Why austerity must be the order of the day for May’s chancellor

On the face of it, the Brexiteers have a bit of explaining to do.

A week before the vote, Boris Johnson dismissed fears about the value of sterling, and accused the governor of the Bank of England of “talking the economy down”.

Yet the economy does seem to have stalled, property funds have had to suspend redemptions, and the pound has collapsed. So what is to be done? The chancellor – whoever Theresa May chooses for the job – faces something of a challenge to kick-start the economy and restore confidence. Fortunately, economic history provides some very clear guidelines.

In 1949, the post-war Labour government devalued the pound by 30 per cent, from a rate of $4.03 to $2.80. The latter rate held until 1967, when the Labour government of Harold Wilson reduced it further to $2.40, a fall of 14 per cent.

By the time of Margaret Thatcher’s first government, the world had moved away from fixed exchange rates to a floating system. Against the dollar, sterling fell by 13 per cent in 1981 compared to the previous year, and by further 14 per cent in 1982.

In each case, the devaluation was followed by periods of strong economic growth. In the five years after the devaluation of the late 1940s, GDP grew by an average of 3.7 per cent a year. Following the Wilson devaluation, the five year average was 3.6 per cent, and the corresponding figure in the 1980s was 3.9 per cent.

These compare to the average over the post-war period of just 2.5 per cent. Obviously, a fall in the value of the pound makes our exports more competitive and enables British goods and services to compete more effectively against imports in our domestic markets. But there was an additional factor which was necessary to take advantage of the devaluations.

In both the late 1940s and mid to late 1960s, the economy was at full employment. There was a bit more slack in the early 1980s, but this was almost entirely in the old industrial areas. In the current situation, we are effectively at full employment. The unemployment rate is only 5 per cent, and a record 74.2 per cent of the working age population are in work. Space had to be created to enable net exports to expand.

In each of the three historical episodes, the then chancellors did so by tightening the fiscal stance. In other words, by implementing austerity.

Under the left-wing government of the 1940s, the policy was dramatic. A budget deficit of over 6 per cent of GDP (over £100bn at today’s prices) was transformed to surpluses of 4.6 per cent in 1949 and 3.4 per cent in 1950. Roy Jenkins changed the 1967 deficit of 3.9 per cent of GDP to a surplus of 1.8 per cent in 1969. And Geoffrey Howe provoked the notorious letter signed by 364 economists by cutting public spending in the early 1980s. In each case, devaluation combined with drastic fiscal tightening worked wonders.

The lesson is clear.

Paul Ormerod

As published in City AM on Wednesday 13th July

Image: Numbers and Finance by reynermedia licensed under CC by 2.0

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ELLIE EVANS

Partner

e: eevans@volterra.co.uk
t: +44 020 8878 6333

Ellie is a partner at Volterra, specialising in the economic impact of developments and proposals, and manages many of the company’s projects on economic impact, regeneration, transport and development.

With thirteen years experience at Volterra delivering high quality projects to clients across the public and private sector, Ellie has expertise in developing methods of estimating economic impact where complex issues exist with regards to deadweight, displacement and additionality.

Ellie has significant experience in estimating the economic impact across all types of property development including residential, leisure, office and mixed use schemes.

Project management of recent high profile schemes include the luxury hotel London Peninsula, Battersea Power Station and the Nova scheme at London Victoria. Ellie has also led studies across the country estimating the economic and regeneration impact of proposed transport investments, including studies on HS2 and Crossrail.

Ellie holds a degree in Mathematics and Economics from the University of Cambridge.