Economic Recovery in the UK: Lessons from the 1930s

Nicholas Crafts

Real GDP GDP

Deflator

Unemployme

nt (%)

Stock Market

Prices

1929 100.0 100.0 8.0 100.0

1930 99.9 99.6 12.3 80.5

1931 94.4 97.2 16.4 62.8

1932 95.1 93.7 17.0 60.2

1933 96.0 92.5 15.4 74.3

1934 102.8 91.7 12.9 90.3

1935 106.6 92.6 12.0 100.0

1936 109.9 93.1 10.2 115.9

1937 114.7 96.6 8.5 108.0

1938 118.2 99.3 10.1 88.5

The UK in the 1930s

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

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

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

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

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

Exchange Rates (1929 = 100)

Pound/Dollar Pound/French Franc

AverageExchange Rate

1929 100.0 100.0 100.0

1930 100.1 99.9 99.6

1931 93.3 93.2 93.7

1932 72.1 71.9 75.2

1933 86.8 68.2 77.0

1934 103.8 62.0 75.4

1935 100.9 59.9 74.5

1936 102.3 66.9 77.7

1937 101.8 100.5 84.7

1938 100.7 137.6 86.9

Source: Dimsdale (1981)

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

Quarterly Real GDP Estimates(Mitchell et al. 2011)

19291 97.5 19311 93.6 19331 94.4

19292 98.9 19312 93.1 19332 96.0

19293 99.9 19313 92.8 19333 97.6

19294 99.9 19314 93.7 19334 99.1

19301 100 19321 94.0 19341 101.2

19302 99.1 19322 93.4 19342 102.6

19303 97.8 19323 92.9 19343 103.5

19304 95.9 19324 94.6 19344 104.0

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

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

Bank Rate Treasury Bill Rate

Yield on Consols

Real Short Rate

Real Long Rate

1929 5.50 5.26 4.60 5.26 5.141930 3.42 2.48 4.48 8.63 8.011931 3.93 3.59 4.40 9.73 9.201932 3.00 1.49 3.75 5.11 7.241933 2.00 0.59 3.39 0.66 5.651934 2.00 0.73 3.10 0.80 4.261935 2.00 0.55 2.89 0.59 3.591936 2.00 0.58 2.93 -2.86 1.221937 2.00 0.56 3.28 -2.09 0.931938 2.00 0.61 3.38 -2.56 0.99

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

Fiscal Indicators (% GDP) (Middleton, 1996)

Public Debt

Receipts Outlays Budget Surplus

Debt Interest

Constant Employment

Budget Surplus

1929 158.4 23.8 24.5 -0.7 7.7 0.41930 159.2 24.1 25.5 -1.4 7.6 1.11931 169.8 25.9 28.2 -2.2 7.7 2.51932 173.6 27.4 27.9 -0.5 7.8 3.01933 179.2 26.9 26.5 0.4 7.0 4.21934 173.1 25.6 25.1 0.5 6.2 3.21935 165.0 25.0 25.3 -0.3 6.0 2.01936 158.7 25.0 25.7 -0.7 5.7 0.81937 147.2 24.5 26.0 -1.5 5.4 -0.11938 143.8 24.4 28.1 -3.7 5.2 -1.5

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

1934Q1 0 1936Q3 0

1934Q2 0 1936Q4 0

1934Q3 +15.7 1937Q1 +393.0

1934Q4 +51.5 1937Q2 0

1935Q1 0 1937Q3 0

1935Q2 0 1937Q4 0

1935Q3 0 1938Q1 0

1935Q4 +178.7 1938Q2 +98.8

1936Q1 +159.5 1938Q3 +29.1

1936Q2 0 1938Q4 0

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

Real Output/Hour Worked in ManufacturingUK growth

(% per year)

US growth(% per year)

US/UK(UK = 100)

1870 195.2

1870-90 1.58 1.75 1890 201.91890-1913 1.33 2.11 1913 241.21913-29 2.46 3.05 1929 264.51929-37 2.90 3.35 1937 274.0

Source: de Jong and Woltjer (2011); data kindly supplied by Herman de Jong.

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

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

Trade Costs Index (Jacks et al., 2011)

UK-France

UK-Germany

France-Germany

Italy-Germany

1929 100 99 99 110

1938 121 122 133 112

1950 122 142 112 127

1960 122 115 91 101

1970 110 105 73 79

1980 74 66 55 61

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

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-side implications (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

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