Britain's Economic Performance

Tony Buxton, Paul Chapman, Paul G Chapman, Paul Temple

• Publisher: Routledge
• Year: 2005
• ISBN:
  9781134751839
• Edition: 2
• Topic: Business
• Subtopic: Business General
• Index: Business

This new and substantially revised edition of Britain's Economic Performance provides a unique assessment of the current state of the supply-side of the economy. Written by a team of highly experienced, policy oriented applied economists, this volume will be a valuable source of reference, analysis and guidance for students and policy-makers.

1
INTRODUCTION

Tony Buxton, Paul Chapman and Paul Temple

As we approach the millennium, the state of the economy is as close as ever to the heart of political and economic debate with economic prospects the subject of much speculation. The longer-term growth of the UK economy, of around 2.5 per cent, has generally been less than that of other major capitalist economies over the post-war period. In the long term one of the fundamental aims of economic policy should be to raise this underlying rate of growth; understanding how this can be achieved is the main objective of this volume. However, more short-term considerations such as an over-heating economy and balance of payments crises have in the past diverted attention from this fundamental objective. The UK economy has long been subject to cyclical changes but the post-war period has seen a succession of severe cycles. The amplitude of economic cycles has increased recently, so that the apparent horrors of the 1950s and 1960s now look like mere hiccups rather than the economic shocks which bring down governments.

So what are the United Kingdom’s economic prospects? Looking first at the short run, by the second half of the 1990s, the recovery from the slump in the first two years of the decade was well under way. At the end of November 1996 in his speech introducing the last budget before the general election, the Chancellor, Kenneth Clarke, felt able to claim:

The British economy is in its fifth successive year of steady, healthy economic growth, with falling unemployment and low inflation. These are the best circumstances we have faced in a generation. This is a Rolls-Royce recovery, built to last. This time—unlike so many previous recoveries—healthy growth has been accompanied by the best inflation performance for nearly 50 years. And restrained growth of earnings has been good news for jobs.

Rolls-Royce motor cars are indeed built to last, but very few people own one. The Rolls-Royce analogy is therefore an appropriate reference to the effects of economic policies since 1979—very few people have benefited, and some are absolutely worse off—and this may well continue into the 1990s recovery. People with very high incomes have gained the most and those with the lowest have suffered the worst. Even in areas where success has been claimed, there is doubt. Inflation has been put at the forefront of policy, yet in the late 1980s the annual rate rose to nearly 10 per cent. Furthermore, in the EU in 1996, only Greece, Portugal, Spain and Italy had higher rates of inflation than the United Kingdom.

In any case, the foundations of the recovery in the 1990s should be scrutinised. It is right to point to low inflation as a signal that capacity had not yet being stretched, and low earnings growth may give the same message. But in the relatively early stages of recovery this is quite common, because capacity is available to raise output without excess demand and Mr Lawson made similar claims in the 1980s. The number of jobs created also rises as a recovery gets under way, and this is not surprising. The true determinant of a successful recovery is that demand is not artificially or temporarily stimulated. It requires several features, including success in international markets, efficiency of domestic firms to remain competitive, and adequate capacity.

Competitiveness is a longer-term issue and is discussed shortly, but the essential feature of a short-run recovery is that it should be investment- and/ or export-led, to avoid capacity and/or balance of payments difficulties. The 1990s recovery seems virtuous because exports have risen rapidly, more than twice as fast as GDP. The exit from the Exchange Rate Mechanism (ERM) and the consequential devaluation of sterling undoubtedly played a part here, but basing a recovery on a devaluation is ultimately a futile exercise—a kind of ‘fool’s gold’. It is worth noting that the late 1970s’ recovery also saw a huge rise in exports, by nearly the same amount relative to GDP as in the 1990s. This was despite a rising pound, based on the potential respite from the United Kingdom’s perennial balance of payments problem which was, in the view of the foreign exchange markets, to be delivered by North Sea oil. Spending on exports was the only category of expenditure to rise faster than GDP in the late 1970s’ recovery, much like the present one, but that was not regarded as a sound recovery, either at the time or in retrospect.

The more important source of a sound recovery in the short run is arguably from the capacity derived from investment in fixed capital. In the recovery since 1992, fixed investment growth has been weak. In the late 1980s, fixed investment rose strongly. Much of it was simply to replace that lost in the huge trough in the 1979–81 period and perhaps also because the 1980s cycle lasted so long so that in the end companies invested strongly. It is possible though that the factor which should be given recognition in the 1990s’ recovery is this high investment growth of the late 1980s, which has meant that capacity, particularly with respect to exports, has not restrained output. The resultant capital cannot be effective for long, however, partly because it is inevitably insufficient to satisfy increasing demand, and partly because it is not endowed with sufficient advanced technology. The absence of strong investment in fixed capital in the 1990s is therefore likely to provoke the bottlenecks of old, and either raise inflation or require remedial economic policy to restrain demand and generate another stop in the familiar stop/go cycle. By the end of 1996, the Bank of England was once again concerned that capacity would be insufficient to match the increase in domestic demand, and was calling for interest rate rises to combat it—a policy which would itself reduce capital expenditure and potential capacity.

In the short run, therefore, there is no room for complacency and this was recognised by the new Chancellor, Gordon Brown, in his first budget. In the longer term the competitiveness of the economy is what determines the speed of economic development. Is there room for complacency here?

THE FACTORS BEHIND COMPETITIVENESS

This book is based on the belief that the sources of differences in long-term economic growth rates can be understood by utilising and developing the concept of national competitiveness. At the level of the individual firm, success or failure is clearly based on competitiveness—the ability to compete and as a consequence to be successful and grow. The translation of the concept to the national level is more problematic, but it can be expressed in a number of ways, the most important of which is that competitive economies will find that the sectors of the economy which are exposed to competition from overseas, whether in goods or in services, will tend either to grow relatively quickly or to disappear entirely. This is a consequence of comparative advantage and a changing international division of labour, and has several favourable repercussions on the rest of the economy. Because the tradable sector relies heavily for its success upon technological advance its growth provides a larger channel for beneficial spillovers. In terms of macroeconomic policy there may be more favourable external financing and the Government should find that its fiscal problems are simpler while real interest rates may be lower, encouraging investment which may further boost competitiveness.

In Britain, the concept of competitiveness first came to the fore as the focus of attention shifted in the early 1960s from concern with maintaining full employment (which had largely been achieved) to one of growth performance; it became clear that growth in Britain was lagging behind that of its neighbours in Europe. Policy discussions were directed to the rapidity with which the balance of payments deteriorated whenever faster rates of demand growth were experienced. Although this was correctly diagnosed as a competitiveness problem, it was seen in very conventional terms, as largely a matter of costs and prices, soluble, with a given exchange rate, by a period of more rapid productivity growth (as for example envisaged in the National Plan of 1965), slower wage growth or, as events turned out, by the ‘one-off’ devaluation of sterling in 1967. Although many apparently believed that devaluation represented a quick macroeconomic fix to Britain’s problems, it was also widely supposed that labour market institutions were responsible for creating the need for devaluation in the first place. It was no surprise therefore that many of the proposals for the reform of those institutions also date from the late 1960s. However, political considerations ensured that such proposals were never seriously acted upon until the inflationary implications of the second oil shock encouraged governments everywhere, but especially in Britain, to put the control of the price level at the very top of the economic agenda.

By the early 1970s some economists were convinced that a freely floating exchange rate might relieve the economy of the awkward balance of payments problem, but this depended upon an ability to control wages and prices. But by the middle of the decade, and with the rapid acceleration of inflation in a devastating wage-price-devaluation spiral, it was increasingly asserted that the principal problem of competitiveness faced by the economy was not one which could be assisted by sterling devaluation alone; rather it was primarily one of ‘non-price competitiveness’—that British producers could not get delivery right, or their marketing, or the specification that consumers desired. Moreover, rising exchange rates in Germany and Japan did not seem unduly to harm their competitive positions in world markets. Meanwhile devaluation and depreciation of the pound could actually be making matters worse by encouraging producers to concentrate on price-sensitive sectors of the market, rather than on more sophisticated sectors where longer-term growth might be quicker, and making them reliant on further devaluations. In many respects the devaluation was a consequence of economic weakness rather than a cure for basic problems; there must be a concern in this respect about the basis for growth since 1992. Of course this does not mean that the currency cannot be overvalued, as it so plainly was in the 1960s and in the early 1990s, but growth following devaluation is no economic miracle.

The whole experience of two decades suggested, however, a deeper question, related not so much to the individual producers themselves, but to the structural aspects of the economy in which decisions are made. After all, apart from simplistic explanations founded upon generalised management failure, how could it be true that British management was consistently under-performing? Again we may turn to the role that idiosyncratic national institutions play in conditioning corporate strategies, i.e. to a notion of structural competitiveness, referring to the fact that national institutions (especially in training, education, labour markets, capital markets, and the physical infrastructure) have consistent effects on individual firm performance. The United Kingdom, for example, has very distinctive patterns in the organisation and financing of industry, in the provision of education and training, in the support by government of R&D, and in the way in which many institutions combine to affect the operation of the labour market. Structural competitiveness is fundamental in explaining why the national economy continues, despite the importance of the processes of globalisation and economic integration, as an essential unit of analysis. Differences between nations in their relative economic performance display remarkable persistence over time, and it is highly improbable that the search for the causes of this can ignore differences in national institutions.

Of course some of this was recognised by the incoming Conservative government in 1979, which subsequently maintained a very consistent view about the nature of the institutional reform required to resolve many of Britain’s economic problems. Institutional reform in Britain was directed primarily at the labour market, whose idiosyncratic institutions, including both the trade unions and methods of pay bargaining, were held to be deeply inimical to industrial success. The guiding ideology was of course that markets should wherever possible be left to their own devices. If there was any ‘model’ for reform, it was to be based upon practices observed in the US, which, rightly or wrongly, is held to be the prime example of the laissez-faire approach to capitalism. After two decades of labour market reform, the ‘flexibility’ of the UK labour market is now frequently espoused as a source of national competitive advantage, especially within the EU, where reform has not been taken as far, and indeed in many instances is perceived to be moving in the other direction. Clearly this difference constitutes a major source of friction for Britain’s membership in the EU. The results of the labour market reform programme can also now begin to be judged. Certainly unemployment rates have declined in the 1990s, and now compare favourably with some nations in Europe. But the costs have been considerable, particularly in relation to the growing inequalities between households and the increased polarisation between ‘job-rich’ and ‘job-poor’ households.

A common theme underpinning many of the contributions to this volume is that the emphasis on the reform of the labour market has become less relevant to improving competitiveness, but there are a host of factors to which policy must attend in addressing a moving target. Arguably what matters most for the advanced economies is their ability to generate investments based upon the generation and utilisation of knowledge as a resource, and hence to shift the pattern of specialisation into earlier stages. of the product cycle. In such a world, government action needs to be founded not just on a philosophy of intervention in markets as a last resort, but upon a philosophy of public good provision—in areas such as education and training, cooperative R&D, and the coordination of investment, i.e. areas where public investment is complementary to private investment and most likely to generate additionality. The importance of these areas is at least partially recognised in the three ‘competitiveness’ White Papers, but the principal question—how government can best assist the private sector in increasing the resources devoted to the accumulation of technological capability—has not been systematically addressed. At the very least, this would require a systematic and frank audit of Britain’s current institutional structure, but such an audit has yet to be carried out. We hope that the current volume goes some way to redress this situation.

The explanation of differences in economic growth rates underpinning our approach can be contrasted with some alternatives. The textbook, neoclassical approach emphasises two fundamental forces in the growth process —population growth and technological change—which are themselves unexplained. The investments required to adapt to these opportunities are signalled by prices and coordinated by markets. Differences in national performance reflect the flexibility of producers to the signals thrown up, as well as to the inherent potential of economies—their ‘endowments’ in terms of the supplies of various factors of production. While the approach recognises that market failures may occur, this does not by itself make a case for intervention, since the idea of ‘government failure’ is pervasive in some influential circles—the view that even if markets are not working as well as they might in theory, there is no necessary reason why intervention should improve matters—politicians, regulators and others charged with the public interest are more likely to act either incompetently or simply in their own self-interest.

In the British case, thinking about policy has also been influenced by the Austrian School, who adopt a more dynamic view of economic growth, emphasising the role of the entrepreneur in spotting and acting upon favourable profit opportunities. In the 1980s much was heard about the creation of an ‘enterprise culture’. The encouragement of enterprise extended well beyond traditional areas of business, into new territory, especially the public sector e.g. in health provision through the creation of health service trusts and associated ‘quasi-markets’.

A rather different school of economists (based mainly in the US) emphasises the institutional framework of the economy and its relationship to the competitive process. Institutions are no mere reflection of market forces, but are shaped in specific periods and may function rather better in some contexts than in others. Compared to the pace of developments in technology, institutional change can be very slow, and mismatch or institutional failure a real possibility. In the United Kingdom, for example, the centralisation of political authority and the adversarial nature of political debate may be exactly opposed to the smooth functioning of more liberalised markets. In Germany the more decentralised power structure, combined with a similar market-oriented culture, may have operated more effectively in promoting competitiveness.

The framework we have adopted in this study is consistent with the approach taken in the previous edition of Britain’s Economic Performance and owes something to all of these approaches; it has also been informed by other, more specific developments in economic thinking, some of which are worth spelling out.

Some otherwise orthodox economists have taken a major leap forward by placing much greater emphasis upon the role of investment processes, not simply in tangible forms of plant, equipment, building and so on, but also in intangible forms— education, training, research and development, marketing, etc. The key point in their reasoning is that investment processes are also essentially learning processes on the part of individuals and organisations. Significantly, the owners of private firms cannot capture all the benefits from investment in the form of higher profits, and hence the social returns from investment will exceed private returns. Clearly, this provides considerable scope for policy intervention, but its effectiveness will depend upon the agents or institutions mobilised for that purpose.

At the same time, views of the nature of technology have been changing— moving away from the idea that technology can best be thought of in terms of ‘codified’ information (e.g. sets of blueprints) which can readily be transferred from one location to another, to a view of technology which is substantially more ‘tacit’ in nature, consisting of the skills of both individuals and teams and the specific competencies of firms. These factors in turn depend upon the prior investment record of the firm—in R&D, training and so on. In short, technology is much more costly to transfer than is commonly supposed, and depends upon the past history of firms and institutions. It follows that recessions may do much more damage to an economy’s technology base than is apparent from the current loss of output. Certain types of company acquisition may have a similar effect. The importance of continuity within firms is well illustrated in the case of Japan, where management seems to realise more acutely that valuable assets are disappearing when a worker is made redundant. The problem is partly that the value of such assets is very difficult to assess from the outside, and the governance structures of economies such as the United Kingdom and the US may be inimical to these kinds of investment.

In short, the view of economic performance that we are putting forward can be thought of as a synthesis of a number of perspectives. The question of competitiveness cannot be reduced to either the effectiveness of markets or the behaviour of firms; institutions and infrastructure, both conceived in the broadest terms, really matter. Moreover, the appropriateness of institutions changes over time. ...

Table of contents

• COVER PAGE
• TITLE PAGE
• COPYRIGHT PAGE
• FIGURES AND TABLES
• CONTRIBUTORS
• PREFACE
• ACKNOWLEDGEMENTS
• 1: INTRODUCTION
• PART I: THE POLITICAL AND MACROECONOMIC FRAMEWORK
• PART II: INTERNATIONAL TRADING PERFORMANCE
• PART III: INVESTMENT AND INNOVATION
• PART IV: THE LABOUR MARKET AND THE SOCIAL FRAMEWORK
• PART V: EUROPEAN INTEGRATION
• PART VI: STRUCTURAL CHANGE, INDUSTRIAL POLICY AND ECONOMIC PERFORMANCE