On the on hand John McDonnell has called for “a New
Economics, laying the economic foundations of a prosperous, fairer and
sustainable society”. On the other hand he has promised to “demand that the
Office of Budget Responsibility and the Bank of England put their resources at
our disposal to test, test and test again to demonstrate our plans are workable
and affordable”. But John McDonnell misses the point: it’s the Old Economics of
the Treasury, the OBR and the Bank of England (what Gavyn Davies has usefully
termed ‘the standard apparatus’) that is at the root of the country’s economic
policy problems. Giving the OBR and the Bank responsibility for judging Labour
policy involves a prior commitment to seeing things their way. And their way is
completely wrong.

For as long as sterling remains a sovereign currency the
exchange rate will be a significant factor affecting the country’s economic
circumstances. But unfortunately both the Treasury (and hence the OBR) and the
Bank (and hence the MPC) hold to the heartfelt belief that “devaluation makes our
exports cheaper” (as Robert Chote puts it with technical precision, it causes “a
change in the relative prices of domestic and foreign goods”). This erroneous
preconception leads them to suppose that any depreciation of sterling will
expand sales volumes for British goods and services (because they’re cheaper)
thus boosting economic activity and employment. Such thinking is completely

Not only are the official expectations without justification
in terms of economic theory, they are also directly contradicted by the
evidence provided by the Office for National Statistics. The figures below
amply illustrate my point.

The ONS figures indicate that the standard expectations are
completely refuted. The devaluation of sterling in the aftermath of the Great
Financial Crisis has been substantial: from $1.87 in the years before the
crisis (2004-2007) to $1.57 in the years after it (2009-2012); from €1.47 in
the years before the crisis (2004-2007) to €1.17 in the years after it
(2009-2012). This devaluation raised the prices of goods imported and goods
exported alike: there has been no “change in the relative prices of domestic and
foreign goods”.

The traded goods price index for exports went from 74.7 in the
years before the crisis (2004-2007) to 94.9 in the years after it (2009-2012);
the traded goods price index for imports went from 74.4 in the years before the
crisis (2004-2007) to 94.9 in the years after it (2009-2012). In technical
terminology, the terms of trade remained unchanged. And this ought to come as
no surprise since you only need seven types of product to account for more than
half of UK exports and you only need the same seven to account
for more than half of the UK’s imports as well. The categories are: Mechanical
machinery; Electrical machinery; Cars; Medicinal & pharmaceutical products;
Refined oil; Crude oil; and Other miscellaneous manufactures. So no wonder prices
of imports and exports move together: their prices are those of the same types
of products and come from the same world markets.

In fact, the ONS data is entirely consistent with the proper
economic theory. In this, the crucial price-relativity affected by the exchange
rate is that between tradables and non-tradables. Tradables being those things
that are internationally portable (e.g. motor-vehicles; feed wheat; consultancy
services etc.,). Non-tradables being those things irrevocably confined to our
shores (e.g. residential property; domestic care services; the infrastructure
of the public realm etc.,). The impact of sterling’s devaluation has been to
raise the sterling prices of tradables across the board (i.e. both the things
we buy from overseas and the things we sell abroad) because their prices are
set in international markets (and not in sterling terms) and these are the
prices which apply equally to ‘imports’ and ‘exports’ (translated into sterling
terms by the same exchange rate), so there is no relative price change such as
the official experts expect. And consider the significant difference that this
makes: the flawed conventional wisdom believes devaluation is expansionary
(increasing domestic output) whilst the correct theory says it isn’t (rather
the opposite when you take’ income effects’ of price changes into account).

A more detailed consideration of the ONS data confirms that
import and export prices within the same (tradable) product categories
habitually move together (being basically the same international price of
course), showing that the UK is well integrated into global market
determination of producer prices for tradables. The pivotal role of the
exchange rate is to alter the balance of activity in the UK economy between the
tradables and the non-tradables sectors
: this comes about because whilst
prices in the latter (non-tradables) are inherently set in sterling, prices in
the former (tradables) are translated into sterling from abroad by the exchange
rate (thus changing when it changes: i.e. increasing when sterling is devalued).

Tradables and non-tradables each account for about half of
national income (GDP) so the scale of this problem posed by this price change is
significant. And because the government itself is responsible for a large part
of the national infrastructure (non-tradable) and for purchases of
(non-tradable) educational and healthcare services (on behalf of the population
at large) this is an issue bearing directly on the economic responsibilities of
government operation. So these observations are particularly pertinent for policy-makers
of a social democratic persuasion. They provide a platform for a party with a
purposive perspective on government: “a New Economics, laying the economic
foundations of a prosperous, fairer and sustainable society” (John McDonnell MP
speaking at UCL on 20th November 2015).

It cannot be in the best interests of the Labour Party or
the people that it aspires to represent that a false picture of the country’s
economic circumstances should be used as the platform for evaluation of the
policies that will affect so many important aspects of commercial performance
as well as standards of individual, household and community life. Sadly there
is no prospect that the reviews instituted by the Shadow Chancellor will challenge
the official standard apparatus: their terms of reference preclude it. The prospects for the country remain as bleak
as before: see (http://www.stparsons.co.uk/files/bleak_midwinter.pdf).