Understanding the UK Economy

Understanding the UK Economy Edited by

Peter Curwen

Macmillan Education

ISBN 978-0-333-51105-3 ISBN 978-1-349-20586-8 (eBook) DOI 10.1007/978-1-349-20586-8 Selection and Introduction ©Peter Curwen 1990 Individual chapters © Bob Sedgwick (ch. 1); Peter Curwen (chs 2-5); Brian McCormick (ch. 6); Paul Marshall (ch. 7); Keith Hartley and Nick Hooper (ch. 8); David Gowland and Stephen James (ch. 9) Softcover reprint of the hardcover 1st edition 1990 978-0-333-51104-6 All rights reserved. For information, write: Scholarly and Reference Division, St. Martin's Press, Inc., 175 Fifth Avenue, New York, N.Y. 10010 First published in the United States of America in 1990 Library of Congress Cataloging-in-Publication Data Understanding the UK economy/ edited by Peter Curwen. p. em. ISBN 978-0-312-04749-8 1. Great Britain-Economic conditions-1945- 2. Great Britain-Economic policy-1945- 3. Great Britain-Foreign economic relations. I. Curwen, Peter}. HC256.5.U56 1990 9D-30893 330.941-dc20 CIP

To Ben and Alex

v

Contents List of Figures List of Tables Preface List of Abbreviations Acknowledgements

Introduction

ix xi xiii XV

xvii

Peter Curwen

The neo-classical world The neo-classical 1930s The Keynesian revolution Neo-classicism in decline Efficiency versus equity Employment, trade and inflation The brief reign of monetarism The Thatcher years The political context

12 13 15

The Macroeconomy

Bob Sedgwick

1

2 3 4 6 7 9

Introduction Peter Curwen The national accounts National income and output, 1977-88 Investment Personal income, consumption and saving Peter Curwen Economic performance Inflation Supply-side economics Peter Curwen Appendix 1.1 Say's Law, the Laffer Curve and the Gutman Effect Appendix 1.2 Supply-Side Measures

2

19 22 31 35 41 47 52 61

64 65

The Financial System Peter Curwen

Financial intermediation Classifying financial intermediaries

69 71

The Bank of England The banking sector Non-bank financial intermediaries Money markets Capital markets 'Big Bang' and its aftermath Investor protection Financial intermediation in the future Conclusion

3

Spending, Taxing and Borrowing Peter Curwen

Introduction Public expenditure The overall tax burden Fiscal drag The tax system The EC and tax harmonisation The Budget The public sector borrowing requirement and public sector debt repayment

4

72

74 83 88 93 95 97 98 102

103 104 112 114 114

123 125

127

External Transactions Peter Curwen

Introduction The system of balance of payments accounts The structure of the accounts The accounts in retrospect Competitiveness Area composition of UK visible trade Commodity composition of UK visible trade Exchange rates Exchange rate issues Is there a balance of payments crisis?

131 132

134 138

145 147 149 151

161

163 vii

viii

Contents

The international monetary system The international debt crisis

5

External Relations

168

Industry and Policy

Keith Hartley and Nick Hooper

Introduction: the policy issues Theory and industrial policy 172 The economics of regulation and regulatory policy 172 policy Competition 175 Ownership 181 policy 184 Subsidy Public purchasing 185 Conclusion 187 188 194 195

The Labour Market

9

Brian McCormick

Introduction Trade unions The legal framework Education and training Employment Unemployment Causes of unemployment The reduction of unemployment Issues in pay determination Conclusion

7

8

Peter Curwen

Introduction The single European market The European monetary system (EMS) Protectionism Reciprocity General Agreement on Tariffs and Trade (GATT) UK/EC budgetary relationships Agriculture Recent EC Budget negotiations Costs and benefits of agricultural reform

6

164

199 200 202 207 212

217 225 227 229 234

Welfare: Inequality and Poverty Paul Marshaii

Inequality and income distribution The concentration of wealth Poverty and income maintenance The response from the system

236 246 251 256

266 268 277 279 287 292 298 305

Macroeconomic policy

David Gowland and Stephen ]ames

Introduction Macroeconomic policy A framework of analysis Methods of monetary control The 1950s and 1960s: the age of demand management The 1970s The 1980s: the Thatcher years The policy in action The decline of Keynesianism Friedman's critique New Classical and radical critiques Financial policy in the ascendant The desirability of intermediate targets Direct controls on credit Are Budget surpluses beneficial?

306 307 310 313

Index

347

315 318 322 326 332 334 336 338 340 343 344

List of Figures 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 1.10 1.11 1.12 2.1 2.2 3.1 3.2 3.3 3.4 3.5 3.6 3.7 4.1 4.2 4.3 4.4

A schematic representation of the UK economy Capacity utilisation Total business investment Companies' net rate of return on capital Personal income, 1977-89 Share of consumers' expenditure, 1988 Total domestic saving as% of GOP at factor cost Real GOP, 1981-87 Annual contribution of stockbuilding to GOP growth Average growth for six-year periods, 1949-54 to 1983-88 The Retail Prices Index Consumer price indices, selected countries, i975-88 Retail banks, balance sheet Building societies, assets and liabilities General government expenditure and planning total in real terms, 1963-64 to 199D-91 General government expenditure as %of GOP, 189D-1986 Public expenditure by function The tax burden Tax revenues as% of GOP, selected OECD countries, 1986 Sources of revenue, 1989-90 PSBR as % of GOP UK balance of payments accounts, 1983-88 Measures of UK trade competitiveness Visible trade balance 'Old' sterling ERI, 1972-88

20 32 37 40 42 43 47 49 50 51 54

4.5 5.1 5.2 5.3 5.4a 5.4b 6.1 6.2 6.3 6.4

57 77

6.5

85

6.6

106

6.7 6.8

109 110 112 113 126 129 135 146 152 157

7.1 7.2 7.3 7.4 7.5 7.6 8.1

International reserves, % change on previous year National subsidies as % of domestic income EMS exchange rate constraints Producer subsidy equivalents, 1979-81 and 1984-86 Price adjustment gap: cereals Price adjustment gap: sugar Employment and training measures, numbers of people supported Civilian labour force of working age and population of working age by sex, Great Britain Workforce and workforce in employment, UK UK unemployment flows, April 1988-April 1989 Unemployment by age, duration and sex, April 1987 and April 1989 International comparisons of unemployment Regional unemployment rates Annual rate of change of weekly earnings of all workers Hypothetical Lorenz curves and the measurement of inequality Measuring the Gini coefficient from the Lorenz curve Dispersion of gross weekly earnings, 1977-87 Lorenz curves as calculated by Morris and Preston (1986) Distribution of wealth, UK, 1976-88 Composition of net wealth of personal sector, UK, 1971-87 Mergers, scale economies and competition

168 174 177 196 197 197 211 213 217 220 221 222 224 226 239 240 243 246 248 249 271 ix

X

8.2 8.3 8.4 9.1 9.2

List of Figures Linkages in the political market: the example of smoking Classifying privatisation The economics of collaboration Relationships among monetary aggregates and their components Bank base rates, 1977-89

276 289 299 311 328

9.3 9.4 9.5

Aggregate demand, aggregate supply and inflation Aggregate demand, aggregate supply and Phillips Curves Alternative approaches to credit control

335 336 343

List of Tables 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 1.10 1.11 1.12 1.13 2.1 2.2 2.3 2.4 3.1 3.2 3.3 3.4 4.1 4.2

National product and GOP, 1988 24-25 GOP at constant factor cost 27 28 UK GOP by industry 1988 GOP, growth of output by sector, 198D-88 29 UK real domestic product by category of expenditure, 1977-89 30 Investment (GDFCF) by type of asset and by sector as a% of GOP, 1977-88 34 Investment by type of asset as a % of GDFCF 38 Personal income, expenditure and 44 saving Real GOP growth 49 52 Output per person employed Assorted price indices 55 Contributions to output prices in manufacturing from changes in cost components 60 Estimated contributions to the growth in output prices 60 Financial intermediaries 72 UK monetary sector, deposit liabilities at 30 Sep 19~8 75 Building society statistics 84 Unit trusts, 1984-88 87 Public expenditure totals 105 General government expenditure, excluding privatisation proceeds, as a % of GOP: plans and out-turns 108 The structure of the UK tax system 114 since 1948 Debt repayments of central government (CGDR) and public sector (PSDR) 128 International comparisons of external net assets 137 Index numbers, UK visible trade 139

UK official reserves, 1973-87 Balance of payments of the UK, 1975-88 4.5 Area composition of UK exports, f.o.b., 1955-88 4.6 Area composition of UK imports, c.i.f., 1955-88 4.7 Commodity analysis of imports 4.8 Commodity analysis of exports 4.9 Selected sterling exchange rates and effective exchange rate index (ERI), 1972-89 4.10 Selected external indebtedness, 1985 5.1 The composition of an ECU 5.2 Central parity realignments within the EMS 5.3 General government transactions with the institutions of the European Community 5.4 Comparative agricultural data in the EC 5.5 'Cost-price squeeze'; ratio of producer prices to input prices 6.1 Trade unions: numbers and membership in the UK 6.2 UK population 6.3 Employees in employment, by industry, UK 6.4 Measures of unemployment, all workers, UK, 1971-88 6.5 Changes in the methods of recording unemployment statistics, 1979-88 6.6 Ratio of unemployment benefits to average earnings net of tax 6.7 W omens' hourly earnings relative to those of men, 197D-88 6.8 Stoppages in progress, UK, 1967-88 7.1 Cumulative distribution of personal income before tax, UK, 1949-85 4.3 4.4

141 142 148 148 150 150 156 170 176 178 188 190 192 202 212 216 218 219 229 230 233 240

xi

xii

List of Tables

7.2

% shares of main components in total personal income, UK, 1967-87 Cumulative distribution of personal income after income tax, UK, 1949-85 Household definitions used by CSO in estimates of income distribution as modified by state tax/transfer programmes, 1989 Cumulative distribution of original, disposable and final household income, UK, 1976--86 The distribution of wealth in Great Britain, 1911-60 and the UK, 1966--85 The 1940's foundations of the Welfare State in the UK Projections of the elderly population, UK and selected countries Estimates of supplementary benefit take-up Contribution to GOP by sector Employment and productivity A taxonomy of industrial policy Major competition policy measures

7.3 7.4

7.5 7.6 7.7

7.8 7.9 8.1 8.2 8.3 8.4

242 244

245 245 248 254 255 261 267 268 271 280

Firm size and market structures UK privatisations Ownership and market structure: a taxonomy 8.8 OTI and government subsidies 8.9 Government spending on science and technology 8.10 Contracting-out: progress and potential 8.11 Contracting-out: the arguments 8.12 Savings from competition 9.1 GOP, inflation and unemployment, 195D-79, selected years 9.2 Monetary targets and outcomes, 1976--79 9.3 Medium Term Financial Strategy: target ranges and outcomes 9.4 The performance of the economy, 1979-88 9.5 The Lawson boom - selected indicators, 1985-88 9.6 Representative money market interest rates 9.7 Incomes policies 9.8 Stabilisation policy

8.5 8.6 8.7

.

284 290 292 294 297 301 302 304 316 321 324 326 329 331 339 340

Preface We very much hope that the justification for writing a book of this kind is self-evident. If this is not the case, then we simply wish to point out that economic literacy remains at far too low a level in the UK. In seeking to enhance this literacy we like to think that this book will be of interest to a very wide-ranging audience, but we recognise that, in practice, almost all those who read it will be studying a parallel course in economic principles, either at 'A' level or as undergraduates, or will already be acquainted with economic issues either through their work or their reading of the financial press. We hope that the book is sufficiently challenging to interest readers who are already conversant with economics, but not so challenging as to prevent readers who are not conversant with economic theory from following the discussion. We have tried to strike an acceptable balance between analysis and description. It is obviously necessary, in a book of this kind, to describe how the UK functions at the present time, and also how it has functioned in the past where this has been different. It is, however, unilluminating simply to explain what is done in policy terms without simultaneously explaining why, and the reasons why are also to be found in the book where appropriate. It should be noted that the kinds of models to be found in textbooks may often fail to explain why many policies are being pursued, because the real world may be evolving very rapidly and be using fairly crude rules of thumb whilst coming to terms with these changes. It is accordingly our intention to concentrate upon the real world, and to give short shrift to textbook models which cannot shed much light upon it. Most readers familiar with economics will have been taught the subject as a succession of separate boxes labelled 'employment', 'inflation', and so on. There is, as a consequence, a preference for applica-

tions to be organised into similar boxes, to be dipped into one by one as appropriate. We do not care for this approach because, first, it fails to emphasise the fundamental linkages between the various parts of the economy; secondly, it fails to deliver a satisfactory historical perspective; and thirdly, it permits the authors covering the content of separate boxes to offer a subjective interpretation of events which conflicts with that to be found in other boxes. Rather oddly, some books consider this latter point to be a virtue, and express distaste for the imposition of monolithic structures. Our view is that this is very much a vice, and is indicative of lack of editorial control. This book is accordingly approached from precisely the opposite viewpoint - namely, that individual authors should work to a carefully predetermined structure and that stylistic differences should be kept to a minimum. In particular, each author has been asked to set out the pros and cons of every policy debate without prejudice. This does not mean that the authors do not have strong preferences concerning the conduct of policy, nor indeed that they have refrained from expressing them, but rather that they do not seek to persuade by omitting to mention what the counter-arguments are. The issue concerning the need to provide a framework which integrates individual sections has been difficult to resolve. One innovative feature in this respect is the introductory chapter which seeks to provide both a philosophical basis and an historical perspective for all that follows. A second innovation is to set the discussion of fiscal and monetary policy at the end of the book, in Chapter 9, so that it draws together the macroeconomic threads from previous chapters, with Chapter 8 doing the same for the microeconomic threads. The early chapters presume least prior knowledge, but where necessary they are extensively crossxiii

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Preface

referenced to later points in the text where the context rather than relegate it to appendixes. missing information is to be found. Issues which Equally, we recognise that tabular material can be can broadly be said to concern welfare have been boring - and, at times, a poor means of communiallocated a chapter of their own (Chapter 7), rather cation - so where appropriate other methods of than ignored altogether or dispersed in brief and presentation have been used. A point to be emphaunrelated sections throughout the text. sised is that data is expressed in the form normally Certain themes inevitably appear under several used by government and reported in the media. chapter headings - for example, the development Thus, for example, the Public Sedor Borrowing of the Single European Market. Generally speaking Requirement (PSBR) is not simply stated as an they are left dispersed, but cross-referenced to absolute number but as a percentage of GOP. other parts of the book where the same themes Much of the data is adjusted for inflation, and recur. However, in certain cases - for example, whenever space permits the comparable data for agriculture - it has made more sense to collect the other countries is also included. · themes together under one heading in order to The contributors to this book (other than the avoid duplication and the loss of continuity in the editor) have been chosen because they are knowdiscussion. For these reasons, the structure of the ledgeable in their fields. However, too much knowbook may at first sight appear unusual, but we ledge can be a vice as well as a virtue when it believe firmly that it does, in fact, make better comes down to the need to compress a great deal sense than the structures to be found in other texts, of information into a small space, and the authors and we leave it to the readers to judge for are commended to you not so much because they themselves (and hopefully to let us know their are 'specialists' but because they have proved in their previously published work that they have the opinions on the matter in due course). Whilst the book is essentially about the UK facility to communicate to the target audience for economy, it has a stronger international flavour this book. We hope that it makes enjoyable readthan is commonly associated with books on this ing. No doubt you will let us know if that is not the topic. This reflects a whole host of developments, case. One way or the other the editor is more than such as the Single European Market and deregula- happy to accept ultimate responsibility for the tion in general, which are making it increasingly entire finished product, although individual authinappropriate to view policy within the physical ors are responsible only for the chapters which confines of the UK alone. Since this is very much a bear their name. Finally, I would like to thank Gordon Hughes feature of ongoing policy we have deliberately set up our discussion so that it offers clear pointers and the other five anonymous reviewers for their towards the future, and we have chosen to com- thorough dissection of the text in its varying pensate for this by saying much less than is usual stages of completion. There is a myth - propagated, one suspects, by those who write only short about the more distant past. In our opinion the election of the current articles - that textbooks are not refereed adequagovernment was a significant watershed in policy tely, but that has been far from the reality in this terms, for reasons set out in the Introduction. Each particular case. Whilst some suggestions for improchapter is accordingly structured to say relatively vement have been set aside for this edition, it is little about the period before 1969; to provide a anticipated that they will be incorporated in the fairly detailed review of the decade 1969-79; and second edition. Any restructuring of the text in to focus primarily upon the decade 1979-89 and subsequent editions will be determined entirely by especially upon how it has compared with the the suggestions of users, and these are accordingly decade which preceded it. welcomed by the editor. All this places great demands upon the handling of data. We have tried to introduce as much data as PETER CuRWEN possible, and to locate it all within the appropriate

List of Abbreviations ACAS ACT AFBD APC ATM BBC BES BIS BoP BSA CAP CBI CCC CD CFF CGT CR

cso

CTT DCE DHSS DIB OM DTI EAGGF EAP EC ECU EEA EEC EER EFF EFL EFTPOS

Arbitration, Conciliation and Advisory Service Advance Corporation Tax Association of Futures Brokers and Dealers Average Propensity to Consume Automated Teller Machine British Broadcasting Corporation Business Expansion Scheme Bank For International Settlements Balance of Payments Building Society Association Common Agricultural Policy Confederation of British Industry Competition and Credit Control Certificate of Deposit Compensatory Financing Facility Capital Gains Tax Concentration Ratio Central Statistical Office Capital Transfer Tax Domestic Credit Expansion Department of Health and Social Security Defence Industrial Base Deutsch Mark Department of Trade and Industry European Agricultural Guarantee and Guidance Fund Enlarged Access Policy European Community European Currency Unit Exchange Equalisation Account European Economic Community Effective Exchange Rate Extended Fund Facility External Financing Limit Electronic Funds Transfer at Point of Sale

ELs EMCF EMS EMU ERI ERM ET FES FIMBRA FIS FMI FRN FSBR GAB GATT GDFCF GOP GNP HMSO HP IBA IBELs IDC IGA IMF IMRO ISDA LAUTRO LDC

Eligible Liabilities European Monetary Co-operation Fund European Monetary System European Monetary Union Effective Exchange Rate Index Exchange Rate Mechanism Employment Training Family Expenditure Survey Financial Intermediaries and Brokers Regulatory Association Family Income Supplement Financial Management Initiative Floating-rate Note Financial Statement and Budget Report General Agreements to Borrow General Agreement on Tariffs and Trade Gross Domestic Fixed Capital Formation Gross Domestic Product Gross National Product Her Majesty's Stationary Office Hire Purchase Independent Broadcasting Association Interest Bearing Eligible Liabilities Industrial Development Certificate Inter-governmental Agreements International Monetary Fund Investment Management Regulatory Organisation International Swap Dealers Association Life Assurance and Unit Trust Regulatory Organisation Less Developed Country XV

xvi

List of Abbreviations

LDMA LIBOR LIFFE MCA MERM MLR MMC MoD MPC MSC MTFS NBFI NDP NHS. NI NICs NNDI NNP NSB OECD OF GAS OFT OFTEL OMO OPEC OTC PAYE PDI PEP

London Discount Market Association London Inter-bank Offered Rate London International Financial Futures Exchange Monetary Compensatory Amount Multilateral Exchange Rate Model Minimum Lending Rate Monopolies and Mergers Commission Ministry of Defence Marginal Propensity to Consume Manpower Services Commission Medium Term Financial Strategy Non-bank Financial Intermediaries Net Domestic Product National Health Service National Income National Insurance Contributions Net National Disposable Income Net National Product National Savings Bank Organisation for Economic Co-operation and Development Office of Gas Supply Office of Fair Trading Office of Telecommunications Open-market Operation Organisation of Petroleum Exporting Countries Over the Counter Pay As You Earn Personal Disposable Income Personal Equity Plan

ppp PPS PRT PSBR

PSDR R&D RDG RER RPI RPM RSA RSSL SDR SEA SERPS SFF SIB SRO TB TEC TFE TPI TSA TSB UAA USM VAT VER YES YOP YTS

Purchasing Power Parity Perpetual Preferred Stock Petroleum Revenue Tax Public Sector Borrowing Requirement Public Sector Debt Repayment Research and Development Regional Development Grant Real Exchange Rate Retail Prices Index Resale Price Maintenance Regional Selective Assistance Recruitment Subsidy for School Leavers Special Drawing Right Single European Act State Earnings Related Pension Scheme Supplementary Financing Facility Securities and Investments Board Self Regulatory Organisation Treasury Bill Training and Enterprise Council Total Final Expenditure Tax and Price Index The Securities Association Trustee Savings Bank Utilised Agricultural Area Unlisted Securities Market Value Added Tax Voluntary Export Restraint Youth Employment Subsidy Youth Opportunity Programme Youth Training Scheme

Acknowledgements The authors and publishers wish to thank the following for permission to use copyright material: Bank of England for Tables 1.12, 1.13, 4.1, 4.3, 4.9, and Figures 1.7, 2.1, 4.4, and 9.1. Barclays Bank for Table 9.6 and Figure 9.2. Controller of Her Majesty's Stationery Office for Tables 1.1 to 1.9, 1.11, 3.1, 3.2, 3.4, 4.2, 4.4 to 4.8, 5.3, 6.1 to 6.5, 6.7, 6.8, 7.1 to 7.3, 7.5, 8.1, 8.2, 8.5, 8.6, 8.8, 8.9, 8.12, 9.1, 9.3 to 9.5; and Figures 1.5, 1.6, 1.8, 1.11, 1.12, 3.1 to 3.5, 3.7, 4.1 to 4.3, 6.1 to 6.8, 7.3 to 7.6. Council of Mortgage Lenders for Table 2.3 and Figure 2.2. Financial Times for Table 7.8 and Figures 1.2 and 5.2.

Information Division, HM Treasury for Tables 1.10 and Figures 1.3, 1.4, 1.9, 1.10 and 5.4. Institute for Fiscal Studies for Table 7.9 and Figure 7.4.

Organisation for Economic Co-operation and Development for Table 4.10 and Figure 5.3. Statistical Office of the European Communities for Tables 5.1, 5.2, 5.4 and 5.5. The Independent for Figure 3.6. UBS Phillips & Drew for Figure 4.5. Every effort has been made to trace all the copyright-holders, but if any have been inadvertently overlooked the publishers will be pleased to make the necessary arrangement at the first opportunity.

xvii