Gavin Rice is a former Special Adviser at the Department for Exiting the European Union.
Before the crisis caused by Covid-19 struck Europe, many in Britain may well have regarded Donald Trump’s obsession with China as odd.
The bellicose, tough-guy President’s determination to conduct punitive trade wars with the emerging superpower has been dismissed as economic illiteracy or just plain childishness.
Yet we now live in a very different world, and the coronavirus has thrown a harsh and unflattering light onto the conduct of People’s Republic.
The suppression of information about Covid-19’s outbreak in Wuhan has caused understandable outrage and the Government is now moving quickly towards a wholesale review of Sino-British relations.
A harsher and clearer light is now being shone on China’s buy-up of UK assets, its control of foreign debt, its domestic human rights abuses, its complicity in corporate espionage, and the acquisition of Western companies by proxies of the Chinese state (the purchase of 13 per cent of Norwegian Airlines last week is a prime example). Questions are being asked about our reliance on international supply chains.
But the reality is that Covid-19 has merely exposed a truth not hitherto universally acknowledged, and that is the fact that for decades China has not been playing by the rules. Her admission to the WTO in 2001 was supposed to herald a new era of international co-operation, liberalisationm and fair trade practices. As China is welcomed into the rules-based international order, the theory ran, the more she will respect the principles of free trade and an international level playing field.
The theory was wrong. While the Anglo-Saxon world sees trade through the prism of Smith and Ricardo, holding that free trade and fair competition leads to optimal benefit for all sides, China sees things rather differently. Trade is viewed as a method for expanding and extending power and influence, and for acquiring resources.
Moreover, the distinction between the interests of companies and those of the state does not exist. One need only look how China’s Belt and Road Initiative is playing out in South East Asia and the Pacific Rim: when debts to Beijing go unserviced, China acquires assets in bridges, roads and ports, and hence control over its neighbours.
Trump is not the only one to view trade as a competition. While a small degree of modernisation has occurred, for decades China’s central banking elite have artificially manipulated the value of its currency, the renminbi, to keep the exchange rate down and its exports cheap. As dollars, pounds, and euros from Chinese exports flow in, they can only be exchanged for renminbi (also known as yuan) at a rate approved of by the central bank. When extremely low labour costs and widespread state subsidies are factored in, it’s small wonder that Western economies cannot compete.
The Covid-19 pandemic has thrown into question our economic foundations, which currently rely on global supply chains for maximum cost efficiency. In 2018-19 imports from China totalled £44.7 billion, while Britain’s exports to China were worth only £22.6 billion – a deficit of £22.1 billion, with the UK surplus in services dwarfed by a deficit in goods. The threat of global disaster (such as a pandemic) has revealed a complete reliance on surplus nations to manufacturer goods; policymakers are now talking of the need for “supply chain resilience” in earnest.
But perhaps it is now time to look again more closely at the bigger picture. The UK survives on an enormous current account deficit – that is to say, the country imports far more than it exports, factoring in both goods and services. In 2019 this ran to the tune of 4.6 per cent of GDP. Liberal economists say this does not necessarily matter; the gap in the balance of payments will be made up for in other ways. Countries running a deficit compensate for it by benefiting from foreign direct investment (FDI) or overseas purchases of their assets – the capital account.
But is this a good thing? The UK has become a significant net debtor nation, with liabilities overseas far outstripping overseas assets. We are reliant on foreign investment (or, to put it another way, loans that will need to be repaid) and crucially, on selling our houses to foreign speculators. Is this really a sustainable way to run an economy?
This is not simply the fault of inefficient British producers. As Roger Bootle and John Mills persuasively argue in their 2016 paper ‘The Real Sterling Crisis’, there is a strong case that the pound has for many years simply been overvalued. The role of the City and the international desirability of UK assets push up sterling’s value, crippling manufacturing in the regions, increasing regional inequality and destroying jobs.
Faced with razor-thin sterling profit margins and a yuan artificially forced down by central bankers in Beijing, British exporters cannot compete. Pounds flow out of the North and regions as cheap goods are imported, but they don’t come back – they flow into corporate investments and houses in the capital, thus exacerbating the suction effect of London.
The global disruption due to Covid-19 gives the UK an opportunity to revisit this problem and change direction. In general markets are the best way of allocating resources. But in currency markets currencies do not necessarily float to a value that reflects the economic fundamentals. It has been taken as read for many years that governments should leave exchange rates alone, but the reasoning behind this needs re-examination. China openly fixes its nominal exchange rate; the eurozone does the same less obviously, using austerity to force down the real exchange rate of the euro and shoring up Germany’s surplus.
Perhaps it is time that the UK adopted an exchange rate policy of its own. The current government is already contemplating imposing controls on foreign purchases of UK companies. A supertax or outright ban on overseas buy-up of the current housing stock, as has been imposed in New Zealand, could reduce demand for sterling. A staggering 75 per cent of new properties in London are purchased by foreign domiciled individuals and companies.
There could be an inflationary uptick but, as Bootle and Mills point out, the dip in the pound after the 2008 financial crisis only increased inflation slightly, and indeed this was the first time in ten years that inflation fell within the Bank of England’s 1-3 per cent target. Deflation is the real threat to the corona economy. Finally, the devaluations of 1931 and 1992, when Britain crashed out of the ERM, precipitated significant boosts to GDP growth.
Whatever shape the Government’s new approach towards China takes, it should have a rebalancing of the economy as its flagship. Reshoring may be a gradual process, but a scenario in which we rely entirely on China to make cheap goods while running a perpetual deficit cannot be sustained in a post-Covid world. We should never have allowed things to get there in the first place.
Some orthodoxies may have to be abandoned, and post-Brexit we may have to be more willing, like our neighbours, to act robustly in our own interests. Taking a long, hard look at the ruinous effect of the value of sterling would be a radical place to start.