Orthodox Keynesians argued that growth was demand-constrained. There were two versions of this view, one emphasising the balance of payment constraint on export demand, the other the effects of ‘stop-go’ policies on investment demand. The remedy for the first was devaluation; for the second the long-term ‘planning’ of demand, in which devaluation might also figure. Kaldor’s growth model, by contrast, emphasised the supply constraints on faster growth. It was not just a matter of making demand grow faster or more smoothly, but of ensuring an appropriate supply response. Kaldor believed that the main engine of growth was growth in manufacturing output. This was because of the existence of increasing returns to scale in manufacturing industry, and because output per man was higher in manufacturing than in agriculture or services. The growth of manufacturing output in turn depended on the growth of employment in manufacturing industry. But Britain had no ‘surplus’ supplies of labour to transfer from agriculture to manufacturing: it was suffering from ‘premature maturity’. The next best thing was to transfer labour from services to manufacturing by taxing service employment more heavily than manufacturing employment.34 The ‘Keynesian’ analysis found more favour with the Conservatives, the ‘structural’ analysis with Labour, and particularly with Labour’s Prime Minister, Harold Wilson, who was a devotee of Soviet planning. The core proposition, however, which emerged from both sets of argument, was that there were no supply constraints on the growth of the British economy that could not be overcome by policy. In particular, the idea that productivity growth was a function of output growth suggested that, despite an acute labour shortage, a planned expansion of output would carry few inflationary risks, especially if an incomes policy were used to restrain wage costs.
An ‘indicative’ planning system was set up by Selwyn Lloyd in 1961, strengthened by the Labour government’s National Plan published in 1965. In fact, as we know, the planning period, which lasted from 1961–9, brought no increase in the national growth rate. The only things which ‘grew’ faster were the rate of inflation and public spending. In fact, it was in the ‘planning’ period that both took off, setting macroeconomic policy a much more difficult task in the 1970s. The economists, of course, claimed that their policies were misapplied: in particular, they blame Wilson’s ‘political’ decision not to devalue the pound on winning office in 1964. This view is hard to sustain. In retrospect, Wilson’s decision to stop the ‘dash for growth’ represents the last serious, though only partially successful, attempt for ten years to control inflation; his effort to curb trade union power in 1969 foreshadowed the eventually successful efforts of Margaret Thatcher. Wilson was not really a Keynesian. He understood that the main problems of the British economy lay on the supply-side, though his vision was clouded by his commitment to planning. By contrast, Keynesian economists of this period suffered from considerable hubris. They made unwarranted claims to theoretical and practical knowledge. Specifically, the claim that productivity growth depends on output growth is true only up to a certain point and in particular industries. Only in the Communist economies could such a claim be tested to destruction.
It is hard to divide responsibility for policy failures in the 1960s between the economists and the politicians. Policy was more theoretically-based in the 1960s than in the 1950s, largely because the Left was mostly in power – not just in Britain – and was less sceptical of theory than the Right. But both economists and politicians were relentlessly activist. This was an almost universal mindset. Politicians wanted to do too much; but they were encouraged to do so by the Keynesian advisers. Their policies were badly conceived; but they got bad advice.
However, although Britain may have suffered somewhat from its hyperactive policy-makers in the 1960s, the fate of the ‘golden age’ was being settled elsewhere. It was the inflationary financing of the Vietnam war, coming on top of the Kennedy-Johnson tax cuts and social spending programmes of 1963–5, which made inflation a serious world problem, and led to a destabilising sequence of events in which macroeconomic policy was called on to play a much more central – and exposed – role. Once inflationary expectations got established, policy-makers faced a rapidly worsening trade-off between inflation and unemployment. It was no longer a matter of keeping a light hand on the tiller. Policy-makers found they needed to swerve the tiller violently from one side to another, aiming first to halt the rise in inflation, then to halt the growth in unemployment. The increasing violence of these policy ‘U-turns’ contributed to the slowdown in economic growth and the tendency for structural unemployment (or the ‘natural’ rate) to rise from cycle to cycle, which made the old full employment commitment increasingly problematic.
The full force of these problems hit the Conservative government of Edward Heath, newly elected in 1970. Heath inherited not just the Wilson, but, more importantly, the Nixon ‘Stop’ of 1969–70. When British unemployment reached the ‘magic’ figure of one million in January 1972, he decided to reflate the economy in order to reduce it by 400,000 in twelve months. This was a political decision. The Chief Adviser to the Treasury, Sir Donald MacDougall, told him that ‘the attempt to reduce unemployment so quickly would be dangerous because it would lead to inflationary shortages and bottlenecks’ – a sound Keynesian warning, but by now inadequate to the total situation.35 Nevertheless, tax cuts and spending increases went ahead in Barber’s 1972 budget. At the same time, the decision was taken to withdraw the pound sterling from the European ‘snake’ and abolish credit controls. The Bank of England’s idea was to allow interest rates rather than quantitative credit restrictions to control the volume of private borrowing. The problem was that politicians then blocked the rise in interest rates. So a private sector boom was superimposed on the public sector boom. The money supply rose by 25 per cent in 1972–3, and although unemployment came down by 400,000 (in two years) the inflation rate rose from 6 per cent a year in 1972 to 13 per cent a year later.36 The whole episode is a good example of the interaction between technical and political mismanagement. The Keynesian economists gave politicians lame advice. The Bank of England concocted a policy which presumed that the market would be allowed to set interest rates. All this was before the OPEC oil price shock.
The analytical weakness of Keynesian economics at this point was that it could offer no theoretical explanation of the acceleration of inflation between 1968 and 1973. The worldwide explosion of the money supply was attributed to monopoly pricing by labour unions and firms rather than to the financial policy of government. It was considered sufficient refutation of Keynes’s own view that, at full employment, a further increase in the quantity of money is inflationary, to point out that employment was no longer full – or at least as full as it had been in the 1950s and 1960s. This ignored Keynes’s own distinction between ‘voluntary’ and ‘involuntary’ unemployment, as well as Friedman’s much sharper concept of the ‘natural’ rate of unemployment. Ironically, the Barber boom of 1972–3 was the first and last attempt to use full-blooded Keynesian policy to maintain what was then regarded as full employment. When it failed – and when the quadrupling of oil prices gave another savage twist to the inflationary spiral – all governments, including Britain’s, started to give priority to inflation reduction. Rhetorically, as well as analytically, they needed monetarism.
On 22 July 1976, the Bank of England publicly announced the adoption of money-supply targets, though it had already started using them. Fiscal policy needed to be made consistent with the goal of reducing the rate of growth in the money supply. In 1976, public expenditure started to be ‘cash limited’ and for the first time since the Second World War was cut during a major recession. In October 1976, James Callaghan made a speech at the Labour Party conference announcing that the government no longer believed Britain could ‘spend its way’ back to full employment. This is widely taken to be the year when ‘monetarism’ was adopted and the Keynesian full employment commitment abandoned. In fact, the situation was more complicated. The reason given for the public expenditure cuts was to ‘free’ resources for export and private investment as the only means of ‘restoring and maintaining full employment’. This was consistent with a ‘Keynesian’ analysis of Britain’s problem, such as had been presented by Bacon and Eltis.37 What the Labour government retreated from was the commitment to maintain ‘high’ full employment, accepting that in the