THE UK STRATEGY AGAINST INFLATION

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• Publication Date: April 30, 1998
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Confidential
DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
The UK Strategy Against Inflation
Confidential
ER IM 71-74
May 1971
Copy No.
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WARNING
This document contains information affecting the nationa~
defense of the United States, within the meaning of Title
18, sections 793 and 794, of the US Code, as amended.
Its transmission or revelation of its contents to or re-
ceipt by an unauthorized person is prohibited by law.
o1oUP 1
C~dud.J born oaion,adc
Ja.rng.Od fu and
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CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
I May 1971
INTELLIGENCE MEMORANDUM
THE UK STRATEGY AGAINST INFLATION
Introduction
1. In the postwar era the British have tended to attach greater
priority to maintaining high employment levels and defending the sterling
exchange rate than they have to other national economic goals. Thus,
through most of the 1960s the economy's bellwethers were the balance
of payments and the unemployment rate. Now, following large international
payments surpluses in 1969 and 1970 and a 75% reduction (since 1969's
high) in outstanding medium- and short-term debts to other nations
(excluding liabilities within the sterling area). UK policymakers have been
occupied more by the inflation issue. Particularly rapid wage gains and slow
productivity growth since late 1169 have reduced both the comparative
gains from the November 1967 devaluation and the relative profitability
of exporting. Concern for declining international competitiveness and
accelerating inflation have inhibited stimulation of economic growth.
2. This memorandum traces incomes policies since devaluation,
analyzes the 1969-70 wage explosion, and describes London's options in
coping with inflation. The government's emerging game plan to deal with
inflation is outlined, and the longer run implications of sustained inflation
are considered.
Note: This memorandum was prepared by the Office of Economic Research
and coordinated within the Directorate of Intelligence.
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Discussion
Prelude to Inflation
3. The sterling devaluation of November 1967 had the potential of
unleashing rapid and continuing price rises within the British economy.
Increased export profits - an acknowledged devaluation goal - were to
boost incomes without significantly affecting real output for domestic uses
in the short run. Additional inflationary pressure would result from higher
sterling prices for imports of raw materials and intermediate goods. To avoid
inflation and to direct resources toward investment and production for
export, the government introduced a series of contractionary monetary and
fiscal measures between November 1967 and March 1968. An incomes
policy, J formed during the early days of the Labor government in 1964,
was reformulated for the third time in early 1968 to protect the export
price improvement obtained through devaluation. It was hoped that this
would help preserve British competitiveness and avert international
payments problems, thereby avoiding the "stop-go" cycles that had slowed
growth and dampene.1 investment plans.
Incomes Policy After Devaluatic,n
4. The March 1968 announcement of a 3.5%/% targeted ceiling for
annual wage and dividend increases set the stage for the Labor government's
post-devaluation incomes strategy. This ceiling, applicable through 1969,
was based on projections of the long-run rate of growth of productivity.
The government would refer new price and wage demands to the National
Board for Prices and Incomes (PIB), which could recommend a delay of
tip to 12 months.
5. This goal was clearly unrealistic. Following a 16.7%
devaluation J and substantial increases in indirect taxes, it implied a
substantial decline in real wages because of greater sterling import costs
1. As used in this inemorandum, incomes policy refers to the combination
of government measures designed to assure that the rise in money incomes
does not exceed the long-run rate of growth in national output. Most
prominent among these measures has been a wages policy, the execution
of which has been as strong as a wage freeze (mid-1966 -- mid-1967) and
as week as guidelines (for example, in 1965).
2. Although the devaluation is more commonly described as one of 14.3%
in terms of new and old export values, the potential increase in import
prices was 16.7%.
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and higher prices for a range of domestically produced goods. In the event,
basic hourly wages grew 57r6`% and average monthly earnings over 7% in
the year following the March incomes announcement (see Figure 1). With
retail prices up about 6'/0, this meant that real wages were essentially
unchanged.
Figure I
UNITED KINGDOM: Wage and Price Movements
'Manufacturing, men only
"Manufacturing, all employyees. Fragmentary data indicate that the wage drift was
higher than inferred by Ihls graph because womens average earnings grew more
slowly than those of men,
6. Holding real wages nearly constant was a fair achievement
considering the political realities confronting the Labor government. Labor
had used up much of its political capital by imposing an incomes and price
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freeze J from mid-1966 through mid-1967 to avoid a devaluation. The
freeze was followed by a catch-up period between mid-1967 and early 1968
in which wages soared at an annual rate of nearly 12% - just at the time
when devaluation occurred anyway.
7. In this climate of growing hostility toward wage guidelines,
organized labor exerted considerable pressure or the parliamentary Labor
Party to justify wage gains of more than 3.5% annually. The principal
face-saving device was a stipulation that bonuses could be allowed for
"unusual" productivity gains. In many instances, these bonuses were
provided in contracts in which most of the wage increase came in the first
year and the productivity "gains" were simply targets for later years.
The Death of Incomes Policy
8. In 1969, following a spring slowdown, the size of initial pay
demands and the rate of increase of wages picked up rapidly toward yearend.
This reflected, in part, an increasing public awareness that the Labor
government was willing to sacrifice its incomes targets for other objectives.
Thus, in April, the government made it clear that it would allow its delaying
powers to lapse in December if organized labor cooperated in assin a
major labor relations bill.
e government's retreat was c ear w en
e teeth o the labor re ations i I - clauses providing for financial penalties
for strikers - were pulled by the unions and the bill itself withdrawn in
June 1969.
9. The statutory provision for 12-month price and wage delays lapsed
in December 1969. but the government mustered party discipline to sustain
a four-month delaying power enacted in 1966. At the same time as this
minor victory, wages in manufacturing industries rose 4.1% for the month.
With the 1970 election at hand, talk of wage restraints quickly died out.
The Conservatives, elected in June on a platform emphasizing reducing the
government's economic role, made plain their contempt for formal incomes
planning and guidelines. The PIB was to be abolished on 31 March IS'71
and its remaining functions transferred to other government compan ;nts.
3. The wage freeze, which was supported by compulsive and punitive
measures, was modified somewhat at the outset of 1967. Nevertheless, the
index of wages for all industries and services increased only about 2.7%
and earnings 1.0% for the period.
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Related Government Economic Policies
10. Measures accompanying and following the 1967 devaluation were
not necessarily well-coordinated with incomes policy or each other. In part,
this was because devaluation had been precipitously forced on a reluctant
Labor government, with very little time for medium-range planning. But
the timing of later tax measures was also off. Further complicating
coordination was the long-standing Bank of England commitment to support
the prices of government's "gilt-edged" bonds, the market for which tended
to rise and fall with movements in Britain's international payments and
debts. 4] These support activities often raised the money supply by
increasing bank reserves and lending at the wrong times. Finally, staunch
efforts to avoid further runs on sterling made for a relatively inflexible
defense of particular exchange rates within the official margins.
11. The major results of these assorted complications during 1968-69
were perverse increases in consumption and erratic movements in the money
supply. Thus, following the devaluation, the nature of government
statements on reduced expenditure levels for the fiscal year beginning on
1 April 1968 also made it clear that indirect taxes would probably be
raised. J The lag from November to April in effecting indirect tax increases
and the abnormal wage gains that followed the 1966-67 wage freeze
combined to produce a consumption boom. This boom proceeded full-steam
through mid-1968. Another unfortunate gain in consumption occurred in
November 1968, when increases in certain manufacturers' sales taxes were
announced, yet could not begin to work their way through to retail sales
for a matter of months. ,J Such concentrations of consumer demand in
4. The domestic consequences of an international loss of confidence in
sterling typically were: (1) sales of gilt-edged bonds h.v foreign and then
domestic holders; (2) Bank of England purchases to support the price; and
(3) a resulting increase in the money supply that subsequently had to be
offset by constraints on domestic credit to protect the balance of payments.
Thus the primary domestic effect was to undermine the timing of monetary
measures in relation to domestic goals.
5. The heavy reliance siiice devaluation on the "regulator, " the primary
instrument of discretionary changes in indirect taxes, raises basic conceptual
problems, for fiscal theory emphasizes that such tax increases tend to raise
the general p.-ice level. Further increases in direct taxes -- which are already
extremely high -- are. however. much more difficult to obtain.
6. Thus, two lags have tended to complicate the use of indirect taxes
levied at the manufacturers 'stage. The first -- a lag in implementing a policy
decision - spurred consumption in early 1968. The second -- a lag in impact
on retail sales - temporarily spurred consumption in the holiday season
of December 1968. A national retail sales tax would not have suffered the
second lag.
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anticipation of tax increases tended to bid up retail prices rapidly at
particular periods, and the combination of subsequent indirect tax effects
and oligopolistic pricing kept them up. This spurred still higher wage
demands to cover cost-of-living increases.
12. Changes in the money supply also seemed work at
cross-purposes to wage and price restraint largely because of the flank of
England's focus on the gilt-edged market. The average level of the money
stock increased at an above-average rate of 6% in 1968 (a year of a serious
deficit in international payments) and less than 1% in 1969 (when there
was a basic international payments surplus of about $1 billion). Quarterly
movements in some instances were even less well coordinated to incomes
objectives. Thus, even on a seasonally adjusted basis, the most rapid growth
in the money supply during 1968 occurred in the second and fourth
quarters, when public pressure to raise wages to offset the effect of
devaluation and higher taxes were particularly strong. Again in 1969,
substantial inflows of funds from abroad permitted an expansion of the
money supply in the last quarter J to help support a wage boom then
under way.
The Wage Inflation of 1969-70
13. The erosion of the political basis of an active incomes policy and
the occasionally conflicting applications of fiscal or monetary policies set
the stage for rapid wage and price gains in 1969-70. Further complicating
attempts at wage and price restraint was the need to marshall Labor Party
unity for an anticipated close victory in the June 1970 elections. The
Conservative upset put in power men to whom an explicit incomes policy
was anathema and whose sights were fixed on long-run economic goals such
as a reduced government role in the economy, fundamental changes in
industrial labor relations, 8/ and accession to the European Communities
(EC). Not surprisingly, their first encounters with wage demands were not
notably successful, and an implicit incomes policy only began to take shape
by yearend.
7. As in other periods, the Bank of England Juiled to take full advantage
of the opportunity to sell gilt-edged bonds to offset the expansion.
8. A long-awaited Conservative industrial relations bill was introduced in
Parliament oil 3 December 1970. The bill is directed at broadening the
legal reference for union activities and curbing wildcat strikes, which have
been a particular difficulty in the United Kingdom. Financial penalties are
provided for acts defined as "unfair labor practices. " hi addition, the bill
would create a national registry for unions and tend to penalize those unions
that did not regisl-r. Closed shops would be outlawed in all but a few
instances. Th;- bill - which is through Commons - is expected to pass the
House of Lords and become law this summer, but creation of all its
institutional features will require nearly another year.
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The Nature of the Inflation
14. Although it is always hazardous to specify that wage increases
have caused an inflation, the course of British incomes, prices, and profits
since late 1969 strongly suggests this conclusion. Between the last quarters
of 1969 and 1970, basic hourly wages for all industries rose 13.0%, while
the corresponding retail price ncrease trailed at 7.7%. In the manufacturing
sector alone, men's wages went up 11.7%, and together basic wage increases
and wage drift led to gains in average earnings of 14.8% (see Figure 1).
15. Two equally disconcerting indicators over the period were the
growing size of ::.w wage demands and their recurrence in the same
industries after rather short periods. Thus, during 1970, most initial pay
demands moved up from increases well below 20% to ones significantly
higher. At the same time, little attention was paid to the fundamental
precept of incomes policy that no more than one pay increase in relation
to any particular job should occur in a I 2-month period. Indeed, more
than one-third of the nationally negotiated settlements in the first half of
1970 followed comparable settlements by less than a year. 21
16. A striking feature of the recent wage-push inflation has been the
tenacity - and success - with which unions pressed demands despite
growing unemployment. From mid-1969 through 1970, unemployment rose
from 2.2% to 2.6% 10/ (see Figure 2). Indeed, for the whole period since
devaluation, unemployment has been considerably above the 1.6% of
1959-66, but wages have trended upward faster than for the earlier period.
This pattern doubtless reflects increased unemployment benefits on the one
hand and rising wage aspirations on the other.
9. Interestingly, about half the cases of two settlements in a year were
in the public sector.
10. In general, unemployment levels in the last three quarters of 1970
were worse than those for any year since 1940. This pattern persisted into
the first quarter of 1971, when unemployment rose to 2.82. Ly April the
monthly estimate (seasonally adjusted) was up to 3.1%
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UNITED KINGDOM: Wage and Unemployment Patterns
'Estimated
"Wholly unemployed less school leavers. Seasonally adjusted data,
'Ma?iutactunng, non only.
t Derived using quarterly data and Least Squares Method.
17. Combined with a generally slower growth of labor productivity
than in other industrial countries, the rapid growth of British wages in
1968-69 and their acceleration in 1970 meant a serious depletion of the
broader competitive gains from devaluation. Increases in unit labor costs
in the United Kingdom were substantially greater than for its competitors,
as shown below for the third quarter of 1970.
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a. Data compute on a o ar basis.
b. Inoludi;ig effects of 9.3% revaluation of
the mark in October 1969.
First Quarter 1968
= 100
Export
Prices a/
Unit Labor
Costs a/
United Kingdom
113
Competitors' index
(overall)
111
1')0
United States
111
108
West Germany
114
b/
121
b/
Japan
107
-
101
-
18. The salutary effects of the 1967 devaluation are now essentially
exhausted because: (1) it reduced the dollar value of UK labor costs about
8% relative to those of its competitors; and (2) UK labor costs since then
have increased about 8% more than those of its competitors. The loss of
this competitive edge has not yet been reflected in the volume of exports.
However, exports are bound to be hurt in the longer term. The need to
maintain competitive prices has seriously squeezed UK exporters' profits,
thereby discouraging export activities and undermining related investments.
Those facets of competitiveness that must be continually supported by
investment are critical to the United Kingdom, whose most important
exports are engineering goods. This is so because such goods are classically
sold in markets where advertising, attractive delivery times, a reputation
for dependability, and effective after-sales service are fully as important
as price criteria.
19. If the price/cost consequences of wage escalation are likely to
prove inimical to the British balance of payments, the increasing unrest
among laborers that has accompanied the death of an active incomes policy
is even more dangerous. Delivery schedules for the home and export markets
in 1970 were seriously affected by numerous and sustained strikes in the
engineering i,idustries and by a three-week dock strike in July-August. All
told, the loss of worktime to strikes in all industries and services last year
reached I I million working days (see Figure 3), the highest level since the
unusual general-strike year of 1926. Besides the obvious immediate
consequences for production and exports, such strike losses make the British
economy a particularly unreliable source of intermediate goods and capital
equipment. This fact has seriously dampened the interests of overseas
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'Data exclude stoppages Involving fewer than ten workers or one day unless a total
loss of worktime of 100 days in Involved.
investors in establishing or expanding production facilities in the United
Kingdom, LI/ thereby discouraging needed long-term capital inflows.
Financing Wage Inflation
20. The surge in wages beginning in late 1969 was financed largely
by reducing company profits, although there was an accommodating spurt
11. A notable instance is Ford Motor Company, which is reported to be
k actively planning cutbacks in its British operations and announced in late
February 1971 that it had decided against the United Kingdom as a site
for a $72 million engine plant. Ford has been estimated to have invested
as much in the last 10 years in the British auto industry as the rest of
the automotive firms put together.
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in the money supply in the second and third quarters of 1970. A variety
of indicators showed a decline in real private-sector profits after the third
quarter of 1969, but the redistribution in factor returns is most easily shown
in relation to national income. As can be seen in the table, employment
income hay risen from the 67.6% of total domestic income characteristic
of 1959-66 to 71.1% in the third quarter of 1970. For the same periods,
the gross trading profits of private companies have fallen from 15% to 1 !.4%
of domestic income. This was already a long-term trend, but it accelerated
during 1970. Moreover it was probably accentuated late in the year and
in early 1971, whet, monetary policy was significantly tightened.
21. The predictable consequence has been a reduced capability to
finance expansion from companies' own funds. This - compounded with
tight money markets, the slow growth of the economy, and dimmed export
prospects - has meant a projected decline in fixed investment for 1971.
This was already apparent as new machine tool orders, for the home market
dipped sharply in the fourth quarter of 1970. It is hard to imagine how
the rate of increase of British labor productivity can be significantly
enhanced in these circumstances.
The Emerging Game Plan
22. A review of the constraints under which the British government
framed its policies toward wages and prices in 1970-71 provides no grounds
for easy criticism. The surge in the supply of money and bank advances
under the Labor government in the second and third quarters of 1970
imposed upon the Conservatives an immediate requirement for
tighter-than-usual monetary policy. Moreover, this restraint had to be
undertaken in the face of an international interest-rate differential that
significantly favored the United Kingdom and thereby stimulated
inflationary capital inflows. Popular attitudes with respect to growth and
inflation were also serious handicaps. Growing impatience with unusually
high unemployment, slackening investment plans, and two successive years
of slow growth made monetary and fiscal restraint severe political liabilities.
Wage earners tended to address their efforts toward "doing one better"
on the most recently announced agreements, and an unending wage-price
spiral was generally accepted as inevitable. Further complicating the ultimate
achievement of a counter-inflationary mood throughout the economy was
the fact that earlier wage gains had not yet worked tsicir way through to
higher prices.
23. Difficult as these constraints have proved, they are nowhere near
as eracting as the tightropes that must be walked in dealing with labor
and management separately. If the pervasive inflationary psychology is to
be broken and the process of passing the proposed industrial relations bill
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British Wage and Profit Shares in Domestic Income a/
1959-66
1967
1968
Income from employment
67.6
68.5
68.2
Gross trading profits
of private-sector
companies
15.0
13.4
13.5
Other factor incomes
17.4
18.1
18.3
Total domestic income
100.0
100.0
100.0
.
a. No provision is mad,
,. for stock appreciation.
b. Based on seasonally adjusted data.
Percent Y
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
69.0 69.2 #8.8 69.5
12.5 12.5 12.9 12.5
18.5 18.3 18.3 18.0
100.0 100.0 100.0 100.0
lst Qtr
2nd Qtr
3rd Qtr
70.C.
70.5
71.1
12.0
11.6
11.4
18.0
17.9
17.5
100.0
100.0
100.0
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is not to cost large losses of worktime throughout 1971, it is necessary
for government spokesmen to maintain a meaningful dialogue with organized
labor. This has proved extremely difficult because: (1) there is an historic
distrust toward Conservatives among labor unionists; (2) recent settlements
have provided high benchmarks for subsequent "leapfrogging;" and (3) wage
demands have so clearly exceeded levels that would be acceptable to any
British government. Management has proved only slightly more tractable,
despite its traditional good will toward the Conservatives. The squeeze on
corporate liquidity through the first quarter of 1971 that vexed managers
was generally seen by the government - at least in the short run - as an
advantage, for it was likely to stiffen private-sector resistance to wage
demands. To avert the direct translation of wage gains into price increases
continues to require a blend of reliance on competitive forces and
arm-twisting. At the same time, the government has to reply to arguments
from manufacturers - including particularly those who export -- that wage
increases are generally preferable to strikes and redeveloping lost markets.
24. Despite the challenge of developing a strategy against inflation
within these constraints, there has been no dearth of suggestions for
"simple" solutions. Among the suggestions incorporating particularly broad
economic measures have been proposals for: (1) another devaluation; and/or
(2) more explicit and consistent targets for changes in the supply of money.
Although devaluation - which may ultimately prove r.;;cessary in relation
to EC accession (or later monetary union) - would again enhance the UK's
comparative costs, it would also probably exacerbate the present wage-push
inflation. The latter proposal - reflecting increasing concern for the rate
of growth of the money supply - already characterizes British monetary
policy. This particular nostrum, however, entails recognition that (1)
monetary measures a:e almost certain to result in increased unemployment
before the wage-price spiral is broken; and (2) even reductions in the money
supply affect the r conomv with a considerable lag.
25. Other cure-alls proposed as inflation strategies have included the
delineation of an explicit incomes policy (complete with targets), a wage
freeze, and a price freeze. k li,. in the decay of Labor's explicit incomes policy
and the lack of consensus between the Conservatives and organized labor,
it is hard to imagine how a meaningful and credible set of targets could
be contrived from the opposing views of management and workers. 12
Objections to the concept of a wage freeze hark back to the experience
of 1967 to point out that it would probably be followed by an explosive
12. The difficulties notwithstanding, the Confederation of British
Industries and the Trades Union Congress were engaged in secret exploratory
talks on the possibility of a voluntary incomes policy in mid-April 1971.
At the time, the government remained aloof from the discussions.
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make-up session, which could prove quite detrimental to the UK's balance
of payments a year or two hence. The price freeze is the most subtle of
the numerous suggestions, for it focuses its effects directly on today's
bargaining process. With prices frozen and liquid assets still at unusually
low levels, private-sector companies would be forced to hold the line against
wage demands or go under. It is less clear that public-sector enterprises
would behave as well, for their access to credit is generally better. Moreover,
those in the private sector who had been slowest in the past in vaassing
on wage gains would suffer proportionately more as the freeze was invoked.
Substantial consideration
had been given to withdrawing government from unprofitable economic
enterprises and to encouraging increased competitiveness in the private
sector. Similarly, Prime Minister Heath has repeatedly made it very plain
that reform of industrial relations was necessary to reduce the incidence
of costly wildcat strikes. But none of these goals pertained directly to
reducing the rate of wage and price gains in 1970-71.
27. After a number of false starts and stiffening government resistance
toward wage demands, the game plan of the Conservatives began to take
shape in late 1970 and was substantially refined in the budget message
of 30 March 1971. The key elements have been: (1) developing monetary
and fiscal policies designed to limit the growth of demand to the historic
rate of growth in productive potential; (2) using wage settlements in the
public sector as examples of managerial restraint against wage demands;
and (3) arm-twisting of firms in the private sector that face major wage
disputes. Even in the short period since the Conservative electoral victory,
there have been substantial changes in monetary policy within the broad
guideline of restraint. Thus, offsetting abnormally rapid growth in the
money supply in mid-1970 required a November 1970 call for increased
special deposits and a January 1971 restriction of domestic uses of
short-term capital inflows. By late March, however, a new guideline was
announced for quarterly growth in bank advances at a little more than
double the 1970 rate. J The longer term thrust of fiscal policy became
evident in tax changes in October 1970 and a March 1971 budget, both
of which sought to allow increased retention of corporate funds to support
13. On I April the bank rate (that is, the discount rate) was lowered by
one point from 7% to 6%, but this move was motivated as much by a
desire to keep in step with financial developments abroad as by domestic
considerations.
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a higher rate of manufacturing investment and - thereby - a more rapid
rate of growth and increases in employment. The coordination of fiscal
and incomes policies in the short run is decidedly less clear, for the new
budget will facilitate increased consumption in a period of rapidly rising
wages. The nature of the wage objectives was revealed by: (1) "trial
balloons" on 8%-11.5% guidelines for early 1971 leading to a yearend target
of 7%; and (2) the emergence of the "n-1 " rule. The latter approach looks
for reductions of one percentage point in the sizes of successive settlements.
Arm-twisting and consultation are invoked with some regularity in the hope
that they will carry the public-sector norms - or better - over to the private
sector.
28. The clearest and most immediate measure of the government's
resolve in facing down inflationary actions has been its behavior in
public-sector settlements since its election in June 1970. Early, rather
disorganized efforts at indirect influence in respect to local authority manual
workers (September/November) and coal miners (October/November) ended
in distinctly inflationary wages increases of 18%-20% and 12%, respectively.
A much tougher line toward electric utility workers resulted in a December
power strike that cost the unions considerable loss of public sympathy and
led to pay settlement through a court of inquiry. Unfortunately, the force
of government efforts was blunted in this instance by a February court
finding advertised by the government as a 10.9% increase in average earnings
and generally recognized by the public to reach nearer 20% when bonus
schemes and various sweeteners were included. Nevertheless, hearings by
such a court, which was under instruction to consider "the interests of
the public and of the national economy," temporarily supplanted the
monotonous national pattern of strikes and capitulation and provided a
useful vent for government views on appropriate wage and productivity
increases. The courage found in the initial rounds with the power workers
was sustained in a 47-day strike of postal employees. In this case, referral
to a committee of settlement in early March came after the union had
reduced its initial wage demand from an increase of 15% to one of 13%
and government had remained essentially unmoved from an initial offer
of 8%. At about the same time, a settlement was reached with some 140,000
civil servants, who received raises ranging from 9.5%-13.0%. Still treading
a path between the private sector's highs and its own targets, public-sector
management made a firm final offer of 8.8%-11.0% wage increases to
196,000 railwaymen in mid-April.
29. The weakest link in the government's strategy against inflation
is potentially that of obtaining corporate managerial response to
public-sector demonstrations of restraint. Given the spotty incomes record
of the new government thus far, it is amazing that the private sector has
indeed shown scattered signs of rallying. The public was quite cooperative
in enduring the postal strike, and numerous entrepreneurs acted in that
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case to provide substitute services, Earlier, in January, concern over the
possible outcome of a wage demand at a British Leyland automotive plant
in Scotland (where unemployment runs substantially higher than the
national average) had led to a six-month voluntary wage freeze and thereby
provided the government with a prized example that its program was
beginning to have some impact. That a counter-inflationary psychology was
beginning to take hold with private management was evident in a decline
in January 1971 for the first time in 15 months in the forecast of cost
increases cited in the Financial Times "Monthly Survey of Business
Opinion." This impression was strengthened by commentary in The
Economist in late March on a leveling-off of wage increases at 12% and
by observations in the press in April that new wage demands were down
to the 12%-15% range from 1970's characteristic 20% and more.
Nevertheless, the conclusion in early April of a strike against Ford Motor
Company with a pay settlement incorporating 15`70-18% increases in the
first year and 81Ir9% increases in the second year posed an unfortunate
challenge for subsequent union negotiators. L4J
Outlook for 1971
30. The irrefutable facts of the 1969-71 wage explosion are that price
increases have lagged behind wage gains and that each of the wage
settlements continues to exceed prospective productivity gains by a wide
margin. Combined with depleted corporate funds, these facts spell
accelerating unit cost and price increases for much of 1971 irrespective
of any forthcoming government victories in the wages battle. A surge in
retail prices in the first quarter of 1971 was symbolic of things to come.
Although this particular rise probably owed a little to "rounding up" for
new decimalized prices, the year-to-year gain over the first quarter of 1970
was a sizable 8.6%. Of increasing concern is the size and basis of the
7.6`70-8.4% 15/ increase in the wholesale price index for manufacturers'
home sales between the last quarters of 1969 and 1970. This gain in
wholesale prices took place despite very little corresponding change in the
prices of related raw material and fuel inputs. 16/ Rising prices of crude
oil and raw materials, the end of a deficiency-payments system in
agriculture, and some further adjustments to decimalization will all add to
the basic wage push this year to keep prices soaring. The real question
14. At about the same time, Vauxhall, another firm in the automotive
industry, reinforced the adverse effects of the Ford Settlelnent by oJferirg
a 28% pay hike spread over 17 months.
15. The upper end of the rage excludes products of food, drink, and
tobacco manufacturing industries.
16. For all manufacturing industries, material and fuel inputs rose 2.3%
in price; excluding food industries, there was a 0.1% decline.
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for the government is whether the pervasive inflationary psychology can
be broken promptly to halt further hedging against price increases in wage
demands, thereby slowing inflation toward yearend.
31. Further complicating the goal of achieving a slowdown in prices
and wage gains has been the groundswell of public opinion in favor of
immediate reflation, to reduce unemployment. L7/ The budget announced
on 30 March provides a modest first-round stimulus of about #250 million
($600 million) to aggregate demand. Although this superficially appears far
short of the #500 million "initial" stimulus called for by the prestigious
National Institute of Social and Economic Research, [/ the budget
contemplates and supports an increase of 5.3% in consumption (as compared
with 2.8% and 3.3% in the preceding fiscal years). In contrast, both fiscal
and monetary policies have been framed to permit a gain of about 0.5%
in private fixed investment during the fiscal year 1971/72. The objective
of an expansionary budget is to get quick gains in output and
productivity, 19/ thereby moderating the rise in unit costs. At the same
time, however, the fiscal (and monetary) stimulus will make it easier for
the private sector to finance higher wages and will also contribute to
inflation by raising consumer demand.
32. Because of the complexity of wage and fiscal developments and
the heavy dependence of the rate of inflation on psychological factors, it
is quite risky to project cost/price movements for 1971. In November 1970
the Organization for Economic Cooperation and Development (OECD)
projected slowdowns in the UK's annual rates of growth in average earnings
to 12% and wage rates to 10% by the second half of 1971, but both these
projections were based on under-estimates of the 1970 pay gains. As
indicated above, the government speculated in January about the
possibilities of attaining a 7% annual rate of wage increases by yearend
and an 11% rise in earnings for the year (compared to 14%-15% for 1970).
Ironically, these figures were trotted out at the court of inquiry into the
electric power settlement, which eventuated in earnings increases close to
20%. For the moment, it is safe to say that the annual rate of increase
in retail prices is on its way up past 10% and that it may be some months
before the corresponding increase rate for wages falls below that. Thus it
is quite possible that the annual increase for 1971 for both retail prices
17. See footnote to paragraph 16.
18. The difference in the two positions is narrowed by the fact that the
new budget includes tax payments for 1970171 that were not actually
collected until 1971 172 because of the postal strike.
19. Were unemployment lower and industrial capacity utilization higher,
the productivity gains would not be possible. It remains to be seen if the
government 'C Judgment about existing slack is correct.
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and wages will be about 10% and that workers' earnings will rise somewhat
more. Even this rather alarming prospect will depend in no small measure
on sustained, energetic efforts of the government to face down wage
demands. Failing this, there will probably be need to resort to a wage and/or
price freeze and to a substantial further increase in unemployment.
33. The implications of sustained inflation in the United Kingdom
for 1971 are plain. Although the UK economy is currently running at less
than its potential growth, the present inflation will allow only very limited
and cautious use of reflationary measures this year. International prospects
are no more encouraging. Few - if any - other industrial countries will
experience comparable increases in costs and prices in 1971, and British
export competitiveness will likely sink to below the pre-devaluation levels.
For the early part of 1971, however, the adverse effects on the UK's export
volume will likely be offset by increased export prices. The declining
competitiveness will show in a substantially worsened trade balance toward
yearend. Moreover, traditional market positions and export opportunities
will suffer further as wage battles and political strikes over the industrial
relations bill occasion even more losses to worktime than in 1970. 20/
Long-Run Implications of British Inflation
34. Continued rapid inflation will inhibit Conservative strategies to
effect structural changes in the slow-growing British economy. The economic
policies necessary to function in an atmosphere of rapid wage and price
increases will often conflict with those likely to facilitate private initiatives
and a smooth entry into the EC. In particular, sustained inflation will hobble
the Conservative government in: (1) devising policies for faster economic
growth; (2) defending sterling and covering international economic
requirements; and (3) holding the party's present political base.
35. The need in the face of sustained inflation to restrict the growth
in demand through fiscal and monetary restraints will inhibit the degree
to which private initiatives can be actively encouraged. A continuation of
this year's wage and price trends will require maintaining interest and
corporate tax rates at a level still too high to permit an adequate base
for rapid expansion of private investment. Moreover, purposive restraint of
the rate of growth, which is necessary because of inflation, will also tend
to dampen what Lord Keyes called "the animal spirits of investors." A
slowdown in the advance of corporate profits and the demand for
20. Total losses to strikes of 12.1 million workdays in the first quarter
of 1971 already exceeded those for all of 1970. Of the 12.1 million, soric
9.5 million were lost to wage and working conditions disputes and some
2.6 million to political strikes against the industrial relations bill.
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investment could not come at a less auspicious time. Rapid structural change
and improvement in production techniques will be needed to meet the
competition with Common Market manufacturers attendant on EC
accession.
36. Although the British have recently enjoyed a respite from their
near-perennial bouts in defense of sterling, one of the prime effects of
sustained inflation will be a significant weakening in the balance of
payments. LIJ As a consequence, they will probably have difficulty in
covering the net balance-of-payments costs (for the medium term) of
accession to the EC. This is likely to result in economic measures that
would tend to restrain domestic investment and growth, thereby nullifying
some of the Potential gain from EC membership. To avoid this, the British
government may ire forced to devalue the pound prior to accession. As
the lessons of 1967-68 clearly demonstrate, it is extremely important that
the government break the prevalent inflationary psychology before any
devaluation, or even this strong medicine will be quickly dissipated in
another round of wage and price gains.
37. Because inflation acts as a continuing catalyst for dissension
concerning government's role in guidance and management of the economy,
it also threatens to erode the base of Conservative political support. With
only very limited progress in slowing wage inflation in the public sector
and no solid clues on the content of incomes policy in its mildly
expansionary 1971 budget, the government is particularly vulnerable to the
criticism that it is transferring the full responsibility for breaking the
wage/price spiral to private-sector management. Proposals for effective
alternatives - such as wage or price controls - involve a degree of
intervention generally unacceptable and politically costly to the
Conservativ,;s. The slight relaxation of monetary restraints and the modest
reduction of the corporate tax rate may sustain a brief honeymoon with
private-sector management, but there will probably be growing anxiety on
its part as arm-twisting - without guidel."l-q - is increasingly invoked to
11. The principal adverse impact of increasing relative costs and prices is
on the trade account. As indicated in an earlier section of this memorandum,
this is most strongly felt in terms of a reduction in export competitiveness
and profitability. One indirect consequence of inflation that has proved
favorable to the balance of payments has been the need to maintain high
interest rates as one -neans of encouraging saving and restraining the
expansion of credit. This resulted in large inflows of short-term capital in
late 1970 and early 1971. Although the short-term movements indirectly
facilitated debt repayment, they are a mixed blessing because: (1) they
are volatile and could quickly reverse (to Britain's detriment); and (2) they
tend to worsen domestic inflation.
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hold down the inevitable price rises in 1971-72. Organized labor, which
perceives any intervention by a Conservative government in the labor market
as anathema, will likely become more militant in reaction both to broad
government statements on the need for wage restraint and to the
development of a new legal and institutional framework under the industrial
relations bill. 22/ Although the growing popular acceptance of the industrial
relations bill owes much to public resentment toward recent labor excesses,
its passage in a period of inflation is complicated by the fact that related
political strikes, by disrupting pr( duction, fuel further cost and price
increases.
38. Another social conflict exacerbated by the present inflation is
the question of appropriate income distribution within British society. The
most apparent facet of this conflict is the tattle betweer management and
wage-earners, but the process of inflation also takes a toll among
less-organized and less-vocal elements of society. The present rates of wage
and price increases reinforce such trends as: (1) the transfer of real income
away from the self-employed and those on fixed salaries or pensions; and
(2) the transfer of real wealth away from savers. ai Indeed, the only real
gainers in income redistribution in recent years have been those within
organized labor, where support for the Conservative Party is classically thin.
In contrast, the traditional supporters of the Conservatives were the relative
income losers of the late 1960s. Just as this undoubtedly contributed to
the cohesion of the party in the June 1970 electoral victory, failu.e to
offset the steady redistribution of income shares toward organized labor
will serve to undermine Conservative support.
39. The steady erosion of the political consensus underlying Labor's
incomes policy resulted in money wage increases substantially greater than
productivity gains after the 1967 devaluation. Poor timing and coordination
of monetary and fiscal measures during 1968-69 meant lost opportunities
to protect the improved international competitiveness and to lay the
22. An even more pointed conflict with the labor faction could develop
over a recent government proposal to reduce the weekly social security
compensation paid to families of some long-term strikers. Aggressive
government action on this measure could be impeded by the need to
minimize confiicts in an already volatile inflationary setting. It might prove
easier and less contentious to pass such a measure if wage disputes and
their related strikes were less numerous.
23. These tendencies have particular political importance in the United
Kingdom, where a relatively larger share of the population is 65 or over
than in all but a few o!her countries.
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groundwork for solid real growth and productivity gains. A key - and
unsuccessful - battle to pass an industrial relations bill in 1969 absorbed
much of government's energies, wasted its remaining influence with labor
leaders, and diverted its interest from the defense of the often-violated 3.5%
target for annual wage gains. The result of these patterns was a rapid
escalation in wage demands and settlements in 1969.
40. Perhaps already doomed because it was to be an election year, -
1970 saw unusual highs in wage and price gains, losses of worktime to
strikes, and unemployment levels.
Despite increasing monetary restraint
and some stiffening of resistance to public-sector demands, the new
government wis unable to turn the tide before yearend; and fourth-quarter
indexes for retail prices, wages, and earning were up 7.7%, 13%, and
14%-15%, respectively, over the corresponding period in 1969. Although
some progress was made in communicating to the private sector a sense
of government resolve to hold the line against inflationary demands with
which it was confronted, the conclusion of a contract for large wage gains
by the Ford Motor Company and the announcement of a mildly reflationary
budget that contained scant guidance on incomes policy seriously clouded
the outlook for This year.
41. Even allowing 1 jr sustained government success in rallying
corporate management against exorbitant wage increases, UK wages and
retail prices will probably still rise close to 10% in 1971. The principal
causes of this alarming outcome will be: (1) the need to increase product
prices to cover earlier wage gains and adjustments to decimalization; (2)
increasing costs of non-labor inputs such as raw materials and foods; and
(3) the severe difficulty of breaking into the inflationary anticipations that
keep initial wage demands high. In consequence, purposive reflation will
remain very risky, and the economy will continue to grow it less than
its potentir' Moreover, the anticipated cost/price effects will drop British
export competitiveness below the November 1967 level, an outcome likely
to become quite evident in export earnings by yearend.
42. The principal longer term effect of continued inflation would be
to inhibit seriously Conservative strategies to accelerate economic growth.
The ntt;essary stimulus to provide initiatives would be dampened by the
requirement to avert any further impetus to wage and price gains. This
comparative restraint would reduce the scope for expansion 6f domestic
investment incidential to EC accession, and the inflation-related weakening
of the balance of payments would also complicate the process of meeting
the mediam-term costs of Common Market entry. Because the adverse
effects of relative wage and price rises are already in train, Britain may
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be forced to devalue the pound before EC accession; but the experience
of I967-68 clearly indicates that it will be crucial to break the prevailing
inflationary psychology beforehand if this measure is to have some lasting
results.
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