Depreciation Isn’t a Panacea For All Ills

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Iakov Kalinin/Adobe Stock

Popular wisdom suggests a currency devaluation results in a boost to exports and the economy. The devaluation of the currency allows manufacturers, in particular, to sell their products at lower prices in export markets and therefore achieve growth at the expense of their competitors.

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Many countries have been trying to quietly engineer just such a devaluation.

Some have done it overtly, like Japan, and others simply by being part of a bloc, such as Germany – it being widely accepted that the Deutschmark, if it still existed, would have Germany at an exchange rate like Switzerland or Norway, rather than the more competitive Euro.

So when Britain inexplicably voted to leave the European Union and the Pound sterling dropped in minutes on the news, many held the near 17% devaluation as a panacea for Britain’s economic ills, as the onset of a renaissance for manufacturing companies able to aggressively export to the world while simultaneously undercutting competitors.

The reality has proved somewhat otherwise.

The Reality on the Ground

A report in the Financial Times explores the fortunes of two European economies, Britain and Portugal, which have experienced significantly divergent currency paths and yet countered the accepted wisdom that lower exchange rates result in greater exports.

The Financial Times observes the Sterling has fallen 17% since late 2015 against Britain’s trading partners, compared with a 2% rise in the Euro, Portugal’s currency, over the same period.

Yet even allowing for the possible delayed impact of a devaluation, the recent performance of both suggests Britain has gained little or nothing from the supposed advantage.

According to the Financial Times, between January and March this year U.K. output in production industries expanded 2.3% compared with a year earlier — the same rate as the growth in services and less than in construction, the paper says.

So much for a rebalancing toward production, the supposed benefit of a sharp devaluation.

In Portugal, industrial output grew 4.8% over the same period, considerably faster than the country’s 2.8% overall growth rate.

Looking specifically at export values, the situation appears even worse.

British export values to the EU27 were 15.5% higher in the year to the first quarter, ominously for those Leavers who would have the U.K. rebalance trade to the rest of the world, a more rapid improvement than the 13.8% growth rate to non-EU countries.

But compared with Portugal, these figures look disappointing, the Financial Times says; over the same period, Portugal’s exports to outside the EU grew 33.2%, with a 51.6% rise in U.S. exports.

Now, it could be argued that Portugal is benefiting from the improvement in competitiveness that came from a crushing near bankruptcy just a few years before, reaction to which demanded severe austerity and a depression of living standards and wages.

Painful as that was, the Portuguese economy is much more competitive today than it was 10 or even five years ago, which suggests structural reforms, however painful, are a far more effective driver of export success and improvements in competitiveness than a onetime sugar rush of depreciation.

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A rebalancing of Britain’s economy to exports and a boost for manufacturing may therefore be as unlikely as the equally unattainable £350 million a week saving the Leave campaign suckered voters with in the referendum campaign, only to promptly withdraw it when, to their surprise, they found they had won.

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