Look Past The 1970s For Today’s Economic Parallels Say Neil Shearing, Group Chief Economist of Capital Economics

ECONOMICS - History repeats itself says Neil Shearing, Group Chief Economist of Capital Economics.

Fuel shortages, tax increases and a whiff of stagflation have prompted comparisons between the economic situation today and that of the 1970s. But for the UK at least, the similarities with the period immediately following the Second World War are arguably more striking.

Then, as now, there had been a huge shock to the UK’s economic way of life. After the war ended, large numbers of workers were released from the armed forces into the labour market – in the first 18 months after the war, seven million people were “demobbed”. But labour market frictions made it difficult to match this new supply of workers to available jobs. As a result, several sectors, including coal mining and agriculture, faced acute labour shortages while at the same time the overall number of unemployed workers increased. The national unemployment rate increased from virtually zero at the end of the war to just over 3% by 1947. 

This echoes the unusual situation today in which labour shortages have emerged in some sectors despite the fact that unemployment remains above its pre-pandemic level and, as of the start of August, 1.6 million workers were still on furlough. After the war it was demobbed workers that needed to be absorbed into the labour market. Now it is workers that were either furloughed or laid off during the pandemic. 

There are other similarities too. Much like the pandemic, managing the wartime economy necessitated a large expansion in the powers of the state and a huge increase in government spending. By the end of the war, the UK was running a budget deficit equivalent to 22% of GDP. Last year it was 15.5%. In both periods, there was a large jump in public debt. Between 1939 and 1945 public debt increased from 153% to 242% of GDP. Today it is on track to rise to around 105% of GDP this year, up from 80% of GDP before the pandemic.

In both periods the expansion of budget deficits came alongside a large rise in private savings. And in both cases, this increase in private savings was the consequence of government intervention in the economy. During the pandemic, lockdowns prevented consumers from spending income, causing savings to accumulate. During the war, rationing performed a similar role. 

After the war, there was a rebound in private sector spending. This was driven in part by the rundown of accumulated savings by households but also by a rise in capital expenditure by businesses. The improvement in demand against a backdrop of supply shortages fuelled a rise in inflation. What’s more, supply shortages then fed into one another and amplified price rises in a manner that is similar to the situation today. For example, the output of steel in the UK was curtailed by a shortage of fuel, which in turn was held back by a shortage of labour. Finally, to make matters worse, the rise in inflation was exacerbated by a sharp increase in global commodity prices as the world economy rebounded. Between 1945 and 1950 the price of oil rose by 70%. All told, in the six years after the war the overall consumer price level in the UK increased by 35%.

All of this echoes the situation facing the UK and other advanced economies today – and appears ominous for those who worry we are now facing a return to much higher rates of inflation. 

However, in practice the differences between then and now are just as significant as the similarities. The rise in inflation owed more to the removal of wartime price controls than anything else. And it was exacerbated by a devaluation of the pound in 1949. 

Economic structures were also very different to those today. The labour market was much less flexible, which made it more difficult to match workers to jobs. And the nature of labour reintegration was different too. Demobbed servicemen could not necessarily return to their old jobs. Today, the furlough scheme has kept many workers tied to their employers through the pandemic. 

The focus of the government and central bank was different too. The Bretton Woods system of fixed exchange rates that emerged from the war meant that policymakers paid far more attention to the balance of payments than they do today. Inflation was relegated to a secondary concern. What’s more, to the extent that there was any attempt to tame inflation, the government resorted to wage and price controls rather than tighter monetary policy to bring it down. This approach was doomed from the start. 

So what lessons can be learnt from the post-war experience? Two stand out. First, while the challenges facing the economy were huge, the sky did not fall in. In fact, following a recession in 1946, UK GDP growth averaged a solid (though unspectacular) 2.25% a year between 1947 and 1960. This serves as a useful check on some of the more extreme economic pessimism that has prevailed in recent weeks. 

Second, a policy of financial repression played a key role in capping government borrowing costs and ensuring fiscal sustainability in the post-war period. Between 1945 and 1955 the real yield on 10-year UK government bonds averaged around -2%. These ultra-low borrowing costs helped the public debt burden to be brought down gradually over time. The institutional backdrop is very different today. But a decade of quantitative easing has blurred the lines between fiscal and monetary policy. Amid the growing debate about the timing of the first hike in nominal interest rates, the post-war experience suggests that real interest rates in the UK and other advanced economies are likely to remain negative for several years to come.

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