ChainWhat it assumes · how to break it
Start
The pound appreciates strongly and stays high, as it did in 1979 to 1981, helped by North Sea oil and high interest rates.
1
As a result, UK manufacturers lose price competitiveness at home and abroad, and their profit margins are squeezed.
international competitiveness · profit margins
international competitiveness · profit margins
Assumes: Manufacturers compete mainly on price.
But: Firms making specialised, high-quality goods can keep customers despite higher prices.
2
This means less profitable manufacturers cut investment, and some close plants or move production abroad.
investment · deindustrialisation
investment · deindustrialisation
Best link to attack
Assumes: Firms cannot cut costs or raise productivity enough to stay competitive.
Assumes: Firms cannot cut costs or raise productivity enough to stay competitive.
But: Pressure from a strong currency can push firms to raise productivity and move into higher-value products, as many German manufacturers did under a strong Deutschmark.
3
Consequently, labour and capital move from manufacturing into non-tradeable services and sectors that gain from cheaper imports, such as retail.
resource allocation · occupational mobility
resource allocation · occupational mobility
Assumes: Workers and capital can move between sectors.
But: Skilled manufacturing workers may lack the skills services need, so many become unemployed rather than move.
4
Therefore, manufacturing's share of GDP falls, and the loss may be permanent because closed plants and lost skills do not return when the pound falls back.
hysteresis · structural change
hysteresis · structural change
Assumes: Lost capacity is hard to rebuild.
But: New investment can return if a lower exchange rate is expected to last.
End
The structure of the economy shifts away from manufacturing towards services.
Evaluation chain
- E1However, the decline of manufacturing depends on firms being unable to respond to the strong pound by raising productivity.
- E2If firms cut costs, invest in new technology and move into specialised, high-value products,
- E3then they compete on quality rather than price, and the strong pound also cuts the cost of imported machinery and components.
- E4So manufacturing's share of GDP may fall less than expected, and the effect depends on whether firms can shift to non-price competition.
Another way to attack it: Deindustrialisation in the UK also reflects rising incomes, which shift demand towards services, and competition from low-cost producers. A strong pound speeds up a change that was happening anyway.
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Questions this answers
- Assess the impact of a sustained appreciation of the pound on UK manufacturing.
- Discuss the causes of deindustrialisation in the UK.
- Explain how the exchange rate affects international competitiveness.
Diagram
No standard diagram. Use data on manufacturing as a share of GDP and employment, and on relative unit labour costs.
Reverse and related
Depreciation → tradeable sectors more profitable → investment in manufacturing → possible rebalancing.