The Government’s financial policy in Britain during most of the post-war period has been based on ‘demand management’: the attempt to maintain total spending on a smooth upward trend, thereby preserving a high and stable level of employment. This basis for policy, correctly called Keynesian, has recently been displaced by the adoption of targets for money and other financial variables on the basis of a doctrine, monetarism, of which the central contention is that employment cannot in the long run be influenced much by financial policy, and that attempts to change the level of employment from what is dictated by market forces will only cause inflation.
In this article I shall give my own account of what has been wrong with macro-economic policy since the war, and argue that the monetarist policies of the present government are likely to make matters even worse. I also want to explain why an alternative strategy, different from anything so far tried, has some chance of success, and why it is wrong to associate this alternative with any party political position or philosophy, with planning of an intrusive kind, or with anything that can properly be described as a ‘siege economy’.
The principal error of post-war economic policy was not demand management as such, but the confining of this to the management of domestic demand – the manipulation, through fiscal and monetary measures, of private and public spending within Britain. Thus, while full employment and a moderate growth in real income was by and large maintained until about 1973, an extremely destructive process of import penetration was allowed continuously to occur. There would have been everything to be said for import penetration had our exports risen fast as well. But they didn’t. About every seven years, imports of finished manufactures doubled in volume while exports only went up about 50 per cent. The process could be ignored for a surprisingly long time because we started the post-war period with such a large surplus in our trade in manufactures. The adverse trends proceeded without the absolute difference between exports and imports falling. Nevertheless, from very early on there were warnings about this insidious process, which was destroying our industry. Sir Roy Harrod, to his great honour, was writing about it already in the Fifties; Lord Kaldor took up the theme in the Sixties; and the Cambridge Economic Policy Group has followed on, with increasing desperation, throughout the Seventies.
For growth to be sustainable, it is essential that the management of domestic demand be complemented by the management of foreign trade (by whatever policies) in such a way that the net balance of exports less imports contributes in parallel to the expansion of demand for home production. This proposition is a general one which applies to other countries as well as Britain. It has indeed been those countries (notably Germany) whose net export demand has risen fast which have achieved both fast rates of growth and low rates of inflation. The USA has failed in the same ways as Britain, with a declining share of world export markets, a rapid increase in import penetration, a growth rate of output and productivity nearly as poor as our own, and an inflation rate now well up in the league table.
Unfortunately, the defect of demand management in Britain was not merely that long-term trends in foreign trade were ignored, but that the policy was incompetently executed even in its own terms. It was not, as has so often been maintained, that governments placed excessive reliance on inaccurate short-term forecasts: in my opinion, the Treasury economists bear only a small responsibility for ‘stop go’. What actually happened was something far cruder. Governments waited for unemployment to rise to levels they regarded as politically intolerable, engaged in panic-stricken fiscal and monetary expansion, then waited until loss of foreign reserves became politically intolerable and duly undertook panic-stricken fiscal and monetary contraction. The usual objection to ‘stop go’ was that it caused needless instability in output and employment, but I believe the consequences were even more destructive, because of the exclusive role assigned to domestic demand. It was not so much that each expansion was too rapid as that it was a gallop down a cul-de-sac. People were misled by the fact that in the boom periods money and jobs were easier to find by selling foreign goods than by manufacturing them for ourselves.
The present government’s policies, seen in this perspective, constitute a major step in the wrong direction. The strong exchange rate for sterling which is the direct consequence of their monetary policy is reducing net export demand and therefore actually accelerating the adverse trends in our foreign trade. As the Government seems intent on yet more disinflation of domestic demand, all the engines of expansion have now been put into reverse.
I have never understood, nor seen any coherent attempt to explain, how the nation’s vital energies are supposed to be released by this programme, nor can I even see why it should reduce inflation. Indeed, despite the disinflation of aggregate demand, inflation of costs and prices appears actually to be getting worse. Many of those who, to begin with, supported the Government in public discussion are now running for cover: but their consensus appears at the moment to be that monetarism has not failed – because it has not yet really been tried. By this they presumably mean that the money supply and/or the PSBR should be reduced even more, with an even firmer commitment to restrictive long-term targets.
I don’t think the present experiment will survive much beyond 1980. When it collapses, it is crucial that, by contrast with what happened in all previous reversals of policy, measures should be taken to break the adverse trends in net export demand. It should be easier to get this point over now than in the past: since the positive balance of trade in manufactures has just about disappeared, the relative magnitudes of export growth and import penetration have reached a critical point. Imports of manufactures are now already so high that they cannot double again in the next seven years. Even with North Sea oil we should not be able to pay for them. In the absence of new policies, therefore, imports now have to be controlled by the crude method of seeing that people do not have the income to buy them: i.e. by causing domestic output to fall and unemployment to rise.
I think that the widespread allergy to the idea of imposing a control on import penetration comes from the belief that this would necessarily mean import quotas selectively and bureaucratically applied, so as to protect relatively inefficient firms and industries at the expense of the consumer’s freedom. If this were the proposal, people would be absolutely right to oppose it. Apart from the fact that such a policy might be damaging to other countries, it would do nothing at all to alleviate the general condition of stagnation or to improve the average level of productivity. Protectionism so conceived would indeed interfere with liberty and enlarge the power and functions of the bureaucracy. The standard objections to it are, in fact, wholly valid.
My alternative macro-economic strategy is altogether different. First, imports should be non-selectively controlled by a high, uniform tariff or by auctioning import licences, thereby ensuring that the pattern of imports would continue to be determined by market forces. Second, I insist that control of overall import penetration, in sharp contrast with selective protectionism, must be an integral part of an expansionary fiscal and monetary programme. Once having removed the balance-of-payments constraint on growth, the Government is free to expand domestic demand within the only constraint that ought to be operative: our own capacity to produce. All and more of the yield of a tariff (or the proceeds of auctions of import licences) should be given back to consumers in the form of tax reductions so as to raise domestic spending. The level of imports would be as high as under present policies. Domestic production and income would be much higher.
In relation to this strategy, all the old arguments against protectionism are irrelevant. Total national income, output and employment, as well as average productivity, would be raised; prices, at least initially, would be reduced by the tax reduction below what they otherwise would have been; the pattern of expenditure and output would be determined by market, not bureaucratic forces; no individually inefficient firm or industry would be saved from the rigours of competition; other countries on balance would not be harmed, since the total level of UK imports would be no lower as a result of the new policy.
The following questions always arise at this point. Could such policies constitute a sufficient programme for recovery? Would not the long-run effect on inflation be adverse? What about our international obligations, and the possibility that control of imports will result in retaliation?
It would be ridiculous to suggest that this alternative strategy is a panacea which would make all other kinds of policy unnecessary. What I claim is that an expansion of total demand to which the domestic and net export components both contribute in a balanced way is a necessary condition for regeneration. Such expansion would have a fundamentally different character from the outbursts of ‘growthmanship’ which occurred in 1954, 1959, 1963 and, most notoriously, 1973, since it would not bear the seeds of its own destruction. Resources would be assigned, not to the distribution and use of imported goods on an excessive scale, but to a sustainable pattern of steady expansion. Probably such a system would not alone be sufficient to make our economy as strong as it should be. For instance, regional policies would be necessary to ensure that regeneration extended to those parts of the UK which have so far suffered the most severe decline. I do not even rule out that some forms of selective assistance, even protection, to individual industries might be appropriate. But my firm belief is that changed attitudes – a willingness of firms to invest and of labour to adapt rapidly to new technologies – are far more likely to occur under conditions of general expansion than of depression and decay. And the same goes for inflation. The monetarists would have it that the general price of labour is determined in the same way as the price of tomatoes, and that wage inflation must diminish (or must be made to diminish) in response to the threat of unemployment. I take the opposite view: that the determination of wages, unlike the price of tomatoes, is largely the outcome of a non-market process, and that inflation of money wages will be reduced by policies which cause real wages to rise.
If opposition to general import controls eventually hinges on arguments about treaties and foreign retaliation, I know that I will have made out the case. To put up our membership of international organisations as the crucial obstacle to an alternative strategy is to concede that the stragegy is in principle to our advantage, and that we ought to adopt it if we are allowed to.
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