A conventional summary of the Western economy in the 1970s.

 

The Economic Debate

The 1970s in the West saw the emergence into policy of a debate which had been continuous but which was largely conducted amongst intellectuals and policymakers. This was the battle between the Keynesians who had defined the ‘post-war settlement’ and Monetarists who were focussed upon inflation. The consequences of this battle were to be quite serious, and pushed economics and political economy towards a kind of market-based, anti-inflation position which prevailed across the world with few exceptions by 1987-91.

The basic disagreement was between those who believed that Aggregate Demand drove the economy, and that the worst problem in a real economy was unemployment, and those who believed that all policy eventually came down to how sound and trusted the money supply of a country was and could be. The former group argued that governments should spend against the economic cycle, that deficits were not a bad thing, and that the economy could be stimulated fiscally, so that, via the accelerator-multiplier mechanism, it would grow via consumption leading to investment.

The other group, however, argued that investment, and ultimately jobs, came from savings. Savings related to stable real interest rates, and provided banks and individuals with the means to invest in the long run. If the economy was given over to consumption and inflationary growth, this would not reset in terms of a higher price level accompanied by a larger GDP; rather, it would relate in price distortion, deficits, bubbles, and an inevitable series of corrective crashes in the economy. The only thing, in this analysis, which would grow, would be government, and enterprise and innovation would shrink.

A third group emerged who, even if they leaned either way, were more focussed on ‘stakeholding’ (really a term from the late eighties and early nineties) and ‘neo-Keynesianism.’ The former suggested that growth could be achieved by the sort of productivity gains which emerged when states copied West Germany and Japan and encouraged cooperation and dialogue, and joint planning, between all the elements of production—the unions, employers, regulators, and in some cases the suppiers and consumers. The Neo-Keynesians did not disagree with this approach, but sought a more ‘corporatist’ solution to inflation and low productivity. They wished to bring together unions, corporations, and government in national agreements to suppress inflation by tying wage and price rises to productivity growth, only allowing increases by law (or making increases illegal) if there was a lowering of costs or an increase in production.

Ultimately, the policy consensus which won out linked stable real interest rates and radically smaller government to the ‘creative destruction’ of failing or unproductive businesses, the suppression of inflation, and global trade to lower costs and encourage specialisation. This was greatly aided by technology which allowed for the growth of financial markets.

The Background

There was a massive global rise in inflation in the 1960s which had its root in a number of events and processes, rather than any one. To understand this, it is necessary to sketch the ‘post war’ economic settlement in a little detail.

In 1944, at Bretton Woods in New Hampshire, the allies (except the USSR) gathered to define the structure of the post-war world. They would ultimately construct a managed global economy which would, they hoped, avoid the collapse into depression of the 1930s, and the free-for-all of the 1920s. They were in this effort heavily influenced by John Maynard Keynes, who was a British representative at the conference.

The ‘Bretton Woods’ system sought to stabilise world prices by the replacement of the pound by the US dollar as an effective global currency, though the USD remained an American and not an international unit. The USD was tied to gold at a rate of $35 per ounce. States could trade in dollars or operate credit systems for their export companies in the confidence that, if they ever ran into deficits or out of money, they could take their dollars and return them to the US in exchange for gold. Each state promised not to do this except in an emergency, and otherwise to keep their own currencies at stable rates to the dollar.

To maintain liquidity and offer a ‘last resort’ if states did get into difficulty, the US and other countries funded the International Monetary Fund. It was the job of this Washington-based organisation to maintain stability in the world, via conferences, reports, or loans enforced by fiscal commitments to balance budgets by countries which took money. Essentially, the IMF was to provide global insurance to states, and to manage developing countries.

To provide longer term loans and encourage development in the world as new states emerged from decolonisation, the US and UK encouraged the creation of a World Bank. This organisation was of vital importance before the rise of global capital markets, and worked with governments to finance projects to improve their domestic infrastructure and the world economy, such as the Aswan Dam in Egypt.

Finally, Bretton Woods promoted international trade agreements through the General Agreement on Tariffs and Trade (GATT. GATT was a rolling conference which worked via ‘trade rounds’ of talks between trade representatives, which could last years, and which sought to expand international trade on the basis of equality and Most Favoured Nation clauses in treaties. These ‘MFN’ clauses ensured that any member state which signed a treaty with an MFN clause in it, relating to particular goods, would have to give every other member the same tariffs and benefits that they gave every other member, or at least not go higher. In the 1990s, GATT became a permanent World Trade Organisation, which was also tasked with resolving all trade disputes between member countries.

In the 1950s, the US and other western countries also promoted regional trade agreements and areas as the post-war world adjusted to growth again, and states rebuilt from war. These included the European Payments Union, the European Economic Community, and the European Free Trade Area as well as trade agreements in other areas of the globe.

These developments were accompanied by the post war economic settlement in which governments tried to eliminate the worst features of unemployment by encouraging government benefits, created a welfare state funded by taxation to allow for social mobility and productivity, respected and upheld trade unions as a balance to monopoly companies, and provided healthcare or subsidised healthcare insurance as a way to develop economic opportunity and productivity as well as to redistribute income. This was all attached to the growth of infrastructure and exports, and was manageable in a world of low inflation as states rebuilt the world economy.

The Breakdown

In the mid-1960s, this global order began to break down. The USA began to lose its lead as a centre of manufacturing and productivity, and to run trade deficits with Western Europe, and later, with Japan. This weakened the US Dollar and increased the tendency of states outside America to ask for gold to build up their own reserves. The US could initially transfer the gold to maintain the dollar, but a big ‘run’ on gold would have led it to have to reduce the value of the paper dollar linked to gold, which in turn would have raised world prices for everything.

This is in fact what began to happen as the US plunged into the Vietnam war and into funding huge spending on cold war military efforts in places like Indonesia, Africa, and the Americas. Dollars poured out of the US, which new post-colonial states were happy to recycle initially to finance trade, but the US did not react by raising interest rates to keep the dollar at a constant value. By 1967-8 this severely weakened the US, which could not afford a surge of troops in Vietnam at the same time as it maintained Bretton Woods. Secondly, the US spent huge sums domestically on a welfare and government programme known as the ‘Great Society’ which encouraged inflation in the US, but which did not deliver great growth. Thirdly, the space programme added to spending. Rather than raise taxes, cut spending, and raise interest rates, President Lyndon Johnson hoped for growth, but this was lost in the riots and political disorder of his term.

Britain, in Bretton Woods, was still an imperial power, but an exhausted one. It tried to maintain the pound at a high level to the dollar because it had borrowed heavily from the USA, in dollars, to fund the second world war. Britain was forced to devalue the pound, which made the US debt higher in pounds, did not boost exports enough, and raised import prices, twice, in 1948 and 1967. This was seen as humiliating and deeply damaged the Labour governments involved, but a refusal to reform unions or to improve productivity, and the loss of imperial markets as states became independent and switched to trading with the US, forced Britain into crisis by 1970.

Finally, West European and Japanese economic development made it difficult for Britain and America to grow by export anymore, which meant that their costs relative to output fell further. All states, including the communist ones, were also to one extent or another dependent on cheap oil from Texas and the Middle East to power their growth.

This meant that the 1970s would be a decade of massive inflation, which was evident before the 1973 and 1978 oil price rises. In 1973, Richard Nixon removed the dollar from the link to gold, and instead encouraged a world of bond investment based on faith in currencies, private debt, mortgages, and property prices. As time went on, thanks to technology, this would become quite sustainable (only really crashing in 2008) but in the short run it ‘untethered’ global prices. Nixon also continued the high spending of the US Government, and the Vietnam war, which poured further dollars into world markets. Outraged, many workers in Britain and America went on strikes, demanded wage increases, or voted for politicians who promised to control inflation by law rather than by deregulation and interest rates.

This resulted in the beginnings of a massive rebalancing, as the US suffered relative decline, the UK real decline, and the new nations in Africa and South America overborrowed because dollars were available at low interest rates (leading to the 1980s international debt crisis.)

The monetarists suggested with increasing force in this period that the basis of western political, economic, and military problems was the lack of sound money on which people could rely for investment and growth and savings. Instead, they said, people and companies were encouraged to borrow and spend and, with inflationary expectations, to think that they could simply raise their wages faster than inflation to sort problems out. Instead, the monetarists argued, states should raise interest rates above where they needed to be to change expectations, be prepared to endure higher unemployment, cut their budget deficits, and encourage much more international trade based on specialisation and advantage. This last point also went against the Keynesian consensus, as Keynesians argued that trade had a tendency to reduce wages and standards, and that imports were a leakage which functioned like a hole in a bath, increasing their own outflow by getting bigger as they reduced the buying power of currencies unless there was a corresponding increase in exports.

In the UK, the Labour government under Harold Wilson (1974-6) and James Callaghan (1976-9) was forced into a request to the IMF (ironically under false statistical premises) to borrow money. The previous government of Edward Heath had found that its ‘magic’ solution of joining the ‘cold shower of capitalism’ of the EEC in 1972 had not improved British productivity, and indeed that the energy crisis had empowered the mining unions to stop coal supplies unless provided with more cash in a way that brought down the government. North Sea Oil, though discovered, did not begin to provide any sort of solution until the 1980s, and by then, further monetarism, financialisation and Thatcherite economics had adopted many of the monetarists’ ideas anyway.

In the US, President Gerald Ford (1974-7) and President Jimmy Carter (1977-81) also tried to manage their way out of inflation. Nixon (1969-74) had, as already noted, removed the dollar from gold, but also tried to control gas and food prices. Ford went further, trying to organise a national effort to ‘whip inflation now’ (W.I.N.) and achieved some success, but was defeated by Carter, who decided to try to liberalise travel and energy markets to lower costs, as well as to encourage a switch to new forms of power (too early for the technology.) Both Ford and Carter also saw the US begin to monetize its debt by encouraging banks and international investors to buy derivatives of mortgage insurance and, ultimately, mortgages, and to build up loans, credit cards, and international capital flows, though this did not really take off until the presidency of Ronald Reagan (1981-89.) All presidents also continued an effective Keynesian programme of spending on the economy by pouring money into defense build-ups, though Nixon also restricted and reduced the space programme after the Apollo missions.

So—the seventies saw cost-push inflation, productivity decline, monetary inflation, and the beginnings of market liberalisation. They saw a ‘win’ for the Supply-siders and monetarists, and the emergence of globalist arguments for growth. Workers were able to maintain living standards, just, but only if they could push up their wages through unions or had access to credit and cheap property. To some, it seemed that the only people doing worse than the west in the 1970s were the eastern communist regimes, which were equally hit by oil price rises, stagflation and a defensive build up which undermined their dysfunctional planned economies.

The stage was therefore set for a final fight between post-war Keynesian liberalism and the new economics of the monetarists, globalists, and supply siders, and for the final challenge of western socialists to capitalism, as well as for the recessions, financial and corporate growth, and social change of the 1980s.