Forging Ahead, Falling Behind and Fighting Back Read online

  Not only was the actual rate of unemployment higher in the interwar period than before the First World War but so too was the Non-accelerating Inflation Rate of Unemployment (NAIRU). Hatton and Thomas (2013) estimate that it had increased from 5.7 per cent in 1891–1913 to 9.5 per cent in 1921–1938. Besides the structural problems of the staple industries, U* rose in response to the spread of collective bargaining and the introduction of unemployment insurance which reduced the flexibility of the labour market, especially in responding to adverse shocks. These changes can be understood as further consequences of competition for working class votes. The implication was that reform of the labour market was required if unemployment was to return to lower levels on a sustainable basis; a ‘Keynesian solution’ based on stimulating aggregate demand would be inadequate, notwithstanding the positive effects of rearmament in reducing unemployment in the later 1930s.2

  The intractability of the interwar unemployment problem had its roots in the industrial legacy of the early start. Persistent unemployment was an ‘inescapable experience’ for a generation of politicians who would make economic policy after the Second World War, and provoked a strong reaction against the market economy and in favour of much greater government intervention that would have been inconceivable a quarter of a century earlier, as is reflected, for example, by the case of Harold Macmillan, a Conservative who would become Prime Minister in 1957 but was MP for Stockton-on-Tees in the 1930s (Macmillan, 1938).

  4.3 The 1930s: Economic Renaissance?

  If the economy was regenerated between the wars, it might seem natural to expect that structural change played a large part, and this was central to the controversial interpretation put forward by Richardson (1967) which stressed the end of over-commitment and the contribution of ‘new industries’ to productivity growth. A ‘new industries’ interpretation of interwar growth is not necessary for claims that productivity performance improved but it might seem to add to their plausibility.

  Table 4.6 reports on the extent to which ‘new industries’ were responsible for the growth of labour productivity between the Census of Production years of 1924 and 1935 using the widest available definition of the term. Since, on average, they represented about 6 per cent of total employment; their impact in raising the growth of labour productivity could not have been dramatic. There is no reason to think that the contribution of the new industries was particularly special. In any dynamic economy, it is normal for newer industries to grow faster than mature sectors. Clearly, ‘new industries’ more than punched their weight, especially if the calculation is based on 1935 value-added shares, in terms of their impact through intra-sectoral productivity growth. On the other hand, a calculation of their impact through structural change shows that this was very small; productivity growth took place overwhelmingly within sectors rather than through shifts of resources between sectors and, in any case, structural change was relatively slow (Matthews et al., 1982).3

  Table 4.6 Sectoral contributions to manufacturing labour productivity growth (%)

  Growth, 1924–1935 1924 weight Share 1935 weight Share

  New industries

  Motor and cycle 4.6 3.8 10.11 5.1 12.67

  Silk and artificial silk 8.7 0.9 4.53 1.1 5.17

  Chemicals 2.4 2.8 3.89 3.9 5.12

  Rubber 7.6 1.0 4.43 1.2 4.96

  Paper and printing 1.7 4.2 3.75 4.4 4.01

  Electrical engineering 0.9 2.8 1.52 4.6 2.34

  Aircraft 3.4 0.2 0.40 0.7 1.30

  Scientific instruments 3.0 0.4 0.70 0.5 0.82

  Aluminium, lead, tin 1.5 0.5 0.43 0.8 0.64

  Petroleum 4.3 0.2 0.56 0.2 0.50

  Total 3.1 17.0 30.32 22.5 37.51

  Old staples

  Mechanical engineering 1.4 7.3 5.93 7.7 5.83

  Iron and steel 1.8 5.5 6.05 5.7 5.57

  Clothing 1.1 8.0 5.74 7.9 4.90

  Woollens and worsted 1.9 4.5 5.01 3.5 3.64

  Cotton spinning and weaving 1.6 7.1 6.91 3.2 2.79

  Other textiles 1.2 4.1 3.46 3.0 1.89

  Timber 1.3 0.8 0.61 1.1 0.79

  Furniture 0.7 1.2 0.51 1.6 0.63

  Leather etc. 1.0 1.0 0.54 0.8 0.42

  China and earthenware 0.5 0.9 0.28 0.7 0.19

  Rope, twine and net 1.6 0.2 0.19 0.2 0.17

  Shipbuilding 0.1 2.1 0.13 1.2 0.07

  Railway carriage 0.2 0.5 0.05 0.4 0.04

  Total 1.3 43.4 35.41 37.0 26.93

  Source: Broadberry and Crafts (1990).

  Again it is helpful to place the productivity performance of the new industries in an international perspective. Here, two points stand out. First, in most cases labour productivity was further behind the United States than the average for all manufacturing where the USA/UK ratio of real value added per worker in 1935 was 2.24. In chemicals, the ratio was 2.69, in electrical engineering 3.18, in motor vehicles 4.62 (de Jong and Woltjer, 2011). Second, the new industries did not establish a strong position in terms of revealed comparative advantage in exporting, where the most notable feature of the late 1930s was the persistence of the old staples as the United Kingdom’s strongest export sectors (cf. Table 3.8). These comparisons rather temper enthusiasm about the performance of the new industries.

  More generally, it is difficult to accept the suggestion that there was a marked improvement in British growth performance in the 1930s, although there were some positive signs. As is reported in Table 4.4, non-residential investment as a share of GDP was only 6.4 per cent in the 1930s, although R & D rose to 0.4 per cent of GDP. Crude TFP growth averaged 0.6 per cent per year in 1929–1937 compared with 0.7 per cent in 1873–1899 (Feinstein et al., 1982; Matthews et al., 1982). The 1930s did see a strong recovery in GDP after 1933 but, considering the post-1929 business cycle as a whole there is no sign of a trend break in the growth of either GDP or industrial production (Mills, 1991; Greasley and Oxley, 1996). Labour productivity growth in manufacturing was much stronger in the 1930s than before 1913, as Table 4.7 reports, but that table also shows output per hour worked continued to grow faster in United States manufacturing, so that the level of American labour productivity was 2.74 times that of the United Kingdom in 1937 compared with 2.41 in 1913 and 2.64 in 1929.

  Table 4.7 Real output/hour worked in manufacturing

  UK growth (% per year) US growth (% per year) US/UK (UK = 100)

  1870 195.2

  1870–1890 1.58 1.75 1890 201.9

  1890–1913 1.33 2.11 1913 241.2

  1913–1929 2.46 3.05 1929 264.5

  1929–1937 2.90 3.35 1937 274.0

  Source: de Jong and Woltjer (2011); data kindly supplied by Herman de Jong.

  It is, of course, true that the British economy experienced several years of very strong growth in the aftermath of the severe recession of the early 1930s. From 1933 to 1937, real GDP grew by at least 3.1 per cent each year and in total the economy expanded by almost 20 per cent. This should, however, be seen as a cyclical recovery driven by demand rather than as a change in trend growth. The impetus came from a big reduction in real interest rates under the ‘cheap money policy’ adopted in 1932 after the United Kingdom had left the gold standard, subsequently boosted by a fiscal stimulus from rearmament after 1935 (Crafts, 2013).

  From 1932, there was coherence in the Treasury’s thinking which deserved the label of a ‘managed-economy’ approach (Booth, 1987). The central objective was a steady increase in the price level – which on the assumption that money wages would not react also amounted to reducing real wages and restoring profits – subject to not letting inflation spiral out of control. The Chancellor of the Exchequer announced the objective of raising prices in July 1932 and subsequently reiterated it frequently. The rise in the price level was promoted through cheap money, a weak pound, tariffs and encouraging firms to exploit their (enhanced) market power. This strategy was clearly quite similar to a price-level target to increase the expected rate of inflation and reduce real interest rates, even at the lower bound for nominal interest rates. Obviou
sly, this strategy does not represent an irrevocable commitment but it was a credible policy given that the Treasury and the Chancellor of the Exchequer were in charge.4 Cheap money and a rise in the price level were clearly in the Treasury’s interests from 1932 as a route to recovery, better fiscal arithmetic and to provide an alternative to the Pandora’s Box of jettisoning balanced-budget orthodoxy and adopting Keynesianism (Howson, 1975).

  The managed-economy framework successfully promoted recovery but at the cost of a serious retreat from competition in product markets. The interwar economy exhibits symptoms of a considerable increase in market power. By 1935, the share of the largest 100 firms in manufacturing output had risen to 23 per cent following a merger boom in the 1920s; growing industrial concentration and increased barriers to foreign entry greatly strengthened domestic cartels (Hannah, 1983). Mercer (1995) showed that by 1935 at least 29 per cent of manufacturing output was cartelized. A proxy for the price-cost margin [(value-added – wages)/value added] calculated from the Census of Production shows an average increase of 3.8 percentage points across all manufacturing sectors from 1924 to 1935 while in the sectors identified by Mercer as cartelized the increase was 9.0 percentage points. Hart (1968) estimated that the rate of return on capital employed for manufacturing companies had risen to 16.2 per cent by 1937 from 11.4 per cent in 1924.

  There is, however, no evidence that the retreat from competition in the 1930s was good for productivity performance; if anything, the opposite is the case. Broadberry and Crafts (1992) examined the impact of reduced competition on productivity. Controlling for other variables, they found a negative correlation between changes in the price-cost margin and productivity performance for a cross-section of British industries in the period 1924–1935 and that British industries which had a high three-firm concentration ratio had lower labour productivity relative to the same industry in the United States in 1935–1937. They also presented a number of case studies which led them to conclude that cartelization, weak competition and barriers to entry had adverse implications for productivity outcomes. It is also clear that government-sponsored restraint of competition in coal (Supple, 1987), cotton (Bamberg, 1988) and steel (Tolliday, 1987) was ineffective in promoting productivity improvement through rationalization although this was supposedly a key policy objective. The abandonment of free trade was definitely not an ‘infant-industry’ policy; in fact, the largest increases in effective protection went to ‘old’ industries such as hosiery and lace and railway rolling stock (Kitson et al., 1991). A difference-in-differences analysis based on timing and extent of protection of manufactures finds no evidence that tariffs improved productivity performance (Crafts, 2012).

  4.4 Long-Term Implications of the 1930s

  The ‘managed-economy’ strategy for raising the price level in the 1930s was not only understandable as a politically attractive ‘short-term fix’ but it can also be justified as an appropriate policy stance when nominal interest rates are at the lower bound, and monetary stimulus can only be delivered by lowering real interest rates through increasing inflationary expectations. Eggertsson (2012) provides a model which shows that in such circumstances temporarily allowing firms to exploit market power is welfare improving. His paper notes that once the crisis has passed and the economy has escaped from the liquidity trap normal competition policies should be resumed immediately.

  This is, of course, much easier said than done and the British retreat from competition in the 1930s took a very long time to reverse. Average tariff rates on manufacturing imports in the early 1960s were still at mid-1930s levels (Kitson and Solomou, 1990; Morgan and Martin, 1975) while cartelization was also still at mid-1930s levels in the late 1950s.5 In the early post-war years, there was no appetite for introducing an effective competition policy (Mercer, 1995) and, in general, competition policy remained weak and ineffective until the 1990s, while lack of faith in the market economy saw about 10 per cent of GDP taken into public ownership, which typically entailed a state monopoly.

  The political imperative that came from the horrendous experience of unemployment in the 1930s was that, in future, full employment would be the key policy objective. In the famous 1944 White Paper the government made a commitment to ‘the maintenance of a high and stable level of employment’ (BPP, 1944). Also, it came to be widely believed that Keynesian economics provided policymakers with the tools to achieve this goal.6 Accordingly, post-war governments thought that failure to do so would mean electoral defeat. The influential analysis of opinion poll data by Goodhart and Bhansali (1970) gives substance to this belief. They found that unemployment greater than 400,000 (about 1.8 per cent of the labour force) implied that the governing party had no chance of leading in the polls; clearly, presiding over a return to interwar levels of unemployment (never less than 1.8 million) would be electoral suicide. The expansionary fiscal-policy response to quite small increases in unemployment suggests that politicians were well aware of this political arithmetic (Mosley, 1984). During the 1950s and the first half of the 1960s the unemployment rate averaged under 1.6 per cent and was above 2 per cent in only three years.

  The 1930s did not see major changes in corporate governance or industrial relations which remained on the long-term trajectories consistent with a ‘liberal market economy’ established in the nineteenth century. The structure of share ownership moved a bit further in the direction of separation of ownership from control under the impetus of the merger boom of the 1920s, and of heavier taxation which tended to dilute insider holdings somewhat (Cheffins, 2008).7 A study of large manufacturing and commercial companies in 1936 found that in 48 out of 82 there was a ‘dominant ownership interest’, that on average the largest shareholder owned 10.3 per cent of the company and that only in seven did the largest 20 shareholders own less than 10 per cent of the shares (Florence, 1961) while the vast majority of shareholders were private individuals rather than institutions. Nevertheless, institutional investors were starting to see the attractions of equities (Scott, 2002), universal suffrage carried the strong possibility of much more progressive taxation and, following the 1931 Royal Mail scandal, accurate disclosure of corporate accounts which would provide the basis for greatly increased merger and acquisition activity was on the horizon (Chambers, 2014). The likelihood of more far-reaching changes in corporate governance had increased significantly.

  It might be thought that persistent high unemployment of the interwar period and the unions’ defeat in the General Strike of 1926 provided an environment in which the British system of industrial relations would change radically. This was not the case, however; neither the employers nor government attempted significant reform so the key aspects remained unaltered. The 1927 Trade Disputes and Trade Unions Act left intact the main features of the 1906 Act (Lowe, 1987). Employers sought to assert managerial prerogatives on the shop floor but not to make large investments in new systems of production and managerial control (McKinlay and Zeitlin, 1989). Effort bargains were still made under the auspices of craft unionism but with workers’ bargaining power impaired in the years when the labour market was depressed (Lewchuk, 1987).

  While the conduct of industrial relations was sensitive to labour market conditions, the structure was still shaped by the inheritance from the nineteenth century. More unskilled workers were unionized and trade union density in the private sector had risen to 30 per cent by 1935 when collective bargaining covered 36 per cent of workers. Nevertheless, in the late 1930s, the modal form of bargaining was multi-unionism and more than 1,000 unions still survived (Gospel, 2005). The government maintained an approach of ‘voluntarism’ in which industrial relations problems were to be resolved by bargaining between employers and unions with minimal regulation.

  At the end of the interwar period, the United Kingdom still had a system of industrial relations characterized by weak managerial control of effort and multi-unionism, while the corporate governance of large companies continued to exhibit a considerable degree of separation of o
wnership and control. In future, however, these institutional legacies would operate in conditions of generally weak competition in product markets – a situation very different from that prevailing before the First World War. The implication would be more rents to be shared between firms and their workers depending on bargaining power, and more scope for principal–agent problems and managerial failure to proliferate in British industry. Neither of these characteristics could be expected to bode well for productivity performance.

  As it turned out, the ‘Golden Age’ of European growth was just around the corner. In the 1950s and 1960s, Western Europe generally enjoyed unprecedented growth in an episode of rapid catch-up of the United States. This was, however, a time when the United Kingdom grew relatively slowly and, indeed, experienced its most acute period of relative economic decline. Perhaps this was when the penalties of the early start, working through the interaction of its institutional legacies with weak competition, would really be felt; the more so since the decades after the Second World War were a period when an under-performing liberal market economy confronted a halcyon era for the European coordinated market economies.

  4.5 Conclusions

  Growth performance during the interwar years was far from impressive, although in the aggregate there was a small improvement on the disappointing Edwardian period and TFP growth in some sectors, notably in manufacturing, was much improved on the late nineteenth century. The strong recovery from the severe recession of the early 1930s was based on stimulus to aggregate demand from cheap money and then rearmament, rather than faster trend growth of productive potential. Comparisons of productivity performance with the United States show that the United Kingdom failed to match American growth rates. While labour productivity growth in the British economy had risen from 0.5 per cent per year in 1899–1913 to 0.7 per cent per year between 1924 and 1937, the United States achieved 2.4 per cent in the 1920s and 2.5 per cent in the 1930s. Crude TFP growth in British manufacturing at 1.9 per cent per year between 1924 and 1937 was half the American rate of 3.8 per cent per year between 1919 and 1941.