Saturday, June 28, 2008

So what is to be done?

So what is to be done to fix the UK economy? A perfectly fair question, you might think.

However, the problem is that it is too late to fix the problems that are now occurring. There is no magical legislative wand that can magic away the structural problems in the UK economy. It is the idea that such a magic wand exists that is part of the problem. What can be done is to put in place the infrastructure to allow a recovery in the future. The problem is that such infrastructure would require politics and politicians with great bravery, and such politicians do not seem to exist. Instead of facing the reality of the world that we are now in, they pretend that nothing has changed. Such an approach is reassuring in the same way that rushing towards a cliff in a car with no brakes is reassuring. Whilst the driver claims that there is no cliff, that does not make it so.

The first step in reforming the UK economy is to recognise that the world has changed. During the period that we built the current infrastructure the level of competition in the world was far less than it is now. Even the entry of Japan into the world trading system can not be compared with the entry of the so called BRIC economies (Brazil, India and China). The entry of these countries into the system of world trade has created a huge surplus of cheap labour, and the western world has to accept that these economies can not be ignored.

It is not just their cheap labour that creates the threat. It is also the relative freedom of their businesses from regulation and interference from government. A few years ago, I saw the cost model for a range of products with a direct comparison of costs in China and France. In China the products were significantly cheaper but labour costs only constituted about 5% of the cost differential. The rest of the cost difference was built into the entire structure of the economy.

The answer that is commonly provided to solve this problem is that the western economies need to move up the value chain. We can provide the services that support the BRIC manufacturing base. We can do the product design. We can offer our skills in marketing, or consultancy and so on.

This is the great dream that ignores the reality. As the BRIC countries go on expanding their manufacturing, the services that support such wealth creation will naturally move to be nearer to their customers. That means the banks, the legal services, the designers, the marketers and so forth. They will not reside in the UK, the US, or France. They will follow where the money leads. For example, if we take the idea that design can be done in UK and manufacturing done in China it is completely unrealistic in the long term. Good design needs to include an understanding of the manufacturing process, to maximise the resources and technology available. If manufacturing is moved to China, over time, that knowledge will be lost in the UK, but will be gained in China. It is a recipe for long term decline. The same can be said of many of the ideas for moving up the value chain, whether it is consultancy, accounting or any of the other 'strengths' in the Western economies.

However you look at it, for any medium to large sized country, you need a base in manufacturing. Without such a base it will be impossible to remain a competitive economy.

So how do you encourage and maintain a manufacturing base? Here is where the real problem resides. The question to ask is why is so much manufacturing moving to the BRIC economies. As I have already mentioned, it is not just cheap labour, although that is a part.

The real key is that governments have piled huge amounts of legislation on top of companies, such that they are hobbled and no longer able to compete from a base in the UK. A crude example of this is the minimum wage, which tells an employer that they have to pay a wage that may be uncompetitive if they wish to manufacture in the UK. As a result, jobs and wealth are lost to the UK, and instead of productive people the UK has a huge roll of unemployed (and often unemployable) individuals. This adds cost to the government who have to pay for the unemployed, and that cost is passed onto the companies in the form of taxation. How can this make sense? No doubt, some economists will reel out statistics to say 'it ain't so', but simple reason would tell you that, whatever anyone says, if you are competing on labour cost, a minimum wage hobbles the ability to compete.

What of all of the other employment legislation? I worked on a project that was looking at the cost of the European Working Time directive for road transport companies. This crazy piece of legislation had a shocking effect on the costs of companies. The cost of recording and managing the information was quite startling. Furthermore, the rules did not allow drivers to work as they wanted to work, but restricted their freedom, and thereby restricted the flexibility of the businesses. It seems that the European Union knew better how much they needed to earn than the drivers did (it should be noted that safety was already protected through other legislation).

This example is just one example of interfering legislation that both removes the flexibility of labour, as well as imposing costs. The question is; for what? It is not entirely clear what this legislation achieved, except in generating huge costs for all those required to implement it, and to restrict the earning potential of drivers.

Another labour cost is one that is outlined in my essay 'A Funny View of Wealth'. This is the idea that the welfare system already creates an alternate minimum wage. I have quoted a section of the essay below:

'As mentioned before, all things in the UK are not equal due to the minimum wage, but also because the UK employer needs to compete for labour with the UK benefits system (which is an indirect minimum wage that applies to anyone entitled to social welfare benefits). This system allows an individual to remain economically inactive, or to choose an option of accepting a low paid job for very little real remuneration despite a major increase in the expenditure of their labour. In such cases the value of the labour expended is far below the minimum wage as it needs to be calculated as the weekly pay minus the benefits, to give an actual wage for the work done. The rational person in this situation might reasonably ask whether the loss of their free time to work is worthwhile for what will often be little financial incentive as, in this situation, the UK worker is often working for extremely low wages'

I will not address this subject further here, as it is a subject that requires a more detailed review which I will deal with on another occasion. What is worth noting is that the welfare state has now become the 'burden state'. It is no longer a safety net, but an alternative to productive activity.

For the moment, I am just addressing a couple of the problems in the structure of the UK economy. I am very aware, as I write, that this is not a subject that can be covered in a single, off the cuff, post.

As such I will call a halt here, and start addressing some of the concerns in a series of posts over the coming weeks or months. For the next post, I will take a detour, and give an example of where government money is being spent to 'help business'. I think that you will agree that it is a sad and rather pathetic tale, and I hope that you will agree that it highlights the stupidity and waste of government.

1 comment:

  1. You are quite right. We are completely f****d. Even lowering UK wages to Chinese levels and removing all regulatory frameworks will do nothing to make the UK competitive with China (due to sheer economies of scale that the Chinese have). Besides, such a move would be politically impossible, and would you really like to live in a country where most people work 14-hour days, sometimes 6-7 days a week, with a week of holidays in a year for a hundred pounds a month?

    The US will probably do well. Its a big country with many natural resources and can probably reinvent itself and readjust to the new conditions. Germany has still managed to hold on to its advantages in high-end engineering and manufacture. Same goes for Japan. As for the rest of the "developed world" the future looks rather bleak. We might live to see the day where large parts of Europe will be just places for well-heeled Asians to visit, play golf, and take advantage of the inexpensive women.

    The lesson here seems to be that you shouldn't actively choose a game which pits you toe-to-toe with a 450lb gorilla, and not expect to be flattened. But, as you said, it is too late...

    The "moving up the value chain" argument has been voiced by fans of globalization. It has always struck me as the height of stupidity. Do these bozos really believe that a developed economy can be sustained by the efforts of a handful of shoe and handbag designers together with composers of advertising jingles?

    Still, its fascinating (in a sick kind of way) to observe the unfolding events. Reminds me of a line from Jim Jarmusch's "Dead Man", when the Indian asks (a still very much alive) Johny Depp "Did you know the man who killed you?"


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