THE BRITISH ECONOMY ON THE EVE OF THE NIXON-HEATH MEETING

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001700020090-9
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 10
• Document Creation Date: December 22, 2016
• Document Release Date: March 2, 2010
• Sequence Number: 90
• Publication Date: December 1, 1971
• Content Type: IM

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7/--a31 10 '`
Confidential
DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
The British Economy on the Eve of the Nixon-Heath Meeting
Confidential
ER IM 71-237
December 1971
Copy No. 79
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WARNING
This document contains information affecting the national
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.
GROUP I
t%CLDOFD FROM AUTOMATIC
DON NOUADINO AND
OFCLAa$T (CATION
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CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
December 1971
INTELLIGENCE MEMORANDUM
THE BRITISH ECONOMY ON THE 17--.-E
OF THE NIXON-HEATH MEETING
Conclusions
I. The United Kingdom is presently experiencing stagflation -- a
condition of little or no economic growth accompanied by a high inflation
rate. The number of unemployed is the largest in more than a generation,
while retail prices have increased by 10% in 1971. After a lackluster
performance in 1970, real gross national product (GNP) actually fell in
the first half of 1971. Ironically, the foreign payments position has
strengthened - partly as a result of the past year's domestic economic
doldrums. Import demand has been below what it would otherwise have
been while export sales have been good. As a result, the traditional trade
deficit has changed to a surplus this year, and trade prospects for 1972
are encouraging.
2. The domestic economic outlook is less clear. There are signs that
a recovery is under way, but not as vigorous as London would like.
Consumer and investor confidence has yet to be restored, and much
uncertainty remains concerning inflation and the impact of entry into the
European Community (EC). The US monetary and trade measures
instituted in August have not been much of a factor in the British economy's
poor performance, and the reforms sought by Washington probably will
not greatly affect Britain's rate of economic recovery in 1972. Indeed,
short-term capital inflows have pushed UK international reserves to record
levels.
Note: This memorandum was prepared by the Office of Economic Research
and coordinated within the Directorate of Intelligence.
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25X1
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Discussion
The Domestic Sector
3. The term stagflation accurately characterizes the UK economy
in 1971. Indeed, sluggish growth and retrenchment have been the order
of the day sine:: mid-1970. After a below-capacity growth rata of only
2.1% in - 970, real GNP fell slightly during the first half of 1971. In January
1971, average hourly wage rates were 14.2% higher than a year earlier,
and during most of this year's first three quarters retail prices advanced
about 10%. Inflation has moderated slightly since this past summer, but
thij small improvement could be vitiated by vigorous union bargaining this
winter and next spring. Strikes of dock, automobile, and postal workers
contributed to the economy's sluggish performance during 1971. Other
factors hav1 been the working down of inventories and reduced capital
spending generally.
4. Continuing slack domestic demand and increasing labor cods
resulted in a profit squeeze that forced many employers to lay off surplus
workers or postpone new hirings during most of 1971. Unemployment --
normally 2%-2.5% of the labor force - stood at 3% at the beginning of
1971 and increased to more than 4% by early December, when nearly 1
million people - a 30-year high - were out of work. Heavy manufacturing
in the Midlands was hard hit, with the unemployment rate at more than
5%. Scotland and. Northern Ireland suffered even more, with average
unemployment at 6% and 9%, respectively, in October. In addition, many
other workers were placed on short work weeks, and overtime payments
were sharply reduced.
5. Prime Minister Heath's initial strategy against inflation included
restraints on public finance. Thus the Conservatives adopted a policy of
restricting the public sector's claim on resources and of less direct
intervention in the economy when they took office in June 1970. The
policy's keystone was keeping the growth of public expenditures below that
of the economy. The economy's behavior in early 1970 suggested the need
for some government pump-priming; yet the new government raised its
spf nding by only small amounts in 1970 and the first half of 1971.
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6. London did institute some modest reflationary measures this past
March and July and again in November. The March steps included a 2.5%
cut in corporate taxes and an increase in personal income tax exemptions.
In July the government introduced an 18% reduction in sales taxes, stepped
up spending on public works projects, and liberalized tax credit, installment
buying, and depreciation rules. Measures to speed up spending on previously
planned government projects were announced in November. All three sets
of measures have been consistent with Heath's philosophy of making revenue
reductior rather than new spending.. the cuttinr, c'ige of his fiscal policy.
The July measures should have greater impact than those taken in March;
there are already indications that retail sales have responded favorably to
the sales tax cut. The effectiveness of the other measures will not become
apparent until well into 1972, and then only gradually.
The Foreign Sector
7. The current account of the UK balance of payments continued
to strengthen during 1971. For the first three quarters of 1971, the current
account surplus was about $1.6 billion - nearly 70% more than in the
same period of 1970. The improvement in the trade balance was striking.
The United Kingdom traditionally imports more than it exports, but this
situation was reversed in i970. Exports of goods and services during the
first three quarters of 1971 totaled $15.7 billion (13% higher than during
the same period in 1970), while imports were %15.3 billion (up 10% over
1970). There consequently was a trade surplus exceeding $400 million.
8. Several factors are responsible for the United Kingdom's unusually
favorable balance-of-payments position in 1971. First, slack domestic
demand kept imports from increasing as much as they might have otherwise.
Second, a rise in world trade in 1971 has kept demand for the United
Kingdom's exports strong. Finally, net "invisible" earnings have continued
high. Britain's official debt has been reduced, and the inflow of invisible
earnings from banking, shipping, tourism, insurance, and foreign investments
has been good.
9. There is no clear evidence that the US monetary and trade
measures instituted in August 1971 have yet had more than a mi;iimal
impact on the United Kingdom's foreign trade. Exports to the United States
dropped sharply during November, but this was largely due to the US dock
strike. Although government and business spokesmen voiced increasing
criticism of the US trade measures during October .nd November, only
about 8% of the United Kingdom's exports are affected by the import
surcharge. Moreover, most of these exports are either luxury items, the
demand for which is relatively insensitive to price changes, or engineering
products that are highly specialized and not easy to substitute for in the
short run.
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10. The months of monetary uncertainty following the US
announcement do not appear to have significantly deepened or prolonged
the economy's slump. The slump started long before 15 August, and present
consumer and investor uncertainty is much more closely related to inflation,
Common Market entry; unemployment, and the government's hesitant
reflationary policy than to conditions in the foreign sector, which is
performing well.
11. International monetary reserves have increased sharply during
1971 to a record $5.6 billion in November, an increase of $2.8 billion
over the c:nd of 1970. Apart from the current account improvement, Britain
received a massive inflow of funds associated with continuing overseas
confidence in sterling, the tight domestic monetary policy, and a high level
of international liquidity. The capital inflow has continued at a high rate
even since August, when the pound began to float in currency markets.
The economy's strong foreign trade performance and London's traditional
role as a reserve center for the sterling area, are generating upward pressure
on the pound, however, and Bank of England intervention in the foreign
exchange market - creating a so-called "dirty float" - has been provoked
by large inflows of short-term capital.
Economic Problem Areas
12. The most important impediment to Britain's recovery from its
current recession is a widely held feeling of uncertainty on the part of
both consumers and investors. Some of their uncertainty is related to the
feared economic impact of joining the EC. Although the government has
been extolling the advantages of an expanded market for British producers,
some firms have been holding back their spending until the necessary
enabling legislation is enacted and they are in a better position to assess
the effect on British exports. It will probably be six months to one year
before they will be able to appraise confidently their EC opportunities and
be willing to make firm investment plans. Consumers, for their part, are
not sure how entry will affect their standard of living.
13. Consumers and investors are also uncertain about the future
course of inflation. Although increases in wages and prices moderated
slightly this fall, the inflation rate remains unacceptably high. There are
some signs that the government may have at least turned the corner on
this problem, however. In July the Confederation of British Industries (CBI)
obtained a commitment from 200 large firms either to try to forgo price
increases or limit them to a 5% annual rate until July 1972. Moreover,
in recent weeks Britain's Trades Union Congress has shown signs of
becoming more cooperative in seeking more moderate wage settlements.
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The government has set its sights on reducing wage increases to 7%-8.5%
yearly this winter, whereas earlier this year increases averaged 10%-14%.
14. Rising unemployment has probably now replaced inflation as the
government's main economic problem. Although the present 4% rate may
not appear inordinately high compared with recent US rates of some 6%,
much of the difference reflects the fact that the United Kingdom defines
unemployment much more restrictively -- measured in US terms, the UK
rate would be about 5%-5.5%. Labor unions are becoming increasingly bitter
over the sharp increases that have followed mcmth after month. When the
government announced in late November that unemployment had reached
4%, 10,000 workers staged a disorderly protest outside Parliament and union
leaders met with Prime Minister Heath to demand a $2.4 billion increase
in spending to stimulate the economy.
Prospects for 1972
15. Forecasters are predicting that 1972 will bring a moderately paced
recovery. The government officially forecasts a real growth rate of 4%-4.5%
during the first half, led by increases in consumer spending -- especially
for durables. The National Institute for Economic and Social Research
(NIESR), the country's leading private forecaster, recently predicted a
growth rate for all of 1972 of 4%, compared with an estimated 1% for
1971. NIESR foresees increases in both personal consumption and exports
of 4.3%.
16. In view of the mixed economic news in recent months, both
forecasts may prove to be overly optimistic. Both assume that consumers
and investors will react positively tc the government's reflationary measures.
Although consumer spending seems to be picking up, bad economic news
could depress spending and hold the recovery below the forecast rate. The
latest CBI survey shows business confidence picking up, with more investors
expecting an upturn than a downturn. The survey also indicates, however,
that most investors expect to invest less in 1972 than they did in 1971.
17. If consumer and investor spending in early 1972 are much below
the forecasters' targets, the government probably will step in with still more
reflationary measures. Heath's conservative attitude toward government
spending and counter-cyclical fiscal policy appears to be changing to a
reluctant willingness to use the budget to help get the economy moving.
The :.eflationary measures taken in March, July, and November should raise
public spending by 4% in the fiscal year ending March 1972.
18. Because changes in the unemployment rate tend to follow rather
than lead changes in output and sales in the United Kingdom, it is likely
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that substantial unemployment will remain a problem throughout 1972,
whatever reflationary steps are undertaken. The rate will probably remain
above 3.5%, even in the face of a moderate pickup in domestic demand.
19. The outlook for substantial improvement on the inflation front
next year is not as bright as that for output. Although inflation is no longer
increasing, it remains high. Retail prices were 9.4% higher in November
than a year earlier, and the informal pricing agreements among government,
business, and labor will probably not soon bring about a significant
reduction in the inflation, rate.
20. The balance of payments should remain strong in 1972. The
expected improvement in domestic demand will increase imports somewhat,
but strong export growth iii projected to continue, at least through the
first half of 1972. NIESR forecasts a current account surplus of about $2.3
billion, or about the same amount as is anticipated for 1971.
21. Settlement of international monetary difficulties probably will not
greatly influence the pace of Britain's economic recovery. To be sure, an
early settlement on terms favorable to the British would help to revive
confidence, but its other effects would be felt only gradually over a period
of years.
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UNITED KINGDOM: Selected Economic Indicators
INDEX
1909=100 GNP
105 r-- (1963 market prices)
100
95
101
CONSUMER PRICES
I I I
Iv I II
1971
PERCENTAGE
3.9% RATE
-14
.00
_I I I
III IV
1969
INDEX
1903-100
-1100
III IV I II III
1969 1970
MILLION US $ TRADE BALANCE
000 f- (Balance-of-payments basis)
BILLION US $
-10
512742 12-71
I I I I I I
II III IV I 11 III
1970 1971
I I I I I
IIL'' IV: II hI
1969 1970':
INTERNATIONAL
RESERVES
I I I I
IV I 11. Ip
1971 ..
- 7 -
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