Does the British Government Really Control the British Economy?

The post-1900 period saw economic policy take centre stage in government activity. Economic performance increasingly became the primary metric upon which an administration’s record was judged. The changing relationships between the state and the economy, and between domestic and international economies, meant that the degree to which governments could affect the performance of the economy was often unclear. There are some instances where government decisions have led to change, even transformation, in the British economy. It is also clear that, as the period went on, the technical and policy tools at governments’ disposal gave them an increasing number of routes to influencing the economy. Despite this, exogenous factors consistently exercised more influence over the economy’s performance than government policy, which was largely reactionary and usually futile. Though there was, to a degree, a symbiotic relationship between exogenous factors and government policy in that the feedback from prior policy decisions influenced the economic environment in which the made decisions in, exogenous factors’ influence consistently outweighed that of policymakers. As Marx put it, ‘governments make policy, but not in circumstances of their own choosing’, illustrating why, though governments could influence the economy, external factors exercised a much greater effect on the economy’s performance.

Though the ability of policy-makers to influence the direction of the economy is often overstated, this does not mean government policies have zero influence. Despite the circumstances in which policy is formulated being largely out of the government’s hands, policy-makers have some room for manoeuvre within the boundaries established by the economic environment they find themselves in. There is also a degree of feedback wherein prior government policies, such as those on spending and taxation, influence the present-day environment.

A clear example of the impact of policymaking on the economy’s performance, and indeed on the future policy environment, can be seen by studying the Attlee’s post-war economic reforms, a topic on which economic historians have differing opinions. Whilst Tomlinson asserts that ‘this was a period of successful microeconomic management by almost any standards’, Broadberry and Crafts present a more nuanced view wherein they argue that ‘the post-war settlement in the UK was helpful in the short term in achieving a better inflation-unemployment performance but in the long term inhibited productivity growth’. Though there is disagreement on the nature of the impact of social democratic policies, there can be no doubt that this transformative administration’s economic policies had a tangible effect on economic performance, thereby influencing future policymaking conditions.

Thatcher’s three terms in office provide another example of government influencing the direction of the economy. By deregulating credit, large volumes of household borrowing was permitted during the 1980s. This, combined with the fall in council house construction as part of the ‘Right to Buy’ scheme, ‘inflated house prices and other asset values’, as Offer argues. He argues that such price inflation led to the gradual redistribution of ‘wealth and income from consumers to lenders, and from the young to the old’, a process that continues to this day, illustrating how far-reaching government policy can be. Crushing the trade unions at the Battle of Orgreave in 1984 was another policy achievement whose impact can still be felt to this day. Though influential, there is no doubt that, were it not for the unique circumstances Thatcher found herself in, much of these policy changes would not have been possible. Were it not for the Winter of Discontent, as Dorey argues, the Trade Union Act of 1984 could never have been as harsh as it was. He argues that ‘their [unions’] apparently political character enabled critics to claim that trade unions were either ‘running the country’, or ‘holding the country to ransom’’. Similarly, were it not for the collectivism inspired by the experience of the Second World War and a reluctance to return to the 1930s, Attlee’s reforms would have never been politically viable, demonstrating how the government’s policy choices are fundamentally reactionary and determined by circumstances out of its control.

Thatcher and Attlee took power at times of national crisis and used the circumstances to their advantage; as Friedman puts it, ‘only a crisis – actual or perceived – produces real change’. Though there was a degree of policy feedback, the economic environment was largely determined by exogenous factors out of the government’s hands, illustrating why the power of the government to affect the economy remained relatively weak throughout the period.

Though the ability of governments to affect the performance of the economy remained less significant than the influence of exogenous factors for the entirety of the post-1900 period, the emergence of what Tomlinson calls the ‘managed economy’ and advances in macroeconomic theory have somewhat improved the efficacy of government policy.

In the early 20th century, economic policy was built on ‘the gold standard, free trade, and low and balanced budgets’ in what is known as the ‘pre-managed economy’. Free trade limited the state’s ability to protect industries and strike trade deals, the gold standard neutralised monetary policy and low budgets reduced the efficacy of fiscal policy. By the turn of the millennium, British governments benefitted from floating exchange rates, flexible monetary policy and fiscal budgets close to 50% of GDP. The extraordinary monetary response to the 2008 financial crash, and indeed the £500 billion in bank bailouts announced in 2008 by the Brown ministry, would not have been possible were it not for the development of the managed economy.

However, it is important to note that these changes in the ability of the state to influence the economy were themselves largely determined by external factors. For instance, the Ramsay administration and Britain’s civil service resisted fiscal expansion and the abandonment of the gold standard, as illustrated by 1930’s May Report, which recommended slashing public expenditure to the tune of £96.5 million to avoid a deficit. It was the brute force of the Great Depression that had started on far-away Wall Street that forced a devaluation of sterling, and it was only after the Second World War forced policy-makers into deficit spending did they realise the powers of fiscal policy.

It is also important to note that, though governments increasingly attempted to manage the economy, other long-term trends, such as increased trade volumes, international market integration and the internationalisation of the financial sector, have manifested themselves over the course of the period. These phenomena transfer power towards markets and supra-national institutions and away from national governments, thereby cancelling out the effects of the rise of managerialism to a degree.

Aside from some marginally more powerful policy levers, governments have also arguably benefited from leaps in academia’s understanding of the macroeconomy. In the early 20th century, economists relied on microeconomic techniques, discounting the impact of monetary factors on real factors like output, instead assuming Say’s Law. The advent of the field of macroeconomics, initially in response to the Great Depression, has facilitated some policy successes, such as the disinflation of the 1980s, as inspired by the United States where, under Volcker, the Federal Reserve System first contained and then reversed stagflation.

Despite this, Mankiw argues that recent ‘new classical and new Keynesian research has had little impact on practical macroeconomists who are charged with the messy task of conducting actual monetary and fiscal policy’. Indeed the discipline of macroeconomics remains embryonic, as illustrated by the rise of heterodox economics in the wake of the 2008 financial crisis, meaning theoretical advances in the field, though significant, have barely enhanced governments’ abilities to influence the economy’s performance. Clearly, despite an increasing managerialism, globalisation has gradually sapped governments of economic influence, and though macroeconomic models have increased in complexity, their abstract nature means they have barely strengthened governments’ influence on the economy. Finally, many of the fluctuations in the tools available to the state are themselves largely the result of exogenous factors, further demonstrating how little is truly in the government’s hands.

The performance of the British economy since 1900 has largely been determined by exogenous factors out of the government’s control. In order to demonstrate why, relative to the state, external factors were much more influential, we will first explore domestic exogenous factors before examining more international phenomena.

One obvious example comes in the form of the trade union movement. At various points, the unions managed to lobby for desired economic reforms, or simply bring the economy to a standstill. Since the General Strike of 1926, British unions had gradually been gaining influence. Though it was a failure, strike gave a deep and enduring sense of labour solidarity that strengthened the movement for the forthcoming decades. Indeed, in the official Industrial Relations Handbook, published in 1944, the Ministry of Labour and Industrial Relations asserts that ‘Collective bargaining between employers and workpeople has for many years been recognised in this country as the method best adapted to the needs of industry, and to the demands of the national character, in the settlement of wages and conditions of employment’. This clearly demonstrates how, in the tripartite system of industrialists, unions, and the state was just that — a power sharing arrangement between government and external actors. Though it is true that Thatcher used government power to eventually crush the unions in 1984, it was in fact union overreach that facilitated this turn of events, as previously discussed, again demonstrating how government policy is fundamentally shaped by circumstance.

Another instance of exogenous domestic factors having more influence than the state on economic performance regards economic performance during the 1980s. Disinflation is often held up as one of Thatcher’s greatest achievements, but the role of North Sea Oil is often overlooked. Were it not for the oil constituting around 10% of the treasury’s revenues, sterling would have not appreciated as strongly as it did, and inflation in 1989, as estimated by Layard and Nickell, might have been 10% higher. They calculate that North Sea Oil was responsible for 12% of sterling’s appreciation during the Thatcher years, illustrating how important the exogenous ‘blessing of oil’ was to economic performance. Clearly, domestic exogenous factors had more influence over the economy’s performance than government, but it was international exogenous factors that really held sway in determining the performance of the economy.

Though there were many aspects of the domestic economy that the government had little control over, it was International phenomena, ranging from long-term trends to violent cataclysms, that were most important in affecting the performance of the economy.

The Second World War is the most striking example of how international affairs can have a profound impact on the British economy. As Howlett argues, ‘Britain was transformed from a predominantly free-market economy into a centrally managed economy’ in the period 1939-1945. The necessity of the war effort meant a reorientation from civilian to military production, and Howlett points to a rapid expansion in real GDP which peaked in 1943 ‘at a level 27 per cent higher than in 1938, an average annual rate of growth of 4.9%’. This was arguably triggered by the necessity of economic reorientation that resulted from the outbreak of war, though Barnett argues that it was another external factor, the effect of the US’ lend-lease programme, that triggered this impressive spurt of growth. He argues that this exaggeration of wartime achievements led to too burdensome a welfare state being constructed, acting as a drag on the British economy for decades to come. Regardless of who is correct, both hypothesis illustrate the futility of the state in the face of exogenous factors.

Another consequence of the Second World War, and the Cold War that followed, was the advent of the US’ Marshall Aid programme. When Britain’s dollar reserves evaporated in 1947 after the introduction of convertibility, Alford argues that, in alternative circumstances, the collapse ‘might have forced Britain to bow to growing US pressure’ to revise the international role of sterling. However, the ‘growing threat of communism from the East…caused a rapid volte face’ wherein sterling was propped up as part of the European Economic Recovery Programme. The factors leading to this assistance — the Second World War, American economic might, the rise of the dollar as an international currency and the emergence of a bipolar system of international relations — were all completely outside the British government’s control, demonstrating its weakness in the face of international forces.

Another instance of international influence on the British economy comes in the context of the 1976 IMF Crisis when the Callaghan government was forced to borrow $3.9bn from the IMF after sterling’s value against the dollar plummeted. This loan was conditional on the British government accepting IMF supervision, which inevitably meant deep fiscal cuts to stabilise the markets. Cabinet papers from the negotiations with the IMF during the crisis show the extent of the public expenditure reductions demanded. They aimed for ‘savings of about £3 billion in a full year’ which would involve ‘a moratorium for a full year of all public sector construction projects’, ‘the total cancellation of up-ratings of social security benefits and public sector pensions next year’, and ‘a wide range of programmes including health, education, aid, defence and Industrial support’. This example was triggered by the pressure of international markets and resulted in the British government handing over fiscal power to an international institution, demonstrating how globalisation has chipped away at the influence of national governments.

In conclusion, there is no doubt that governments could exercise some degree of influence over the direction the economy and, by way of feedback, the future policy-making environment. One could even argue that the emergence on managerialist economic policy enhanced the government’s power over the economy. Despite this, throughout the entirety of the period, exogenous factors consistently proved more influential than government policy. At home and abroad, long term trends and conflicts, external institutional actors and sudden geopolitical cataclysms all exercised more influence over the performance of the economy than British governments at any given time.

BIBLIOGRAPHY:

  • J. Tomlinson, Public Policy and the Economy Since 1900, New York, OUP, 1990
  • P. Williamson, National Crisis and National Government: British Politics, the Economy and Empire, 1926-1932, Cambridge, CUP, 1993
  • N. Mankiw, ‘The Macroeconomist as Scientist and Engineer’, Journal of Economic Perspectives, vol. 20, no. 4 (2006), pp. 29-46
  • S. Broadberry, N. Crafts, ‘British Economic Policy and Industrial Performance in the Early Post-War Period’, Business History, vol. 38, no. 4 (1996), pp. 65-91
  • A. Offer, ‘The market turn: from social democracy to market liberalism’, The Economic History Review, vol. 70, no. 4 (2017), pp. 1051–1071
  • P. Dorey, ‘Weakening the Trade Unions, One Step at a Time: The Thatcher Governments’ Strategy for the Reform of Trade-Union Law, 1979–1984’, Historical Studies in Industrial Relations, vol. 37 (2016), pp. 169-200
  • P. Clarke, C. Trebilcock, B. Supple, Understanding decline: Perceptions and realities of British economic performance, Cambridge, CUP, 1997
  • R. Layard & S. Nickell, ‘The Thatcher Miracle?’, The American Economic Review, vol. 79, no. 2 (1989)
  • R. Floud & P. Johnson, The Cambridge Economic History of Modern Britain, Cambridge, CUP, 2004

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