Danger! Danger! Devaluation!

Right now, Brexiters keep claiming that devaluation is good for the economy. They're almost certainly wrong.

Intuitively, a fall in the pound is a bad thing: anything we buy from overseas goes up in price and since a high proportion of what we buy comes from overseas, our cost of living will go up.

But then Brexiters jump in and say "Devaluation is great, because it means more exports and that will make the economy grow." As a general rule, because Brexiters often distort the truth, you should be skeptical. So, are they wrong here too?

It's a good question. Recently I was at my Dad's house and we were watching a TV show called "Factory Wars" on the Yesterday channel. I was surprised to find a bloke from The Institute of Economic Affairs. Why was an economist from a lobbying organisation with secretive funding (hint, Big tobacco and the climate denying US groups like the Heartland Institute) on a history show?

Basically he was using it to push free market ideology. He claimed that the UK escaped the recession in the 1930s because it implemented austerity unlike the US which implemented a Keynesian New Deal. This was completely different to how I'd understood these economies in the 1930s: on the basis that austerity empirically doesn't work; its easy to explain why, and it was the Keynesian New Deal that empowered the US to manufacture the armaments that helped the allies overcome the Nazis.

It's not coincidence that the IEA offered a completely different explanation than what is normally understood: they're based at 55, Tufton Street where Vote Leave was also based. So, again we have another ideologue whose views we should suspect.

So, I checked out what really happened in the UK's economy in the 1930s? Economics Help is really useful. Basically, the crash of 1929 caused a lot of hardship in the UK, but in the mid to late 1930s we dropped the gold standard; which lead to a deflation of the pound and this lead to a mild economic recovery in the south, but the North still had it tough.

So, it looks like Brexiters might be a bit right, and the IEA were misleading as normal. But is it?

Devaluation Model

Actually we can work this out ourselves, because it's easy to model. In our model (for a business, but it can apply at a larger scale) we consider just three variables:

1. Profits
2. Internal costs (labour minus rises in the cost of living due to buying overseas goods, maintenance of equipment etc). We assume this is a constant.
3. Imports (including the increases in the cost of living for employees from overseas goods).

Case A

In the first scenario, we consider a company with reasonably high import costs (50%), a profit margin of 30% and the rest is internal costs (20%). If the pound deflates by 25%, then imports go up to 50*1.25 = 62.5%. So, now our profits are 30-12.5 = 17.5% profits. This means that the company needs to sell 30/17.5 = 71% more goods, but the domestic market will buy less, and the overseas market will only find its products are 25% cheaper (due to devaluation).

So, the question is: is it like overseas customers will buy 71% more, if it's 25% cheaper? This seems unlikely to me.

Case B

Let's consider the second case: profits are 70%, internal costs 20% and imports are 10%. Imports increase by 25% => 12.5%, so we now need to sell: 70/(70-2.5) = 3.7% more. OK, so in this case our product is 25% cheaper, and we only need to sell 3.7% more for us to make more profit, this seems plausible.

So, we have to ask ourselves, what kinds of businesses are like this? Mass market manufacturing (cars, aircraft, smoke alarms) will rely a lot on imports and will make a relatively small profit. Apple, for example has margins between 20% to 30%. Dyson is also about 21%. DELL has an operating profit of just 1.1%. Companies producing consumer items such as smoke alarms have fairly low margins which explains why they would move to cheaper EU countries.

What companies are like case B? Services and financial companies are like that. However, financial companies are likely to move out of the UK due to Brexit, so this means service companies would benefit.

However, to some people, UK manufacturing companies can look good: namely, if you hold a lot of offshore wealth, then UK manufacturing companies struggling under devaluation look like a good buy. In other words, disaster capitalists with offshore accounts, such as people like Jacob Rees Mogg and a large proportion of Conservative party members and MPs.

Epilogue

Brexiters are wrong: it's just a front for their disaster capitalist mission. We can summarise our model and convey why in a simple table:

So, why did the UK not crash due to a double-whammy of austerity and devaluation in the 1930s? That's pretty simple, being the biggest power bloc at the time meant that although most of its food (91%?) was imported along with a significant proportion of goods, a great deal of this was essentially an internal market, with the added advantage that many resources, particularly coal were internal.

Capitalising the Cumbrian Floods

Naomi Klein's book: The Shock Doctrine (2007), makes the insightful, but surprising claim that free-market capitalists use economic and climate disasters to push forward neoliberal ideological policies. This is called #disastercapitalism . 

The idea is this: people normally resist free market solutions to all sorts of cultural norms. For example, the NHS in the United Kingdom is deeply valued to the extent that an amateur choir can achieve a Christmas number 1 in the pop charts by releasing a song that defends it.

What Disaster Capitalism does though is use the dislocation, caused by a traumatic event to railroad purported solutions to inject free-market answers while people are still reeling in confusion from the event. For example, in the case of climate change related events, you would think it would be the other way around: that people would rapidly form the association between global warming and and the current event and make strong calls for the government to turn more rapidly away from fossil fuels.

Surprisingly, although some people do this, by and large no such response occurs. Instead what happens is that people are preoccupied with the immediate need for relief and consequently suppress or ignore statements or opinions that relate the event to climate change. For example, after the Hebden Bridge flooding of 2012, they released a web page where they talk about "what work has been done since last Summer, and what’s also planned in the medium and long terms". There's no mention of climate anything. You can skip to the forum too. So, from the 2012 forum, topic "Floods Practical Solutions", of the 19 posts, there's one reference to climate ("Has anyone mentioned Treesponsibility? The group was set up to leessen (sic) the effects of climate change in the Valley by planting trees"). Another flood-related topic is no longer on the server. Of the other topics "Floods Sandbags" (no references); "Floods, The Politics" 20 refs: "Climate change certainly seems to be contributing to the problem, but it will be hundreds of years, if at all, before we will see the results of any effort we make to counter climate change."(i.e. let's not think about it right now); "Every Councillor and every senior Council Officer in Calderdale needs to read the Pitt Review of the 2007 floods and act on the recommendations. They should also understand where Climate Change is leading us." (which was written by the Green Party Candidate and brushed aside in the next post with "I'm not sure that right now is the time to be pushing 'I told you so' stuff"); "Only yesterday a report was mentioned on the BBC from the Committee on Climate Change that warns of more of these downpours in the future.". Another Green party comment "Our own Government and its agencies have to stop talking about flood threats in terms of one in 30 or 100 years. With climate change it could happen next month again". This was countered in the next post and in a couple of later posts: "As I said, there is no evidence to link the recent wet weather with man made climate change and for that reason the Green Party and other opportunists should not use terrible events such as the recent floods to progress their agendas."

Given that people are cautious to make any link, particularly during the events themselves, it becomes relatively easy for the government to exploit it. And indeed this is just what they've done. In response to questions about how the Government had made cuts to the Environmental Agency prior to the Cumbrian floods in early December 2015, the government then offered Council Tax and business tax cuts as relief.

Doesn't this strike anyone as being rather odd? As if anyone's need for flooding relief was somehow related to how much they pay in council tax? Isn't it also more likely that homes built closer to flood plains are likely to be in lower council tax areas and therefore there's less to claim back, though they're more likely to be flooded? And how is a business's profits related to the amount of damage they'd suffer? And isn't it likely that a business that was making more money would find it easier to cope with the cost anyway?

The only common factors in all of this is that:

1. The 'flooding relief' potentially has greater benefits for Cumbrians who are better off, compared with those who aren't.
2. The relief needs to be applied from across the country to those in need, not localised to the area in question. How is a community's ability to fund its own relief related to the extent of the disaster?
3. Business taxes (and possibly Council taxes) pay for things like welfare, so in a sense the flooding disaster is being used to make cutbacks in welfare: although the rich across the country aren't paying for the flooding relief, the poor in the UK will have less money as a consequence.

And guess what, Liz Truss is planning to apply the same approach to the flooding in the North of England again - they have no idea if it works, but it's already policy.

“Of course, you’ve asked about funding and we’re looking at schemes similar to what we put in place in Cumbria to make sure families and businesses are supported,” said Truss.

 Disaster Capitalism to a tee.