An integral part of this blog has been to bridge the gap between the Economic theories that we learn in the classroom, and how these models can be reflected in real life examples. It can be restrictive to solely apply Economic theories to contemporary examples- meaning it would be useless to evaluate the effectiveness of Monetary policies in 2018 when the dominant school of Economic thought has evolved from Monetary to Neo-Liberal to Globalist in the last 30 years. Therefore, often Economists must look to the past to learn from the benefits and drawbacks of certain policies- and learn the lessons of history.
The 1970s saw Britain fall from its position as Europe’s dominant economy. Uncontrollable inflation, recession, wage caps and union activity crippled Britain’s economy. The 1970s brought Britain back from the euphoria of prosperity of the 1960s, to reality. Britain’s industry was growing at a slower rate than its main European rivals, as well as experiencing much more volatile shifts in purchasing power of their currency. The austerity measures implemented in reaction to inflation caused industrial discontent, and furthermore trade-union action brought about mass energy shortages, culminating in the notorious “three day week.” Britain had wasted their potential to establish themselves as a global superpower alongside the Soviet Union and the US, due to a failure to foster sustainable economic growth, and a failure to increase productivity. As such, British industry became a pariah in the community of developed economies, and a symbol of poor levels of productivity. In 1975, for each car that an American worker produced, their British counterpart would produce one third of a car.
Arguably, this degradation in British economic strength stemmed from the structural inadequacies of the British economy. A culture of myopic policy making, falling export competitiveness, an ineffective devaluation of the pound, and a misbalance between supply and demand side policies in the 1960s culminated to create a climate where economic growth was impossible in the 1970s.
The increase in living standards of the 1960s masked the gradual degradation of the British economy, as it became less internationally competitive. The post war global industrial environment had left many economies unable to expand their productive potential. The capital of European countries had been focused towards military armament, and many of these strategic factories had been destroyed in military invasions. An example of this infrastructural devastation was seen in the post war situation of Germany. The near annihilation of the industrial city of Dresden, food production at 50% of its 1939 level, and an industrial output decrease of 30% meant that the German economy effectively had to start from scratch. However, the “altruism” of American foreign policy was based on George Kennan’s Long Telegram of 1946, which stated that communism “feeds on diseased tissue.” In other words, the less economically developed a country is, the more vulnerable it will become to a communist invasion. This ideology prompted the European Recovery Program, (aka Marshall Plan) which was implemented in 1948, subsequently providing $17 billion in aid to 16 different countries by 1953.
This aid allowed for the emergence of new economies. Improved international co-operation and US loans meant that war-torn economies were able to modernise and specialise, using the shared technological enterprise of already developed nations. The once bleak prospect of rebuilding an entire economy became the exciting potential to rebrand the economy. Primarily, this opportunity was seized by Japan and Germany, who were transformed from war torn economies with limited post-war labour, to respectively the 2nd and 3rd largest economies by 1989. In Germany, this evolution became known as “Wirtscaftswunde ” (economic miracle). The influence of Walter Eucken meant that the newly formed West Germany combined low corporate taxes and interest rates to spur investment. In the six months after the reintroduction the Deutsche Mark in June 1948, productivity had increased from 50% of its 1936 level, to 80% of this level. West Germany’s economic growth continued to increase, until in 1958, domestic production was four times greater than the level ten years previously.
Germany acted as an example of how a post-war economy could transform into a productively efficient country, who were able to grow sustainably. UK’s growth during the 1950s and 1960s did not follow this same formula of correct balance between demand and supply side policies.
During this period, the UK were still experiencing economic growth, but less so than other European markets. Growth was exemplified by an increase in manufacturing output of an average of 3.1% per year. In historical terms, this figure may have been considered high, but it trailed behind many other advanced European countries such as Germany and France. It quickly became clear that other European markets were overtaking Britain in terms of rate of production increase. “Figure 1” shows the comparative growth of the three leading Western European economies in the third quarter of the 20th century.
To highlight the economic failure of Britain in terms of export competitiveness, it is necessary to analyse the economic development in terms of manufacturing of the UK, compared to the equivalent in West Germany from 1950-1970. During this period, as West German production increased exponentially, foreign investors quickly saw the potential for growth in this newly formed country. As such, foreign investment flooded inwards. This injection was compounded by low levels of corporate tax and subsidies in the form of tax breaks for emerging markets (such as nuclear energy). These measures allowed for short term growth, however, the inward foreign investment into the West German manufacturing industry also allowed for the expansion of productive potential. This was achieved by the successful implementation of supply side policies, such as the lowering of corporate taxes.
As West German productivity and efficiency increased, the cost of production fell for exportable goods. This led to a drastic increase in demand for German exports. German exports grew from 10% to 19% of GDP from 1950-1960. As such, even when German demand slackened domestically, a high capacity utilisation of German manufacturing industry was maintained because of export led growth.
On the other hand, in Britain, the macroeconomic objective of a favourable balance of payments was quickly becoming a difficult feat to achieve (Figure 2). Indeed, a higher percentage of wages were dedicated towards importing cheap goods from economies such as Germany. As propensity to import goods increased, firms and households alike quickly realised the ease of importing cheaper components and goods from abroad, to save in production costs. As such, UK’s imports rose from 21% to 30.9% of GDP from 1960-1972, whilst exports fell from 20.2% to just 17.3% of GDP from 1960-1967. The imbalance between Supply and Demand side policies meant that consumer demand quickly exceeded British domestic production potential. An example of this imbalance can be seen by the British stubbornness to innovate public transport routes, as Britain still relied on inefficient steam trains well into the 1960s, whereas Germany and France had evolved into cheaper electricity and diesel alternatives by this point.
A reason for the stagnation of inward investment into the UK was that foreign investors were put off by the volatility of the pound during the 60s and early 70s. Howard Wilson controversially devalued the pound in 1967 from $2.80 to $2.40 (14%), in an attempt to rebalance the trade deficit and boost export led growth in domestic industries. In reality, this devaluation led to a fall in investor confidence, as foreign firms did not want to convert their capital into the devaluing Sterling, if they did not think that the government would prioritise maintaining the value of that original investment.
The crippling of British long term growth was accurately reflected in the myopic nature of British Policy makers, who prioritised the “Shovel in Ground” immediate impact strategies, over long term supply side investment. This meant that because politicians were unlikely to be re-elected if they did not cause immediate, visible change to their communities within four years, often officials were more concerned with short term growth over long term sustainability measures. Indeed, Peter Clarke argued that the British obsession of ‘Butskellism’ Keynesian style of fiscal expansion to stimulate economic growth during the 1950s and 1960s was “short sighted.” In other words, up until the 1970s the consensus was that the economy could not defer from the Philips curve, such that a high unemployment rate could not exist simultaneously with high inflation rates. However, by 1969, both unemployment and inflation were rising together. Fiscal stimulus to encourage economic growth and reduce unemployment became redundant, as it fed the growing rates of inflation, whilst doing little to reduce unemployment. Thus, this policy myopia meant government failure arose, which exacerbated the inflation crisis.
Therefore, it can be argued that a fundamental source of the economic difficulties that the UK faced during the 1970s was a result of the previous governmental administration failure to implement effective supply side policies. This meant that whilst newly branded economies such as France and Germany were driving their export led industry, Britain were slow to innovate their manufacturing industries. Germany quickly overtook UK in terms of productivity, as they were able to use foreign investment to enhance their capital, allowing them to expand their productive potential. Historian Michael Kitson summarised that “Despite growing at a faster rate than in earlier periods, it has been argued that the golden age was tarnished as Britain failed to achieve its potential.” The long term disadvantage of this “tarnishing”, was that it meant that UK began to lag behind other European economies. The movement into a trade deficit represented a structural inefficiency, which hampered British manufacturing export led growth throughout the 1970s.
My next post on “An Investigation into British Economic Difficulties Experienced in the 1970s” will focus on the so-called “Barber Boom”, and how Edward-Heath’s fiscal expansion of the 1972 Budget led to an exacerbation in inflationary pressures and subsequent stagflation.