The 'Golden Years'

Once World War 2 had come to an end, the government had a changed view on the economy. There was a unanimous agreement that the economy could not be returned to the conditions of the 1930s. A prime opportunity had presented itself for economic betterment to take place. The war experience could fuel this improvement along with breakthroughs in Keynesian economic theory.

In weighing up what exactly the government could do to improve the economy from the 1930 levels, three main areas appear. Firstly, could they try a policy of nationalisation? The short answer to this was no. Many key industries were already under national control, such as steel, coal and the railways and most other important industries were so highly regulated already that nationalising them completely would have been ineffective. So, the policy of nationalisation was crossed off the list. Could they try and raise public spending? Well, in reality - not really. Public spending was already high at 37% of GDP in 1948, most of this going on social safety nets rather than boosting the economy. Any further public spending would be unsustainable. There goes public spending off the list. The option that was chosen was macroeconomic management.

The 1950s was a period of breakthrough for Keynesian theory. It saw the policy of demand management come to flourish - or better known: 'Stop-Go'. The idea behind this policy was constant tweaking of the economy to keep it heading in the right direction and to avoid overheating or recession. When unemployment began to rise, the government would loosen policy and when the economy looked like it was overheating the government would tighten policy again. Did it work? Eh... In some senses, yes, in most other senses, not really. If you place a high priority on unemployment then it could be passed as a success - unemployment reached historically low levels and fluctuated around the 1.5-2.5% mark. Living standards also rose. However, this was at the cost of frequent balance of payment crises, slower growth than the UK's major competitors and inflation (although not runaway inflation).

The policy had a famous critic in the form of the economist RCO Matthews. He had his doubts about Keynesian theory. The basic thrust of his argument was that the reason unemployment was so low wasn't to do with the policy the government had implemented - this policy only affected unemployment at the margin. He claimed that demand was higher than pre-war levels, but not because of financial policy. Tax was higher than spending, budgetary policy tended to be deflationary and interest rates were consistently higher in the 50s.

So what could the other reasons for the low unemployment be? Some have put it down to high investment rates. Investment was especially higher than in 1939 and most of it was coming from the private sector. Investment is a fickle economic variable that depends a lot on confidence. From 1950-1973 there was a world economic boom which is the reason for this high investment. In Europe and Asia, war had hit harder than in the US. This left a lot of scope for 'catch up' growth to repair the war damage using the best practice techniques. Many workers also moved into more productive sectors such as services instead of agriculture. As well as this, world trade barriers come down and the Bretton Woods system begins to function efficiently as the USA pump the system with overseas aid and defence spending. Overall, world demand increases which fuels investment and productivity growth. This growth in world trade in a way drags the British economy along with it.

Another contributory factor for the higher investment comes from Broadberry. Productivity rises were higher than wage rises which favours job creation. As well as this, wage restraints continued through the 1960s, essentially increasing firms profits allowing investment to take place. The wage restraints were supplemented by cheaper imports of food and raw materials to keep living standards rising.

We can conclude the 'Golden Age' by saying that, yes, full employment was pretty much achieved, but it wasn't all down to the wonders of government policy. They were helped a great deal by very favourable conditions around the world. With hindsight, we can also see that this is only a temporary purple patch for Britain as problems begin to crop up. 

The Circular Flow Of Income

*I'd like to start by wishing everyone a happy new year! I hope you all had a good time over the festive period and are getting back into the swing of things as life returns to normal. I've had a great 4 week break and am now back studying, which mean the blog will be starting again on a consistent basis until Easter!*

Today's focus will be on the circular flow of income. I'm aware this has already been discussed but like I mentioned in a previous post I do plan on going over things again in a little more depth. The best way to learn about the circular flow of income is to actually see the flow graphically:

I'll now break the flow down into it's different sections, starting with the inner flow. The inner flow consists of the factors payments going from the firm to the households and payments for goods (consumption) flowing in the opposite direction. Firms pay money to households in the form of wages, interest and rent in return for the services of these factors of production. On the other side, households pay money to firms when they consume the firms goods and services. Note we're talking only about domestic firms and domestic households here.

In a scenario where all money was spent then that would complete the flow. However, in reality, not all money is spent. This is where the concepts of injections and withdrawals from the flow come in. Withdrawals are exactly what they sound like: money being taken out of the flow. It comes in three main forms. Firstly, savings. When money is deposited in banks or other financial institutions for the future that money has been withdrawn from the flow. Taxation is another withdrawal. Income tax and national insurance comes out of a households income whereas VAT comes out of a households consumption. Receiving benefits from the government is essentially a 'negative tax'. It's a tax that is flowing in the opposite direction. Therefore the total withdrawal in the form of net taxes is total taxation minus benefit payments. The final withdrawal is import spending. This is money that has left the flow of income because it is spent on goods and services abroad.

Injections, defined as additional money flowing into the economy, also comes in three forms. Firstly: investment. Investment is money that firms spend after gaining it through financial institutions. Secondly there is government spending. This includes such things as spending on roads, hospitals, schools and the like. It does not include state benefits, that is important to note! Finally, the other injection is export spending. Money that has come from people abroad buying our domestic goods and services.

There is a slight relationship between the withdrawals and injections into the circular flow of income. For example, suppose more money is saved (withdrawal) then more money will be available for banks to lend out to firms for investment (injection). The higher taxation is (withdrawal), the more like the government are to increase spending (injection). However, we must remember that these choices are made by different people. The choice to save and the choice to invest are made by two completely different, independent parties and therefore each will have their own agenda. Due to this we can say that injections may not equal withdrawals, however they could.

The final point I'd like to discuss here is equilibrium in the circular flow if income. Like most things in economics, market forces are able to bring the circular flow to equilibrium. I'll give an example. Suppose that injections exceed withdrawals. This may be because investment has rise, but irrespective of the reason due to  this national income will rise (because of more money circulating). A higher national income means that people can consume more, but as well as this people can also save more, pay more taxes and buy more imports. Therefore withdrawals will rise, and continue to rise up to a point where it is equal to injections. This is when equilibrium has been reached and national income will remain constant until another change occurs.

Thank you for reading guys and girls. Contact me if you have any questions or feedback, have a good day/night! Sam.