Tory leadership contender needs more than a Ukip-style campaign to buy British and boost Commonwealth trade

The economic vision

Andrea Leadsom said in her set-piece speech on the UK’s economic prospects that the financial markets were coping well and the FTSE 100 was performing better than rival stock markets. The pound was only falling because currency dealers bet the wrong way before the referendum vote, believing the UK would stay in the EU, she said. The UK’s borrowing costs remained among the lowest in the world.

Notwithstanding her previous criticism of Mark Carney for talking down the economy and being part of a conspiracy of experts campaigning to keep the UK in the EU, she said the governor of the Bank of England was right to say the country would survive the uncertainty surrounding Brexit.

As for the future, she said a lower-valued pound would be good for the country, encouraging consumers to shun imports and buy British. Exports would be the priority for her government.

As a first move, she would seek tariff-free trade with the EU and then conduct talks with countries in the Commonwealth, which represents a market of 2.3 billion consumers, many of them in fast-growing economies.

Andrea Leadsom calls for 'prosperity not austerity' in Tory leadership pitch Read more

She would preside over a country with better training, “smarter working” and high standards of company behaviour. Together with higher exports, this would lead to more jobs, higher pay for workers and prosperity being taken “to every corner of the country”.

Is Leadsom right?

There was no detailed policy announcements to support her claim that a Leadsom premiership would put the UK on a path to greater prosperity.

Her main aim was to say that the current uncertainty gripping the markets was being overplayed. The FTSE 100 has gained ground to stand at 6,528 points at midday on Thursday and it is true the UK government can borrow at historically low interest rates.

But the stock market rallied only after it became clear Britain would not actually leave the EU for at least two years, probably longer. Shares also went into overdrive at the prospect of an interest rate rise in the US and cuts in the cost of borrowing by the Bank of England and the European Central Bank.



It should also be noted that the FTSE 100 is full of international companies that report most of their revenues in dollars. The falling pound has made their profits more valuable, raising their share price.

The FTSE 250, which is almost exclusively made up of smaller companies that rely more heavily on the UK for their business, is down by 8% since the referendum vote.

Leadsom said the pound had tumbled to a 31-year low against the dollar and a three-year low against the euro as investors priced in the market’s mistake of forecasting a remain win.

However, Holger Schmieding, the chief economist at Berenberg bank, said another view would be that the current uncertainty has driven away foreign investors, reducing demand for sterling. This is acute in the commercial property industry, which relies heavily on investment from overseas. The UK’s balance of payments deficit of 7%, the largest in the G7, has also played a role. It shows that the UK has been living beyond its means for some time.

Schmieding agreed with Brexiters that the pound’s fall should not be overplayed. “Despite the heightened political and economic uncertainty, the fall in sterling has been orderly so far. After an initial sharp fall of 8.4% between 24 and 29 June, sterling seems to have found a bottom in recent days. It is still trading 9% above the 2009 lows.”

The bad news, according to Schmieding, was that weaker sterling was unlikely to boost exports much, despite Leadsom’s claims.

“Although the UK’s exchange rate is currently down by 15% on a trade-weighted basis compared to last November’s peak, experience with previous sharp depreciations suggests that the boost to exports will be limited. Trade-weighted sterling fell by 30% during the financial crisis, but the trade deficit remained at 3% of GDP. Why? The fall in foreign demand matched the fall in domestic demand. The exchange rate made only a small difference.”

Schmieding pointed out that a lower pound made UK households poorer. “Since UK households consume many foreign goods and services, the drop in sterling makes them poorer in real terms. Over time, the rise in import prices will contribute to higher inflation. Higher inflation will slow the growth of, or even lead to a reduction in real wages – real wage growth is the primary determinant of domestic demand growth.”

Leadsom said she wanted to boost growth with high-paid, export-led jobs. Schmieding said the economy “will rebalance the wrong way”.

“The trade deficit should begin to fall in the coming months. But it will happen for the wrong reason,” he said. “A healthy rebalancing would involve growth in exports. Since lower sterling will not boost exports much, the fall in the trade deficit will be driven by lower imports instead – reflecting weaker domestic demand.”

The Bank of England governor said the UK’s balance of payments deficit meant it was “relying on the kindness of strangers”. Schmieding agreed.



“This deficit is funded by foreigners who are willing to lend to the UK. Strong growth attracts investment, recessions deter it,” he said. “Until the UK economy and its financial markets stabilise, a sterling crisis remains a key tail risk. With each day that passes, the risk falls a little, the outlook becomes a little clearer and the post-vote shock fades. But political and economic risks loom large.”

Leadsom pitched for a deal with the EU that offers tariff-free trade. How she can achieve that without conceding free movement of labour is not clear.

She said the UK could expand exports to fast-growing countries in Asia, Africa and South America. There was no plan to back up this claim. It can take five years or more to secure trade deals with foreign governments.

It is possible for the UK to trade under World Trade Organisation rules, accepting existing tariffs and regulations, but that is unlikely to bring a big boost to exports and turn around a long-term decline in the manufacturing sector, which is smaller now than before the 2008 crash.

Verdict

Leadsom’s analysis lacks credibility and her plan for the future lacks policies.

As a vision, it ranks alongside that of Ukip, with her emphasis on building relations with the Commonwealth, and consumers rejecting foreign-made goods in favour of buying British.

A lower currency can bring some benefits, but not if it is a judgment on the strength of the economy. If the UK suffers a recession, that is a more important factor than a fall in the pound. Foreign investors will flee.

Some anti-EU economists say good riddance, but just like Leadsom’s “buy British” campaign to help the balance of payments and boost the economy, a shift to higher domestic investment is going to take a long time and will need to reverse more than 30 years of reliance on foreigners.