EconoMatters, Rethinking Europe

UK: How a Development Economist Sees It

To a development economist, the future macroeconomic policy needs for Britain seem fairly obvious.

Credit: Rareclass


  • Before Brexit, UK economy exhibited features that were seen at the end of various boom episodes in emerging markets.
  • What’s there to be proud of about the UK, pre-Brexit? There was neither external nor internal balance.
  • UK needs a rebalancing toward more regional equity, the creation of pro-poor growth and jobs.
  • Those who didn’t see Brexit coming now feel that nothing good can come out of the “pounded British pound.”
  • The pound's fall and the withdrawal of banks from London could well be a blessing in disguise.
  • Maybe, just maybe, Britain is at the first stage of a sustainable development upswing.

Before the Brexit vote rolled around, the UK economy and polity stood out for one very surprising fact: It exhibited features that could be found at the end of various boom episodes in emerging market countries.

The distortions triggered by the boom centered around London and some satellite services, with high-paying jobs in the financial sector and attracting some smart cosmopolitan crowd (and much low skilled labor).

Meanwhile, an overvalued exchange rate for the British pound burdened manufactures’ profits and wage levels, which had a very direct impact on people with only basic skills.

What’s there to be proud of about the UK, pre-Brexit? There was neither external nor internal balance. The current account of the balance of payments stood at 7% of GDP.

Productivity growth has been absent for long and ranks below the level obtained by its European peers.

In addition, the UK public sector has been reduced to the bones in various areas, so there has been little room to compensate the poor for unfavorable market outcomes.

A glitzy house of horrors – for the people

Meanwhile, super-rich foreigners are able to launder their money by investing in London’s real estate. The price increases they triggered ultimately came to the detriment of young families trying to establish an existence in the British capital.

The role of the City may be unrivalled as the financial center of Europe, not least thanks to becoming a magnet for speculative property flows from Russia, China and the Middle East.

As for the rest of the country, regional imbalances between the prosperous South and the rest of the UK have deepened. And compared to other developed countries, the UK has a very unequal distribution of income. Out of the 30 OECD countries, the UK is the sixth most unequal.

What needs to be done?

To a development economist, the macroeconomic policy needs for Britain seem fairly obvious. Brexit addresses these needs only very tangentially.

The crux of the issue for the UK thus is not leaving the EU, especially as the UK did not suffer from the Euro straightjacket.

What is needed in the UK is a rebalancing toward more regional and personal equity, the creation of pro-poor growth and jobs, implying the need to tame the City plus its satellites.

As well, a more competitive exchange rate, infant industry support and a public sector, reborn and rebalanced, are essential to any strategy to bring the UK back on a sustainable development path.

Where does the British pound stand?

Well, today the British pound stands 20% lower as measured by the BIS real effective exchange rate index. And parts of the financial industry threaten to move elsewhere.

Whether you love it or hate it, there is no denying that both of these developments are a result of Brexit.

Paint it black: Most of the observers who did not see Brexit coming now deny that anything good can come out of the “pounded British pound.” They were and are uniform in their warning that Brexit would cause a sharp recession.

In my mind, they make two statements that simply don’t add up:

1. Elasticity Pessimism

Many people seem to believe that real exchange rates don’t matter for adjustment — that is, that external and internal devaluation (downward adjustment of non-tradables and wages relative to trading partners) don’t help alleviate imbalances as trade and resource flows fail to respond.

The Center for European Reform, a privately sponsored think tank that gets more media attention than the quality of its opinion-heavy output might suggest, is just one example.

The notion of “elasticity pessimism” that was popular post World War II, but has been largely refuted by considerable evidence of emerging countries.

Those countries did succeed with crowding in foreign demand by sustained real exchange rate devaluation. To be sure, a short-term flash crash will not provide the incentives and signals that a sustained real devaluation will confer.

2. Devaluation makes Britain poorer

It is often argued that a cheaper pound makes Britain poorer. The Economist, not seldom on the wrong side of history (remember Africa – A Failed Continent?), titled recently: “Brexit is making Britons poorer, and meaner.”

Iinternational trade theory has taught us that a devaluation makes a country poorer if that devaluation leads to a deterioration of its terms of trade.

Moreover, trade diversion effects of leaving the EU can outweigh trade creation effects, as the UK economy redirects its focus toward global markets.

According to Fritz Machlup´s definitive 1956 study, there is a “strong presumption that the devaluation of an overvalued currency leads to better resource allocation.” This mirrors the UK case, so that an improvement of UK’s terms of trade should not be excluded.

3. The finance “curse”

In many poor countries, resource dependence generated slower growth, reduced economic diversity and it also produced economic instability, inequality, conflict, rent-seeking and corruption.

The term “Dutch Disease” indicates that the risk of low growth due to resource dependence can apply to rich countries as well. The term describes the decline of the manufacturing sector in the Netherlands after the discovery of large gas fields in 1959.

As regards the UK, the “Finance Curse” produces similar effects, often for similar reasons. Beyond a certain point, a growing financial sector can do more harm than good.

Before the Brexit vote, the Tax Justice Network had released a very readable pamphlet, entitled “The Finance Curse: Britain and the World Economy.” Its conclusions might silence those who are determined to paint the outcome of Brexit black.

After all, a more competitive British pound and a reduced size of the country’s finance sector are definitely two things worth striving for.

As the report argued: “Downsized finance itself will provide the basis for such a transformation with, for instance, finance losing its virtual monopoly on UK talent.”

Why then not paint it rose?

The pound’s fall and the withdrawal of banks from the City could well be a blessing in disguise. Maybe, just maybe, Britain is at the first stage of a sustainable development upswing.

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About Helmut Reisen

Helmet Reisen is the former Head of Research of the OECD Development Centre. Follow him @HrReisen

Responses to “UK: How a Development Economist Sees It”

Archived Comments.

  1. On November 2, 2016 at 3:37 am siddhartha1 responded with... #

    A fall in the value of the pound simply lowers the buying value of the pound for consumers, and a reduction in the size of the finance sector in the UK will achieve nothing more than a lowered GDP.

    For these two negatives to become positive, the question is whether Prime Minister May’s government can indeed come up with anything that will improve regional and personal equity.

    Whenever the Prime Minister moves to create what you call “pro-poor growth and jobs”, it will be interesting to see whether her government enunciates and implements a proper industrial policy and can indeed reinvigorate the public sector (the latter needs to be restored after the incessant Thatcher-style attacks on it and on any spirit of public service since the 1980s).

  2. On November 5, 2016 at 4:32 am 6Story5 responded with... #

    Helmut Reisen’s voice must be one of the few in the German speaking world to argue the case for Brexit. The story though is much bigger than he credits. It is not just about the economy. In 1972, Prime Minister heath entered the EEC/EU in a putsch against parliament, which the German Constitutional Court would never have accepted. The 1972 European Community Act declared that EEC/EU law took direct effect, with no appeal. In this way, the two major offices of state in Whitehall, the Foreign Office and the Treasury, were able for forty four years top avoid parliamentary scrutiny at homùe, and de fact in the EU. The UK joined the Committee of Permanent Representatives as the champion of a forceful Commission and of a supranational ECJ. In this way, Whitehall centralised power further; pushed through EU legislation favourable to the City; told British voters that in Heath’s words ” the days of the nation state were gone”(ie that your votes are not very important), and saw the massive development of London. June 23 killed Heath’s version of the EU stone dead. It was a major victory for our constitutional democracy, how big a victory may be guaged by the determination of the so called “pro Europeans”, like Nick Clegg, to reverse it.

  3. On November 5, 2016 at 11:53 am Helmut Reisen responded with... #

    Very interesting points, indeed. To be sure,I do not try to make the case for Brexit. I just was struck by the similarity of the British situation with, say the Southern Cone of Latin America in the early 1980s. I do think that a hard Brexit would have positives that the mainstream tries to suppress.