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Chapter One - page 1

OUT OF CONTROL

The world economy has changed its nature. Since the early 1970s it has become highly unstable and has favoured the rich over the poor. Unfortunately, even if politicians accepted this, there would be very little they could do.

For a quarter of a century after World War II, most young men in Britain, almost regardless of their level of ability and education, could confidently assume that they could find themselves some sort of job within a few hours whenever they needed one. Admittedly, the job might be utterly boring and without prospects, but nevertheless it would provide them enough income on which to live remarkably well. It was a marvellous time to start out in life.

But a sea-change took place at the beginning of the 1970s and twenty years later roughly a third1 of the men aged between 18 and 24 were either unemployed or 'economically inactive'- a term applied to those people without work who have given up what governments see as their economic function of keeping wage rates down by continual job-hunting, and who have thus made themselves ineligible for the dole. At any one time an estimated 100,000 young men2 were homeless as a result of inadequate incomes, some sleeping on city streets, while theft, the crime for which this age-group is most frequently responsible, almost tripled between 1971 and 19923 . "For many youngsters, crime has become a matter of survival in this new society which appears to cater only for the winners" Stewart Lansley of the Henley Centre for Forecasting wrote4 . "Today, denial of the new trappings of consumerism means a denial of full citizenship.... The result has been a growing lack of community cohesion and a declining sense of social commitment."

Despair engendered by poverty and involuntary idleness drove increasing numbers of young men to suicide: in 1992, 500 males aged between 18 and 24 killed themselves in Britain, 80% more than ten years earlier. Indeed, suicide became the second most common cause of death for all young people5. Other age-groups were affected by the rise in unemployment, of course, but it struck most harshly at the young who, right across the EC, were twice as likely to be jobless as anyone else of an age to work. In France, for example, in 1995, 45% of those leaving school with their baccalaureate and 80% of those without any exam successes were unemployed nine months later. Robert Castel, a sociologist, was not alone when he warned of the danger of society breaking down6.

What had gone wrong? How did an economic system which had enabled Britain to keep overall unemployment between 1.2% and 2.1% of the working population from 1945 to 1970 alter to such an extent that later governments were entirely unable to hold the problem in check?

Graph 1.1 The number of people unemployed in Britain, the white barred area, rarely exceeded 600,000 between the end of World War II and 1974. It then began to climb rapidly as a result of the couhtry joining the EU and reached over 3 million. The gray area shows that European Free Tade Area countries continued to enjoy low unemployment until they either joined the EU themselves or prepared to join it. Their joblessness rates have since tripled.
As the graph shows, unemployment rose rapidly after 1974, only falling back in periods in which the economy enjoyed brief booms but, even then, never returning to the level of its previous troughs. The difference between the trend in this latter part of the graph and that in the earlier one is so marked that by the early 1990s, even optimists were forced to admit that full employment would not return when world economic conditions improved and that the problem was 'structural' - that is, created by changes in the way the economy worked.

The first structural change took place on Sunday, August 15th, 1971. Facing a range of problems which appear like molehills today but seemed mountains at the time - a trade deficit of $4bn., and unemployment and inflation rates both moving up towards 5% - President Nixon took the United States off the gold standard, thus removing the last fixed link between paper money and real goods. His action destroyed the gold-exchange standard currency system set up by the 1944 Bretton Woods agreement under which the dollar was convertible into gold and all other major currencies were convertible into dollars. Under the system, countries had been able to expand the amount of money they had in circulation as long as they could keep their exchange rates in step with the gold-based dollar. Without it, the value of their currencies was based on nothing but confidence and fluctuated in response to the whims of the market to an unprecedented extent. The monetary world had no foundation, no fixed point - "a floating non-system" the German Chancellor Helmut Schmidt called it - and central banks were forced continually to adjust interest rates and the amount of money in circulation on the basis of how their national economy was perceived internationally rather than the volume of trade going on.

"It was a change of monumental proportions that not only redefined money but created the opportunity to dramatically speed up the rate at which transactions between companies and countries took place" Joel Kurtzman, a business columnist on The New York Times, writes in his 1993 book, The Death of Money.7 "It created enormous arbitrage possibilities and set the stage for the invention of a myriad of new financial products. It also initiated the process of decoupling the 'money' economy from the 'real' economy. As a result, two-plus decades later, the money economy where transactions take place purely for financial or speculative gain, and the real economy, where the world's raw materials, goods and services are produced and traded, are badly out of balance. That was Nixon's economic legacy."

Another important economic change took place immediately before unemployment began its climb. On January 1st, 1973, Britain, Denmark and Ireland joined the EEC, a move which required their governments gradually to harmonise their economies with those of the six existing members. This limited their economic freedom and, as graph two shows, these three countries' unemployment levels - and those of the EEC as a whole - became significantly worse than those of other countries which were also coping with death of the gold-exchange standard but which decided to stay in the European Free Trade Association (EFTA) rather than join the Common Market.

The Kennedy (1967) and Tokyo (1979) GATT treaties also restricted the ways in which the British and Irish economies could be managed. The treaties' signatories undertook to reduce the rates of duty that they imposed on imports from other participants. This effectively prevented them from using import duties to cure trade deficits and to create more jobs by protecting home producers from overseas competition. As a result, Britain was subjected to a flood of shoes, clothing and textiles from cheap labour countries and employment in UK firms manufacturing these products fall from 973,000 to 412,000 between 1973 and 19938. Other industrial sectors were similarly affected and, by 1982, a country which had had a trade surplus in manufactured goods in every peace-time year for more than a century and which in 1972 had exported goods worth 55% more than those it imported went into what became a chronic trade deficit. By 1993, this deficit had grown to 13.4bn. If the goods it represented had been made domestically, the additional activity would have created at least a million extra jobs9.

A fourth structural change was the complete abolition of exchange controls in 1979, four months after the Conservatives came into office under Mrs. Thatcher. This concession enabled the banks and financial institutions which had contributed so generously to the Tories' election fighting fund to move their money to wherever in the world they could obtain the highest return: if, after allowing for any differences in risk, a project in New Guinea promised to be more profitable for the promoters than one in Newcastle, New Guinea was where the institutions felt their money should be. The fact that the total benefits from a project located in Britain were likely to be considerably higher to the British people than one overseas was ignored. Sectional interests triumphed over the public good.

These four changes left Britain without most of the powerful economic management tools it had previously used to create the space within which governmental policies could be carried out. In particular, the Keynesian methods of economic management which had produced full employment and relative stability in Britain between 1945 and 1970 became unusable because, if a government now ran a budget deficit to stimulate domestic demand to increase employment, it could no longer use tariffs and quotas to control imports and prevent overseas competitors taking a lot of the extra work away. Indeed, if it was so much as hinted that the Chancellor of the Exchequer was planning to increase the public sector deficit, investors would fear that the increased demand for imports would depress the international value of sterling and move their funds to other currencies, precipitating the decline in the value of the currency they sought to escape. In short, the four structural changes heightened the degree of instability in the British economy while simultaneously leaving those responsible for managing it with far fewer methods for its control. Other governments got themselves into the same position, of course, with the result that the world economic system became so unstable that it was extremely liable to catastrophic collapse. As the graphs show, interest rates and exchange rates have been more unstable recently than at any other time in the past five hundred years, making it extraordinarily risky and difficult for anyone to try to build up any sort of small business along conventional lines.

Once the British government had signed away its right to use duties and quotas to control imports, it had only one way left to end unemployment.

Volatility of interest and exchange rates continues
Graph 1.2 Since 1973 exchange rates and UK interest rates have fluctuated much more widely and violently than in the preceding quarter-century. This is shown here by the movement in the value of the US dollar in terms of sterling (scale on left), and UK long-term interest rates (right).
This was to lower domestic costs sufficiently to make home-produced goods and services so competitive internationally that they displaced imports and attracted sufficient export orders to enable all available workers to be offered jobs. This approach sounds fine until one looks at what it entails. There are two main ways in which a country can cut its costs compared with those of its competitors. The easiest and most effective is by devaluing its currency. Unfortunately, however, this method is unavoidably inflationary because the increased costs of imports in terms of the national currency have to be passed on to consumers and even if a way could be found to avoid these price rises it would be undesirable to use it. This is because if import prices fail to rise, there is no price incentive for people to switch to home-produced products, thereby creating jobs in the firms making them. One of devaluation's most powerful modes of action is lost.

Since inflation is highly unpopular with the electorate, the banks and, most crucially, international investor-speculators, both Labour and Conservative governments have avoided devaluing except when compelled to do so as in the exchange rate crisis of September 1992 when devaluation proved its worth by generating an export boom. They were therefore left with the only other way of reducing domestic price levels relative to those overseas - by improving efficiency and productivity. All sorts of 'supply-side' measures were taken to boost efficiency including the elimination of restrictive practices such as union demarcation agreements in the workplace, the 'Big Bang' reforms in the City, and the rules against building societies lending for things other than house purchase. These changes were generally welcomed by people who escaped the human cost of bringing them about because no-one likes the idea of paying a high price for goods or services because one group or another, whether it be printers on newspapers, solicitors in conveyancing or a state monopoly in telecomunications, has a stranglehold on a particular activity and refuses to allow others to do it more cheaply. Calling a business 'competitive' became the highest form of praise.

The problem with promoting this type of efficiency, however, is that one man's cost is another man's wage packet and if unions, firms or institutions are forced to compete more aggressively with each other because the protective barriers they have erected around their activities over the years are broken down, jobs are lost and the wages and salaries paid to those remaining fall, cutting sales and hence employment in the shops and services which supply them. In other words, in their efforts to create employment, successive governments promoted policies which destroyed it. Only if an industry's turnover increased in real terms after its restructuring was there any possibility that additional jobs would be generated to replace those which the efficiency drive had eliminated. In most sectors, this increase in turnover either did not happen or was inadequate to offset the losses from continuing productivity drives. The country found itself struggling up an escalator moving down: in any year in which Britain's total turnover as measured by its gross national product did not grow by over 3%, the number of jobs lost because of 'rationalisation' and labour-saving technologies exceeded the number of new ones created and unemployment rose.

Few criticised the thinking behind the methods taken to achieve greater international competitiveness because the British public and its political leaders had collectively lost their way. I suspect that, if asked, most politicians regardless of their party affiliation would have said that they were working to defend and, if possible, advance the welfare of their fellow citizens. After some prompting almost all might have also said that the higher the real wages that those citizens received, the higher their economic welfare, and hence their total welfare, other things being equal. But no matter how leading the questioning, not one of them would have pointed out that there was a fundamental incompatibility between raising public welfare and the tactics they were pursuing. Nor would they have admitted that, by removing the protective barriers around the British economy, they had inadvertantly created a system in which being competitive in both home and overseas markets boiled down to reducing their citizens' wage levels faster than their rivals. Almost no-one in politics saw that the commonly-accepted goal for the economic system, the welfare of the citizen, was being sacrificed to make the economy perform and that, quite quickly, many people's wages were likely to fall to Third World levels.

But the politicians should not be criticised too harshly: they were blinded by out-dated economic theories. The real blame for what went wrong must be taken by the economics profession which failed to point out that free trade could prove seriously damaging in the circumstances in which it was being introduced.

The conventional proof of the superiority of free trade assumes the economies of both trading partners to be in equilibrium before trading begins - in other words, to be producing at the highest level possible given their technology. This means all their factors of production - land, labour and capital - must be fully occupied. The proof also assumes that the partners reach another similar equilibrium once trading is in progress. If they can assume these two equilibria, most undergraduate-level economics students can show that in a two-country, two-commodity world with perfect competition, the trading equilibrium is better than the non-trading one because it allows both countries to have more of the two traded commodities than they would if they did not trade.

But it is very doubtful whether a proof based on these limited circumstances has any relevance to our present world. This is because most countries are not generally working at maximum production since they are using neither the latest technology nor all their factors of production since unemployment will exist and their manufacturing companies will usually have unused capital equipment. As a result, even the most sophisticated economist has to struggle to say anything useful about whether the post-trade situation is likely to be better or worse than the pre-trade one, particularly if he or she attempts to take into account any changes in the distribution of income brought about by the growth of trade. Certainly, since the most significant feature of the post-1973 period has been the steady growth of unemployment, equilibria did not exist in most countries which moved towards freer trade. In these circumstances, economists should have admitted that it was impossible for them to say whether higher imports and exports and the removal of the further trade restrictions would prove beneficial. That almost every economist of note failed to do so is a black mark against a profession whose overwhelming support for free trade has been based on faith and intellectual idleness rather than evidence.

No-one would open a corner shop without a very much more thorough analysis of whether it might prove beneficial for the majority of participants than was ever obtained for the various phases of the EEC and GATT experiments. In an interview with the editor of an Irish business newspaper, The Sunday Business Post, in June 1993 shortly before he took up his post as the Secretary-General of GATT, Peter Sutherland claimed that the world economy would benefit by $200 billion if the Uruguay round was completed. It was scarcely surprising that he used this figure as it was the only estimate of the benefits of the round available and had already been quoted to such an extent that the public could not be blamed for thinking it reliable. In fact, the figure comes from a short briefing document Trade Liberalisation: What's at Stake? produced by the OECD in Paris and, when, several months before Sutherland's interview, French journalists had asked the OECD's secretary-general, Jean-Claude Paye, about it, an embarrassed Paye had dismissed the estimate as 'pretty theoretical' and stressed that, if benefits on that scale were ever achieved, it would be over a ten-year period and at the expense of some developing countries10.

The authors of the paper, Ian Goldin and Dominique van der Mesbrugghe, were not surprised that their figure was quoted so widely - "After all, we were the only ones to try to quantify the gains" van der Mesbrugghe told me11 - but were alarmed at the importance being placed on what was in reality little more than an educated guess. The $200bn estimate acquired an aura of authority. "I call that $200bn a biblical number now" van der Mesbrugghe said, agreeing that it had entered the mythology of our times. And, even though later workers have produced similar estimates using different methodologies, he doesn't think that makes his figure any more likely to be correct. "We all used the same trade data and made similar assumptions about which distortions would be corrected and to what extent" he said.

The one aspect about which van der Mesbrugghe was sure their paper was correct was the one which Sutherland, an Irishman speaking to an Irish audience, signally failed to mention, much less stress. It was that, in the developed world at least, rural communities would lose as a result of the dismantling of agricultural support structures, while urban dwellers would reap the gains. And so, just as five years earlier, the potential gains forecast by the equally unreliable Cecchini Report had provided the excuse for remote and rural areas to be sacrificed in order to create the EC's Single Market in 1992, so an estimate in which even its authors had no confidence was used, along with with selective quotation, to justify a further far-reaching liberalisation of world trade.

The forces pushing for these liberalisations were, in fact, exactly the same groups which had urged Mrs. Thatcher to lift exchange controls - the financial institutions, transnational companies and retired people living on private means. Taken together, free trade and the free movement of capital had a profoundly damaging effect on the share of national income going to the rest of the economy, the people who work for their living and depend on their pay. The figures show this quite clearly. In 1952, two eminent economic historians E.H. Phelps-Brown and P.E. Hart published a classic paper12 which showed that between 1870 and 1950, wages stayed between 36.6% and 42.3% of national income, varying only slightly with the trade cycle and showing no clear time-trend.

Graph 1.3 The proportion of national income going to wage and salary earners in Britain was on a generally rising trend between 1870 and 1975. Since then, rents, profits and interest payments have taken a much larger share of GDP, throwing the trend into reverse.
Their definition of wages excluded salaries. However, if one recalculates their results taking salaries and wages together, not only is the share of national income taken by labour very much more stable from year to year but it rises steadily from 54.8% in 1870 to 65.3% in 1950. In other words, over the eighty-year period during which the well-being of ordinary people improved substantially, the share of national income going to those working in the economy increased at the expense of those receiving rents, interest payments and dividends.

If we bring the Phelps-Brown and Hart time series up to date we can see that the slowly-rising trend continued for the next twenty years until, by 1974, 70.45% of the Gross Domestic Product went to pay wages and salaries. After that year, however, the trend went sharply into reverse. By 1987, only 63.8% of GDP was paid for work done, an unprecedented fall in so short a time and one which was largely brought about by the introduction of technologies to increase competitiveness which involved the replacement of human labour by two other factors of production, capital and fossil energy.

Interestingly, 1974 was also the year that the Index of Sustainable Economic Welfare (ISEW) for the United Kingdom began to decline. ISEWs were devised because using a country's national income per head to provide an indication of the economic welfare of its citizens has several very serious drawbacks . One arises because the goods and services produced in a country in the course of a year - which is what its national income consists of - might be shared out very unequally. Another occurs because the country's citizens will not get to consume or otherwise benefit from a high proportion of their output because some of it will be exported (to be replaced by a greater or lesser value of imports), some ploughed back into the economy as new investment and some used on tasks such as cleaning up pollution or fighting crime to keep the system running in a tolerable way. Some of their production - such as the goods and services they produce for themselves at home - will not be included in the official statistics which only cover things which are bought and sold.. And then some of the production the people do buy may make them no better off but simply keep things as they are. For example, if traffic noise increases so much that they have to install sound-proofing to sleep well at night, the products they purchase to deaden the noise count towards national income but scarcely represent an overall gain. And finally, some components of national income may have been produced by depleting the country's physical capital - crops grown using methods that cause soil erosion, perhaps - and a correction is needed to allow for this13.

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