This paper seeks to explain the apparent contradiction in the UK's manufacturing trade performance over the past two decades: on the one hand, the early 1980s witnessed a substantial contraction in manufacturing employment along with a considerable surge in imports and decline in UK exports; on the other hand, UK trade performance, particularly exports, seems to have improved in the second half of the 1980s and early 1990s. The paper shows that the substantial, but temporary, appreciation of sterling in the early 1980s caused permanent damage to both the UK's trade performance and industrial base; and that the UK's relative investment performance, via its hypothesised impact on product quality, helps to explain the subsequent improvement in UK trade performance since the mid-1980s.
I INTRODUCTIONThis paper seeks to explain the apparent contradiction in the UK's manufacturing trade performance over the past two decades: on the one hand, the early 1980s witnessed a substantial contraction in manufacturing employment along with a considerable surge in imports and decline in UK exports; on the other hand, UK trade performance, particularly exports, seems to have improved in the second half of the 1980s and early 1990s. The paper investigates whether the substantial, but temporary, appreciation of sterling in the early 1980s had a permanent impact on the UK's trade performance; and whether changes in the relative quality of UK products helps to explain the subsequent improvement in UK trade performance since the mid-1980s. This paper therefore has two major objectives. The first objective is to use the framework of endogenous growth theory to evaluate the relationship between innovation, product variety, product quality and UK trade performance. The paper experiments with several different proxy variables for product quality: patents, R&D expenditure and investment. 1 The second objective is to investigate whether UK trade relationships exhibit hysteresis and to ascertain 570 1 Although our measures of R&D, etc, may capture innovation, product quality or variety, we will later use the term`product quality' to refer to all of these possible effects. the extent to which trade in particular commodities is subject to hysteresis. 2 Within the framework of hysteresis, it is theoretically possible for trade volumes to respond quite differently to large fluctuations in exchange rates in comparison to small fluctuations. However, Orcutt (1950) develops an alternative theory based on switching costs which predicts a similar outcome. Any such effect may be particularly relevant to UK trade volumes given the large temporary appreciation of sterling in the late 1970s and early 1980s. We attempt to capture any UK hysteresis effects by: (a) testing whether the competitiveness elasticities of trade volumes vary in response to the magnitude of any change in the exchange rate, and (b) testing whether the profit margins embodied in UK import prices reacted symmetrically to the large temporary sterling appreciation in the early 1980s.We ...