Economic Recovery in the UK: Lessons from the 1930s

1. Economic Recovery in the UK: Lessons from the 1930s Nicholas Crafts

2. The UK in the 1930s

3. Relevance to Today • First fiscal consolidation and then fiscal stimulus at the ZLB • 4 per cent growth from 1933-37 but double-dip recession in 1932 • The initial growth strategy was based on raising the price level and taking control of monetary policy away from the B of E

4. The 1930s Recovery: 1st Phase • Started during fiscal consolidation which between 1930 through 1934 reduced structural deficit by 4%GDP • Strong growth 1933-35 based on monetary stimulus which offset negative impact of fiscal policy: cf. the ‘foolproof way’ to escape the liquidity trap • Exit from gold standard plus cheap money provided stimulus; housing investment led the recovery

5. The 1930s Recovery: 2nd Phase • From 1935 onwards rearmament takes centre stage • Large exogenous fiscal shock with short term interest rates held constant • Suggests significant fiscal multiplier in 1930s conditions

6. The “Managed Economy” in 1930s UK • Post-1932 policy package included capital controls, devaluation, tariffs, cheap money and cartels • Understandable as a short-term fix at a time of high unemployment; raise P, reduce RW • Regrettable in terms of long-term implications for productivity performance; retreat from competition very hard to reverse

7. Medium-Term Implications of Devaluation • Permitted cheap money policy • Nominal and ex-post real interest rates fell • Fiscal sustainability improved as deflation ended • International competitiveness improved; change in net exports modest contribution to demand growth during recovery

8. Exchange Rates(1929 = 100) Source: Dimsdale (1981)

9. Double-Dip Recession • Quarterly GDP estimates reveal that after initial recovery in late 1931/early 1932 there was another recession in 1932 q2 and q3 • So, unlike the USA, devaluation did not signal the turning point • Adds weight to Eggertsson (2008) argument that devaluation was not sufficient in USA but had to be part of bigger package ( the New Deal) that committed to future inflation

10. Quarterly Real GDP Estimates(Mitchell et al. 2011)

11. The ‘Cheap Money’ Policy • Was a coherent framework arrived at by mid-1932 with HMT not B of E in charge (Howson, 1975) • Aim to raise the price level and to underpin this by holding exchange rate at $3.40 then FFr. 88 (Howson, 1980) • Short term interest rates kept at lower bound and real interest rates fell • Credible because it was clearly in HMT’s interests as a route to recovery that did not open Pandora’s Box and improved fiscal arithmetic

12. Interest Rates(%) (Dimsdale, 1981; Chadha & Dimsdale, 1999)

13. Fiscal Policy • Became ‘Keynesian’ only with rearmament • Early 1930s is episode of tightening (over-riding automatic stabilizers) provoked by worries about fiscal sustainability • Defence expenditure rose from £118 mn. in 1934 to £181 mn. in 1936 and £353 mn. in 1938 • Defence Loans Act in 1937 to use deficit finance of military - £400 mn. over 5 years; ‘defence news’ has significant effect on real GDP; fiscal multiplier may have been about 2

14. Fiscal Indicators(% GDP) (Middleton, 1996)

15. Estimates of Net Present Value of Changes in Expected Defence Expenditure(£ 1938 million)

16. The 1930s: Onward and Upward? • Trend growth did not increase (Greasley & Oxley, 1996; Mills, 1991) • Correctly measured, the labour productivity gap with the US widened further • TFP growth remained modest and investment stayed low • This is not the optimistic picture that the over-commitment school painted

17. Real Output/Hour Worked in Manufacturing Source: de Jong and Woltjer (2011); data kindly supplied by Herman de Jong.

18. Competition and Productivity Performance • Literature on postwar UK says weak competition a big problem for productivity until 1980s (Crafts, 2012) • Weak competition in product markets nurtured infamous industrial relations and management problems • Vested interests politically strong enough to block strong anti-trust and trade liberalization policies (Mercer, 1995) so 1930s legacy lasted a long time

19. UK Protectionism • Tariffs on UK manufacturing remained at 1930s levels until the mid-1960s; when trade costs fell mark-ups collapsed • Median tariff twice that in West Germany in the late 1950s (PEP, 1962) • Major reason for weak competition in UK product markets in the early postwar period

20. Trade Costs Index(Jacks et al., 2011)

21. Market Power and UK Productivity Performance(Broadberry & Crafts, 1992, 1996, 2011) • In 1930s increased market power substantially reduced productivity growth • 1930s tariffs did not improve productivity performance • In early postwar years, collusion undermined productivity performance • Both pre- and post-WWII, high CR3 associated with low levels of UK labour productivity relative to US

22. The “Managed Economy” Revisited • Can see why the policy target of raising prices seemed important • But, depending on how this is achieved, raising the price level can have bad supply-sideimplications (cf. the New Deal) and in 1930s UK this is big downside • Retreat from competition hard to reverse and would sustain bad management and dysfunctional industrial relations later on

23. Lessons • Conventional inflation targeting may be inappropriate with fiscal consolidation at the ZLB • Fiscal stimulus can help recovery when interest rates are held constant if sustainability not an issue • Severe recessions can risk bad supply-side policies that can seriously damage long-run growth – perhaps the EU and WTO are useful constraints