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The Case for UK Import Substitution

With Britain’s current-account deficit running at over 7% of GDP – by far the largest since data started being collected in 1955 – sterling's 16% depreciation since the June Brexit vote could be regarded as a boon. But a weakening pound could actually hurt British competitiveness.

LONDON – The most dramatic economic effect of the United Kingdom’s Brexit vote has been the collapse of sterling. Since June, the pound has fallen by 16% against a basket of currencies. Mervyn King, the previous governor of the Bank of England, hailed the lower exchange rate as a “welcome change.” Indeed, with Britain’s current-account deficit running at over 7% of GDP – by far the largest since data started being collected in 1955 – depreciation could be regarded as a boon. But is it?

Economists would typically argue that the way to balance a country’s external accounts is through a fall in its currency, which would make imports more expensive and exports cheaper, causing the former to fall and the latter to rise. Higher import prices – a net loss for the country – would be offset by the higher employment and wages generated by the more competitive position of the country’s exports.

But in order for currency depreciation to work its magic, more demand for exports must be forthcoming when the exchange rate falls (or, as economists say, the price elasticity of demand for exports must be high). But various studies have shown that the price elasticity of demand for UK exports is low. For example, a recent paper by Francesco Aiello, Graziella Bonanno, and Alessia Via of the European Trade Study Group finds that “the long-run level of exports appears to be unrelated to the real exchange rate for the UK.”

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