‘EU is a saturated and declining economy’ – Interview with Economist Ruth Lea

‘EU is a saturated and declining economy’ – Interview with Economist Ruth Lea
Ruth Lea is an eminent economist who is currently Economic Adviser at the Arbuthnot Banking Group. I caught up with her in Central London to talk about a variety of EU and Brexit-related issues…


You were a strong supporter of Britain’s exit from the ERM back in 1992. What was it like?

I was over the moon. I was chief economist at Mitsubishi Bank at the time and my Japanese colleagues asked me what on earth was going to happen. I told them that the British economy would now recover. It had a good chance because the Government’s economic policies had failed – which made me rather unpopular with the Government at the time! I was regarded as a bit of an oddity but I was right. The economist Roger Bootle was another one who hit it absolutely 100 per cent on the nail. When we were in the ERM we were subject to German interest rates – it wasn’t the ECB that decided interest rates because they didn’t exist then – the Bundesbank did. When we joined it was during German unification and there was a huge inflationary boost in West Germany. Of course, the Germans are neurotic about inflation, so up went the interest rates, up went our interest rates, and the housing market as a consequence took a terrific hit. The economy was in recession. I thought the economy wouldn’t leave recession until we could actually cut the interest rates. Then, hey presto, on the 16th of September 1992, we fell out of the ERM. Interest rates were cut and the rest is history.

You called it right on the ERM and backed Brexit at the referendum, but at one stage you were in favour of EEC membership. What changed?

I agreed with joining the EEC back in 1973 because this country looked like a total basket-case. We were the sick man of Europe and in the meantime the six member states appeared to be doing exceptionally well and had recovered in the post-war years better than Britain had done.  It was like jumping on something in the hope that it would help but of course it really was the wrong solution. It was only when Mrs Thatcher came in and started to get on top of industrial problems by cutting regulations and taxes that they started getting on top of the problems in the British economy. I was a civil servant in the Treasury at the time and it was not made clear to the British people that this was not just an economic project, it was a political project. If some of us, including myself, had done more homework at the time we would have looked back at the Treaty of Rome in 1957 and realised that they talked about the ever closer union of the peoples of Europe. Some people claim that the Europeans were dishonest with us but that’s untrue – it was our politicians that were dishonest with us.

If Margaret Thatcher’s economic policy saved the country, how would you describe your economic worldview? Has the Government abandoned Thatcherism?

I’m a free trader, I was the head of the policy unit at the IoD, and at that time we were very much Thatcherites, we believed in taking off the burdens of business, reducing regulations and taxes and letting them get on with it. I don’t believe in trying to steer or plan the economy or even have much of an industrial strategy. I was the director of the Centre for Policy Studies, the think-tank that Margaret Thatcher put together with Keith Joseph back in the 1970s. It would be nice now to see a Conservative government who would try some Thatcherite principles but at the moment I think they are a trifle distracted by Brexit, which is understandable.

Remainers say that it’s madness to walk away from the Single Market; why would a Thatcherite like yourself want to lose trading access to 500 million consumers?

The idea that you need to be in a Single Market to have access to it is one of the biggest loads of nonsense that I have ever encountered. The United States has access to the Single Market, China has access to the Single Market. All this talk about not having access to the Single Market when we leave is frankly bunkum. The German car exporters and French wine exporters will want access to our market – we have a huge trade deficit with countries that are in the European Union – almost £30 billion with Germany alone, so it’s in everybody’s interest that we have mutual access to markets.

If the French and the Germans want to trade so much, why do we always hear the idea that the EU can be the only winner from any negotiation?

If we left the European Union without a deal there’s a strong likelihood it would impact upon the exports from Germany, France, Italy and Spain, so it’s mutually beneficial that we do a deal. Of course I’m just talking about economics and business but I have little doubt that a lot of the business organisations in Germany are lobbying for a trade deal with the UK and have been for a while.

The counter-argument to my quasi-rational optimism is the idea the European Union will want to punish us for leaving – cutting off their nose to spite their face. They could say ‘it might damage German car exporters but so what?’ because for them the European Union as a political project is of supreme importance. Some of them have the temerity to say that we must be punished for Brexit. They don’t want the UK to prosper because this might give the green light other countries who might want to leave as well. There is an element of truth to this argument but at the end of the day I think pragmatism will actually win out and there will be a trade deal.

How important is a free trade deal with the EU? During the Referendum campaign the idea of a ‘Gravity-model’ took hold which basically suggested you will always do far more trade with geographically close countries. 

I didn’t know anything about Gravity-models until I saw ‘Project Fear’. It just struck me like something that was concocted in 1810. It’s not where the world is – it’s so old fashioned. For things like car exports where there is a lot of interaction between EU factories and our factories I can see that the idea might have some relevance. But for things like services it doesn’t make sense. Financial services being affected by the Gravity model? I don’t believe it. You don’t need to have a market twenty miles across the channel if you’re dealing with financial services – the world has moved on from there. The big growth in services is coming from places like China and I think people forget that we’re a big services exporter. I think the proportion of our total goods and services exports services is well over 40 per cent and rising.

People have still got this notion that when you’re talking about exports you’re talking about goods, but for the UK services are the jewel in the crown. We have a very nice surplus on services trade whereas we have quite a substantial deficit on goods – much to the benefit of Germany. The gravity model looks back to a time when you actually had to get on a ship to get everything across which doesn’t apply to services. Even on goods the costs of freight are now relatively trivial when you think of these enormous container ships. But the proof of the pudding is the eating. Where has the most rapid growth been over the last ten years in trade markets? It hasn’t been between the UK and the EU. If you’ve got a fast growing economy that’s where exports will grow, not in slow-growing, saturated economies.

In the absence of a trade deal, one option would be to adopt unilateral free trade. Economists for Free Trade, who backed Brexit during the referendum believe removing all trading barriers on imports would benefit the economy: do you agree with this approach?

I was initially asked to join Economists for Free Trade when it was Economists for Brexit around 18 months ago but I don’t agree with their preferred deal of unilateral free trade, cutting tablets completely and going on to WTO Rules.  I think if we’re in a situation where British exports are facing tariffs – for example on food exports or car exports but we have zero per cent tariffs on imports into this country, our exporters would rightly complain.  It’s not a matter of protecting industries, it’s about giving them a level playing field so I don’t go along with the unilateral slashing of tariffs. It’s helpful to be able to have preferential trade deals with key trading partners, including the European Union. What they’re proposing is feasible but it’s far from being optimal.

Some commentators have said that the devaluation of the pound could offset WTO tariffs with the EU in the event of no-deal. Are there any downsides to the devaluation of sterling?

I’m still of the opinion that devaluation gives the economy a competitive boost. People have argued that it doesn’t seem to have come through very much for exports so far, but there are very long lags and it takes quite a lot of time to re-engineer a business in response to price changes, which is essentially what devaluation is. Of course there are downsides if you’re a consumer of imports in this country and we’ve seen that because inflation has obviously risen. However when I hear people talk about how inflation has picked up – my goodness it is still only three per cent and it was five per cent in 2011! Sometimes I wonder what’s wrong with these people. There are pluses and minuses but in the long term I’m fairly relaxed about devaluation.

It’s unlikely we’d be discussing the devalued currency if we’d adopted the euro. What did we gain from keeping the pound?

When you join the single currency you lose your monetary independence and you can see that with a country like Greece or Italy who can’t decide their own interest rates. Both countries have a 20 per cent competitiveness gap with the most competitive economy within the euro-zone. In other words, they need a 20 per cent devaluation of their currency to get their competitiveness up to German levels. So you are hamstrung in monetary policy which is vitally important to the management of the economy. In 2008 when the financial crisis started in earnest (and then of course we went into a deep recession in 2009) the Bank of England cut interest rates very aggressively in 2008 and 2009 and I think that saved the economy quite honestly. If we’d been in the euro we couldn’t have done that.

There’s another aspect to being in the euro.  Because of the Stability and Growth fund, member states are supposed to keep their public sector deficit within 3 per cent of GDP.  Our deficit to GDP ratio is still about 2.5 per cent. The European Commission could have come in and told us to cut back on spending in order to cut the deficit at a time when we were in recession.  That’s what they did with Greece.

If we’d joined the euro and still voted for Brexit we would not necessarily have had to leave the single currency but I still think it would be almost certain. It would be procedurally difficult to achieve but not impossible. Currency unions have broken up in the past but it would have been another headache.

The euro seems to have contributed to the dire economic situation in Greece. What will happen now?

I’ve long since giving up trying to predict what I think will happen to the euro. I thought Greece would leave the euro in 2012 when Greece was under such enormous pressure and Wolfgang Schäuble, the German minister of finance, hinted pretty strongly that Greece should leave the currency. However, the political feeling was that this project had to go on.  In all of our discussions about the European Union we must never forget how a lot of the main politicians in Europe, especially the Germans, are fanatically attached to the importance of the project. They decided that for political reasons Greece should stay in the euro.  In Greece GDP is basically not growing and they have 25 per cent unemployment. However, when you look at the Greek politicians its hard to say which one of the is going to actually bite the bullet by saying Greece should leave the euro; apparently none of them in any position of power.

For economic reasons I believe they should leave the euro and devalue their currency, but that’s economics as opposed to politics and in Greece politics wins the day. Similarly, Italian growth performance since joining the euro has been poor. They’ve got relatively high unemployment, and an enormous public sector debt but they live with it because they’ve decided, or at least the political class has, that for political reasons they need to stay in the single currency.

How will the EU cope without our money?

They’ll be short of about £8 billion so they’ll either have to cut their expenditure or somebody else will cough up. I would like to see agricultural cut back because I think some of that spending is absurd. But that’s easier said than done – you try telling that to French farmers! I don’t think it would be terribly popular. Germany could cough up some more. Also Ireland is becoming a net contributor, perhaps they will pay more?

What’s the worst thing we could do in the negotiations?

Ongoing payments beyond the transition period would be ludicrous and totally unacceptable. It could well be that we pay something like £10bn into the budget during the transition which would be a sensible agreement but after that we would be fully out. If we continue to contribute to certain programmes like security that would make a lot of sense, but apart from that we shouldn’t pay anything else.

The employment rate in Britain is at the highest rate since 1971, so why did a recent poll show almost half of Britons think the UK economy is in recession?

I like to give a balanced view of the economy, giving the pluses and minuses of things like devaluation. However, when you talk to some Remainers you’d think that just about everything was going wrong. They’re in denial about the economy but they’ve got to be a lot more responsible. They’re not helping confidence in this country and their negativity is not a good idea because what they’re saying may become a self-fulfilling prophesy. Look, we are going to leave the EU, lets get this firmly fixed in our minds. So move the dial instead of just being eminently and permanently negative, please just be realistic. I’m not triumphalist and I’m not unaware of the difficulties with leaving the EU, I’m aware of it for all the reasons we’ve discussed. But I haven’t changed my mind and we all have to get behind David Davis and what he’s trying to do to get this relationship right with the EU.

During the referendum campaign certain business groups and the City seemed pessimistic about Brexit. Could they be contributing to the negative economic view?

The CBI and a lot of business organisations clearly want a trade deal but I think they now accept the fact that we will eventually leave the Single Market and the Customs Union. They will try to push a trade agreement but I think the priority would be the continuation of tariff free trade on goods – of course, you only have tariffs on goods.

When it comes to The City, there’s something called a passport which means banks can trade throughout the European Union without having to register with separate regulatory authorities in order to trade throughout the EU. I have little doubt that they would like a continuation of something along the lines of regulatory equivalence – a sort of quasi-passport.  I’m sure that’s what the city would like to see. If we are being pragmatic I can’t see why the European Union wouldn’t negotiate that sort of agreement on equivalence because it’s in their interests just as much as ours.

In the European Union we cannot decide our own regulations, trade deals with third countries or control immigration. Once we are out we will be able to amend regulations as we see fit. Personally I’d like to see more trade with Commonwealth countries. On immigration we will be able to have a bespoke policy and just have the immigrants we think are suitable and appropriate for the social and economic needs of this country. Of course, once we are finally out we will be able to save about eight or nine billion pounds a year which is no bad thing. Whether that’s Thatcherite or not, it’s actually living in a country when we can make our own economic decisions.