INTRODUCTION

In the years since the Second World War the role of money, and the use of monetary policy, has been peculiarly subject to the whims of intellectual fashion in economic thought, in Britain as elsewhere. At the outset the most commonly held view among British economists was that ‘money does not matter (much)’ for maintaining high employment, fostering economic growth or controlling inflation. By the 1970s, however, monetary policy had become a major issue in public policy debate; under Mrs Thatcher in the 1980s it became front page news. The ‘monetarist’ view that money matters a lot especially so far as inflation is concerned had come to dominate among economists and policy makers. The objectives of monetary policy have also changed, from facilitating government borrowing at low interest rates to supporting a fixed exchange rate and then to combating inflation with a floating exchange rate, to exchange-rate stability and back to price stability.

The monetary history to be described here runs from the nationalization of the Bank of England by the first majority Labour government in 1945–6 to the restoration, by another Labour government, of operational independence to the Bank in 1997–8. For the purposes of this chapter it is divided into four periods: (i) the immediate post-war policies of the 1945–51 Labour governments under Prime Minister Clement Attlee, when the Keynesian’ downgrading of monetary policy was still in the ascendant; (ii) the 1950s Conservative governments’ revival’ of monetary policy which, in spite of confused aims and uncertain methods, effectively reassigned it to the preservation of external balance with a fixed exchange rate; (iii) the 1970s and early 1980s, which saw new attempts at monetary control in competition and credit control’, the adoption of monetary targets (that is, announced targets for the rate of growth of the money supply somehow defined) and the medium-term financial strategy of Mrs Thatcher’s first government; and (iv) another reorientation of monetary policy after the abandonment of monetary targets, first towards exchange-rate stability and then back to price stability by means of inflation targeting.

INTRODUCTION

By historical standards, British manufacturing enjoyed a very high rate of productivity growth during the period 1951–73. Nevertheless, this was still a relatively low rate of growth compared to most West European countries, so that Britain was slow in catching-up with the United States, the world productivity leader in manufacturing (and the economy as a whole). Since 1979, much of the manufacturing productivity gap that opened up with other West European countries after the Second World War has been eliminated, but this has occurred through a decline in employment rather than an acceleration in output growth.

The slow growth before 1979 can be explained by difficulties associated with the shift of markets away from the Empire towards Europe and by industrial relations problems associated with attempts to apply US style mass production technology (Broadberry 1997c). Attempts to avoid deindustrialisation during this period led to the adoption of highly interventionist industrial policies, which contained deindustrialisation but did not really solve the underlying problems. After 1979, government support for ailing industries was drastically reduced and legislative reform transformed industrial relations. At the same time, there was a move away from US-style mass production technology and a revival of flexible production, a traditional British strength. Also, the adjustment to European markets was by this stage largely complete.

In considering the performance of British manufacturing since the Second World War, it is important to avoid the excessive pessimism of the ‘declinists’, who undoubtedly dominated the literature of the 1980s (Wiener 1981; Kirby 1981; Dintenfass 1982; Pollard 1984; Elbaum and Lazonick 1986; Barnett 1986; Alford 1988).

Overview and Introduction

Thus concluded an inquiry into Britain’s industrial performance and her future industrial prospects in 1928: it aptly captures the picture of industry in the interwar years as having both positive and negative aspects, sound characteristics but equally constraints on its ability to realise its full potential. As indicated in chapters 1 and 4 above, industry before the war was not without its problems: shares of world trade slipped as other nations industrialised; new industries born of the new technology of electricity, motor power and chemicals were relatively slow to develop; Britain’s productivity performance seemed less impressive than that of its main rivals. However, these concerns were small compared to the chorus of predictions of gloom which characterised the interwar years: a collapse in international trade, and with it our export markets, signalled a picture of doom to contemporary commentators.

There was, however, another side to industrial performance in these years: a story of successful industries, firms adapting to change, technological innovation and entrepreneurial energy. How do we explain this? Which industries and firms prospered, and which did not? Why were some industries able to adapt to change, but others not? What were the implications for the long-run performance of the economy? Insights from industrial economics help us to identify constraints on change and provide the theoretical framework for this chapter.

INTRODUCTION

The period between the mid-nineteenth century and the eve of the Second World War is often represented as one of transition for the British state: from small, laissez-faire government to embryonic modern government, that of the managed-mixed economy and welfare state which has endured – albeit much changed – to the present day. This transition necessarily entailed a transformation in terms of government’s scale, scope and impact upon the economy, which, in turn, was underpinned by a transformation in the accepted role of government in the economy. The proper role of government is a perennial of political and economic discourse, but from the classical economists onwards it has been understood in terms of the cardinal choice that all societies must make: that concerning ‘the degree to which markets or governments – each with their respective flaws – should determine the allocation, use and distribution of resources in the economy’ (Wolf 1993: 7). For the classical economists, as for mainstream economists today, this cardinal choice between government or market starts from the presumption that markets are instrumentally superior and then proceeds by way of politics and history to investigate how and why in practice there occurred shifting conceptions of markets’ and governments’ capabilities which justified disturbing the status quo and which resulted in this long-term trend towards big government.

In a telling phrase, Okun (1975: 119) noted that ‘the market needs a place, and the market needs to be kept in its place’. The primary purpose of this chapter is to establish how and why those boundaries were set, at what level of government and with what consequences for efficiency and equity, the twin benchmarks by which government’s economic role is routinely assessed.

INTRODUCTION

The 1920s and 1930s were years of transition, most obviously between the First and Second World Wars. But they were also years of transition between the long nineteenth century, when Britain was the world’s leading creditor nation, its leading trading nation and the producer of a third of the world’s manufactured exports, and the years after 1945, when the country was overtaken in terms of per capita incomes, productivity and growth rates by many of its European competitors. The story of the interwar period is thus the story of how this transformation came about. It is the story of Britain’s loss of economic pre-eminence.

The interwar years were troubled not just for Britain, of course, but for the entire world. Growth slowed in virtually every industrial country. Growth was also slower everywhere than the post-Second World War norm. The 1920s were dominated by political disputes and inflations that disrupted economic growth throughout Europe, the 1930s by a business cycle downturn of exceptional depth and duration, a downturn that came to be known as the slump in Britain and the great depression in the United States. All market economies were affected. Thus, any critique of Britain’s economic performance in this period is more compelling if it can be shown that the country performed poorly not just in an absolute sense or in comparison with the golden age of growth after the Second World War, but also relative to other advanced industrial economies.

INTRODUCTION

In many times and places, household and economy were overlapping institutions. Indeed, the word economics comes from the Greek oeconomica, meaning the science or art of managing a household. The traditional household brimmed with economic activities. Based on kin but extended to include living-in servants, apprentices and lodgers, it was the scene of production as well as consumption and reproduction. Allocation of labour and resources was not egalitarian, but all members participated. In contrast its modern counterpart has suffered a dramatic ‘loss of function’. Needs that were formerly met by family members working within the home are now met by outside agencies, and individuals interact with the wider economy and society not through their households but independently. The household has wasted economically, shrunk in apparent size and become dependent on the earnings of its male head, or very recently its two adult earners (Parsons 1959).

The contrast between pre-industrial and modern families implicates economic change in the household’s loss of function. Urban industrial life not only involved significant changes in how goods and services were produced but also reallocated the transformed activities between the household and the market economy. This chapter is about these processes as they occurred for the first time in the context of another pioneer experience, industrialisation in Britain in the eighteenth and nineteenth centuries: ‘ours was the society which first ventured into the industrial era, and English men and women were the first who had to try to find a home for themselves in a world where the working family, the producing household, seemed to have no place’ (Laslett 1965: 18).

INTRODUCTION

British agriculture developed in a distinctive manner that made important contributions to economic growth. By the early nineteenth century, agricultural labour productivity was one third higher in England than in France, and each British farm worker produced over twice as much as his Russian counterpart (Bairoch 1965; O’Brien and Keyder 1978; Wrigley 1985; Allen 1988, 2000). Although the yield per acre of grains was no higher in Britain than in other parts of north-western Europe, the region as a whole reaped yields twice those in most other parts of the world (Allen and O’Gráda 1988; Allen 1992.)

Most accounts of British farming link the high level of efficiency to Britain’s peculiar agrarian institutions. In many parts of the continent, farms were small, operated by families without hired labour and often owned by their cultivators. Farms often consisted of strips scattered in open fields, and animals were often grazed on commons. Peasant farming of this sort was consolidated by the French Revolution. In contrast, in Britain, the open fields were enclosed, farm size increased and tenancy became general. While this transformation had been underway since the middle ages, it reached its culmination during the industrial revolution. Furthermore, it is often claimed that the agrarian transformation made important contributions to industrialisation by increasing output and supplying the industrial economy with labour and capital.

THE UNEMPLOYMENT PROBLEM

Unemployment is an enduring feature of industrial market economies – indeed it is often seen as one of the most unfortunate side effects of the capitalist system. Between 1870 and 1939 the understanding of unemployment, attitudes and policies towards it, and the scale and structure of unemployment itself, underwent considerable change. Before the 1890s the problem was perceived as one of personal deficiencies and lack of industrial quality among the workers concerned; by the turn of the century it was understood as reflecting lack of organisation in the labour market; and by the 1930s it was seen by many as a problem of the malfunctioning of the entire economic system.

In mid-Victorian times, middle-class observers saw unemployment as the result chiefly of indigence or incapacity and largely a feature of the lowest stratum of society. For steady and respectable workmen thrown out of work by cyclical downturns, unemployment was temporary and its effects were ameliorated by self-help or mutual aid. But fact and circumstance conspired to alter these perceptions as awareness of, and concern about, unemployment increased. One ingredient was the findings of social investigators such as Charles Booth whose social survey of London revealed poverty and deprivation even among the families of relatively respectable workers. Another was the series of official inquiries ranging from the Royal Commission on Labour (1892–4) to the Royal Commission on the Poor Laws and Relief of Distress (1905–9), which took evidence on unemployment and the workings of the labour market. Such discussions were accompanied and informed by a widening range of labour market statistics collected by the Labour Department of the Board of Trade, which was formed in 1892.

INTRODUCTION

The nineteenth century saw a few utopian socialist experiments, and Victorians uncontroversially resorted to municipal ownership in a wide range of public utilities. In the twentieth century, a remarkable series of political experiments with nationalisation has given applied economists and historians an even richer variety of material for investigation and encouraged systematic empirical investigation of the record of different systems of ownership. In the communist bloc, whole economies were transformed from semi-feudal or capitalist market economies to socialist planned economies, of many varieties. They shared the common characteristic that the material means of production were largely owned by the state and many basic allocative decisions – on consumer choice as well as allocations of investment – were made centrally. By the end of the 1980s the economic inefficiency and political bankruptcy of such socio-political systems precipitated their widespread collapse and/or extensive marketisation.

Yet experience of state ownership has not been confined to the totalitarian socialist countries. Among the liberal democracies, there was a wide range of state ownership, though their powers were usually somewhat less than in Soviet central planning. There are considerable problems in measuring the size of the state-owned industry sector in different economies, not least because of the variations in national statistical definitions of these industries (Pathirane and Blades 1982). Nonetheless, it is clear that Britain did not have an unusually high degree of public ownership, by European standards, even at the peak of public ownership before the 1980s privatisation programme began.

AN IMPERFECT FINANCIAL MARKET?

At the opening of the twentieth century (Joseph 1911), it was implied that the financial sector had the face of Janus, a characterisation many historians have subsequently adopted and further developed. While the markets facilitated a mounting volume of foreign borrowing from the mid-1850s, domestic clients were, it has repeatedly been maintained, increasingly ill served, to the detriment of investment at home (see also chapter 8 above).

The charge laid against financial institutions largely relates to industrial finance (Saville 1961), and to the argument that an imperfect capital market primarily directed savings into overseas securities. These yielded less than 5 per cent immediately prior to the First World War, while total capital invested at home returned more than 10 per cent. This comparison, however, greatly overstates the apparent illogical bias in the financial sector’s workings, since much overseas investment comprised publicly marketed and fixed-interest bonds whereas a significant proportion of domestic returns was generated by privately held unsecuritised equity (McCloskey 1970: 451–5). When analogous domestic and overseas financial assets are compared, foreign securities either carried only somewhat higher coupons or distributed slightly greater dividends, reflecting the rather bigger risks that their ownership entailed (Cairncross 1953: 227–31); these risk and return relationships were confirmed by Edelstein (1976). He also found that, although returns on both home and overseas publicly issued securities fell secularly as their respective marketed volumes increased, during periods of domestic boom such as the mid-1890s, the small differential favouring foreign stocks diminished. However, when overseas investment began to mount again – as from 1897 – the ‘risk premium’ on comparable foreign securities once more increased.

THE SETTING

Although large for an island, Britain does not rank among the bigger countries of western Europe. The land surface of the island is 230,000 square kilometres: that of France, the largest west European country, is 552,000 square kilometres; Spain is almost as large as France (505,000 square kilometres), while Germany (357,000 square kilometres) and Italy (301,000 square kilometres) are also substantially larger than Britain. If, for purposes of comparison, western Europe is taken to consist of the area now comprising the Scandinavian countries, Poland, Slovakia, Hungary, the Czech Republic, Austria, Switzerland, Italy, Germany, the Netherlands, Belgium, France, Britain, Ireland and the Iberian peninsula, then Britain occupies only 5.7 per cent of the land surface of western Europe. In the early modern period the British population did not greatly exceed the total to be expected from its proportionate share of the land surface of western Europe. For example, in 1680 the population of Britain was about 6.5million, or 7.6 per cent of the west European total of about 86 million. Yet in 1840 the British share had risen to 10.5 per cent (18.5 million out of a total of 177 million). By 1860 the comparable totals were 23.1 and 197 million and the British percentage had reached 11.7, an increase of almost 60 per cent compared with the situation 180 years earlier. Since 1860 there has been a further rise in the British share of the west European total, but it has been much slower and more modest. In 1990 the population of Britain was 56 million, 13.1 per cent of the west European total of 429 million.

INTRODUCTION

How do we account for the Industrial Revolution? In recent years, economic historians have had to redefine what they mean by the industrial revolution and to reassess its significance. On the one hand, the findings published in the 1990s by Crafts, Harley (Crafts and Harley 1992; Harley 1998) and others have reduced estimates of the rate of economic growth during the classic years of the industrial revolution, 1760 to 1830. These findings have been reinforced by recent work by scholars such as Antràs and Voth (2003) and Clark (2001b), who have shown that the sharp revisions downward to Deane and Cole’s (1967) estimates of the rates of growth and productivity change during the industrial revolution made by Crafts and Harley were, if anything, too optimistic and that little if any real per capita growth can be discerned in Britain before 1830. These conclusions are consistent with Feinstein’s (1998) recalculations of the growth in real wages, which showed very little secular increase before the mid-1840s. As a macroeconomic phenomenon, then, the Industrial Revolution in its ‘classical years’, 1760–1830, stands today diminished and weakened. It is now also widely realised that the Industrial Revolution was not ‘industrialisation’. On the eve of the Industrial Revolution Britain was a highly developed, commercialised, sophisticated economy in which a large proportion of the labour force was engaged in non-agricultural activities, and in which the quality of life as measured by the consumption of non-essentials and life expectancy was as high as could be expected anywhere on this planet.

INTRODUCTION

In the analysis of the structure of modern economies, it is common to identify three sectors: agriculture, industry and services. The dividing line between services and industry is a rather grey area but services are usually taken to include, at a minimum, transport, communications, retail and wholesale trade, recreational activities, banking and professional services, as well as many activities directly financed by government like education, health and social services. For long seen as peripheral to economic development, services came by a quiet revolution to dominate the economies of the Western world by the end of the twentieth century. Services increased in the nineteenth and early twentieth centuries, but for many historians this was a feature of industrialisation, not the driving force. Technological developments in industry and the railways, along with increasing occupational and spatial specialisation, promoted the growth of separate sectors like wholesaling, insurance and telecommunications and increased the importance of education and training for the supply of technicians and scientific manpower. The rise in per capita incomes generated a demand for better health and for wider access to recreation and the performing arts. However, it was the second half of the twentieth century which saw a truly remarkable rise in services. Specialist firms supplying professional services like accounting and computer support mushroomed and, in conjunction with the continuing rise in employment in health, education and retail trade, ensured that services became the dominant source of employment for Britain’s labour force.

SCOTLAND AND INDUSTRIALISATION

The period from the beginning of Queen Victoria’s reign to the Second World War was a good one for the history of the Scottish economy. It was characterized by flourishing heavy industry, based on iron and steel manufacture that generated a diversity of engineering products and was fuelled by coal. This was the era when the railway network spread throughout the economy, even to remote parts of the Highlands, and when British finance and technology played a leading part in fostering economic progress throughout the world. Scotland was a full participant in that process, providing more than its fair share of inventors, scientists, industrialists and financiers. Indeed, for Scotland, the Victorian era produced much to support the claim that it was the country’s greatest era of innovation and growth. Industrialisation proceeded on a scale hitherto unsurpassed and created a continuous urban sprawl in the central belt, along the valleys of the Clyde and the Forth. It was an era in which Scottish goods were traded throughout the world, and in which Scottish finance helped underwrite the expansion of the international economy.

In popular perception, too, the great period of Scottish economic advance took place in Queen Victoria’s reign. As Devine observed in his survey of Scottish history, in the formal opening of Glasgow City Chambers by the Queen in 1888, and in hosting the 1901 International Exhibition in Kelvingrove Park, an event attended by 11.5 million visitors, Glasgow had established its position as a great international centre of industry and as the second city of the Empire.

INTRODUCTION

In the fifty years following the end of the Second World War, the British people enjoyed the fruits of an unprecedented period of sustained economic growth. Real personal disposable income per capita (i.e. income after direct tax) grew at an average annual rate of 2.4 per cent over the period 1949–95. By the end of the twentieth century the average Briton was about three times better off than in the late 1940s, and in real terms earned and spent £2.95 for every £1 earned and spent in 1949. Yet despite the palpable economic achievements of the post-war period, there has been continuing concern about the failure to distribute the benefits of economic growth to all sections of the population. For example, if we define poverty in terms of having an income less than half the national average, then the number of people living in poverty rose from 5 million in 1979 to 13.5 million in 1990/1 (Hills 1993). If instead we look at physical indicators, the picture is no less depressing: between the mid-1970s and the late 1990s the difference in life expectancy at birth for men in professional and in unskilled manual jobs rose from 5.5 years to 7.4 years (Department of Health 2002).

This failure to eradicate, or even reduce, the level of economic and social inequality is all the more surprising given the significant expansion of public welfare expenditure in the post-war period. Between 1949/50 and 1996/7, real spending on social security benefits grew at an average annual rate of 4.5 per cent, more than 50 per cent faster than the rate of real income growth.

INTRODUCTION

One of the most enduring features of Britain’s post-war economic development has been the persistence of the ‘north–south divide’. Incomes, employment growth, job opportunities and even education expenditure have all remained substantially lower in the less prosperous regions of northern and western Britain than in the booming south. Such a pattern of uneven development has presented major problems for policy makers. In addition to the obvious disadvantages to the less prosperous regions, the south-east has also experienced difficulties from its boom conditions. For example, soaring house prices have acted as a formidable barrier to in-migration from less prosperous areas, have eroded local social services (as nurses, teachers and other public sector workers are priced out of housing markets) and fed back into employers’ costs – as workers demand higher wages to meet their accommodation bills.

The costs of uneven regional development also have a national dimension. Macroeconomic stabilisation is made more difficult by the coexistence of labour shortages and inflationary pressures in the south and substantial unemployment in Britain’s ‘peripheral’ regions. For example, during the boom of the mid–late 1980s tight labour markets in the southeast fuelled wage inflation that was in turn transmitted to other regions with higher unemployment through national wage agreements, interplant agreements for multi-plant firms, and wage-setting based on relative earnings in related occupations. The resulting national inflationary pressures forced government into deflationary policy, despite the persistence of substantial unemployment and unused capacity in less prosperous regions.

The importance of services to the achievements of the industrial revolution is gradually becoming realised. Britain may have been by 1851 the ‘workshop of the world’, but it was also the pioneer service economy, with over 30 per cent of its labour force already devoted to the provision of services to domestic and overseas markets, contributing almost half of national income. Services further increased in statistical significance after 1850: by 1939, half the labour force was employed in the tertiary sector. It seems right to argue that services played an important role in the maturing of modern Britain. Yet it may also be right to argue that they played a role in slowing down British economic growth and contributing to the catch-up by other economies.

THE TERTIARY SECTOR

The boundaries of the service sector are famously imprecise, its content notoriously heterogeneous. Fisher (1952), who coined the term, ‘tertiary sector’, to distinguish services from primary (agriculture, mining) and secondary (manufacturing, construction) activities, noted that it was defined not from any positive attributes, but rather as a residual claimant, ‘a miscellaneous rag-bag into which everything has to be thrown that cannot conveniently be fitted anywhere else’. The heterogeneity is reflected in Adam Smith’s famous compilation, ‘some both of the gravest and most important, and some of the most frivolous professions: churchmen, lawyers, physicians, men of letters of all kinds; players, buffoons, musicians, opera singers, opera dancers, etc.’ (Smith 1976 [1776]: 331).

INTRODUCTION

Since the Second World War, many economic historians have come to see human capital as a weakness of the British economy since the late nineteenth century, particularly when compared with the United States and Germany. Although there is an element of truth in this, it is important not to exaggerate the British shortcomings in this area, particularly in the period before 1945. Britain can be seen as falling between an emphasis in the United States on formal education and a German emphasis on vocational training, but the extent of human capital gaps varied with the country of comparison, the time period and the sector of the economy.

There is strong evidence of a British shortfall in formal education compared with other rich countries including Germany as well as the United States in the mid-nineteenth century. However, Britain closed the gap in primary schooling during the late nineteenth century, and although the United States moved to a system of mass secondary education and rapidly expanded higher education in the first half of the twentieth century, Britain’s increase in secondary schooling during this period was not unimpressive and remained on a par with Germany’s. Although the modern German system of vocational training was already well established in industry and to a lesser extent in services by the early twentieth century, Britain still provided a supply of skilled workers for industry, through the system of apprenticeships, and for services, through professional qualifications, that far exceeded the supply of vocational training in the United States.

INTRODUCTION

Suppose that a deadly plague had swept through Britain in 1860, exterminating its entire population of 23 million people. Suppose then that immediately thereafter a sea-borne group of 23 million unschooled Eskimos (Inuit) had come upon Britain and settled the initially unpopulated area, but still possessing all the buildings, machinery and materials of the mid-Victorian economy at its height. One would expect a massive fall in the production of the economy to occur, given the unsuitability of Eskimo skills for the mid-Victorian environment and economy of Britain. This should be attributed to a mismatch of skills, not to some inherent naïveté of the Eskimos. Indeed, an analogous transference of the mid-Victorian British population north of the Arctic Circle would result in a similar initial drop in output relative to Eskimo levels, and survival itself would be at stake, given the unsuitability of Victorian English skills for subsisting in an Arctic environment.

Just how large the fall would be is of course subject to considerable speculation. One can get some sense of possible magnitudes by looking at the difference between the actual share of national income going to labour in Britain c. 1860 and the share that labour would have received if paid at unskilled wage rates. Labour’s share of national income for Britain in 1856 has been estimated at 57.8 per cent (Matthews et al. 1982: 164). Gross domestic product for the United Kingdom in 1860 has been put at £683 million (Feinstein 1972: T4). The United Kingdom working population in 1860 was around 12.98 million people (Feinstein 1972).