Project Syndicate's Skidelsky/Pilkington: Too Poor for War

08 November 2022

Decades of deindustrialization have hollowed out the UK economy and made it woefully ill-prepared for wartime disruptions. As the financial speculators who funded its current-account deficits turn against the pound, policymakers should consider Keynesian taxes and increasing public investment.

A wartime economy is inherently a shortage economy: because the government needs to direct resources toward manufacturing guns, less butter is produced. Because butter must be rationed to make more guns, a war economy may lead to an inflationary surge that requires policymakers to cut civilian consumption to reduce excess demand.

In his 1940 pamphlet “How to Pay for the War,” John Maynard Keynes famously called for fiscal rebalancing, rather than budgetary expansion, to accommodate the growing needs of the United Kingdom’s World War II mobilization effort. To reduce consumption without driving up inflation, Keynes contended, the government had to raise taxes on incomes, profits, and wages. “The importance of a war budget is social,” he asserted. Its purpose is not only to “prevent the social evils of inflation,” but to do so “in a way which satisfies the popular sense of social justice whilst maintaining adequate incentives to work and economy.”Joseph E. Stiglitz recently applied this approach to the Ukraine crisis. To ensure the fair distribution of sacrifice, he argues, governments must impose a windfall-profit tax on domestic energy suppliers (“war profiteers”). Stiglitz proposes a “non-linear” energy-pricing system whereby households and companies could buy 90% of the previous year’s supply at last year’s price.

In addition, he advocates import-substituting policies such as increasing domestic food production and greater use of renewables. Stiglitz’s proposals may work for the United States, which is far less vulnerable to external disruption than European countries. With a quarter of the global GDP, 14% of world trade, and 60% of the world’s currency reserves, the US can afford belligerence. But the European Union cannot, and the UK even less so. While the UK has been almost as aggressive as the US in its response to Russia’s actions, Britain is far less prepared to manage a war economy than it was in 1940: it makes fewer things, grows less food, and is more dependent on imports.

The UK is more vulnerable to external shocks than any major Western power, owing to decades of deindustrialization that have shrunk its manufacturing sector from 23% of gross value added in 1980 to roughly 10% today. While the UK produced 78% of the food it consumed in 1984, this figure had fallen to 64% by 2019. The British economy’s growing reliance on imported energy has made it even less self-sufficient. For decades, the financial sector propped up the UK’s hollowed-out economy.

Financial flows into the City of London allowed the country to neglect trade and artificially maintain higher living standards than its export capacity warranted. Britain’s current-account deficit is now 7% of GDP, compared to a current-account surplus of 1.3% of GDP in 1980. Until recently, the British formula had been to finance its external deficit by attracting speculative capital into London via the financial industry, which had been deregulated by the “big bang” of 1986.

This was brilliant but unstable financial engineering: foreigners sent the UK goods that it otherwise could not afford, Britain sent them sterling in return, and foreigners used the pound to buy British-domiciled assets. But this was a short-term fix for the long-term decline of manufacturing, enabling the UK to live beyond its means without improving its productivity...

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