnell framework represents a break from dominant Left thinking in the Western economies and elsewhere, a ‘keynesianism’ which has nothing to do with Keynes. This argues that increased Government spending will increase economic activity on a sustainable basis. In this case by ‘spending’ is meant current spending. Government current spending has risen by £90 billion in nominal terms under the Tories without ever supporting a sustainable recovery. In fact, it is a marker of economic failure, as cuts have simply led to depressed activity, more poverty and upward pressure on tax credits and social security spending. Taxing one average paid worker to subsidise the wages of one poorly paid worker does not lead to growth.

Instead, investment leads growth. It is the most important factor in determining growth after the division of labour/socialisation of production. The effect of investment on raising output is measured as the Incremental Capital Output Ratio (ICOR), which simply measures the ratio of changes in the capital stock and changes in the level of output. The Office for National Statistics’ current estimate of the ICOR is 4. This means that that the capital stock must increase by £4 billion in order to increase output by £1 billion. The return on investment takes place over several following years.

Chart1. ONS Capital Stock Output Ratio
 
Assuming no change, this means that every £4 billion of increased public sector net investment will yield an additional £1 billion in output, as well a large increase in tax revenues (and reduction in welfare outlays) based on that increase in output. If current ratios are unaltered, then a £4 billion increase in investment will yield a £1 billion increase in GDP and (using UK Treasury analysis) a £750 million improvement in Government finances (comprised of rising revenues and, in a smaller degree lower outlays). This is an annual return on investment directly to the Government of 18.75% per annum for the entire life of the investment. It is about 10 times greater than the Government’s average cost of borrowing. This underpins the mathematical logic of Government borrowing to invest. 

Brexit effect

However, current ratios are altered. Removing the UK economy from its largest market and replacing that with an unknown series of tariffs and non-tariff barriers will have a wholly detrimental effect. 

Yet this will not even primarily be felt in terms of trade, but investment. Investment fell in 2016, which is highly unusual either outside of recessions or as a precursor to them. It was clearly a Brexit effect. Removing the UK from the EU Single Market will depress the level of investment, both domestic and from overseas. It will also reduce the efficiency of that investment, as the UK will be required to pay more for the world’s most advanced capital goods and may even have less access to these in areas such as aerospace, biotech, renewable energy production and storage and so on. 

As the OBR has little or no firm information to go on, its lower GDP forecasts after 2017 do not reflect likely Brexit outcomes. They are simply based on an analysis of current trends. Therefore the forecast level of GDP and the improvement in Government finances is likely to be significantly worse. 

Labour Politics 

If the Brexit timetable is accurate, it is planned that the UK will be outside the EU Single Market before the next election. If the OBR is proven right, the current budget will already be in surplus before then too. 

But Labour does not have to wait until that time before setting out its alternative. The maximisation of economic growth depends on the accumulation of productive capital through investment. But to be politically sustainable, there must also be easily identifiable improvements in the living standards of the population both through its real incomes and its public services. Therefore, a political judgement is required in the allocation of resources. 

Labour can announce now that it would spend, say, £20 billion of the current budget surplus the OBR has forecast in beginning to reverse austerity in key areas such as the NHS, social care, public sector pay and childcare. That can be announced now as a solid commitment for its first year in office, Financial Year 2020/21. A sustained programme of publicity can be used to illustrate how the NHS will improve in each area, or how public sector pay can rise in the first year, and so on. 

The remaining £10 billion, of the £30 billion, could be added to Labour’s commitments on investment. Here, it seems that the pledge is to increase public sector investment by a further £25 billion in each year. This could now rise to £35 billion to improve rail, build homes, invest in renewable energy and so on. 

This means Labour can promise both to increase current spending, which is what will determine votes and support, as well as increasing investment which will actually sustain recovery. From that, further Government funds can be then allocated to both spending and investment in proportion, based on the 18%-plus returns from investment. In this framework the returns on investment from the previous year can be added to government investment and government consumption. 

Labour must also answer a key question that will be posed What if the OBR is wrong, or significantly lowers its forecasts to reflect the deal on exiting the EU as it becomes more apparent? From the point of view of people who believe that Brexit leads to prosperity this is not a major risk. But, if that risk materialises, then Labour must have a plan for that eventuality, and an answer now, otherwise it has no funding basis for its pledges. 

The current Labour policy has a ‘knock-out’, where the fiscal rules can be suspended in a crisis, with interest rates at zero as a trigger-point. If it is going to use the OBR forecasts as the basis for pledges, and the forecasts could change very adversely once details of the Brexit terms are known, it needs another ‘knock-out’. 

A Brexit/OBR knock-out would maintain the pledges to increase investment and begin to reverse austerity. But, if the forecasts are much worse or the emerging Brexit deal is clearly very adverse, Labour can pledge to meet these by emergency increased borrowing. Labour would also politically need to oppose the Brexit effects by opposing the Brexit deal itself. 

Summary

The Hammond Budget makes no pretence to deficit reduction. It is simply a transfer of incomes from poor to rich and from workers to business. The attack on the ‘self-employed’, who are mainly now casualised workers, is a high-risk strategy, which reflects the expected growth in casualisation in the post-Brexit economy. 

This policy is cloaked with a reactionary determination to balance the entire budget, including even investment. John McDonnell’s framework is borrowing only for investment and balancing the current budget, which is entirely correct. As the OBR is forecasting large surpluses on the current budget balance, these forecast surpluses can be used now to illustrate the benefits of the Labour position of beginning to reverse austerity and increase investment. This is a vote-winning and sustainable combination. 

But the OBR could be wrong, especially as it cannot now take into account the effect of any Brexit terms deal. Labour could adopt an OBR/Brexit ‘knock-out’ on its spending and borrowing plans. If the forecast or the reality deteriorates sharply it would not change those plans but would temporarily increase borrowing to cover both. This would also require politically opposing any Brexit deal which led to such a negative outcome.

Monday, 6 March 2017

Britain isn't booming. It's in a crisis

By Tom O'Leary

The latest UK GDP data confirm that the British economy remains in a crisis. As government spokespersons never tire of telling us the opposite, and are dutifully echoed by the majority of the media, then it is important to set out the factual case on the economy and to explain where the discrepancy between rhetoric and reality arises.

Once the factual analysis is made the following points are clearly established:
  • The UK remains in a crisis
  • On key measures of the living standards of the population, the UK is in the worst position of all the advanced industrialised economies
  • Fundamental economic factors mean that this crisis is set to deepen
  • The project of austerity will be resumed with a vengeance in response to Brexit
The UK economy grew by just 1.8% in 2016. This is below the average growth level since the recession, which itself has been miserably weak. On a calendar year basis, the recovery began in 2010. Since then GDP growth has been an average of 2%, so 2016 was among the slower years in a poor recovery.
In the 7 years prior to recession, from 2001 to 2007, GDP growth averaged 2.75%. The effect of compounding means that even apparently small differences in growth rates have a large impact on levels of economic activity over time. In the 7 years since recession, a growth rate 0.75% lower leads to a GDP level that is nearly 5.5% lower.
Incomes stagnate, wages fall
Most people do not care about GDP levels, for the very reasonable idea that what matters to them is their own living standards. Of course, without GDP growth its level cannot rise and it is therefore extremely difficult to raise living standards in aggregate. But rising GDP is by itself no guarantee of generally rising living standards (Chart 1 below).
 
Chart1. UK GDP and Per Capita GDP Growth, % Change, 2000 to 2016
 
In a society with expanding population per capita GDP will always necessarily grow more slowly that GDP growth itself. But the change on this measure has been dramatic. The beginning of this period saw growth rates in per capita GDP in excess of 3%. In 2016 it was one-third of that level, at 1.1%.
Again the cumulative effect of compounding apparently small differences in growth rates is very substantial. In the 7 years prior to the recession the level of per capita GDP rose by 16%. In the 7 years since, this measure of average output per person has risen by just 8.7%. If the period of the recession is also included, when per capita GDP fell, then the increase in per capita GDP since 2007 has been just 1.9%. No wonder most people believe the economy remains in a crisis.
But the actual situation for workers and the poor is even worse than this data suggests. Severe recessions of the 2008-2009 type are caused by a fall in profits. Although workers are clearly not better off from a recession, the statistical effect of a sharp fall in profits is frequently to lower the profit share and so raise the labour share of national income.
In Marxist terms, the initial effect of falling profits lowers the rate at which surplus value is extracted. The purpose of austerity is to reverse this phenomenon, by driving down wages, raising taxes and lowering public spending that benefits workers and poor, at the same time increasing hand-outs to businesses and the rich, cutting their taxes and increasing privatisation of publicly-owned assets to boost profits, and so on.

Chart 2 UK Nominal Profits, £ and Labour Share of National Income, %
 
As we have already noted, per capita GDP has risen by just 1.9% since the recession began. But this is not shared evenly. At first, the effect of falling profits has been to raise the labour share of national income (as shown in Chart 2 above). Austerity is designed to reverse that and has been partially successful. In 2007 labour’s share of national income was over 51%. Now it is just over 49%.
 
Crucially, the labour share data is based on the compensation of all employees, including very senior management, whose total compensation has risen. Taking wages alone, the picture is even worse. The chart below is taken from the Financial Times. It shows 4 categories of countries in the OECD. The UK is on its own, the only country where the economy has expanded since the recession but where wages have also fallen.
 
Chart 3. FT- UK Alone in GDP Expansion and Wage Contraction
 
Running on empty 
The GDP data reveal that the outlook for the economy is deteriorating. In a capitalist economy growth is determined over the medium-term by the accumulation of capital, first as profits then as investment. But profits growth remains weak and business investment actually contracted in 2016!
 
The UK has had many failed experiments in attempting ‘consumer-led growth’, and the current failure is set to come to an end. Without rising incomes, which must be based on rising output to be sustainable, then all attempts to force Consumption to lead the economy end in a debt-fuelled failure. As Investment is key to the growth of output, only Investment can lead the economy higher on a sustainable basis.
In 2016 Household Consumption accounted for almost the entirety of recorded GDP growth. GDP expanded by £35.5 billion last year, while household consumption rose by £34.6 billion. As we have seen incomes and wages have not risen to keep pace with consumption. In fact incomes have stagnated and over the medium-term wages have fallen. The growth in investment (GFCF, Gross Fixed Capital Formation) was just £1.4 billion over 2016.
This continues the post-recession trends in the UK economy. Startlingly, there has been no growth in Investment (GFCF) since before the recession! In 2007 the real level Investment was £313 billion. In 2016 it was just £310.6 billion (Chart 4).
 
Chart 4. UK Real GDP and Components, 2007 to 2016, £ billion
 
SEB has repeatedly argued that it is not possible for Consumption to lead the economy. If it were possible, rising Consumption alone would be sufficient to induce rising Investment. But that is clearly not the case in the British crisis. The combined rise in Consumption from households and government since 2007 has been over £110 billion. But Investment has in fact contracted. The proponents of Consumption-led growth have no credible explanation for these developments.
 
Without Investment, and with Consumption forced to retreat without the support of rising output and incomes, then the medium-term outlook for the economy must be a gloomy one.
Tory way out of the crisis
Brexit poses a new problem in the British economic crisis, and one which will exacerbate the current trends of low investment and falling real wages. It is also likely to lead to job losses in key sectors.
 
The CBI estimates that 90% of UK exports to the EU will be hit with either tariffs or non-tariff barriers, or both. This would be a very large blow to UK businesses and their profits. The question that arises is therefore, how to increase profits in an environment of contracting access to key markets? The answer must be to do more of the same, driving down wages, increasing taxes, privatisation, reductions in social spending, and so on. The promise of the Tory government to its business supporters will be that all this can be accelerated once freed from the shackles of EU protections for workers’ rights, consumer standards or environmental regulations.
It is doubtful whether this can work. If output continues to grow very slowly, then labour’s share of national income must fall sharply in order to boost profits sufficiently to revive investment. The share of the total social product which benefits workers and the poor must be cut exceptionally harshly, and so on. But the probability of failure will not prevent the project from being initiated. It will be a Poundland Thatcherism, draping vicious anti-worker and anti-poor policies in the cloak of nationalism and ‘getting the country back’.
The rhetoric about Britain’s great economic performance is simply that. It has no factual substance. Living standards have fallen since the crisis. The UK is in a unique position among the advanced industrialised countries as GDP has expanded but wages have contracted. This is a conscious strategy to revive profits. Until they revive sufficiently, investment will not recover. But the new challenge of Brexit means that this project must be redoubled. From the perspective of the Brexit-supporting Tories, there must be a compensation for business to off-set the loss of access to its major market.
 
The struggle over the direction of the British economy is set to be a prolonged one.

Thursday, 2 March 2017

There is no ‘People’s Brexit’

By Tom O’Leary

The certainty that Brexit will push living standards lower is not really a forecast- it is already happening. Fundamental economic forces mean that Brexit can only have a negative outcome.

Immediately following the referendum the pound fell sharply and has more or less stayed at that lower level since. The 13% decline means that CPI inflation is moving remorselessly higher and will continue to do so. Higher inflation means lower wages and incomes in real terms. 

People are already worse off, and Brexit has not even begun. On the current timetable negotiations are supposed to be concluded in early 2019. Only at that point will the massive disruption caused by Brexit really begin to take effect. 

We will see then whether all the car makers stay, or if the Government has to bribe them with our money to stay. In either event we will be worse off. There should be no silly crowing about the probably departure of the banks either. Most workers in finance are not paid much more than average wages (and 165,000 of them are in unions). In all industries where there is deep connection to the EU there are likely to be job losses or contraction, whether these are complex supply chains, key export markets or simply the dependence on the free movement of labour (such as the NHS, hotels, agriculture). 

The Government has prioritised reducing immigration over increasing prosperity. This too will make us worse off. Migrants are disproportionately workers. Two thirds of EU migrant population are in work, while less than half the UK population is, as they are in school, college or have retired. Reducing them will lower output and output per capita. We will pay the price in terms of lower tax revenues and even worse public services.

There is no socialist or even ‘people’s Brexit’. Everyone operating in the UK will still be subject to the laws of the market. The problem will be that the market will suddenly be much smaller and less productive than the EU Single Market the UK has been participating in for the last 25 years. If the Tories continue to get their way, there will also be a stripping away of the workers’ environmental and consumer rights that were instituted under the EU’s ‘Social Chapter’. These have long been a Tory target for abolition in the UK. Post-Brexit, the economy will be operating behind a series of tariff and non-tariff barriers as others protect their markets. All of these will make the economy less competitive and will increase costs. 

Of course, the pound could depreciate sharply again to offset these disadvantages, but this would lower living standards and real incomes even further. If currency devaluations alone were the answer then Britain would be an earthly paradise. In 1940 there were 5 US Dollars to the pound. Now there are 1.25. Over the same period the relative size of the UK in the world economy has shrunk dramatically in real terms, to less than one-third its proportion of world GDP, 2.3% now versus 7.3% in 1940.

Chart 1. US Dollar/UK Pound Exchange Rate 1940 to 2016
Source: FRED database

There is a widespread notion on the right that Brexit will lead to ‘taking back control’ of the economy. Unfortunately, this is also shared by important sections of the left. It is a delusion. The 1930s saw a whole series of countries taking back control, in what might be called an early anti-globalisation movement. Although the authors of these policies are now widely and rightly derided their arguments will actually be very familiar.

It was said that other countries were taking our jobs, they are dumping their output on us causing our industries to fail and that those industries need protecting and government support, or state aid. Once we have done that, then we would be able to trade freely with the whole world. Of course, the more virulent version also included vile invective against foreigners, immigrants, Jews, gay men and others. When the economic policies went spectacularly wrong, the racist invective became policy.

The reason these policies failed spectacularly should be clear. Behind the protective barriers, costs rise, potential markets are closed off (especially as they respond with barriers of their own), industry becomes less not more productive, profits decline and workers are laid off. The economic crisis that ensued was finally resolved only by general rearmament.

What Adam Smith called the division of labour and Marx called the socialisation of production is actually the most powerful economic force of all. Ever since some of us made the spears and others went hunting with them, we have all collectively benefited from the socialisation of production. Statistically, a key measure of this socialisation are inputs and these grow faster than GDP itself. 

If a country cuts itself off from world markets, or simply erects barriers between itself and the world then it diminishes its own participation in the international division of labour, the international socialisation of production. Now, instead of being part of an intricate supply chain making cars, there are tariffs and other barriers which increase the cost of production. The UK becomes a less efficient place to make cars and production shifts at some point to the larger market where there are fewer or no barriers. Or pharmaceutical companies importing inputs (biochemical products, electron microscopes, processing equipment, and so on) find they now come with the additional costs of tariffs.

As a result of all this, investment is likely to be diverted to the bigger market, the market not burdened with tariffs. This is where the investment returns will be greater. Investment is the second most powerful determinant of growth, after the socialisation of production.

The UK will experience lower investment and even that investment will become less efficient, as access to the most technologically developed investment goods becomes more expensive. The UK economy will become a low investment centre of low-cost, low-value added production and wages and living standards will reflect that. So too will public services. 

If I cut my daily calorie intake in half, I cannot say what my weight will be in three months’ time, but it will be lower. Forecasting a disastrous Brexit is not project fear. It is a certainty. It is fundamental economics.

A slightly amended version of this piece first appeared in the latest issue of Labour Briefing (Co-operative).