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Land of H ope and G lory People of a certain age can remem ber when the British Empire seemed immutable, with a currency whose value remained always stable at close to five dollars to the pound. But now all has changed; the Em pire is gone, and the pound peren nially seems to be the weakest in stead of the strongest trading cur rency. Its value declined to $4.03 in 1940, to $2.80 in 1949, to $2.40 in 1967—and then to $1.70 during this spring's precipitous decline, repre senting a 42-percent drop from the level set by the 1971 Smithsonian Agreement. At that point, an inter national rescue party came to the rescue—reminiscent of Kitchener at Khartoum—by providing the United Kingdom with a $5.3-billion standby line of short-term credit. This 11-nation aid package, along with the recent agreement by the key coal miners' union to abide by the Government's proposed wage program, stabilized the situation and gave the U.K. a welcome breathing space. Indeed, even as the pound rose to $1.77, it ap peared undervalued to most observ ers, based on relative inflation rates and trade relationships among the major trading nations. But this development left unanswered the larger question of the U.K.'s ability to surmount the structural prob lems facing her ever since World War II or even earlier, as typified by the two ugly but descriptive terms which Britain introduced into the language—“ stop-go policy" and “ stagflation." 1 Combatting problems Ironically, Britain's domestic situa tion has improved significantly in recent months. Real output has recovered from the late-1975 reces sion low, and it should strengthen even more over coming months, perhaps returning to the 1973 peak level by late 1976. Just as planned, this is an export-led recovery, with export demand rising at a 13percent annual rate in the first four months of this year in response to the ever-cheaper pound. The na tion suffered an enormous £3,650 million current-account deficit in 1974 in the wake of the worldwide industrial boom and the OPECimposed oil increase. But some progress has already been made in redressing this situation, and over the next several years, the balance of payments may actually return to surplus—helped by North Sea oil, which should provide a net contri bution of £1,300 million to the pay ments balance by 1978. Most importantly, the U.K. has be gun to combat its severe inflation ary problem, cutting in half the 30percent rate of inflation recorded last summer. (Still, new pressures will develop as the prices of import ed goods rise in the wake of the latest devaluation.) Fiscal and monetary policies have played a role in this decelerating inflation. Government borrowing this spring fell significantly from the year-ago level, although the £11 -billion defi cit (in relative terms) remained much larger than even the U.S. (continued on page 2) Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. deficit. Monetary policy began to tighten in 1975, as the growth of the money supply went from an unpar alleled 31-percent annual rate in the second quarter to a 12-percent rate in the final quarter of the year. The latter figure was close to the average money-supply growth of the entire 1971-75 period. Controlling incomes Nonetheless, the crucial element in the U.K.'s anti-inflation program has been an incomes policy, cen tered around a Government-Trade Union Congress pact to control wage increases. On the heels of 1974's 26-percent average increase, the two sides agreed on a “ social contract," whereby the TUC pledged to keep wage demands in line with the cost of living in return for the Government's pledge to defend current living standards and to distribute social burdens fairly. Last summer, the Government and the TUC agreed to limit all wage increases to no more than £6 a week—a limit which has been gen erally respected. The rise in average earnings has come down from the spring-1975 level of 25-30 percent to about half that amount today, and the average increase would have been even smaller but for the completion during this period of a legally-mandated movement to e qual pay for women. Following up, the Government in its latest pact with the TUC has called for a 41/2percent rise in average wage rates over the next twelve months, ac companied by income-tax cuts. 2 Several factors could curb the ef fectiveness, or the popularity, of this incomes policy. Real wages and salaries have fallen significantly over the past year of wage restraint, and they could fall slightly more over the next year. The losses are concentrated among highersalaried workers; the real income of individuals at the £10,000 annual salary level has dropped more than 20 percent over the past three years, and could fall another 5 to 7 percent by mid-1977. This factor helps explain the resurgence of the “ brain drain," with many managers and professionals following Ringo Starr, Sean Connery and the Rolling Stones to warmer climes. Continuing problems The state of Britain is typified by the sickly performance of its national ized industries, which occupy “ the commanding heights" of the na tional economy—coal, steel, elec tricity, gas, railways and airlines. Their poor showing reflects a series of government decisions to impose non-economic priorities on eco nomic enterprises—for example, by preserving services to remote com munities or preserving outmoded jobs in older industries. Yet the U.K.'s structural problems (and resultant poor growth record) date back at least a hundred years, and not just to the onset of nation alization policies in the post-1945 period. A Brookings Institute study group, writing in British Economic Prospects (1968), attributed this sit uation primarily to industry's chronic reluctance to invest in new processes. This situation, according to the study group, can be blamed more on poor management prac tices than on the frequently-cited troubles caused by unions. (As evi dence, foreign-owned firms in the U.K. generally earn a higher return on capital than do British firms.) Part of the problem is Britain's low basic wage structure, which in turn reflects its poor growth record. This system encourages over manning, hoarding of labor, and a proliferation of overtime not linked to product demand. (Not too sur prisingly, during the period of three-day workweeks brought on by the 1974 coal strike, output held up far better than anticipated as labor efficiencies were temporarily adopted.) The system also fosters wage drift unrelated to productivity gains, and discourages labor-saving investment and technological inno vation. As a result, the nation's export performance has not bene fited as much as might be expected from the U.K.'s apparent advantage in wage costs. Thus, over the past two decades, Britain's share of world trade in manufactures has dropped from 23 to 7Vi percent. As depicted in the Brookings study, British industry is basically defen sive and custodial in outlook, un able to respond quickly and in a sustained way to export opportuni ties. But Charles Kindleberger argues that this verdict is too harsh (January 1974 Challenge), since Brit ish businessmen over the past cen tury have frequently taken advan tage of new business opportunities 3 and maximized profits within their limits of operation. Innovation—within limits Kindleberger adds, however, "The issue is not altogether whether Brit ish industry maximized within a static framework, but largely why it did not break out of existing con straints through creative response and innovation." During the first century of the Industrial Revolu tion, Britain had been a major source of new products and new processes, and it was often the first country to apply inventions origi nated elsewhere. But by 1900, while the flow of inventions and discover ies continued, the rate of applica tions declined. "The British re sponse to change was to continue along old ways, exporting old prod ucts." Then as the Continental na tions and the United States built up their strength (and their tariff barri ers), Britain followed the alter native of selling ever-increasing quan tities in protected Empire markets. These long-standing problems have been aggravated by yet newer problems in the 1970s, forcing a major reordering of priorities. Thus, the Government places primary emphasis today on investment in promising manufacturing projects through the National Economic De velopment Council. The magnitude of the shift was signaled last fall by (former) Prime Minister Harold Wilson, who pointed out that in dustrial development would take precedence over consumption— "or even our social objectives." William Burke uoiSujLjSBM • HBJfl • MEM BH • uo §8 j o E !U J O J !|B 3 • • epeAaN • oijepi E U O Z JJV • '0 3 S I3 U B J J U B S ZSL ON llWlHd aivd 30VJLSOd s n 1IVW SSV13 lSMId BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) Selected Assets and Liabilities Large Commercial Banks Amount Outstanding 6/02/76 Loans (gross, adjusted) and investments* Loans (gross, adjusted)—total Security loans Commercial and industrial Real estate Consumer instalment U.S. Treasury securities Other securities Deposits (less cash items)—total* Demand deposits (adjusted) U.S. Government deposits Time deposits—total* States and political subdivisions Savings deposits Other time deposits^ Large negotiable CD's 88,732 67,412 2,516 22,345 19,883 11,083 9,448 11,872 88,318 24,962 306 61,199 6,463 25,996 26,656 11,423 Weekly Averages of Daily Figures Week ended 6/02/76 Member Bank Reserve Position Excess Reserves Borrowings Net free(+)/Net borrowed (-) Federal Funds—Seven Large Banks Interbank Federal fund transactions Net purchases (+)/Net sales (-) Transactions of U.S. security dealers Net loans (+)/Net borrowings (-) Change from 5/26/76 Change from year ago Dollar Percent + + + + + + + + + + + + + + + + + + + + - 1,788 1,622 1,337 48 17 29 267 101 1,478 1,335 152 181 150 38 52 21 + + + + + + + + + + - 3,345 2,625 1,129 948 226 1,197 1,333 613 2,654 1,609 163 1,094 855 5,806 2,483 4,133 Week ended 5/26/76 3.92 4.05 81.40 4.07 1.15 12.11 16.43 4.91 3.10 6.89 34.75 1.82 11.68 28.76 8.52 26.57 Comparable year-ago period 166 + 11 + 155 + + 55 1 54 + + - 378 - 271 + 2,113 + 318 + 42 + 125 1 124 819 ♦Includes items not shown separately. ^Individuals, partnerships and corporations. Editorial comments may be addressed to the editor (William Burke) or to the author. . . . Information on this and other publications can be obtained by calling or writing the Public Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 544-2184. B>|SE|V
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