Sunday, October 04, 2015
Denis Healey and the IMF
Posted by David Smith at 12:45 PM
Category: Thoughts and responses

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This is from my book Something Will Turn Up, on Denis Healey and the IMF.

If the West as a whole had problems, brought on or exposed by the end of the cheap energy era, Britain had much bigger ones. When Harold Wilson and his chancellor, Denis Healey, travelled to France in November 1975 for the Rambouillet summit Britain’s inflation rate had hit 26.9 per cent the previous August and was still more than 25 per cent. Though price changes were much more volatile in the distant past, often reflecting agricultural harvests, official figures show only two years when inflation in Britain was higher than in 1975: 1800 and 1917. 1975, when inflation appeared to be out of control, was a terrible year for the British economy. In April, in what looks like an unusually well-judged call, the Wall Street Journal, then the oracle for American investors, ran the unforgettable headline ‘Goodbye, Great Britain’ and advised its readers to get out. If 1975 was a bad year, there was worse to come, and it was to come very quickly: 1976 was even worse.

The Wall Street Journal had picked up what was happening to the British economy, and it was not alone. Since the war, Western governments had operated Keynesian demand management policies, adjusting taxation and government spending in a counter-cyclical way, and thus trying to smooth the extent of the cycle; by dampening booms and heading off busts. If that was the strategy during the golden age up until 1973, the policy followed by Wilson and Healey from 1974 to 1976 was Keynesian demand management on steroids.

They really believed, it appeared, that you could spend your way out of recession. The numbers are astonishing. In the fiscal year 1974-5, public spending rose 35 per cent in cash terms, or nearly 13.5 per cent in real terms. In 1975-6 there was a further strong rise, of almost 25 per cent, in public spending in cash terms, although most of this was eaten up by the sky-high inflation rate. The strategy was well-described by Joel Barnett (inventor of the Barnett formula for determining government spending in Scotland, Wales and Northern Ireland) and Chief Secretary to the Treasury at the time. Barnett, who had direct responsibility for public expenditure under Healey, wrote in his book Inside the Treasury about the surge in public spending:

‘The Chancellor had made the fundamental decision to react to the oil crisis in a different way from the Germans and Japanese, and indeed from many other countries. Instead of cutting expenditure to take account of the massive oil price increases of 1973, which in our case cut living standards by some 5 per cent, the Chancellor decided to maintain our expenditure plans and borrow to meet the deficit.’

And borrow he did. The public sector borrowing requirement, the amount that the government has to borrow to bridge the gap between expenditure and tax revenues, increased sharply. The PSBR had been eliminated by the previous Labour Chancellor, Roy Jenkins, to the point of generating a budget surplus in 1969/70. It had risen under Anthony Barber, reaching £4.5 billion in 1973-4. The first two years of the new Labour government pushed the PSBR up to £8 billion in 1974-5 and £10.6 billion in 1975-6. It was a gamble that failed spectacularly. Other countries, which had adopted more restrictive policies in the wake of the OPEC oil price hike, recovered more quickly and escaped the worst of the inflationary excesses suffered by Britain. Germany, traditionally the most inflation-averse of countries, held its inflation rate to no more than 7 per cent. In America the high was 11 per cent. Other countries also, unsurprisingly, avoided the extreme damage to their public finances of the kind suffered by Britain.

There are certain periods you look back on and wonder how people could have been quite so misguided. The politics of the period contributed. Britain had a rampant trade union movement cock a hoop after defeating the Conservatives in the ‘Who runs Britain?’ election of February 1974. Harold Wilson was a prime minister who, though it was not known at the time, was preparing to stand down before the 1974-79 parliament reached its mid point. He resigned in March 1976, to be succeeded by James Callaghan (chancellor at the time of the November 1967 sterling devaluation). Wilson left behind a puzzled country and one of the most controversial honours lists in years, sometimes called the ‘lavender list’ because it was drawn up by one of his advisers on lavender notepaper. It include honours for one businessman, Sir Eric Miller, who committed suicide a year later while under investigation for fraud, and a peerage for another, Lord Kagan, who was convicted for fraud in 1980. It was that kind of period.

One common way for economists to think about economic policy is by reference to the targets of policy and the instruments available to achieve those targets. If four of the main targets were unemployment, inflation, external balance (a sustainable balance of payments position) and internal balance (a manageable budget deficit), this was a time when they were wildly missed. Not only was inflation high, unemployment soaring and public borrowing at record peacetime highs but the current account of the balance of payments was in large deficit.
The rise in world oil prices pushed Britain into a current account deficit of 4 per cent of gross domestic product in 1974 and, though it subsequently improved, Britain was dogged by twin deficits – budget and balance of payments – in its efforts to cope with the oil shock. The surprise was not that there was an economic and financial crisis; the surprise would have been if there had not been one.

Nor was the huge increase in public spending in 1974 and 1975 a classic Keynesian response. Men were not set to work digging holes or building roads. Rather, most of the big expansion in spending was on welfare – pensions, social security and unemployment benefit – and soaring public sector pay. The public sector was not alone. In the industrial relations climate of the time, employers had only limited success in holding back the tide of rising wages. Average earnings rose by 26.5 per cent in 1975, prompting the adoption of a statutory incomes policy in July of that year. The damage, however, had been done. With the recession hitting output, Britain’s unit labour costs – wages and salaries per unit of output – rose by 30 per cent in 1975. This was the reality behind the collapse of British industry.

It was a grim cocktail of appalling industrial relations, sky-high inflation, fast-falling competitiveness and deep problems for both the public finances and the balance of payments. Nor was it obvious how the spiral would end. Some things, and some decisions, look better with hindsight. The economic policy of the 1974-76 period, however, will probably never undergo such a re-evaluation, and quite rightly. Goodbye, Great Britain had it about right.

Though I met him, I never really got to know Denis Healey, Labour chancellor in one of the worst and most humiliating years for Britain in the modern era. A longstanding friend of mine was Derek Scott, a fine economist who worked as his special adviser. He always insisted that Healey was much misunderstood and that other chancellors would have buckled under the kind of pressure he faced, though the fact that much of that was self-inflicted somewhat mars the claim. I also knew many others who cut their teeth in Downing Street or the Treasury in that period. As well as this, and fortunately, Healey made his public and private views well known, not least in his entertaining autobiography, The Time of My Life. Healey was the chancellor who had to turn to the International Monetary Fund to bail out Britain’s economy, though he was a surprisingly popular figure, with poll ratings some of his successors could only envy. His good-natured response to being one of the main targets of the comedy impressionist Mike Yarwood, one of Britain’s biggest stars in the 1970s, helped.

Britain had been instrumental in the establishment of the IMF at the Bretton Woods conference in 1944, even if the post-war international monetary system was not the design favoured by Lord Keynes, the UK’s representative. Few in 1944, or subsequently, could have imagined that its biggest rescue, overseen and heavily influenced by the US Treasury, would be of Britain. Healey, once he saw the light, was a brave but ultimately misguided chancellor who raged against the irresponsibility of many in his party. He had three broad strands in his attitude to the IMF rescue. The first was that he had been badly advised by Treasury officials from the moment he took over at the Treasury, the second that the IMF rescue was triggered by unreliable official data and even more unreliable official forecasts. The third was that he could not wait for the moment when the IMF would be out of his hair, which he called ‘sod off day’.

There was some truth in both of Healey’s first two complaints. The official Treasury, alarmed by a government apparently prepared to preside over runaway wage inflation and profligate public spending, had an uneasy relationship with its chancellor, culminating in its advice in March 1976 to secure a gradual depreciation in the value of sterling; a planned gentle depreciation turned into a rout, which made the IMF rescue both inevitable and necessary.

As for the numbers: the air of crisis was exacerbated by misleading figures suggesting, wrongly, that public spending had risen to more than 60 per cent of GDP. It did not, though it did reach the equivalent of 49.7 per cent of GDP in 1975-6, figures now show, a record then and a record now. The public finances were, by any measure, in need of repair, the budget deficit – public sector net borrowing – reaching a post-war high (at the time) of 7 per cent of GDP. There were to be larger deficits later, in the early 1990s and in the aftermath of the global financial crisis of 2007-9. At the time, however, the impression was of an economy out of control and of the desperate need for a rescue, not just the $3.9 billion IMF loan, but more importantly the external discipline that the loan imposed, with deep spending cuts insisted upon by the IMF and William Simon, the US treasury secretary who acted as a stern midwife during the lengthy negotiations that culminated in the bail-out. The team was headed by a former Bank of England official, Alan Whittome. His deputy was David Finch, an Australian, and the Fund's managing director, Johannes Witteveen, was also heavily involved. Simon, with the support of his Under-Secretary, Ed Yeo, and the chairman of the Federal Reserve Board, Arthur Burns, were keen to pursue a 'hands-on' approach to British economic policy. Simon, who viewed Britain as something approaching a lost cause, made an unscheduled visit to London in November 1976 to help oversee matters. That demonstrated how far power had shifted from Britain. A country that once dictated terms to the rest of the world now had to accept the conditions insisted upon by others.

It could have gone differently. Anybody who wants a glimpse into the battles of the time should look at the cabinet papers of the time, labelled on every page with Top Secret but now released under the 30-year rule. On November 22 1976, Healey set out the plans, which included a £3 billion cut in government spending, which he said was necessary. The cut, equivalent to a real-terms drop of 4 per cent, came through in the 1977-8 fiscal year. ‘Having considered all the possibilities, I am convinced that we need to make a significant adjustment in fiscal policy, to meet the situation,’ Healey set out in his memorandum. ‘And it is clear from my discussions with them that the IMF team here share that judgment.’ Not everybody agreed with Healey, including not everybody in the cabinet. A week later another memorandum was put up for discussion, this time from Tony Benn, the Energy Secretary, whose death in 2014 produced an outpouring of tributes of the kind normally reserved for former prime ministers. Benn, in his memorandum, headed ‘The Real Choices Facing the Cabinet’, set out what he described as his alternative economic strategy. The ‘IMF road’ would be deflationary and would, he said, ‘surrender from that moment to any demands that may be made upon us whatever their consequences for the British people’. His strategy involved the imposition of tough import controls to achieve ‘a secure home market’, a reduction in interest rates and legislation to provided the government with new reserve powers to intervene more heavily in industry. It was not quite a command economy but it was not far away from it. But Benn’s alternative strategy was not adopted. The cabinet, with some trepidation, stuck with Healey.