Economic Growth in Europe since 1945

This volume re-examines the topic of economic growth in Europe after the Second World War. The contributors approach the subject armed not only with new theoretical ideas, but also with the experience of the 1980s on which to draw. The analysis is based on both applied economics and economic history. Thus, while the volume is greatly informed by insights from growth theory, emphasis is given to the presentation of chronological and institutional detail. The case study approach and the adoption of a longer-run perspective than is normal for economists, allow new insights to be obtained. Individual chapters cover Belgium, Denmark, Germany, Spain, France, Ireland, Italy, the Netherlands, Portugal, Sweden and the UK. Further chapters explore general European institutional arrangements and historical circumstances. The result is a genuinely comparative picture of postwar growth, with insights that do not emerge from standard cross-section regressions based on the post-1960 period.

Economic growth in Europe since 1945

Centre for Economic Policy Research The Centre for Economic Policy Research is a network of over 250 Research Fellows, based primarily in European universities. The Centre coordinates its Fellows' research activities and communicates their results to the public and private sectors. CEPR is an entrepreneur, developing research initiatives with the producers, consumers and sponsors of research. Established in 1983, CEPR is a European economics research organization with uniquely wide-ranging scope and activities. CEPR is a registered educational charity. Institutional (core) finance for the Centre is provided by major grants from the Economic and Social Research Council, under which an ESRC Resource Centre operates within CEPR; the Esmee Fairbairn Charitable Trust; the Bank of England; 17 other central banks and 40 companies. None of these organizations gives prior review to the Centre's publications, nor do they necessarily endorse the views expressed therein. The Centre is pluralist and non-partisan, bringing economic research to bear on the analysis of medium- and long-run policy questions. CEPR research may include views on policy, but the Executive Committee of the Centre does not give prior review to its publications, and the Centre takes no institutional policy positions. The opinions expressed in this volume are those of the authors and not those of the Centre for Economic Policy Research. Executive Committee Chairman Vice-Chairman

Anthony Loehnis Guillermo de la Dehesa

Jan Bielecki Honor Chapman Quentin Davies Sheila Drew Smith Otmar Issing

Philippe Lagayette Peter Middleton David Miliband Mario Sarcinelli Catherine Sweet

Officers Director Deputy Director

Richard Portes Stephen Yeo 1 November 1995

Economic growth in Europe since 1945 Edited by

NICHOLAS CRAFTS and GIANNI TONIOLO

CAMBRIDGE UNIVERSITY PRESS

PUBLISHED BY THE PRESS SYNDICATE OF THE UNIVERSITY OF CAMBRIDGE

The Pitt Building, Trumpington Street, Cambridge, United Kingdom CAMBRIDGE UNIVERSITY PRESS

The Edinburgh Building, Cambridge CB2 2RU, UK 40 West 20th Street, New York, NY 10011-4211, USA 477 Williamstown Road, Port Melbourne, VIC 3207, Australia Ruiz de Alarcon 13, 28014 Madrid, Spain Dock House, The Waterfront, Cape Town 8001, South Africa http: //www. Cambridge. org © Centre for Economic Policy Research 1996 This book is in copyright. Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. First published 1996 Reprinted 1999, 2002 A catalogue record for this book is available from the British Library Library of Congress Cataloguing in Publication data applied for ISBN 0 521 49627 6 hardback ISBN 0 521 49964 X paperback

Transferred to digital printing 2003

Contents

List of List of tables Preface List of contributors

figures

Postwar growth: an overview Nicholas Crafts and Gianni Toniolo 1 Introduction 2 Main trends in postwar European growth 3 Previous interpretations of European postwar growth 4 Recent developments in growth theory 5 Europe's postwar growth in a long-run perspective: some quantitative aspects 6 The years of high growth 7 Slowdown and instability 8 Factors in the performance of individual countries 9 Concluding comments Institutions and economic growth: Europe after World War II Barry Eichengreen 1 Introduction 2 The model 3 The structure of domestic institutions 4 The evolution of domestic institutions 5 The structure of international institutions 6 The decline of the postwar settlement 7 Conclusion

vn

page xii xv xxi xxiii

1 1 2 8 14 16 20 25 27 31 38 38 43 45 50 53 58 65

viii

Contents 3

4

5

6

7

The varieties of Eurosclerosis: the rise and decline of nations since 1982 Mancur Olson 1 Introduction 2 A recapitulation of the theory 3 Economic growth since Rise and Decline 4 Distinctive institutions and common processes 5 Distinctive institutions and inescapable logic Why the 1950s and not the 1920s? Olsonian and non-Olsonian interpretations of two decades of German economic history Karl-Heinz Paque 1 Introduction 2 An Olsonian interpretation of the two postwar records 3 A non-Olsonian mode of interpretation Convergence, competitiveness and the exchange rate Andrea Boltho 1 Introduction 2 Competitiveness and the exchange rate 3 Western Europe in the 'Golden Age' 4 Country experience 5 Conclusions Statistical appendix British economic growth since 1945: relative economic decline . . . and renaissance? Charles Bean and Nicholas Crafts 1 Introduction 2 The legacy of the 1930s and World War II 3 Reconstruction 4 The Golden Age 5 Shocks and stagflation 6 Recovery in the 1980s and its legacy 7 Bargaining models and productivity change 8 Human capital formation 9 Deindustrialization 10 Conclusions Appendix Economic growth in postwar Belgium Isabelle Cassiers, Philippe De Ville and Peter M. Solar 1 Introduction 2 Postwar economic growth: main features, structures and institutions, initial conditions 3 The phases of postwar economic growth 4 Structural change and the control of industry 5 Conclusion

73 73 74 78 81 91

95 95 96 100 107 107 108 110 116 124 126

131 131 138 140 142 147 149 153 158 159 160 162 173 173 174 180 198 201

Contents 8

9

10

11

12

France, 1945-92 Pierre Sicsic and Charles Wyplosz 1 Introduction 2 Aggregate performance 3 The legacy of the 1930s and reconstruction 4 The 'vingt glorieuses' (1954-76) 5 Shocks and stagflation in the 1970s 6 A partial recovery 7 Human capital 8 Institutions 9 Conclusion Economic growth and the Swedish model Magnus Henrekson, Lars Jonung and Joakim Stymne 1 Introduction 2 Aggregate performance 3 A review of macroeconomic policies 4 Ultimate causes of Swedish economic performance 5 Conclusions Characteristics of economic growth in the Netherlands during the postwar period Bart van Ark, Jakob de Haan and Herman J. de Jong 1 Introduction 2 The major facts 3 The legacy of the 1930s 4 World War II and the reconstruction years 5 The 'golden years' from 1950 to 1973 6 Shocks and sluggish growth during the 1970s 7 Continuity and change during the 1980s 8 Labour market and wage policies 9 The performance of the export sector and exchange rate policy 10 The public sector and economic growth 11 Conclusions

ix 210 210 211 217 219 223 226 229 232 236 240 240 242 252 256 280

290 290 292 301 302 305 309 311 312 315 317 322

Portuguese postwar growth: a global approach Jodo L. Cesar das Neves 1 Introduction 2 Postwar growth: the setting 3 Postwar growth: the phases 4 Some particular themes 5 Conclusions

329

Growth and macroeconomic performance in Spain, 1939-93 Leandro Prados de la Escosura and Jorge C. Sanz 1 Introduction 2 Spain's economic performance in the long run

355

329 329 335 346 352

355 355

x

Contents 3 The legacy of the 1930s and the Civil War (1936-9) 4 Reconstruction: Spain under autarky, 1939-59 5 The Golden Age: years of accelerated growth, 1959-75 6 Shocks and stagflation: the transition from dictatorship to democracy, 1975-85 7 Recovery of the late 1980s and its legacy: the integration of Spain into the EEC 8 Concluding remarks

361 362 369 372 375 378

13 Irish economic growth, 1945-88 Cormac OGrdda and Kevin O'Rourke 1 Introduction 2 Irish growth and the economic convergence debate 3 Irish economic history, 1945-92 4 Investment 5 Human capital and emigration 6 Trade policies 7 Rent seeking and interest groups: the political economy of growth 8 Some simple cross-section evidence 9 Conclusion

388

14 Italy Nicola Rossi and Gianni Toniolo 1 Introduction 2 The aggregate performance: an overview 3 Total factor productivity, market structure, scale economies and capacity utilization 4 The legacy of Fascism and the war 5 Setting the stage: reconstruction and stabilization 6 An 'economic miracle'? 7 The roots of the malaise, 1963-73 8 Productivity slowdown, 1973-92 9 Concluding remarks Appendix

427

15 West German growth and institutions, 1945-90 Wendy Carlin 1 Introduction 2 The growth weakness of the Weimar Republic 3 Reconstruction, 1945-61 4 Golden Age growth, 1961-73 5 Slow growth, 1973-90 6 Is there a West German economic model and, if so, has it affected growth? 7 West German growth - what does it tell us about the prospects for growth in East Germany?

388 389 398 404 407 409 413 416 419

427 428 430 438 439 441 442 445 449 450 455 455 460 463 468 473 482 489

Contents 16

17

18

An exercise in futility: East German economic growth and decline, 1945-89 Albrecht 0. Ritschl 1 Introduction 2 Macroeconomic performance: a brief overview 3 The legacy of the 1930s and the war: how bad a start? 4 The productivity gap in the making, 1945-50 5 East Germany's transition to Communism: a brief review 6 The 1950s: an East German Wirtschaftswunderi 7 2 fast 4 you: frustrated catching up, the Berlin Wall and attempted reform during the 1960s 8 The Golden Seventies: a belated Wirtschaftswundert 9 The road to bankruptcy, 1980-9 10 The aftermath of unification 11 Conclusion

xi

498 498 499 504 508 511 513 517 519 522 528 532

Postwar growth of the Danish economy Peder J. Pedersen 1 Introduction 2 The aggregate growth performance: an overview 3 The legacy from the 1930s and the war and reconstruction years 4 Growth factors and sectoral shifts in the postwar years 5 Growth and economic policy since 1950 6 Concluding comments

541

Reflections on the country studies Nicholas Crafts and Gianni Toniolo 1 Introduction 2 The idea of a 'Golden Age' 3 The accumulation of capital and the acquisition of knowledge 4 The impact of economic policy 5 Growth economics

576

Index

582

541 543 551 554 563 570

576 577 578 579 580

Figures

1.1 Trend growth of real output per person in Italy, 1870-1990 page 17 2.1 Initial (1950) GDP per man-hour and growth, 1950-73 39 2.2 Wartime and postwar (1938-50) change in GDP per man-hour and growth, 1950-73 39 2.3 Investment share and growth rates of GDP: 16 countries, 1950-89 40 2.4 Growth rates of GDP and exports: 16 countries, 1950-89 42 5.1 Effective and real exchange rate: Germany, 1950-70 115 5.2 Effective and real exchange rate: Italy, 1950-70 115 5.3 Effective and real exchange rate: France, 1950-70 116 5.4 Effective and real exchange rate: Spain, 1950-70 117 7.1 Sectoral growth rates of output: Belgium, 1953-86 185 7.2 Sectoral growth rates of capital formation: Belgium, 1953-86 185 7.3 Sectoral employment: Belgium, 1953-86 186 7.4 Sectoral shares of wages in value added: Belgium, 1953-85 189 7.5 Relative value-added prices, sheltered sector/open sector: Belgium, 1953-86 191 7.6 Indices of competitiveness: Belgium, 1969-91 192 7.7 Net financial need of the government as a share of GDP: Belgium, 1953-93 194 7.8 Labour force, employment capacity and actual employment: Belgium, 1953-88 196 8.1 GDP: France and Germany, 1950-92 213 8.2 Unemployment rates, 1973-93 215 8.3 Real franc exchange rate, 1949-92 216 8.4 Investment rate: France, 1890-1984 218 8.5 Factor reallocations 224 8.6 Inflation and unemployment: EU and France, 1971-92 225 8.7 Investment rates and non-wage share in national income: France, 1949-92 * 226 8.8 GDP growth rates: selected countries, 1974-83 227

xii

List of figures xiii 8.9 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 9.9 9.10 10.1 11.1 11.2 12.1 12.2 12.3 12.4 12.5 12.6 13.1 13.2 13.3 13.4 13.5 13.6 13.7 14.1 14.2 14.3 14.4 14.5 14.6 15.1 15.2 17.1

Real consumer wages: France, 1946-91 Industrial production in Sweden and OECD, 1960-92 Annual percentage changes in Swedish GDP and the Swedish business cycle, 1945-90 Structure of Swedish employment, 1945-91 Private and public sector gross saving as a percentage of GDP: Sweden, 1950-92 Swedish capital formation by category, 1950-92 The competitive and sheltered sectors of the Swedish economy, 1952-90 Cumulative changes of public and private employment in Sweden, 1960-93 Public employment as a share of total employment in Sweden, 1950-93 GDP and taxation in Sweden, 1950-93 Average hourly wages for blue-collar workers in Swedish manufacturing, 1990: II Growth rates of real GNP in the Netherlands and the world trade volume, 1951-94 GDP per capita relative to Portugal, average, 1950-90 Log per-capita output, HP trend and subperiods, 1945-91 Spain's real GDP per head: comparative performance, 1850-1993 Rate of inflation: Spain, 1929-93 Relative price of capital goods: Spain, 1950-90 Budget balance of central government and public administrations: Spain, 1940-93 Current account balance: Spain, 1940-93 Employment, labour force and the rate of unemployment: Spain, 1955-93 GDP per capita indices: Ireland, 1950-88 GDP per capita, initial level and growth: Europe, 1950-88 GNP per capita, initial level and growth: Europe, 1979-88 GDP per worker, initial level and growth: Europe, 1950-88 GDP per employed worker, initial level and growth: Europe, 1964-88 Investment shares: Ireland, UK and the rest of Europe, 1950-88 Equipment share and price: Europe, 1960-85 TFP levels: Italy, 1938-90 Profitability: Italy, 1938-90 Market power: Italy, 1938-90 Scale economies: Italy, 1938-90 Capacity utilization: Italy, 1938-90 Inequality and poverty: Italy, 1973-91 Manufacturing productivity levels, 1950-89 Profitability and capital accumulation in manufacturing: Germany, 1951-90 Log GNP per capita: Denmark, 1890-1990

228 249 250 252 259 261 263 267 269 271 276 316 333 336 357 364 365 366 367 372 392 393 394 396 397 405 406 434 436 436 437 437 449 458 471 543

xiv

List of figures 17.2 Growth in real GNP: Denmark, 1946-91 17.3 Change in aggregate real GNP per employed person: Denmark, 1949-91 17.4 Change in hourly productivity of labour, manufacturing industry: Denmark, 1949-91 17.5 Annual change in total factor productivity: Denmark, 1967-91 17.6 Factor quality corrected estimates of TFP change in sheltered and exposed sectors: Denmark, 1967-89 17.7 Gross investments to output ratio, aggregate economy: Denmark, 1948-91 17.8 Relative change in machine capital per employed person: Denmark, 1949-91 17.9 Relative price and output share of machinery investments: Denmark, 1948-91 17.10 Aggregate export and import ratios: Denmark, 1948-91 17.11 Total taxes relative to GNP: Denmark, 1948-91 17.12 Sector GDP deflators relative to aggregate GDP deflator: agriculture, manufacturing industry and private service industries in Denmark, 1948-91 17.13 Relative price between sheltered and exposed sectors: Denmark, 1948-91 17.14 Rate of unemployment: Denmark, 1948-91 17.15 Rate of increase in nominal and real wages: Denmark, 1949-91 17.16 Ratio between user cost of capital and industrial wages: Denmark, 1955-91

544 547 547 549 550 555 555 556 558 562

562 563 564 565 567

Tables

1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 1.10 1.11 1.12 1.13 1.14 1.15 2.1 5.1 5.2 5.3 5.4 5.5 5.6 5.7

European growth, 1890-1992 page 2 War damage and reconstruction 4 GDP per person growth in Eastern Europe 5 GDP per person in 1990 international dollars 6 Unemployment rates 7 Differences in the sources of growth 9 TFP growth in different periods 10 Demand fluctuations and growth 11 Income elasticities of demand for exports 13 Estimated trend rates of growth of output per person in different periods 16 Using the Levine-Renelt model to account for changes in European growth of output per head 18 Comparative levels of labour productivity in manufacturing 21 Actual and forecast convergence, 1950-86/7 28 Growth performance and its sources relative to the European average: an analysis based on Levine-Renelt 29 Some new growth variables 31 Intra-European trade: percentage liberalized at selected dates 59 Indicators of European competitiveness, 1950 113 Selected indicators of European competitiveness, 1920s and 1950 114 Changes in selected macroeconomic indicators: Germany and Italy, selected dates 119 Indices of revealed comparative advantage: Germany and Italy, selected dates 119 Trade liberalization in OEEC countries, 1952-8 121 Changes in selected macroeconomic indicators: France and Spain, selected dates 121 Indices of revealed comparative advantage: France and Spain, selected dates 122 xv

xvi

List of tables 5.8 Indicators of foreign trade changes: France and Spain 6.1 Growth of real output per head and productivity, 1950-89 6.2 Estimates of comparative levels of productivity, 1950-89 6.3 Differences in the sources of growth, 1950-87 6.4 Levine and Renelt accounting for UK growth shortfall, 1960-73 6.5 Some comparisons relating to investment 6.6 Inflation and unemployment: UK, 1950-89 6.7 National debt, money supply and balance of payments: UK, selected dates 6.8 Growth rates of output, capital stock and TFP: UK, selected dates 6.9 Revealed comparative advantage rankings: UK and USA, selected dates 6.10 The short-term UK macroeconomic position, 1948 and 1951 6.11 Research and development and patenting, 1938-89 6.12 Labour force with intermediate vocational qualifications, 1979 and 1988 6.13 Labour productivity comparisons in international companies: reasons for differentials, 1972 6.14 Productivity outcomes in UK nationalized/privatized sector, selected dates 6.15 Productivity of labour in manufacturing, 1987: sources of German lead over UK 6.16 Panel regressions of total factor productivity growth in British industry 6.17 Value added in high-technology industry, 1979 and 1988 7.1 Major growth indicators: Belgium and north-west Europe, 1913-90 7.2 Final demand growth: Belgium, 1953-86 7.3 Sectoral cost, price and productivity growth: Belgium, 1953-86 8.1 Aggregate performance: France, 1950-92 8.2 Ratio of variances: France relative to other countries 8.3 Ratio of variances: France relative to other countries 8.4 Capital growth: France, 1930-58 8.5 TFP growth by industries, and relative prices of value added: France, 1950-92 8.6 Accounting decomposition of TFP growth: France, 1950-92 8.7 Estimates by Maddison (1987) of the effect of education on growth: France and Germany, 1973-84 8.8 Highest degree obtained and unemployment rate: Germany and France, 1989 8.9 Proportion of employees without degree according to relative earnings: France, 1970 and 1985 8.10 Credit outstanding in France, 1956 8.11 Share of French exports by destination, 1952-84 9.1 Growth in GDP per man-hour in 16 OECD countries, 1870-1970

123 133 134 135 136 137 138 139 139 140 141 144 144 145 149 152 155 160 175 186 189 212 214 214 217 220 223 230 231 232 233 235 242

List of tables xvii 9.2 Growth in GDP per man-hour in 16 OECD countries, 1950-70 9.3 Average annual growth rate of GDP, GDP per person employed and GDP per capita, 1950-70 9.4 Average annual growth rate of GDP, GDP per person employed and GDP per capita, 1970-92 9.5 Growth rate of total factor productivity in the private sector in 14 OECD countries, 1970-85 9.6 Proximate sources of economic growth in the non-government sector, 1950-90 9.7 Composition of GDP: Sweden, 1950-90 9.8 Macroeconomic outcomes: Sweden, 1940-93 9.9 Saving as a percentage of GDP: Sweden, 1950-92 9.10 Gross investment as a share of GDP: Sweden, 1950-89 9.11 Growth in productivity per hour worked in the competitive and sheltered sectors of the Swedish economy, 1951-90 9.12 The public sector share as a percentage of GDP in Sweden and in the OECD, selected dates 9.13 Total tax wedge on labour income: Sweden, 1952-92 9.14 Share of labour force having completed secondary education, 1987 9.15 Share of labour force having completed tertiary education, 1987 9.16 Before-tax educational premiums (Mincerian rates of return) in Sweden, 1968-91 9.17 Percentage increase in the hourly wage attributable to an additional year of labour market experience: Sweden, 1968-91 10.1 Population, gross domestic product, GDP per capita and GDP per hour worked: Netherlands, north-western Europe and the USA, 1913-90 10.2 GDP per head of the population and GDP per hour worked: Netherlands, north-western Europe and the USA, 1913-90 10.3 Distribution of spendable income in the Netherlands, 1959-90 10.4 Sectoral shares of employment in the total economy of the Netherlands, 1909-90 10.5 Value added and labour productivity by sector of the economy in the Netherlands, 1950-90 10.6 Value added per person employed in agriculture, manufacturing and the rest of the economy, 1950-90 10.7 Labour force, employment, hours worked and labour force participation: Netherlands, 1913-90 10.8 Average unemployment rates and growth rates of wages in the Netherlands and north-western Europe, 1929-90 10.9 Average growth rates of investment and annual compound growth rates of capital stock, capital intensity and the capital-output ratios: Netherlands, 1947-90 10.10 Capital intensity and total factor productivity in the Netherlands as a percentage of the average for France/Germany/UK and the United States, 1950-90

243 243 244 245 246 247 249 258 261 264 269 272 274 274 275 276

291 292 293 294 294 295 296 297

298

299

xviii

List of tables

10.11 Decomposition on growth of GDP and the contribution of total factor productivity growth in the Netherlands, 1950-90 10.12 Educational distribution of the Dutch labour force, 1960, 1971 and 1987 10.13 Labour costs, labour productivity and unit labour costs in manufacturing: Netherlands, 1950-90 10.14 Exports and export surplus as a percentage of GDP, export volume and terms of trade in the Netherlands, 1929-90 10.15 Government expenditure in the Netherlands as a percentage of net national income, 1955-90 10.16 Tax revenues in the Netherlands as a percentage of gross domestic product, 1965-89 11.1 Average per-capita product of the world countries in relation to Portuguese per-capita product 11.2 Growth accounting for phases: Portugal, 1952-91 11.3 Sources of output growth in Portugal, 1959-74 11.4 Growth, unemployment and political instability in Portugal, 1946-91 11.5 Portuguese external relations, 1948-91 11.6 Portuguese exchange rates, 1946-91 11.7 Portuguese government debt, 1946-91 11.8 Portuguese demand shares, 1952-90 11.9 The Pianos de Fomento 11.10 Portuguese exports by sector, 1938-90 11.11 Portuguese imports by sector, 1938-90 11.12 Portuguese exports by country, 1938-90 11.13 Portuguese imports by country, 1938-90 11.14 Postwar emigration from Portugal, 1946-91 11.15 Portuguese adult illiteracy rate, 1940-91 11.16 Rates of return to education and job training in Portugal, 1977 and 1985 12.1 Comparative performance of Spain's real GDP per head, 1850-1993 12.2 Sources of Spain's economic growth, 1965-90 12.3 Relative growth of Spain's real GDP per head, 1950-85 12.4 Differential growth of Spain's real GDP per head, 1965-90 12.5 GDP and employment composition: Spain, 1929-93 13.1 Economic growth in Ireland, the UK and Europe, 1950-88 13.2 Maddison and Heston-Summers GDP per capita 13.3 Gross investment, 1961-90 13.4 Investment by use: Ireland, 1953-90 13.5 Returns on investment in transport equipment, selected years 13.6 Net migration in Western Europe, 1950-87 13.7 A measure of two-way trade, North and South, 1926-91 13.8 Calmfors-Driffill indicators of economic performance 13.9 Cross-section analysis, 1950-60 13.10 Cross-section analysis, 1960-73

300 300 313 315 318 320 332 333 334 337 337 337 338 338 340 348 348 349 349 350 351 351 356 359 359 360 368 391 399 405 406 407 409 411 416 418 418

List of tables

xix

13.11 Cross-section analysis, 1973-88 13.12 Cross-section analysis, 1950-88 14.1 Levels and growth rates of real per-capita GDP: G7 countries, 1938-89 14.2 Main economic indicators: Italy, 1951-90 14.3 Value added per labour unit: Italy, 1951-89 14.4 Regional value added per labour unit: Italy, 1951-89 14.5 The sources of growth: Italy, 1938-90 (revenue side) 14.6 The sources of growth: Italy, 1938-90 (cost side) 15.1 The proximate causes of growth: Germany, 1870-1989 15.2 Convergence of value added per hour in manufacturing and the total economy: Germany, 1950-90 15.3 Growth accounting for manufacturing: Germany, France, Italy and UK, 1950-88 15.4 The balance between productivity and wages in industry: Germany, 1948-52 15.5 Sources of growth of non-agricultural employment: Germany, 1955-73 15.6 Educational and vocational qualifications of German and foreign employees, 1984 15.7 Apprentices as a share of employment in Germany, 1950-88 15.8 Comparative levels of labour productivity per hour, manufacturing: Germany, USA and Japan, 1973-90 15.9 German export competitiveness, 1979 and 1990 15.10 World market shares of Germany and its competitors, 1980 and 1990 15.11 Comparisons of productivity measures in the biscuit industry: quality effects 15.12 The transition from school to work: comparison between Germany and the USA 16.1 Growth of per-capita output and productivity: East Germany and West Germany, 1950-89 16.2 Population and the labour force: East Germany, 1950-89 16.3 Human capital investment in East Germany, 1950-89 16.4 Estimates of comparative East German levels of productivity 16.5 Output of GDR industry as a percentage share of total output of Potsdam Germany, 1944 16.6 Capacity losses due to war damage and dismantling: East Germany and West Germany, 1936-50 16.7 Population in Potsdam Germany, 1939-50 16.8 Capital-labour ratios in German manufacturing, 1950 16.9 Output in East German manufacturing, 1945-50 16.10 East German manufacturing output per person employed, 1936 and 1950 16.11 Company data on East German productivity, 1936-50 16.12 East German reparations to the USSR 16.13 Per-capita consumption in early postwar Germany

419 420 428 428 429 430 433 434 456 457 457 464 468 469 475 476 477 478 480 486 500 502 502 503 505 506 507 507 509 509 510 513 513

xx

List of tables 16.14 Composition of output and investment by major sectors: East Germany, 1936-60 16.15 The efficiency of investment: East Germany and West Germany, 1950-60 16.16 The efficiency of investment: East Germany, 1960-70 16.17 Output of consumer durables by categories: East Germany, 1950-70 16.18 Growth in the East German economy, 1970-80 16.19 The efficiency of investment: East Germany, 1970-80 16.20 East Germany's cumulative trade balance in the 1970s 16.21 The efficiency of investment: East Germany, 1980-9 16.22 World market and COMECON prices for crude oil, 1972-89 16.23 Growth in the East German economy, 1980-9 16.24 Valuta mark/mark exchange rate for East German exports, 1970-89 16.25 East Germany's trade balance and foreign debt, 1980-9 16.26 East German trade with Western countries, 1980-9 17.1 Long-run growth performance in international perspective 17.2 Annual change in GDP per work-hour in Denmark and average for 16 countries, decades 1870-1989 17.3 Average annual rate of growth of real GNP: Denmark, EC4 and other Nordic countries, 1950-92 17.4 Annual change in total factor productivity: Denmark, 1966-91 17.5 Average change per year in total factor productivity, labour productivity and capital productivity in the private sector, 1966-91 17.6 Indicators of sectoral shifts: Denmark, 1945-50 17.7 Sectoral GNP growth indicators: Denmark, 1950-89

515 515 519 520 521 522 522 523 524 525 526 527 528 545 546 546 548

549 554 561

Preface

Our principal aim in organizing this volume has been to present case studies of postwar growth in individual countries written in such a way that the book as a whole gives the reader a genuinely comparative picture. The collection also contains papers on important aspects of the general experience of growth, and an overview chapter which is intended to provide the context into which the country studies fit. The work which is reported in this book is the outcome of a network which operated during 1992-3 sponsored by the SPES programme of the European Commission, directed by Crafts and Toniolo and administered by CEPR. This organization permitted the establishment of a common format for the country studies and facilitated exchange of ideas and mutual criticism of initial drafts, with the result that the papers are more comparable than would otherwise have been the case. The reawakening of economists' interest in growth since the mid-1980s has been one of the principal reasons for this project. At the same time, it is now quite a while since the last exercise of a similar kind, the much used and respected collection edited by A. Boltho (The European Economy: Growth and Crisis, Oxford University Press, 1982). The authors in this volume are able to revisit the topic of postwar growth armed not only with some new theoretical ideas, but also with the experience of the 1980s on which to draw. Moreover, on this occasion the analysis has been based not only on applied economics, but also on economic history. Thus, while the book is greatly informed by insights from growth theory, the approach in the country studies emphasizes the presentation of chronological and institutional detail. The case study approach and the adoption of a longer-run perspective than is normal for economists allow insights to be obtained which do not emerge from standard cross-section regressions based on the post-1960 period. These various themes are developed in the overview chapter by Crafts and Toniolo. This paper focuses particularly on the so-called Golden Age of growth conventionally dated as 1950-73. Two important points which stand out are that the catch-up of leading countries by followers was much stronger in this period than xxi

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Preface

in any other, and that this catch-up was by no means automatic, but was based on particular institutional arrangements and historical circumstances. These are explored at a general level in the contributions by Boltho, Eichengreen and Olson, while Olson's well-known ideas relating to Eurosclerosis are scrutinized for the central case of Germany by Paque. Authors of the country studies were asked to consider the role that catch-up and convergence played in each case, and also to examine more generally the determinants of productivity performance and to consider the legacy of the interwar and wartime experience. Clearly, investment in 'broad capital' was expected to be a central concern, but this would be seen in its institutional context, which could be expected to have influenced incentives to invest. The extent of institutional differences across Western European countries is broad enough to make this a potentially rewarding exercise, but the research required to address this issue fully remains a large project for the future. Each country study contains an overview of performance and a brief chronological account of growth divided into similar subsections. There is also an opportunity to take up interesting aspects of growth specific to individual countries. The set of countries comprises most of Western Europe together with East Germany. East Germany has been included not only because of unification, but also because it allows further insights into what the West got right after World War II. Members of the network on European growth also devoted a good deal of effort to exploring quantitative aspects of economic growth, with a view to improving understanding of and facilitating access to the key raw materials of a database for studying postwar growth. In addition, the evidence on key topics such as convergence, investment in broad capital and trend growth was evaluated on a cross-sectional basis. This work should be seen as complementary to the present volume, in terms of providing further interpretation of postwar economic history and also factual material for reference, and it is to be published as B. van Ark and N.F.R. Crafts (eds.), Quantitative Aspects of Postwar European Economic Growth in 1996.

List of contributors

Charles Bean Centrefor Economic Performance, London School of Economics, and CEPR Andrea Boltho Magdalen College, University of Oxford Wendy Carlin University College London Isabelle Cassiers Universite catholique de Louvain and FNRS Nicholas Crafts London School of Economics and CEPR Joao Cesar das Neves Universidade Catolica Portuguesa, Lisbon Jakob de Haan University of Groningen Herman J. de Jong University of Groningen Leandro Prados de la Escosura Universidad Carlos III, Madrid Phillippe De Ville Universite catholique de Louvain Barry Eichengreen University of California, Berkeley, and CEPR Magnus Henrekson Institute for Industrial and Social Research, Stockholm Lars Jonung Stockholm School of Economics Cormac 6 Grada University College Dublin and CEPR Mancur Olson University of Maryland Kevin O'Rourke University College Dublin Karl-Heinz Paque Institutfur Weltwirtschaft, Kiel Peder J. Pedersen University of Aarhus Albrecht O. Ritschl Universitat Pompeu Fabra, Barcelona Nicola Rossi II Universita degli Studi di Roma Jorge C. Sanz Ministerio de Economia y Hacienda, Madrid Pierre Sicsic Banque de France and NBER Peter Solar Vesalius College, Vrije Universiteit, Brussels Joakim Stymne Stockholm School of Economics Gianni Toniolo Universita degli Studi di Venezia and CEPR Bart van Ark University of Groningen Charles Wyplosz Graduate Institute of International Studies, Geneva, and INSEAD, Fontainebleau

xxm

1

Postwar growth: an overview NICHOLAS CRAFTS and GIANNI TONIOLO

1

Introduction One of the most difficult and intriguing tasks of a theory of economic growth is to combine both the disruptive and the integrative, the qualitatively changing and the quantitatively steady, aspects of the process. (Kuznets, 1965: 23)

We still refer to the past fifty years as the 'postwar': this is perhaps the best tribute to the fact that the 'second Thirty Years War' (1914-1945) marked a major watershed in the history of mankind. So much so that it proved to be a major intellectual watershed as well. In fact, until fairly recently, 1945 often marked the borderline of historical research, more recent decades being considered as the playing ground for journalists, political scientists and sociologists. Only the boldest, or most inconsiderate, scholars entered thefield,and they did so at their own risk. The same can be said of economic historians: with few exceptions, they have been reluctant to apply the tools of their trade to the 'postwar' period, more often than not leaving it as the domain of applied economists. Things are changing, however, and the half century following the end of the Second World War is now increasingly seen as being ripe for historical investigation, much beyond the Marshall Plan years that have attracted much recent attention. This chapter aims at reviewing the performance of the European economy since 1945 in a longer-run perspective, which sees the period from 1913 to 1973 as being an exceptional one in the history of 'modern economic growth', in that it departed from the secular trendfirst(1913-45) by under- and then (1945-73) by overperforming. In this chapter, the European economy is tentatively seen as an aggregate, at least in fieri. If the interwar years of slow and volatile growth were characterized by nationalism and wars that crystallized national economic peculiarities, the subsequent period of high growth resulted in a convergence of per-capita incomes that can be seen and understood as being both the cause and the effect of a broader social and institutional convergence. 1

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Table 1.1. European growth, 1890-1992 (average annual growth) Period

Real GDP

Population

1890-1992 1890-1913 1913-50 1950-73 1973-92

(1) 2.5 2.6 1.4 4.6 2.0

(2)

Real GDP per capita (3)

Real GDP per person-hour (4)

0.6 0.8 0.5 0.7 0.3

1.9 1.7 1.0 3.8 1.7

2.6° 1.6 1.9 4.7 2.7"

a

1890-1987. 1973-87. Note: GDP and population are aggregates for 12 countries (Austria, Belgium, Denmark, Finland, France, Germany, Italy, Netherlands, Norway, Sweden, Switzerland, United Kingdom, all adjusted for boundary changes). Sources: 1870-1989, Maddison (1991); 1989-92, OECD (1993). Countries are those for which col. (4) can be calculated.

b

2

Main trends in postwar European growth

By 1870 all European countries were experiencing that 'epochal innovation' which Kuznets called 'modern economic growth'. Some of them, the pioneers, had already proceeded a long way along the road leading to ever increasing material welfare; others, the late-comers, were just taking their first steps. Since then, the aggregate real GDP of Western Europe1 has grown at an average annual rate of 2.3 per cent, or about 1.7 per cent per annum, per capita. The secular trend fits well with Kuznets' definition of'modern economic growth' as a process characterized by 'rates of growth in per capita income rang[ing] mostly from about 10 percent to over 20 percent per decade' (Kuznets, 1965: 18). While the long-run trends follow the steady quantitative change predicted by such authors as Colin Clark, Kuznets, Abramovitz and Chenery, Table 1.1 shows that the performance of the European economy during individual relevant subperiods diverged considerably from the secular trend. The perspective of secular trends in 'modern economic growth' is a useful starting point in considering the economic history of Europe during the half century following the end of the Second World War. In particular, such a perspective is helpful when considering the standard subdivision into two distinct periods, the first, to about 1973, being characterized by very high growth rates and near-full employment, the second showing a rather sluggish performance in terms both of output and employment. Here, the longer-run view conveys two messages: (1) the period 1950-73 was truly exceptional in the process of'modern economic growth', (2) the subsequent growth record can hardly be regarded as unsatisfactory. The exceptional character of the 'high-growth years' is better judged in the light of the poor European performance during the previous three decades. Whether or not one agrees with Kuznets2 that major wars are somehow endogenous to the process of modern economic growth, they certainly coincide with a considerable slowdown in European growth between 1913 and 1950, plausibly not unrelated to the boom of

Postwar growth: an overview

3

the following two decades. As we shall see, the catch-up for ground lost in two world wars and in the most severe economic depression to date is one of the reasons explaining the much above average growth rates of the 1950s and 1960s: other reasons, discussed in section 6, relate to domestic and international factors likely to be exceptional in the history of modern economic growth. Post-1973 growth looked uncomfortably low in the light of expectations created during the previous quarter of a century. However, if both the longer run and the predictions of the then-prevailing theory are taken into account, the picture looks considerably less dismal. In particular, Europe's per-capita output growth is (1) just slightly below the secular trend,3 (2) equal to that achieved during the 'belle epoque' of the world economy (1890-1913), (3) distinctly better than the belle epoque if seen in terms of GDP/hour worked, (4) much above the pre-1890 rates.4 It is hard to pass a negative judgement on such a record, particulary if it is confronted with the neoclassical growth theory assumption of diminishing returns to factor inputs. Having assessed the postwar European performance against the longer-run background of'modern economic growth', we may now turn to a brief appraisal of some quantitative features of the main subperiods. 2.1

War damage and reconstruction

The damage induced by war on the individual national economies is relevant to our analysis of long-run growth in that: (1) its sheer dimensions provided a rationale for American aid, with the attendant new 'international order' and technology flow, and (2) domestic reconstruction was often accompanied by important institutional changes. Table 1.2 provides an impressionistic picture both of the extent of war-induced economic setbacks and of the speed of reconstruction. In 1945 the GDP of France, of the three Axis countries and of the Netherlands had fallen back to late nineteenth-century or early twentieth-century levels. One or two generations of work and accumulation had been lost. Belgium fared a little better. Of the belligerent countries, only the United Kingdom managed to contain the post-1943 economic collapse to minor proportions; it could not, however, avoid a serious post-war slump. Neutral countries in our sample fared distinctly better and, in fact, managed to grow throughout the conflict. If the economic effect of the war was devastating, the speed of recovery was so impressive as to take by surprise informed observers, trade unions, entrepreneurs and policy-makers alike. In five years at most, Europe recovered the ground lost relative to the highest prewar income levels.5 It is, thus, quite safe to place the end of the first phase of reconstruction and the beginning of a new era in the history of European economic growth in 1950. 2.2

The high-growth years

As we have seen, the years 1950-73 witnessed a unique episode in the history of European 'modern economic growth' - so much so that the period is now often referred to in the literature as the 'Golden Age7. Not only were growth rates exceptionally high (Table 1.1), but cyclical fluctuations were mild6 and inflation rates socially acceptable.7

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Table 1.2. War damage and reconstruction

Austria Belgium0 Denmark Finland France Germany Italy Netherlands Norway Sweden Switzerland United Kingdom

Pre-war year when G D P was the same as in 1945

Year when G D P recovered the highest prewar level

(1) 1886 1924 1936 1938 1891 1908* 1909 1912 1937 never never never

(2) 1951 1948 1946 1945 1949 1951 1950 1947 1946

Annual rate of GDP growth during 'reconstruction' (1945 to year in col. (2)) (3) 15.2 6.0 13.5 19.0 13.5 11.2 39.8 9.7

a

Interpolations. ^Relative to 1946. Source: Data from Maddison (1991: 208-19).

Productivity growth is, obviously, the core phenomenon to be investigated in the present context: detailed measures and analyses of its determinants are, therefore, provided in the individual country studies included in this book. In the last column of Table 1.1, an attempt is made at estimating Europe-wide long-run changes in labour productivity. Although aggregation and index number problems make estimates in Table 1.1 more questionable than those for individual countries, the table itself leaves little doubt as to the order of magnitude of the general acceleration in productivity that took place in Europe during the Golden Age, making it a unique episode in the 'modern economic growth history' of the Old Continent. Four features of this extraordinary event are worth noting: • It is a distinctly European phenomenon, Japan being quantitatively and otherwise a case of its own,8 North America and Australia showing a much less pronounced deviation from the secular 'norm', 9 and other successful countries such as the NICs entering their phases of high growth in later decades. • High growth rates, relative to previous and subsequent records, characterize almost all the individual European economies, regardless of their social, political and economic institutions. • The period is strongly characterized by both /?- and a-convergence, to use Barro and Sala-i-Martin (1991) terminology. In other words, during 1950-73 we observe both a pronounced tendency for initially poorer countries to grow faster than richer ones and a decline in the cross-sectional scatter of per-capita output growth.

Postwar growth: an overview 5 Table 1.3. GDP per person growth in Eastern Europe

Czechoslovakia Hungary Poland Bulgaria Romania

Czechoslovakia Hungary Poland Bulgaria Romania

GDP/person 1950 (1990 international dollars)

GDP/person 1973 (1990 international dollars)

Growth of real GDP/person 1950-73 (% per year)

3480 2482 2447 1654 1175

6995 5601 5334 5294 3458

GDP/person 1973 (1990 international dollars)

GDP/person 1992 (1990 international dollars)

Growth of real GDP/person 1973-92 (% per year)

6995 5601 5334 5294 3458

6457 5639 4819 4132 2531

-0.4 0.0 -0.5 -1.1 -1.3

3.1 3.6 3.4 5.2 4.8

Source: Maddison (1995).

• Exceptionally low unemployment rates prevailed. In most countries, the 'triumph of full employment' was a historically distinct feature of the period. While we leave a discussion of the above-mentioned features of the period to sections 5 and 6, dealing with the causes of growth, a brief quantification of the last three points might be in order here. Table 1.3 provides some evidence showing that 1950-73 growth rates of per-capita GDP in Eastern Europe were roughly as high as those prevailing in the West (see also Ofer (1992)), while the Iberian economies under Salazar and Franco were among the fastest growers in the West itself, as Table 1.4 shows. A useful, if impressionistic, perception of the convergence processes may perhaps be drawn from Tables 1.3 and 1.4. We observe both a strong tendency for initially poorer countries to grow faster than richer ones and a decline in the cross-sectional scatter of per-capita output. As a result, in the early 1970s, the dispersion in levels of per-capita income among European countries was much less pronounced than it had been a quarter of a century earlier. Moreover, the formation of a core of economies characterized by roughly similar standards of living was, by then, well under way. Several features of the experience of Western Europe stand out: • The ratio between the highest and the lowest per-capita incomes fell very fast between 1950 and 1973, and more than halved in the period of 1950-92. • By the early 1990s there had emerged a 'core' group of nine countries with a very similar per-capita income all within ± 8.0 per cent of the median, whereas in 1950 only two were.

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Table 1.4. GDP per person in 1990 international dollars

1. Switzerland 2. UK 3. Sweden 4. Denmark 5. Netherlands 6. Belgium 7. France 8. Norway 9. W. Germany 10. Finland 11. Austria 12. Ireland 13. Italy 14. Spain 15. Portugal 16. Greece

1. Switzerland 2. Sweden 3. Denmark 4. W. Germany 5. France 6. Netherlands 7. UK 8. Belgium 9. Austria 10. Finland 11. Italy 12. Norway 13. Spain 14. Portugal 15. Ireland 16. Greece

1950

1973

1950-73 growth % (rank)

8939 6847 6738 6683 5850 5346 5221 4969 4281 4131 3731 3518 3425 2397 2132 1558

17953 11932 13494 13416 12763 11905 12940 10229 13152 10768 11308 7023 10409 8739 7568 6229

3.1 (12) 2.4 (16) 3.1 (12) 3.1 (12) 3.4 (10) 3.5 (9) 4.0 (8) 3.2(11) 5.0 (4) 4.2 (7) 4.9 (5) 3.1 (12) 4.9 (5) 5.8 (2) 5.6 (3) 6.2 (1)

1973

1992

1973-92 growth % (rank)

17953 13494 13416 13152 12940 12763 11932 11905 11308 10768 10409 10229 8739 7568 7023 6229

21036 16927 18293 19351 17959 16898 15738 17165 17160 14646 16229 17543 12500 11130 10711 8238

0.9 (16) 1.2(15) 1.7 (9) 2.1 (5) 1.7 (9) 1.5 (12) 1.5(12) 1.9 (7) 2.2 (3) 1.6(11) 2.4 (2) 2.9 (1) 1.9 (7) 2.1 (5) 2.2 (3) 1-5(12)

Source: Maddison (1995). • Both Switzerland at the top and Greece at the bottom remained in the same positions. • There is an inverse rank correlation between initial level of income and growth, which is particularly marked in the Golden Age. A similar inverse correlation for the Golden Age between initial income level and

Postwar growth: an overview

7

Table 1.5. Unemployment rates

Twelve countries (benchmark years)

Four countries (benchmark years)

1929 1938 1950 1973 1989

1920-9° 1930-8 1932* 1950-9 1960-73 1962 1974-81 1982-9 1990-3

4.0 5.0 4.5 2.9 7.4

4.4 7.1 12.8 4.2 2.5 1.9 5.2 8.8 9.2

a

Three countries only (excludes Italy): France three years only. Three countries only (excludes France). Sources: Maddison (1991), OECD (1993).

b

subsequent growth is noticeable in Eastern Europe in Table 1.3. Here, however, performance is somewhat less impressive in the years 1950-73 and, obviously, very disappointing since 1973. Comparison of Tables 1.3 and 1.4 indicates that, normalizing for initial income level, East European countries' growth was less than for comparable Western European countries in 1950-73. For example, Czechoslovakia does about as well as Ireland, which is an unusually poorly performing country in the West, while the rapidly rising difference between Austrian and Czech income levels as the postwar period unfolds is a stark testimony to Communist failure. Finally, while labour market statistics are among the least comparable over time and cross-country, there can be little doubt that European unemployment reached its lowest secular level during the so-called Golden Age. Some evidence is provided in Table 1.5, showing benchmark-year unemployment rates for twelve European countries10 and period averages for the four largest ones.11 Data for years up to 1913 are not available on a roughly comparable basis, but scholars agree that it is unlikely that unemployment reached the low levels of the 1960s. Moreover, it is believed that data for the interwar period tend to underestimate underemployment and, therefore, unemployment when measured according to postwar statistical definitions. 2.3

The post-1973 slowdown

The end of the Golden Age is often conventionally dated as 1973, the year of the first oil shock. In accepting this benchmark year, we imply neither that a sudden discontinuity in productivity growth can be detected in this particular year, nor that its main cause is changing terms of trade energy input. It is true, however, that the early 1970s saw a major departure from the main trends of the previous two decades, heralded by the end of the so-called Bretton Woods system in 1971 and characterized by severe shocks both to aggregate supply and aggregate demand. As mentioned earlier, production and productivity growth levelled off around the

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secular trend (Table 1.1). The slowdown affected market and socialist economies alike (Table 1.3). Unemployment rates almost trebled in the 1980s relative to the 1960s (Table 1.5). Cyclical volatility increased with several European countries experiencing negative growth rates in 1975, some time between 1980 and 1983, and again in the early 1990s. Prima-facie evidence of ^-convergence appears to be much weaker after 1973. In the aggregate of the European twelve and America, GDP per person grew roughly at the same rate despite Europe's lower 'starting' point. Intra-European association of growth rates with initial GDP levels is less clear-cut than it appeared to be in the previous (1950-73) period (Table 1.5). Nevertheless, by 1992, not only was the dispersion in per-capita income levels among the sixteen countries in Table 1.4 much less pronounced than it had been forty years earlier, but there had emerged a distinctive core of nine countries with a very similar per-capita income, all within ± 8.0 per cent of 16900 1990 international dollars. 3

Previous interpretations of European postwar growth

Between the early 1960s and the early 1980s, an earlier vintage of growth theory produced a large research effort on the European experience. The focal point of this writing was the rise and fall of the Golden Age. There are interesting themes to be considered from both traditional neoclassical and Keynesian writers. This section offers a brief and somewhat critical survey of this literature. 3.1

Growth accounting

The use of growth accounting to investigate postwar growth was pioneered by Denison (1967) in a deservedly famous study. Perhaps the best-known recent research in this tradition is that of Maddison (1987), subsequently updated and revised (1991). The central approach embraces a traditional neoclassical (Solow) view, based on diminishing returns to factor accumulation and exogenous total factor productivity (TFP) growth. The methodology relies on assumptions rather than estimation and uses factor shares to weight the contributions of capital and labour. The main proximate source of the acceleration in growth during the Golden Age and subsequent slowdown emerges as TFP growth. A large role is assigned to residual efficiency both in speed-up and slowdown and also in the growth rate gap between the UK and, on the other hand, France and Germany in 1950-73 (see Table 1.6). A similar pattern of TFP growth shows up in Table 1.7, which takes in a wider group of countries. Rapid TFP growth reflected, in part at least, technology transfer, postwar reconstruction and structural change. Growth accounting also sees a strong supporting role for increased physical capital formation in the faster growth of the Golden Age compared with before and since, although this is given relatively little weight in explaining the UK's slower growth. Surprisingly, human capital formation is seen as playing only a very minor role in accounting for variations in growth rates. The reliability of conclusions drawn from growth accounting has, of course, often been questioned and is potentially undermined by the advent of new growth theory which stresses the importance of human capital and externalities to investment. The general thrust of

Postwar growth: an overview 9 Table 1.6. Differences in the sources of growth (% per year)

1913-50 Labour input Education Capital input Total factor productivity Backwardness Other specific Residual efficiency 1950-73 Labour input Education Capital input Total factor productivity Backwardness Other specific Residual efficiency 1973-87 Labour input Education Capital input Total factor productivity Backwardness Other specific Residual efficiency

France

Germany

UK

-0.17 0.36 0.65 0.67 0.04 0.06 0.57

0.38 0.24 0.62 0.28 0.20 -0.09 0.17

0.12 0.33 0.82 0.35 -0.04 0.05 0.34

0.18 0.39 1.84 3.02 0.71 0.43 1.88

0.15 0.19 2.27 3.50 0.70 0.54 2.26

0.01 0.20 1.75 1.27 0.17 0.35 0.75

-0.24 0.56 1.48 0.92 0.11 0.19 0.62

-0.49 0.05 1.28 1.01 0.28 0.22 0.51

-0.19 0.41 1.12 0.82 -0.25 0.33 0.74

Source: Derived from Maddison (1991) as in Crafts (1992a).

early empirical work of this kind is to regard growth accounting's treatment of physical capital as basically acceptable, but to argue that the approach underestimates the role of human capital by ignoring training and externalities (Oulton and O'Mahony, 1994). In placing his findings in a historical context, Maddison stressed the special and unrepeatable characteristics of the Golden Age, including liberalization of international trade, successful macroeconomic management and a backlog of opportunities for catch-up growth (1991: 168). Growth accounting has proved fruitful in suggesting working hypotheses like these, but cannot in itself test them. The growth accounting approach has also been used to consider the experience of Eastern Europe, which, as Table 1.3 demonstrated, shared in the growth of the Golden Age. Here the data difficulties are potentially particularly daunting, but research is now becoming available which seems to correct more successfully for the problems like hidden inflation that bedevil this area. The adjusted figures in Table 1.7 show that the pattern of acceleration and decline in TFP growth also appears in Eastern Europe, but at lower rates, again suggesting that catch-up was important but less successfully achieved.

10 Nicholas Crafts and Gianni Toniolo

Table 1.7. TFP growth in different periods (% per year)

Belgium Denmark France West Germany Italy Netherlands UK

Czechoslovakia Official Adjusted East Germany Official Adjusted

1950-62

1960-73

1973-9

1.9 1.8 3.5 4.5 4.3 2.6 1.3

3.9 2.8 4.0 2.7 4.6 3.1 2.3

1.5 1.2 1.7 1.8 2.2 1.5 0.6

1.4 1.3 1.7 0.8 1.3 0.9 1.6

n.a. n.a.

2.3 1.3

2.1 0.3

-1.5

4.0 2.9

2.4 1.8

1.9 1.0

-0.5

1979-90

0.2

1.2

Note: Data for 1950-62 and East Europe relate to GDP, others to business sector. Sources: Denison (1967), OECD (1991a), Klacek et al. (1993) and Ritschl (1996).

3.2

Eurosclerosis

The notion of sclerotic tendencies in economic growth performance achieved widespread attention in the 1980s. The seminal work was that of Olson (1982). The approach is based on public choice economics and argues that democracies tend through time to accumulate interest groups which inhibit growth unless these turn out to be encompassing organizations. Thus, 'distributional coalitions slow down a society's capacity to adopt new technologies and to reallocate resources in response to changing conditions, and thereby reduce the rate of economic growth' (Olson, 1982: 65). Olson developed his argument both to explain the general speeding up of TFP growth in the Golden Age and the subsequent slowdown, as well as to account for the different experiences of countries like Sweden, West Germany and the UK. He argued that trade liberalization, and particularly the formation of new arrangements such as the European Community, broke down interest group barriers to growth, although eventually these reappeared in the new context. Fast growth in the early postwar period in countries like Germany compared with the UK would be expected since distributional coalitions were temporarily destroyed by initially totalitarian government and then more fully by foreign occupation. Better growth in Sweden than the UK could be explained by the highly encompassing nature of Swedish but not British special interest groups, as reflected, for example, by the different nature of their trade unions. Further reflections on these themes can be found in Olson (1996). Although political economy considerations surely do play a serious part both in the success of postwar reconstruction and in relative success and failure in postwar growth, the original formulation proposed by Olson has been quite strongly criticized in subsequent research. Two points have been well made in recent papers.

Postwar growth: an overview

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Table 1.8. Demandfluctuationsand growth (% per year) Effect of standard deviation of Y Austria Belgium Denmark Finland France Germany Ireland Italy Netherlands Norway Portugal Spain Sweden Switzerland UK

1.3 1.1 1.3 1.6 0.9 1.5 1.2 1.4 1.4 0.8 1.6 1.5 0.9 1.8 0.9

Effect of standard deviation of RM -1.1 -0.5 -1.1 -1.5 -0.6 -0.8 -0.8 -0.8 -0.9 -0.5 -1.1 -0.9 -1.0 -0.9 -0.9

Sum 0.2 0.6 0.2 0.1 0.3 0.7 0.4 0.6 0.5 0.3 0.5 0.6

-0.1 0.9 0.0

Source: Derived from Kormendi and Meguire (1985: 149, equation (4)). First, the suggestion that Germany was purged of sclerotic interest groups in the 1940s is hotly contested by Paque (1994). Second, more generally, Unger and van Waarden (1994) suggest that the overall impact of interest groups on growth is much less adverse than Olson claims, and that the differing experiences of the 1930s and 1940s had little impact on the subsequent power of distributional coalitions. Econometric analysis of international cross-sections has also tended to reject the sclerosis hypothesis. Crafts (1992b) found that adding various measures of corporatism as a way of looking at the degree of encompassing in organizations added no explanatory power to a conventional model of catch-up growth. Similarly, Castles and Dowrick (1990) found that, having allowed for capital and labour growth and an initial income gap, a variable measuring time since the last interruption to domestic democracy was insignificant. 3.3

Demand stabilization

Keynesian economists have always stressed the absence of economic crises in the Golden Age, and have argued that the postwar commitment to demand management and the stability achieved under the Bretton Woods system were more conducive to investment and growth than the shocks of the 1920s and 1930s. Similarly, the stagflation of the 1970s is blamed for the abrupt ending of the Golden Age. Arguments of this kind also feature prominently in Maddison (1991). Perhaps the best-known exposition of these views is by Boltho, who argues that 'If cheap technology and abundant labour and raw materials were not novel features of industrial Europe, something else must still explain why in the 1950s and 1960s they led to "supergrowth"... Such an explanation would seem to have to come from the demand side'(1982: 15).

12 Nicholas Crafts and Gianni Toniolo

The best-known attempt to test this hypothesis was that of Kormendi and Meguire (1985), some of whose results, based on international cross-section regressions for 1950-77, are reported in Table 1.8. They found that a higher variance of output was actually positively rather than negatively related to growth, but that greater variation in unanticipated money (RM) did, as expected, reduce growth. Comparison of equations with and without investment as an additional explanatory variable led Kormendi and Meguire to conclude that the impact came partly through greater investment, but more through higher returns to investment. These results provide rather mixed support for Boltho's position. They do not suggest that fine tuning via demand management explains relative success and failure in growth, but they do indicate that unpredictable policy is bad for growth. No comparison is available with other periods, but it does seem probable that monetary shocks were larger in the interwar period, and the regressions show that this might have had a serious adverse effect on growth. While this may be true, Boltho's emphasis on demand as the key difference between the interwar and postwar periods seems to be overstated. In particular, it underplays the much greater postwar ease of technology transfer relative to the previous decades, together with the reduced importance of natural resources and domestic market size in making it easier for Europe to catch up with the USA in the postwar period (Nelson and Wright, 1992). 3.4

Export-led growth

An alternative Keynesian view of postwar growth was put forward by Thirlwall (1979) following in the footsteps of Beckerman (1962) and Lamfalussy (1963). Here the central hypothesis is of a balance of payments constraint on demand and thus on growth. The full story then involves virtuous (vicious) circles in which better (worse) export demand growth prospects promote higher (lower) investment, which enhances (retards) productivity and competitiveness, and further reinforces differential export growth prospects. Theflavourof these arguments is well reflected in the following: 'Rates of growth of capacity, and hence output, in the long run are determined by expectations about future demand prospects' and cthe first place to start seeking an explanation of widely divergent growth rates is in the field of the conspicuous role played by buoyant exports and the foreign balance in determining relative growth rates in Europe in the last decade' (Beckerman, 1962:916,918). Shortly afterwards, estimates of income elasticities of demand for exports by Houthakker and Magee (1969) seemed to show a starting point for these virtuous and vicious circles; their results, reported in Table 1.9, showed a huge apparent advantage for Japan over the UK. However, subsequent research has not been very kind to these export-led growth hypotheses. Three points in particular should be noted. • Houthakker and Magee's estimates are now generally regarded as unreliable. Balassa calculated constant market share (ex-ante) elasticities based on a detailed disaggregation of trade by commodity and market. As Table 1.9 shows, these indicate quite minor differences in initial positions and thus no real basis from which the vicious/virtuous circles could develop.

Postwar growth: an overview

13

Table 1.9. Income elasticities of demand for exports

Austria Belgium Denmark France Germany Italy Japan Netherlands Norway Sweden UK

Houthakker and Magee (1951-66)

Balassa (1953-71)

1.59 1.87 1.69 1.53 2.08 2.95 3.55 1.88 1.59 1.76 0.86

2.04 1.98 1.82 2.04 2.27 2.07 2.00 1.91 1.82 1.93 2.20

Sources: Houthakker and Magee (1969) and Balassa (1979).

• Indeed, it seems likely that Houthakker and Magee's estimates reflect differences in export supply capabilities. Krugman (1989) set out a plausible model based on intra-industry trade, in which countries with a faster rate of growth of productive potential exhibit a faster rate of increase in the variety of their exports, gain world market share and appear to have faced higher income elasticities of demand for exports. In Krugman's reformulation, all the differences originate on the supply side. • The Beckerman/Thirlwall model depends on an absence of conventional neoclassical price effects, which would correct balance of payments disequilibria, and, at bottom, supposes a world of real wage rigidity. This is widely rejected empirically as an acceptable long-run proposition (Layard et al, 1991: 210).

3.5

Labour supply

A number of writers have seen an elastic labour supply as a key factor underwriting the supergrowth of the Golden Age and another reason why, in the 1950s especially, German growth couid outstrip that of the UK. Several variants on this theme were proposed during the 1960s. As was mentioned earlier, Denison (1967) found reallocation of labour from low-productivity agriculture to be a major (transitional) addition to T F P growth. A much more controversial hypothesis was advanced by Kaldor (1966). Kaldor argued that the manufacturing sector was central to postwar growth and that Verdoorn's Law operated in this sector, i.e. that labour productivity growth was a positive function of the growth of employment. This might be seen as a kind of dynamic economies of scale. Countries in which there were reserves of agricultural labour or substantial immigration could benefit from Verdoorn's Law and would experience faster growth. Relatively slow growth would be the outcome in the UK. A number of subsequent articles challenged these claims. Crucially, Kaldor's

14 Nicholas Crafts and Gianni Toniolo approach and that of his disciples, Cripps and Tarling (1973), assumed away catch-up growth based on reducing the technology and capital/labour ratio gaps between Europe and the USA. The econometric evidence in favour of Verdoorn's Law as a general proposition was readily shown to be very weak (Chatterji and Wickens, 1983; Gomulka, 1971; Rowthorn, 1975). The most intriguing version of the labour supply hypothesis was proposed by Kindleberger (1967). He was careful not to claim too much: 'the availability of excess labour does not determine the levels at which growth will be maintained . . . An elastic labour supply supports high rates of investment... But the labour supply... is a permissive rather than an initiating or even a determining factor' (1967: 4). Kindleberger invoked the famous Lewis model of development with unlimited supplies of labour, and argued that an elastic labour supply sustained the share of profits. This prediction is not, however, one which would be derived from the models of growth and unemployment normally applied to European economies today. In the standard bargaining model framework of the NAIRU model, profits share is independent of the bargained wage and of union power, while at the macro level unemployment adjusts to bring the target real wage into line with the feasible real wage (Layard et ai, 1991: 100-9). In a growth model employing intertemporal maximization, accumulation depends on the return to investment and the perceived opportunity cost of investment, not the share of profits. Nevertheless, Kindleberger's suggestion that wage moderation may have been important to the launching of the Golden Age is still one that deserves to be taken seriously, and it is explored in considerable detail by Eichengreen (1996). While at the macro level unemployment can sustain profits, at the micro level, where investment decisions are made, the expected rate of return depends on workers' ability to commit themselves to restrain wage claims, despite the fact that they are too small to influence the NAIRU. Postwar circumstances may indeed have been unusually favourable to the creation of institutions which would facilitate wage moderation by workers in return for high investment by firms. Overall, this earlier body of work suggests that the Golden Age was an unusual period and provides some useful insights both into the achievement of high growth and into the relative success and failure of individual countries. Nevertheless, at the very least it must be recognized that even the most plausible of these accounts leaves a large number of loose ends. By comparison with more recent theorizing on growth, several points appear rather unsatisfactory. In particular, there is very little emphasis placed on human capital, demand seems to be given too much prominence, and questions of catch-up and convergence are treated in a rather casual fashion. Above all, the large role left for 'residual efficiency' changes in growth accounting suggests a need for further research. 4

Recent developments in growth theory

As we have seen, until quite recently mainstream economics analysed economic growth in terms of the Solow model and its empirical counterpart, the growth accounting pioneered by Abramovitz, Denison and Kendrick and continued most notably by Maddison (1987). Nevertheless, economists were uneasy about this. As

Postwar growth: an overview

15

van de Klundert and Smulders put it, 'The neoclassical model can explain the stylized facts as listed by Kaldor ... However, the way in which the model explains these facts is unsatisfactory. All long-run growth stems from factors outside the model . . . An intuitively appealing model of growth would allow for permanent effects of savings and taxation by endogenizing technological change' (1992:180-1). Three aspects of recent attempts to improve upon traditional growth economics are of particular interest to postwar European experience. First, accumulation of capital plays a bigger part in growth outcomes in the new growth theory. The concept of capital which is embraced is typically 'broad capital', which subsumes both physical and human components, the latter comprising skills and/or a stock of knowledge. A common feature of balanced growth solutions involves a constant steady-state ratio of physical to human capital, and an implication of this approach, at a minimum, is that diminishing returns to the accumulation of reproducible factors of production are much less severe than in a traditional Solow model. The well-known Mankiw, Romer and Weil AugmentedSolow model (1992) has an exponent on broad capital in a Cobb-Douglas framework of 2/3, double that on capital in the Solow model. In general, there is a strong expectation that with a broad concept of capital there may be important externalities to investment. Some models, including, for example, the famous Rebelo (1991) Y = AK formulation, assume constant returns to broad capital formation, in which case growth can be regarded as fully endogenous. It should be noted that radical revision to growth accounting methods may be required if models of this kind are empirically verified. Second, savings/investment decisions are now explicitly placed in terms of optimizing behaviour rather than exogenous as in the Solow formulation. Similarly, substantial attention has been given to introducing imperfect competition into growth models to provide an appropriate incentive structure for investment in innovative activity (Romer, 1994). An important implication of these developments is to allow economic policy and institutional structures a much greater potential impact on growth outcomes through the investment processes on which they impinge. A third important feature of recent work is research into convergence. The traditional neoclassical and Augmented-Solow growth models embody convergence to a steady-state growth rate. If countries had identical technology and the same savings and population growth rates, then in the long run convergence would in all cases be to the same steady-state growth rate and per-capita income level. The speed of convergence depends in particular on the severity of diminishing returns to capital. (No such mechanism operates in the Rebelo model.) As this convergence process takes place, we would expect in the cross-section of countries to observe both a negative relationship between the initial level of income per head and subsequent growth, and also a reduction in the coefficient of variation of per-capita income, which would eventually tend to zero. Barro and Sala-i-Martin (1991) called these /?- and cr-convergence respectively. Actually, the process which may be observed is probably more likely to be one of 'conditional convergence', as growth accounting implicitly assumes, as economic historians have always tended to believe, and as new growth theory emphasizes. Here allowance would be made for additional variables such as 'social capability', technology gaps and accumulation strategies, and these would be controlled for in

16 Nicholas Crafts and Gianni Toniolo Table 1.10. Estimated trend rates of growth of output per person in different periods (% per year)

Belgium Denmark France Germany Italy Sweden UK USA

1860-1914

1920-39

1951-73

1974-89

0.90 1.77 0.96 1.47 1.47 1.52 1.04 1.70

1.01 1.58 0.78 2.91 0.21 3.03 1.56 0.86

3.90 3.46 4.92 5.11 5.31 3.42 2.24 1.54

2.09 1.59 1.42 1.26 2.05 1.62 1.83 1.89

Note: Dataset taken from Maddison (1991); start date for Italy = 1861, USA = 1869. Source: Crafts and Mills (1996), which includes full details of estimation methods, statistical significance and testing for unit roots. regressions of income on initial income level. Conditional convergence might in principle be based on initial disequilibria in factor proportions, or on technology transfer in a world where obstacles are reduced. Indeed, 'technological catching-up' might be observed in contexts which produce local rather than global convergence (Durlauf and Johnson, 1992). It should be recognized that, while the new growth economics has produced a substantial volume of empirical research, in several important respects theory has run ahead of measurement, especially with regard to examining differences within the advanced countries rather than between the First and Third Worlds. This is particularly true with respect to measuring human capital, which is unfortunate given the new weight attached to it by theory, and in the area of quantifying influences on the ex-ante decision to invest. 5

Europe's postwar growth in a long-run perspective: some quantitative aspects

Section 2 established the broad quantitative elements of the unique experience of the Golden Age and of the subsequent slowdown. In this section we scrutinize the data more closely, using modern analytic tools to review key ideas both from economic history and the new growth economics. Initial insights into growth in the Golden Age can be obtained using time series econometrics, as in Crafts and Mills (1996). Some of their results are summarized in Table 1.10. Crafts and Mills' approach takes seriously Maddisons's suggestion of epochs in growth, and estimates a segmented trend with breaks at 1914,1919,1939, 1950 and 1973 for countries with long-run GDP data. Tests are also given of the Janossy (1969) hypothesis, well known to students of West German growth, that the Golden Age was an era of reconstruction and rapid recovery back to a long-run trend path of growth as in the Solow model, based on a constant exogenous rate of Harrod-neutral technological change and, thus, labour productivity growth.

Postwar growth: an overview

17

6.50-

6.00-

5.50-

' Reverse Janossy' extrapolated trend

5.00-

4.50-

Fitted trend

V

4.00

1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 Figure 1.1 Trend growth of real output per person in Italy, 1870-1990

The estimates in Table 1.10 give strong support to the hypothesis that for European countries the trend rate of growth was exceptionally rapid during the Golden Age. The technical details of the estimation also establish that the hypothesis of a unit root in GDP per person can be rejected in favour of the segmented trend stationary alternative in every case, a result which goes against the idea of fully endogenous growth with constant returns to accumulation. Further testing revealed that, when growth slowed down again, in all but one case (Denmark) European countries were enjoying a higher output per person to that which might have been expected simply on the basis of extrapolating their pre-1914 experience. However, although the pure Janossy hypothesis is generally rejected, in a number of cases backward extrapolation of the post-Golden Age trend does go back to join the actual series at a pre-disturbance date, if the final break of trend is dated by an endogenous search procedure. Italy is a case in point, as is shown in Figure 1.1, where the contrast with the USA stands out. Thus, the Janossy (1969) stress on reconstruction as an important ingredient in Golden Age growth in many European countries is still useful, even though his traditional constant-trend neoclassical growth model appears too rigid. Levine and Renelt (1992) conducted an extensive analysis of the findings of empirical work on growth in the 1960-89 period, based on international cross-section datasets. Their work is set in a catching-up framework and provides estimated equations to account for growth, while at the same time investigating the robustness of alternative specifications. Their results offer an alternative to Maddison-style growth accounting and do not impose assumed elasticities of output with respect to physical and human capital formation. In Table 1.11 we use one of Levine and Renelt's equations to consider what new

18 Nicholas Crafts and Gianni Toniolo Table 1.11. Using the Levine-Renelt model to account for changes in European growth of output per head

Constant Initial GDP/head Investment/GDP Secondary enrolment Primary enrolment Government/GDP Forecast Actual

1923-38

1950-73

1973-89

2.01 -2.43 1.42 0.16 1.90 -0.62 2.44 2.12

2.01 -2.49 2.22 0.68 1.99 -0.87 3.54 3.84

2.01 -3.55 2.06 0.79 1.79 -1.27 1.83 2.14

Sources: Estimates are for unweighted averages of European countries in Maddison (1991), excluding Belgium and Switzerland, and use Levine and Renelt (1992) equation (ii), with population growth and irrelevant dummies ignored. The initial income variable was expressed as a percentage of the US level in each year, and this figure was then multiplied by 1950 US income per person as measured by Levine and Renelt. Basic sources of data were Maddison (1991), Mitchell (1988) and OECD (1991b), augmented for interwar investment by Maddison (1992) and for interwar government consumption expenditure by den Bakker et al. (1990), Feinstein (1972), Hansen (1974), Hjerppe (1989), Krantz and Nilsson (1975), Rossi et al (1992), Sommariva and Tullio (1986) and Villa (1993). growth theory might suggest accounts for the speeding up and slowing down of European growth in the postwar years. This equation predicts growth of output/person using measures of the initial productivity gap, investment and government consumption shares and school enrolment rates as independent variables. Although Levine and Renelt doubt the robustness of the government consumption variable, we include it here given the strong evidence that there is a robust relationship in OECD countries, if not across the whole world (Dowrick, 1992). Taken at face value, the results in Table 1.11 indicate the following: • The acceleration in growth in the Golden Age came from greater investment in both physical and human capital, rather than a larger initial income gap than in the interwar period. • The speed-up in growth in the Golden Age has a significant unexplained component (of about one-third); the Golden Age saw improved growth which may reflect an enhanced catch-up capability in the postwar world and/or adverse effects of protectionism and demand shocks in the interwar period. • The slowdown in growth after 1973 is quite well explained and reflects lower scope for catch-up, as captured by a lower initial income gap and a rising share of government consumption. Compared with the results obtained by traditional growth accounting, this approach attributes more of the acceleration in growth in the Golden Age to human capital and less to TFP growth. Thus 1.41 percentage points of the 1.72 increase in growth between 1923-38 and 1950-73 is attributed to broad capital accumulation. However, the slowdown after 1973 is attributed much more to erosion of catch-up

Postwar growth: an overview

19

opportunities than in Maddison's work (cf. Table 1.6) - in Table 1.11 this explains about three-fifths of the change in growth rate pre- and post-1973. Such mechanical exercises must, however, be treated with some scepticism, as the failure fully to account for the change in growth before and after the Second World War underlines. A central difficulty is the crudeness of the proxy for human capital formation, which, as with traditional growth accounting, does not encompass on-the-job and vocational training. Also, although the results hint at an enhanced 'social capability' for growth in postwar Europe, they cannot identify its source and in that respect offer no advance on earlier growth accounting. The suggestion that there was something different about the post-1945 growth process is strengthened by explicit consideration of convergence. As has been widely recognized, the evidence is against /?- and cr-convergence prior to 1950 in Maddison's (1991: 53) dataset for the advanced countries. Since 1950 /?- and crconvergence in GDP/hour worked have been strongly present. Conditional convergence since 1960 in the OECD has been extensively analysed by Andres et al. (1996). They broadly support the Mankiw et al. (1992) analysis in that they find a convergence coefficient of about 2 per cent per year and slowly diminishing returns to broad capital, which has an exponent of about 0.8. These results are subject, however, to a number of important qualifications. In particular, Andres et al. find that convergence characterizes the period before 1975 rather than after, and that the model estimates are not stable over subsamples, suggesting differences in the underlying production functions across countries. Indeed, according to Broadberry (1996), at least as far as manufacturing is concerned, the evidence suggests that there is a European 'convergence club', but that North America still has a large productivity lead after the Golden Age. This may prove hard to reduce further as market size and natural resource endowments still play a role, albeit less significant than before the Second World War. In other words, North America may belong to a different 'convergence club', and this suggests that there were limits to the profitability of imitating American methods. Broadberry's long-run data are shown in Table 1.12. This table tends to suggest that catching up in manufacturing was incomplete during the Golden Age, and that other elements such as structural change and reduced productivity gaps elsewhere in the economy also played a part in overall catch-up. An important element in the catch-up growth of the Golden Age was clearly a reduction in technology gaps, which had previously been sustained by protectionism and limited transferability of American know-how (Nelson and Wright, 1992). Verspagen (1995), in an investigation of cr-convergence based on analysis of the effects of patenting on growth, concluded that catching-up effects were related to genuine convergence in technological competence, but that nevertheless serious differences in technological capabilities remain, i.e. that the technology assumptions underlying pure neoclassical growth models did not obtain. These results are in many ways similar to those of Helliwell (1992), whose econometric study found strong convergence effects in technical progress in the OECD during 1963-89, with evidence that these were intensified by increasing openness to international trade. Ben-David (1993) filled out this picture by establishing also that cr-convergence among European countries was particularly marked in the immediate aftermath of episodes of trade liberalization.

20

Nicholas Crafts and Gianni Toniolo

Overall, what picture has emerged from this long-run perspective? The following are the key points. • The central aspect is the highly unusual nature of growth in the Golden Age, 1950-73, which has been revealed by each of the approaches we have considered. The period was one of unprecedentedly rapid catch-up by Europe of the USA and, among the European countries, one which is characterized by both /?- and aconvergence in Barro and Sala-i-Martin's terminology. • The empirical implementation of new growth theory considered in Table 1.11 offers further support for the argument in section 3 that traditional accounts of postwar growth give too little weight to human capital. At the same time, the improvement in growth relative to the interwar period is not fully accounted for by current methods of quantification. • While reconstruction played a part in the Golden Age, catching up involved far more than this. Technology gaps were reduced and investment reached unprecedently high levels. As Abramovitz put it (1986: 395), this was 'the period when - exceptionally - the three elements required for rapid growth by catching up came together... large technological gaps; enlarged social competence... and conditions favouring rapid realization of potential'. • The European countries seem to have been in an Augmented-Solow rather than a Rebelo-type world - in which case the ending of the Golden Age should not have been such a surprise. This seems to be a reasonable inference based on the results of Andres et al. (1996) and Mankiw et al. (1992), together with the general absence of a unit root in GDP. In the longrun, though perhaps not straightaway, weakly diminishing social returns to the postwar investment boom could be expected, and scope for catch-up would be diminished. 6

The years of high growth

As we have seen in the previous sections, the so-called Golden Age (roughly dated 1950-73) is unique in the history of the European economy in terms of both growth rates and cyclical stability. So far we have examined a number of quantitative explanations of the causes of the Golden Age. Some of them are more satisfactory than others. The recent stress on conditional convergence, human capital and endogenous technical change has undoubtedly advanced understanding for this fast-growth episode. Nevertheless, much remains to be explained. In order to fill out the picture, we now consider some key historical and institutional factors that make the 1950s and 1960s a unique period in the economic history of Europe. 6.1

The legacy of the 1930s and of the war

During the interwar years, the aggregate European economy grew at a slower pace than the American, in terms both of output and of productivity. The performance of Europe was also below its pre-1913 record (Maddison, 1991). The features of the European slowdown during the 1930s were likely to give way to a process of catch-up according to a neoclassical view, if we consider the latter as a function of an increasing gap between steady-state and actual output per worker (Barro and

Postwar growth: an overview

21

Table 1.12. Comparative levels of labour productivity in manufacturing (UK output per employee = 100)

UK USA Canada Australia Germany Netherlands Norway Sweden Denmark France Italy Japan

1870

1913

1929

1938

1950

1973

1989

100 204 132

100 213 230 138 119

100 250 256 102 105 102 109 94 115 82 59 32

100 192 218 101 107 117 95 100 98 76 49 42

100 263 227 96 96 88 103 118 88 84 68 20

100 215 229 86 119 133 104 128 89 114 96 95

100 177 185 81 105 128 85 121 93 115 111 143

100

90 102 79 59 24

Source: Broadberry (1996). Sala-i-Martin, 1991). The latter resulted from the slowdown in the accumulation of physical capital not being matched by an equal deceleration in human capital formation. Even during the war, the depletion rate of the two kinds of capital was biased against physical assets, particularly those in the social overhead stock. In addition, diffusion of technology speeded up and American know-how was more fully deployed in Europe. In effect, the new postwar world offered greater opportunities for effective technology transfer (Nelson and Wright, 1992). A typical situation for swift catch-up growth was thus created: once trade and intellectual barriers were removed, the transfer of technology - both embodied and disembodied - was met by an adequate stock of human capital in the recipient countries that made possible a rapid narrowing of the gap between steady-state and actual product per worker. In a more general Abramovitz (1986) framework, one may say that Europe's overall 'social capability' for growth had been hibernating, but had not been destroyed. 6.2

Reconstruction and postwar settlement

Wartime loss of output was considerable. In the largest continental countries (Germany, France and Italy), the productive effort of more than an entire generation was lost as 1945 per-capita incomes stood at around the 1900 levels, as Table 1.2 reported. The speed of'reconstruction' (by which we mean the recovery of the 1938 levels of production per head) took most observers by surprise. Infiveor six years, at most, the losses in output and capital stock were made good. The process of reconstruction does not need to concern the present discussion of longer-run causes of postwar growth, except for noting (1) that it provides yet another proof of the existence of an exceptional 'social capability' for growth almost everywhere in Europe and (2) that it is likely to have set in motion the exploitation of scale economies and thus longer-run increasing returns.

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Nicholas Crafts and Gianni Toniolo

The social, legal and political institutions, both international and national, created soon after the war are of paramount importance in explaining the extraordinary growth of the 1950s and 1960s. The establishment of such institutions, or the 'postwar settlement' as it has come to be known in the literature (Eichengreen, 1993), is plausibly seen (Maier, 1987) as the terminal point in a process aimed at reversing the crisis that afflicted European liberal capitalism at the end of the nineteenth century. In this view, two related problems needed to be solved during the twentieth century by the elites superintending Western European societies: those of legitimation and those of production. The leaders of the 1920s 'rallied with persuasive justifications of capitalist entrepreneurship', but 'they did not solve the economic dilemma of continuous production and high employment... only by the 1950s were afflictions that undermined capitalist stability effectively overcome as a whole. The cumulative achievement required the institutional flux that was left in the wake not of one but of two wartime upheavals' (Maier, 1987: 162). Rather than simply contrasting the unwise outcome of the Versailles Peace Conference with the prudence of Bretton Woods and of the Marshall Plan, this perspective to twentieth-century history helps in understanding the roots of the second 'postwar settlement' and, thus, its pervasive and lasting impact on European societies. In employing its newly found leadership to 'ensure the primacy of economics over politics and to de-ideologise issues of political economy into questions of output and efficiency', the United States simply encouraged an existing trend, did not impose it (Maier, 1987:146-9). It is then possible to speak of a 'consensual American hegemony', in the sense that a social basis for productivity-enhancing politics had acquired solid foundations in Europe. The 'postwar settlement' consisted of two mutually reinforcing parts: international and domestic. The high investment ratios that characterized the Golden Age rested on more or less explicit social pacts aimed at increasing productivity, whereby workers exercised wage moderation on the understanding that capitalists would plough back their profits into the productive process. The relative degree of economic success of individual countries depended to a fairly large extent on the ability to make the 'pact' appealing and credible in the long run. The international setting was crucial in both respects. On the one hand, it made the pact appealing by guaranteeing a minimum standard of living during the early postwar years through the Marshall Plan and the European Payments Union.12 On the other hand, it created an environment (characterized by stability in domestic prices and exchange rates, and by growing international trade) which made agents confident about the real value of their incomes as well as about their future increases. A somewhat similar pact was reached in Eastern Europe, albeit with a higher degree of coercion. There too production goals acquired primary social relevance. The socialist state, with the crucial political mediation of the party, took upon itself the role of guaranteeing a high rate of investment and full employment in exchange for low wages and social discipline. 6.3

Causes of growth during the Golden Age

We have seen that catch-up was an important element of postwar European growth, particularly during the so-called Golden Age. Nevertheless, we maintain that

Postwar growth: an overview

23

catch-up is by no means an automatic phenomenon. The peculiar economic, institutional and political circumstances created by the Great Depression, autarky, war and reconstruction were particularly favourable to postwar European growth in general and to catch-up in particular. In what follows, we briefly discuss the interplay of favourable factors that made this unique episode in the economic history of Europe possible. Most explanations are unsatisfactory. This is true both of those advanced in the 1960s and of the most recent ones proposed by the 'new growth theory'. A stress on the pure mechanics of 'catch-up' is likewise inadequate. In order to account for the exceptional speed and stability of European economic growth in the 1950s and 1960s, one must take into account the equally exceptional circumstances whereby a number of factors affecting the production system and the macroeconomic structure were allowed to interact with singularly apt institutional arrangements in the international economy and in the individual countries. The main 'virtue' of backwardness lies in the fact that agents can appreciate the enormous gains potentially involved in borrowing technology and capital from more advanced countries, once the 'social capability' for growth is created in the recipient country. The introduction of the Taylorist system looked particularly promising in economies that, by the early 1950s, enjoyed a level of per-capita income (not too far off the US level in the early 1920s) characterized by high income elasticity of demand for consumer durables. Some of these countries had begun experimenting with mass production just before the war (the UK, Germany). The appreciation of the existing potential for growth is witnessed by the number of productivity missions sent to, or invited from, the United States to see 'how American prosperity could be emulated' (Glyn et al.y 1990: 56). In order to take full advantage of the adaptation of American technologies to European conditions, business and trade union practices had to be adjusted accordingly. The speed and the lasting impact of adaptation varied from country to country, but the spread of the new productivity ideology, stressed by Maier, was universal. The 'new international order' was crucial in inducing both entrepreneurs and workers to adopt the necessary changes in their respective behaviours. In particular, it provided both a short-term bridge to the new growth path and a guarantee of its payoff in the long run. It was this extraordinary mix, seldom to be found in other historical circumstances, that triggered the 'virtuous circle' of the Golden Age. It was often the case that governments were faster than either workers or business organizations in appreciating the potential long-run benefits to be drawn from the new situation; almost everywhere they created a social and institutional environment consistent with long-run sustained growth. For imported technology to produce high productivity growth, an educated and disciplined workforce was a necessary precondition. As we have seen, one of the great advantages of Europe over other areas lay precisely in the 'previous accumulation' of good-quality human capital. Some wage moderation, however, was necessary for productivity gains to generate investment ratios high enough to yield economies of scale and further productivity gains. Wage moderation depended (1) on a fairly elastic supply of labour (as described in Kindleberger (1967)), and (2) on the expectation of long-term improvement in the workers' standard of living. The latter condition could be created only by a credible commitment on the part of

24

Nicholas Crafts and Gianni Toniolo

employers to plough back retained profits into investment. A stable international business environment, expectations about a steady decrease of barriers (both tariff and non-tariff) to trade and about the stability of the foreign exchange at a slightly devalued rate made the commitment both possible and credible (Eichengreen, 1996). On the domestic front, conditions for a pledge to high rates of investment were reinforced by a monetary policy which, for being aimed at keeping a fixed parity with the dollar, promised low inflation rates as well. Controls on international capital movements - a feature of the Bretton Woods system - allowed some governments to pursue a policy of'artificially low' interest rates, thereby providing a further stimulus to investment in manufacturing, housing and infrastructure. A commitment to welfare state provisions was also instrumental in moderating wage demands. In terms of new growth theory, these institutional arrangements played a role similar to that of low direct taxation, and indeed operated to counteract the record levels of direct taxation which were a further aspect of the new postwar European scene. Parallel growth of investment, productivity and real wages was a key element in the unique episode in the economic history of mankind that has come to be known as the Golden Age of capitalism. Income distribution was crucial to the continuation of this process. As long as it was consistent with a balanced growth of consumption and investment, high rates of growth in output and productivity could continue in an environment of extraordinary macroeconomic equilibrium, which came to be built into expectations and, therefore, to be an important reinforcing element of the growth process itself. In section 8 below we briefly discuss some of the country-specific features of the process of rapid growth of 1950-73. Here, however, we would like to stress that many of the causes that are likely to explain such process are common to all the countries that shared in it. In particular, the overwhelming importance of the international environment in generating and sustaining growth is witnessed by the fact that, while Spain and Portugal did not experience in 1945 a real break with the past and were throughout ruled by authoritarian regimes, their rates of growth accelerated in response to the decision to link the economic future of both countries to that of the West. Thus, in 1953, with the so-called Pact of Madrid, Spain allowed the United States to open airforce and navy bases in return for technological aid and, more generally, for better prospects of long-term integration in the 'Atlantic economy' (see, for instance, Preston (1991)). Portugal almost doubled its average rate of growth, relative to the previous decade, after joining the Bretton Woods system in I960.13 The Irish case can, perhaps, be taken as a proof a contrario. The Anglo-Irish agreement of 1948 was too narrow in international scope to result in a positive shock to entrepreneurial expectations, while the best performing years of the Irish economy are those that followed the 1958 commitment to trade liberalization (6 Grada and O'Rourke, 1996).14 Relatively rapid productivity growth also surfaced in Eastern Europe during the Golden Age, although here a high rate of capital accumulation enforced by Communist governments loomed large. Indeed, growth in these countries relied heavily on the mobilization of factors of production into the industrial sector, in which central planning tended to promote inefficient use of resources together with inferior innovation performance (Bleaney, 1988: ch. 4). Given these characteristics of the

Postwar growth: an overview

25

Communist bloc, marked tendencies to slowdown towards the end of the Golden Age were to be expected as capital stock growth and capital productivity growth declined and transfers from the backward sector dried up (Ehrlich, 1993: 312-19). 7

Slowdown and instability

After the early 1970s, the pace of expansion of European production and productivity fell back to its secular trend, close to Kuznets' modern economic growth averages. In particular: • The average annual growth rate of GDP fell to 2.6 per cent in 1973-9 and 2.0 per cent in 1979-90; the performance in the latter period was slightly worse than that of the USA (Glyn, 1993: table 1). • Investment rates equally declined by about 3 percentage points for the whole of the business sector and 1.3 per cent for manufacturing in 1979-89 (Armstrong et ai, 1991: tables A5 and A6). • Both GDP per worker and manufacturing output per hour worked growth halved relative to the Golden Age. If seen in a broad secular perspective, the explanandum in postwar European economic history appears to be not so much the slowdown of the 1970s as the growth spurt of the previous two decades. Nevertheless, a large body of literature exists trying to explain the reasons for and the timing of the slowdown as well as why the hopes for a revival of the Golden Age after two oil shocks have proven short-lived.* 5 The reasons for the longer-run unsustainability of the high growth rates of 1950-73 are to be found in the very success of the Golden Age,16 and in the fact that it rested on the simultaneous - and improbable - occurrence of a number of favourable factors. As we have seen, high growth was made possible by the gains deriving from the transfer of the (Taylorist) mass production technology in a receptive (socially capable) environment stabilized by a strong American leadership. This made possible an efficient co-ordination in the bargaining process for income distribution, leading to high and balanced demand for investment and consumption and, therefore, to macroeconomic stability, which in turn reinforced the process in a sort of virtuous circle. As the individual building blocks of this construction interacted in a mutually reinforcing process, so the cracking and eventual crumbling of one or a few of them undermined the solidity of the entire building. Triffin (1957) was the first to point to the self-defeating instability of a system of international payments which postulated both growing American current account deficits and the willingness of the Europeans to hold dollar-denominated reserves rather than gold. It was first of all rapid growth itself - more than American domestic monetary policies - that stressed the stability of the Bretton Woods system and eventually brought it to an end (Bordo, 1993). In a broader perspective, one can say that it was American leadership itself that rested on feet of clay. Soon after the war, its legitimacy hinged on the United States providing economic assistance in return for policy compliance; US hegemony lost some of its legitimacy in European eyes when, rightly or wrongly, they perceived the Bretton Woods system as being utilized 'to exact tribute through seignorage (accumulating dollar liabilities abroad and buying European assets with an overvalued currency)'(Maier, 1987:149). At the

26

Nicholas Crafts and Gianni Toniolo

same time, the pursuit of international leadership slowly lost consensus at home as 'American hegemons... could not demand renunciation on the part of the American working classes for the sake of providing liquidity to the West' (Maier, 1987: 150). International leadership could be exercised only as long as its domestic costs were relatively negligible, and for this very reason could not be maintained in an expanding world. At the same time, returns deriving from high investment rates and from the transfer of technology eventually began to diminish. And, since the (more or less implicit) social pact governing class relations in most European countries rested on the ability of the economy to deliver rapidly expanding standards of living to the workers, it became less and less feasible to maintain the particular income distribution that had made possible both high investment rates and macroeconomic stability. As the latter began to flounder and profit shares to fall, the postwar social pact was virtually over in a number of countries, and a chain reaction of scrambling for income distribution was set in motion. In countries such as France and Italy, where both the economy and social cohesion were weaker, tensions surfaced in the late 1960s: they set in motion a decline in profit rates incompatible with the long-run continuation of the postwar boom, while at the same time tax rates were now rising quickly. If the above factors explain the deterioration of the delicate international and domestic equilibria of the Golden Age, other more specifically economic reasons may be found behind the long-term decline in productivity in Europe, as well as in Japan and the United States. Among these, one might mention: (1) a slowdown in the potential for exploitation of economies of scale, (2) changes in production technology and (3) changes in demand patterns. Taylorism and chain production technology were particularly apt at producing economies of scale internal to thefirm;at the same time they were singularly fit to profit from the possibility of drawing relatively unskilled labour from agriculture to manufacturing. This technology slowly gave way to new productive methods (highlighted, for instance, by the Japanese lean production in the automotive sector), the introduction of which was partly a response to a new consumer sophistication (emphasis on quality, individual specification of products and the like) resulting from growing incomes and, therefore, from Europe's economic success itself. However, the shift to new production processes required long and costly adjustments not only on the shop floor but, much more importantly, in society at large. In particular, a moreflexibleuse of resources (labour) in response to demand and supply shocks was postulated. Such changes took a long time to come about and are not yet fully embedded in the European work culture and organization. At the same time, growing per-capita incomes entailed a demand shift to the service sector. Studies on the latter's productivity do not yield unequivocal results, and show a wide cross-country dispersion both in the levels and in the rates of growth of productivity. They seem, however, to point in the direction of slower productivity growth relative to the manufacturing sector (e.g. Elfring, 1988). From the point of view of catch-up and convergence, post-1973 European growth experience was much less clear-cut than during the Golden Age. In particular: (1) relative to the USA, the productivity catch-up proceeded at a slower rate during the 1970s and stopped, if not reverted, in the following decade (underperformance

Postwar growth: an overview

27

vis-a-vis Japan continued throughout), and (2) evidence of intra-European catch-up is weaker than in the past (Table 1.4), but the previous convergence process within Europe continued. As mentioned earlier, partly as a result of the latter process, around the Netherlands and Sweden's median per-capita income (Table 1.4) a cluster of nine countries now exists, with incomes falling within an interval of ± 8.0 per cent. If we take it, with Blanchard (1991), that capital and labour mobility are likely to produce convergence, the clustering of so many European countries in the same per-capita income range may be seen partly as the result of increased factor mobility within the community, as well as the result of its enlargement from the mid-1970s onward. The standard subdivision of the most recent period in Europe's economic history - 1973-79 and 1979-92 - is still the most useful when focusing on policy making and on institutions (the latter including the rise and fall of the European Monetary System). The 1973-9 period was substantially one of transition and adjustment. The changes in industrial relations, highlighted by the wage explosion and strikes which accompanied the end of the Golden Age, account for most of the double-digit inflation that characterized ten of the sixteen countries in our sample. However, money supply accommodation of distributional conflicts was only a transitory solution. The response to the second oil shock, therefore, showed that an overall change in policy stance was under way in most European countries. Floating exchange rates had created a vicious circle of inflation in the weaker economies, and had added uncertainty to the business environment everywhere due to the much increased level of speculative capital flows. The creation of the European Monetary System (EMS) in 1978 was seen as a response to this situation, in that it required member countries partly to renounce their monetary sovereignty. Similarly, after the dollar crisis of 1978-9, the Federal Reserve inaugurated a period of tight money. This overall change in policy stance opened the way to Industrial restructuring': in some countries (Germany) it went almost unnoticed, being the continuation of a process of mergers and reorganization that had started much earlier; in others (UK, Italy) it was the result of a deliberate policy aimed at increasing productivity. In the latter case, it was made possible by the intervening weakening of the trade unions17 due to high unemployment in the 1970s as well as to broader changes in the composition of the labour force. However, except in the case of the UK where industrial restructuring resulted in higher output per worker, labour productivity growth was on average lower in the 1980s than in the previous decade. 8

Factors in the performance of individual countries

In earlier sections we have emphasized common aspects of postwar European experience. Now we switch the focus to an analysis of'winners' and 'losers', and to briefly considering the contribution made by new growth theory in explaining relative success and failure. Table 1.13 gives a first view of success or failure in the postwar convergence process and takes account of different initial starting points which imply, in an augmented neoclassical model, differential scope for 'catch-up growth'. The estimates are based on the well-known Barro and Sala-i-Martin (1991) model of

28

Nicholas Crafts and Gianni Toniolo

Table 1.13. Actual and forecast convergence, 1950-8617 (GDP I hour) (US'A =100)

Australia Austria Belgium Canada Denmark Finland France Germany Italy Japan Netherlands Norway Sweden Switzerland UK

Actual

Forecast

78 74 86 92 68 67 94 80 79 61 92 90 82 68 80

81 43 60 86 61 48 58 47 48 27 64 61 67 72 73

Argentina Brazil Chile Columbia India Korea Mexico Peru Philippines Taiwan

Actual

Forecast

28 25 33 28 4 21 27 20 11 20

50 29 53 38 8 18 35 34 20 15

Source: Crafts (1992a) based on applying the Barro and Sala-i-Martin (1991) model to data supplied by Maddison. convergence, with its suggestion that on average catching up reduces the productivity gap by 2 per cent per year. Two points stand out in the table. • European countries tend generally to exceed predicted rates of convergence, while the opposite is the case for South America. Perhaps Europe and South America belong to different convergence clubs and have different steady-state income levels; perhaps this table also emphasizes the unusual conjuncture of conditions favourable to catch-up in postwar Europe. • While the model's predictions are unbiased, nevertheless there is a wide variation of performance around the forecast convergence rate. Some European economies did distinctly better than others on this normalized basis: for example, France and the Netherlands outperformed Denmark and the UK. The estimation of catching-up growth models might offer some clues to this experience, and Table 1.14 returns to the Levine and Renelt equation discussed in Table 1.11. This allows comparisons of predictions of growth for each country with the average, based on the factors listed in the table. The model works surprisingly well, given that it was estimated for a much wider sample, and also predicts quite a wide range of outcomes within Western Europe, partly because it embodies quite a strong catching-up effect. To reduce distortions from reconstruction, the Golden Age is viewed in terms of the post-1960 period. Table 1.14 suggests that during the Golden Age differences in initial income level had the largest single effect on relative growth performance, given the large initial dispersion of income levels. As with traditional growth accounting, relatively little difference between countries shows up in education, as enrolment trends were very similar across Europe, although France and Germany on the positive side and Spain on the negative side are noticeable in the 1960-73 period. The UK's weak

Postwar growth: an overview

29

Table 1.14. Growth performance and its sources relative to the European average: an analysis based on Levine-Renelt (% per year)

1960-73 Austria Belgium Denmark Finland France W.Germany Ireland Italy Netherlands Norway Portugal Spain Sweden Switzerland UK 1973-39 Austria Belgium Denmark Finland France W. Germany Ireland Italy Netherlands Norway Portugal Spain Sweden Switzerland UK

Scope for catch-up

Investment Education Public sector

Unexplained

Total

0.24 -0.08 -0.85 0.13 -0.15 -0.66 1.18 0.71 -0.30 -0.51 1.95 1.27 -0.61 -1.78 -0.49

0.24 -0.24 -0.03 0.21 -0.03 0.07 -0.32 0.03 0.08 0.38 -0.02 0.01 -0.12 0.36 -0.55

-0.11 0.19 0.04 0.05 0.55 0.43 -0.20 -0.19 -0.01 0.16 -0.01 -0.34 -0.17 -0.17 -0.08

0.02 0.06 -0.21 0.02 -0.02 -0.08 0.04 0.05 -0.03 -0.09 0.10 0.34 -0.33 0.25 -0.19

-0.32 0.24 0.42 -0.14 -0.28 -0.59 -1.23 -0.23 -0.37 -0.67 0.85 1.89 0.40 0.11 -0.32

0.07 0.17 -0.63 0.27 0.07 -0.83 -0.53 0.37 -0.63 -0.73 2.87 3.17 -0.83 -1.23 -1.63

0.33 -0.20 -0.35 0.17 -0.28 -0.20 1.30 0.36 -0.26 0.08 1.13 0.77 -0.63 -2.05 -0.18

0.22 -0.28 -0.30 0.29 -0.07 -0.15 0.02 -0.03 -0.18 0.47 0.38 0.04 -0.26 0.17 -0.39

-0.02 0.11 0.08 -0.05 0.24 -0.07 0.05 -0.04 -0.01 0.12 -0.18 0.13 -0.03 -0.07 -0.01

0.02 0.14 -0.44 -0.07 0.02 -0.07 0.05 0.18 0.13 -0.09 0.21 0.31 -0.55 0.35 -0.14

-0.20 0.24 0.86 -0.59 -0.06 0.74 -1.07 J 0.08 -0.03 0.47 -1.29 -1.20 0.82 0.65 0.37

0.35 0.05 -0.15 -0.25 -0.15 0.25 0.35 0.55 -0.35 1.05 0.25 0.05 -0.65 -0.95 -0.35

Sources: As for Table 1.11. record in physical investment is highlighted as a problem, as is the relatively large public sector in Denmark and Sweden. In terms of 'unexplained' performance, which presumably reflects aspects of 'social capability' not captured in the regressions, Ireland stands out as a disappointment, but a notable feature is the lack of correlation in this component between the two periods. Once again, it is important to treat the results of this accounting exercise with caution. Clearly, at best this approach cannot deal with issues of endogeneity, nor can it explain why investment strategies differed. Moreover, the proxies for human capital formation (enrolment ratios) are crude and, in particular, ignore training.

30 Nicholas Crafts and Gianni Toniolo

Also the results are somewhat at odds with those of other studies, such as Dowrick and Nguyen (1989), suggesting that in comparisons of the advanced countries the precise attribution of sources of growth is quite sensitive to small changes in specification of the model. Nevertheless, the exercise confirms that normalizing for catch-up potential still leaves something to be explained. We can think of two rather different, although potentially complementary, ways of using new growth theory. The first would be essentially microeconomic in focus and would consider the roles of Marshallian externalities, learning effects and specific technological expertise in fostering differences in comparative advantage and growth potential, as in Lucas (1993). The prospect of serious research along these lines is exciting and may ultimately prove fruitful. At present, however, the second line of research is further advanced and, as set out above, offers the main existing set of empirical evidence. This research looks at the overall accumulation strategies of different countries in an effort to explain differences in growth performance through both the extent and the effectiveness of investment. If catch-up is not automatic and 'social capability' for growth varied within postwar Europe, this may be part of the reason for the results in Tables 1.13 and 1.14. Although a macro perspective will undoubtedly miss part of the story, there are good reasons, in principle, for expecting it to be useful. In particular, it should be noted that relatively weak productivity performance frequently appears to have been a national rather than a sectoral phenomenon (Dosi et ai, 1990). Quite a number of variables have been suggested by researchers working in the new growth economics as additional explanatory factors in winning and losing in the growth league. Data on some of these are reported in Table 1.15. Among these European countries, the differences are generally not very large, and such variables may be much better at separating third world 'failures' from OECD 'successes' than at explaining high investment or 'social capability' for growth in a European context. There are, however, more important reasons for doubting the value of standard new growth variables in providing a full account of postwar European growth based on new growth economics. These appear to be particularly important in the areas of incomplete catching up and incentives to investment. They relate to the roles of institutions and policy in economic growth. Abramovitz, in stressing that catch-up growth is not automatic, noted that it can be blocked by 'vested interests, established positions, and customary relations amongfirmsand between employers and employees' (1986:389). As noted in section 3, attempts to operationalize this proposition in regressions following up sclerosis in an Olsonian framework have not been successful. Such influences may in fact not be amenable to quantification and may, in the end, be unduly neglected by analysis of this kind. In the case of incentives to invest, the position is more complicated and less well understood. The potential value of new growth theory is to place investment and the growth to which it gives rise in an optimizing framework, in which success and failure are the outcome of rational behaviour rather than the laundry list of scapegoats provided by traditional economic history. In such an approach, institutions and government policy will surely matter, but may not be easy to model. For example, empirical investigations of the effects of taxation on growth have

Postwar growth: an overview

31

Table 1.15. Some new growth variables LLY (1964/5) Austria Belgium Denmark Finland France Germany Italy Netherlands Norway Sweden Switzerland UK

0.48 0.46 0.46 0.39 0.42 0.65 0.59 0.52 0.47 1.01 0.35

Td/Y(%) RD/Y(%) (1960)

(1970)

19.7 16.9 15.9 14.9 21.5 21.6 20.4 21.7 17.9 19.0 10.6 19.1

0.61 1.31 0.96 0.78 1.91 2.06 0.88 2.01 1.10 2.25 2.18

Sources: LL Y is ratio of liquid liabilities to GDP as denned by King and Levine (1993), Td/Y is direct taxes/GDP from OECD (1981), RD/Yis research and development spending/GDP from OECD (1991c). provided much less decisive results than one would expect from the a priori reasoning of new growth theory (Easterly and Rebelo, 1993). Part of the reason for this may be that readily available measures are of average rather than marginal tax rates. Also, ex-ante capital taxation rates depend crucially on expectations of inflation, as the work of King and Fullerton (1984) emphasizes. Bean and Crafts (1996) and Eichengreen (1996) both explore a related point: namely, the possibility of firms and their workers making credible commitments to a high investment/wage moderation equilibrium. They recognize that government may have an important role in brokering a 'social contract' and ensuring appropriate industrial relations. Such 'deals' in postwar Europe were likely to involve higher taxes and welfare spending as part of the package, which, in context, were investment enhancing rather than the opposite. In general, recent work on investment has stressed the importance of irreversibilities and the sensitivity of required rates of return to the degree of uncertainty in the economic environment (Pindyck and Solimano, 1993). All these considerations will not be captured by a conventional 'tax rate' measure, but should, in principle, be subsumed in the ex-ante hurdle rates imposed on investment decisions in different countries in different time periods. Such data would capture the full flavour of recent theorizing, but unfortunately do not presently exist. 9

Concluding comments

Recent developments in growth economics have changed the way we think about the postwar period, but they have by no means yet provided us with a complete

32

Nicholas Crafts and Gianni Toniolo

understanding of the Golden Age and subsequent slowdown. Nevertheless, current models and empirical techniques allow more plausible insights into the experience than was possible with the older theories reviewed in section 3. The main findings of this overview essay are the following: • It is useful to think in terms of epochs of growth. In that context, the years c. 1950-73 stand out as a time when European growth was exceptionally rapid and the economic environment favoured rapid catch-up and convergence. Postwar reconstruction of the international economy delivered a large positive shock to the European economy. • New growth theory seeks to place more emphasis on factor accumulation and less on unexplained TFP growth in explaining long-run growth. Empirical investigation using the Levine and Renelt (1992) approach supports this interpretation of the acceleration of growth postwar and, in particular, suggests that human capital formation deserves much greater weight than it was accorded by earlier writers. Obtaining better measures of human capital formation is a high priority because it is in this area that empirical work suggests that externalities may be especially important, whereas it seems that for physical capital these are trivial (Oulton and O'Mahony, 1994). • Nevertheless, a significant fraction of the acceleration in growth during the Golden Age does not seem to be readily accounted for by new growth models. This would appear to result from changes facilitating technology transfer and raising returns to investment. There may be a role here for some of the policy changes stressed by early postwar accounts, including trade liberalization and demand stabilization, in eliminating obstacles to the faster growth which had prevailed between the wars. • The slowdown after 1973 appears less surprising when viewed in a long-run context and against the evidence, which suggests that in the end there are diminishing returns to investment in broad capital and that the notion of reverting to earlier trend rates of growth still has some validity. • A full understanding of Europe's Golden Age of economic growth requires a subtle appreciation of the impact of policy and institutions on incentives to invest and obstacles to complete catching up. Recent work in growth theory provides new insights which will require detailed historical research before their full implications can be brought out. NOTES This paper is produced as part of a CEPR Research Programme on Comparative Experience of Economic Growth in Postwar Europe, supported by a grant from the

Commission of the European Communities under its SPES Programme (no. SPESCT 910072). We received very helpful comments from Steve Broadberry, Mark Harrison, Brendan Walsh and members of seminars at University College Dublin, Strathclyde, North Carolina State at Chapel Hill and Warwick Universities as well as at the CEPR Conference, 'Europe's Postwar Growth' at Oxford, December 1993. We are to blame for any errors. 1 Western Europe is by and large the 'unit of observation'of this book. In this context it comprises the twelve countries mentioned in Table 1.1. Further on we

Postwar growth: an overview

2

3 4 5

6 7

8 9

33

shall refer to Europe as a unit including sixteen countries (the above-mentioned twelve plus Spain, Portugal, Ireland and Greece).Were data for these countries available and reliable for the whole 1870-1993 period, their inclusion would not have greatly altered the figures in Table 1.1, their demographic weight being roughly 15 percent of the total. See, for instance, Kuznets (1965:48-58). He argues that modern economic growth necessarily produces a shift in the disparities in economic and social conditions among nations due to 'rapid growth of new units or relatively rapid decay of others. [Such shifts] often produce elements of aggression by which the new leaders attempt to claim the prerequisites of economic power, the old and surviving leaders attempt to deal with the new weakness that may have arisen' (1965:50). Given the wide scope for measurement errors and sensitivity of growth rates to the selection of beginning and end years, the difference between the long-run performance and that of the post-1973 years is hardly significant. Between 1870 and 1890 the rate of growth of per-capita output in the twelve countries included in Table 1.1 was only 0.7 per annum (data from Maddison (1991)). Reference here is made to the highest peacetime income, since wartime production (which peaked in 1942 or 1943) is at best of dubious significance in terms of long-run growth in income and welfare, particularly as far as defeated countries are concerned. Discussion of business cycles is beyond the scope of this paper: suffice it to say that never during the period did any European country suffer a decline in GDP. The average inflation rate in the four largest European countries (France, Germany, Italy and United Kingdom, totalling about threequarters of the population of the twelve countries in Table 1.1) between 1950 and 1973 was 4.0 per cent when measured by consumer price indices. It was 8.4 between 1973 and 1989 (10.0 if Germany is excluded). The 1950-73 record compared unfavourably with the virtual absence of inflation in the two decades preceding the First World War, when consumer prices rose on average by 0.6 per cent per annum in the four countries during 1890-1913. (Data from Maddison (1991: 296-307). Japan's growth in GDP per capita between 1950 and 1973 was 8.0 percent per annum, two and a half times faster than Japan's own secular trend (1900-92), tentatively put at around 3.1 per annum (Maddison, 1995). Rates of growth in real GDP per capita Country

1900-92

Australia Canada

1.5 2.1 1.8

USA

1950-73 2.4 2.9 2.4

1973-92 1.4 1.7 1.4

Source: Maddison (1995). All three countries show (1) a secular rate of growth within Kuznets' 'norm' and not far from the European average, and (2) much less pronounced acceleration and deceleration during 1950-73 and 1973-92 than was the case with the European economy as a whole. 10 The same twelve as in Table 1.1. 11 France, Germany, Italy and the United Kingdom, totalling between 75 and 80 per cent of the aggregate labour force for the twelve countries in Table 1.1. Given the rather similar size of the three labour markets, arithmetic averages provide a

34 Nicholas Crafts and Gianni Toniolo fairly accurate assessment of the unemployment rate for the four-country aggregate. 12 The latter mattered in as much as it allowed the avoidance of a choice between devaluation and domestic deflation, had full convertibility been chosen early in the game (Eichengreen, 1993: 86-9). 13 Portugal's average growth rate in GDP per capita was 3.87 percent in 1950-60 and 6.45 percent in 1960-73. 14 The commitment was taken in the Government's Programme for economic expansion in 1958, later known as the First Programme (6 Grada and O'Rourke, 1996). 15 See, for instance, the excellent bibliography in Marglin and Schor (1990). 16 The catch-up process by its own workings undermined the bases of the growth boom to which it gave rise' (Abramovitz, 1990:9). 17 Judging from the number of days' strikes per 100 employees, this was certainly the case in the UK, France and Italy, where they declined sharply in the 1980s relative to the 1970s. They remained stable in Germany and the Netherlands and rose in the Scandinavian countries. (Data on strikes from Glyn (1993)). REFERENCES Abramovitz, M. (1986) 'Catching up, forging ahead and falling behind', Journal of Economic History, 46, pp. 385-406. (1990) The catch up factor in postwar economic growth', Economic Inquiry, 38, pp. 1-18. Andres, J., R. Domenech and C. Molinas (1996) 'Growth, convergence and macroeconomic performance in OECD countries: a closer look', in B. van Ark and N.F.R. Crafts (eds.), Quantitative Aspects of Postwar European Economic Growth, Cambridge: Cambridge University Press. Armstrong, J., A. Glyn and J. Harrison (1991) Capitalism since 1945, Oxford: Blackwell. Balassa, B. (1979) 'Export composition and export performance in the industrial countries, 1953-71', Review of Economics and Statistics, 61, pp. 604-7. Barro, R. and X. Sala-i-Martin (1991) 'Convergence across states and regions', Brookings Papers on Economic Activity, pp. 107-82. Bean, C. and N.F.R. Crafts (1996) 'British economic growth since 1945: relative economic decline... and renaissance?', in N.F.R. Crafts and G. Toniolo (eds.), Economic Growth in Europe since 1945, Cambridge: Cambridge University Press. Beckerman, W. (1962) 'Projecting Europe's growth', Economic Journal, 72, pp. 912—25. Ben-David, D. (1993) 'Equalizing exchange: trade liberalization and income convergence', Quarterly Journal of Economics, 108, pp. 653-79. Blanchard, O. (1991) 'Comment', on Barro and Sala-i-Martin (1991). Bleaney, M. (1988) Do Socialist Economies Work?, Oxford: Blackwell. Boltho, A. (ed.) (1982) The European Economy: Growth and Crisis, Oxford: Oxford University Press. Bordo, M. (1993) The Bretton Woods international monetary system: an historical overview', in M. Bordo and B. Eichengreen (eds.), A Retrospective on the Bretton Woods System, Chicago, IL: Chicago University Press. Broadberry, S.N. (1996) 'Convergence: what the historical record shows', in B. van Ark and N.F.R. Crafts (eds.), Quantitative Aspects of Postwar European Economic Growth, Cambridge: Cambridge University Press. Castles, F.G. and S. Dowrick (1990) The impact of government spending levels on medium-term economic growth in the OECD, 1960-85', Journal of Theoretical Politics, 2, pp. 173-204.

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(1996) The varieties of Eurosclerosis', in N.F.R. Crafts and G. Toniolo (eds.), Economic Growth in Europe since 1945, Cambridge: Cambridge University Press. Oulton, N. and M. O'Mahony (1994) Productivity and Growth, Cambridge: Cambridge University Press. Paque, K.-H. (1994) 'Why the 1950s and not the 1920s?', CEPR Discussion Paper No. 981. Pindyck, R.S. and A. Solimano (1993) 'Economic instability and aggregate investment', NBER Macroeconomics Annual, 7, pp. 259-303. Prais, S. (1993) 'Economic performance and education: the nature of Britain's deficiencies', National Institute Discussion Paper No. 52. Preston, P. (1991) 'Spain', in A. Graham and A. Seldon (eds.), Government and Economies in the Post-war World, London: Routledge.

Rebelo, S. (1991) 'Long run policy analysis and long run economic growth', Journal of Political Economy, 99, pp. 500-21.

Ritschl, A. (1996) 'An exercise in futility: East German economic growth and decline, 1945-89', in N.F.R. Crafts and G. Toniolo (eds.), Economic Growth in Europe since 1945, Cambridge: Cambridge University Press. Romer, P.M. (1994) The origins of endogenous growth', Journal of Economic Perspectives, 8(1), pp. 3-22. Rossi, N., A. Sorgato and G. Toniolo (1992) 'Italian historical statistics: 1880-1990', mimeo., University of Venice. Rowthorn, R.E. (1975) 'What remains of Kaldor's Law?', Economic Journal, 85, pp. 10-19. Sommariva, A. and G. Tullio (1986) German Macroeconomic History, 1880-1979,

London: Macmillan. Thirlwall, A.P. (1979) The balance of payments constraint as an explanation of international growth rate differences' Banca Nazionale del Lavoro Quarterly Review, 128, pp. 44—53. Triffin, R. (1957) Europe and the Money Muddle, New Haven, CT: Yale University Press. Unger, B. and F. van Waarden (1994), 'Interest associations and economic growth: a critque of Mancur Olson's Rise and Decline of Nations', CEPR Discussion Paper No. 894. van de Klundert, T. and S. Smulders (1992) 'Reconstructing growth theory: a survey', De Economist, 140, pp. 177-202. Verspagen, B. (1996) Technology indicators and economic growth in the European area: some empirical evidence', in B. van Ark and N.F.R. Crafts (eds.), Quantitative Aspects of Postwar European Economic Growth, Cambridge:

Cambridge University Press.

Villa, P. (1993) Une Analyse Macroeconomique de la France an XXe Siecle, CNRS

Editions.

2

Institutions and economic growth: Europe after World War II BARRY EICHENGREEN

1

Introduction

The quarter century that ended around 1973 was for Western Europe a Golden Age of economic growth. Real GDP rose nearly twice as rapidly as over any comparable period before or since.l Understanding the sources of this admirable performance would shed important light on the causes of the slowdown through which Europe has suffered subsequently. Part of the explanation is surely 'catch-up', as Abramovitz (1986) emphasized. The gaps that had opened up vis-d-vis both the United States and Europe's own prewar trend as a result of nearly two decades of depression and war offered exceptional scope for growth after 1945. Figures 2.1 and 2.2 summarize the standard evidence on the operation of these effects.2 But cross-section regressions relating growth rates to per-capita GDP differentials show that 'catch-up' and 'spring-back' explain only part of the postwar acceleration: purged of their effects, growth from 1950 to 1973 was still more than 50 per cent faster than it became subsequently.3 And even in so far as these factors provide the explanation, understanding what enabled post-World War II Western Europe so effectively to exploit the opportunity for closing the gap can have important implications for countries in Eastern Europe and the developing world currently seeking to join the 'convergence club'. Aside from catch-up, the proximate cause of postwar Europe's growth miracle was high investment. Net investment rates in Europe were nearly twice as high in the 1950s and 1960s as before or since.4 Scatter plots like those of Figure 2.3 suggest that increasing the gross investment share of GDP from 20 to 30 per cent increased the growth rate by as much as 2 percentage points. Countries with different investment rates were not identical in other respects, of course; multivariate regressions for this period, using Maddison's sample of sixteen advanced countries, which attempt to control for some of these differences, suggest that an extra 10 points on the investment rate translated into a more modest half a point on the growth rate.5 Still, together with catch-up this gets us a long way towards 'explaining' in an accounting sense postwar Europe's rapid growth. 38

Institutions and economic growth JUU

-

250-

• Germany • Austria • Italy \

\ • France 200- Finland \ ,

O

B e l g i u m ^ Netherlands Denmark* • \. Norway y * \^ 150" Sweden \^ Switzerland •

\. • UK

100"

\ • USA

\ \

50100

200

300 Initial

400

500

Source: Maddison (1982: 212). Figure 2.1 Initial (1950) GDP per man-hour and growth, 1950-73 J\J\J

\^

• Germany N.

• Austria

• Italy

250Finland ^ y 2002 O 150"

• France \

J^Netherlands Belgium • Denmark Norway N. •• Sweden Switzerland •

> • UK

100-

USA^V 50-25

\

i

25 Shortfall

50

75

Source: Maddison (1982: 212). Figure 2.2 Wartime and postwar (1938-50) change in GDP per man-hour and growth, 1950-73

39

40

Barry Eichengreen o.io0.090.08-

0 0.07-

1 0.06|

0.05 0.040.03 0.02 0.15

0.20

0.25 Investment share

0.30

0.35

Regression /-statistic 3.00. Finland from 51, Japan 52. (a) 1950-73

0.045 0.0400.035 Q

0.030 0.025 0.020 0.015 0.010 0.15

0.20

0.25 Investment share

0.30

0.35

Regression /-statistic 3.31. (b) 1973-89 Figure 2.3 Investment share and growth rates of GDP: 16 countries, 1950-89

Institutions and economic growth

41

Two things then remain to be understood: what made this high investment possible, and what made it so productive? This directs our attention to the other elements of the postwar growth recipe: wage moderation and export growth. Wage moderation stimulated both the supply of and the demand for investment - demand by making investment profitable, supply by making available the profits to finance it.6 The openness of European economies and the growth of their exports, whose volume expanded in the 1950s and 1960s by more than 8 per cent a year, allowed investment to be allocated to the sectors where its contribution to productivity growth was greatest. Nations could exploit their comparative advantage without being constrained by the composition of domestic demand. (Figure 2.4 displays the export-GDP growth nexus, indicating, suggestively, that it collapsed after 1973.) Having stripped another layer off the onion, what next must be explained is wage moderation and the growth of trade. Both were achievements by the standards of the interwar period, when exports stagnated and wage pressure was intense.7 Part of the explanation is surely that postwar policy-makers and market participants had learned from the disasters of the interwar years and determined not to repeat them. But the desire for a better outcome may not suffice; mechanisms are needed to achieve it. The argument of this chapter is that postwar growth benefited from the presence of institutions singularly well suited to reconstruction and growth. Those institutions solved commitment and coordination problems in whose presence neither wage moderation nor the expansion of international trade could have taken place. On the domestic side, social and economic institutions disseminated information and monitored the compliance of economic interest groups with the terms of their agreement to moderate wage claims and boost investment.8 They helped to lock in the bargain by creating bonds that would be lost in the event that someone reneged. They worked to coordinate the terms of the agreement across sectors of the economy. On the international side, institutions were created to coordinate national programmes of economic restructuring along export-oriented lines, and to lend credibility to European governments' commitment to openness. This encouraged countries to restructure their economies and to exploit more fully their comparative advantages, enhancing the productivity and profitability of investment. Institutions were not equally well adapted to the needs of growth in all European countries. Some, notably the UK and Ireland, failed to develop the relevant domestic institutions. Others, such as France and Italy, managed to do so only with delay. Some countries, like France in the 1950s, failed to align domestic arrangements with the evolving international framework and to exploit the opportunities offered by the external sector. These different institutional responses go a fair way towards accounting for variations across countries and over time in European growth performance. To complete the story it is necessary to account for these different responses. The argument of this chapter is that the relevant socioeconomic institutions necessarily displayed considerable inertia. Their function, in part, being to serve as coordinating mechanisms, their very nature created coordination problems for altering them. Institutions function as standards, giving rise to network externalities that tend to lock in their operation. The exceptional circumstances of war and reconstruction provided singular opportunities for coordinating wholesale adjustments in institutional

42

Barry Eichengreen 0.10-j 0.090.08-

§ 0.07 -I 3 0.062 |

0.05 0.040.030.02 0

0.05

0.10 0.15 Growth rate of exports

0.25

0.20

Regression ^-statistic 5.35. (a) 1950-73

0.0450.040 0.035 -

i

0.030 0.025 0.020 0.015 0.010 0.035

0.040

0.045

0.050 0.055 0.060 Growth rate of exports

0.065

0.070

Regression f-statistic 1.51. (b) 1973-89 Figure 2.4 Growth rates of GDP and exports: 16 countries, 1950-89

0.075

Institutions and economic growth

43

arrangements. Even under these extraordinary conditions, however, radical changes in coordinating institutions were necessarily difficult to organize. Inevitably, the important institutional changes of the postwar period were only marginal adaptations. They were feasible only where considerable progress had already been made in developing the institutional structures required for growth after World War II. Because of the evolving structure of the institutions analysed in this chapter, it is important to be precise about the period under consideration. I concentrate here on the institutional arrangements of the recovery period (1945-9) and thefirstpostwar decade of sustained growth (1950-9), and on the critical departures from pre-1945 institutional arrangements that made possible the inauguration of Europe's postwar golden age. Subsequently, one sees in many countries the institutional structures of the postwar years weaken and break down. I examine institutional responses to these difficulties in the 1960s, which typically involved heightening the centralization of wage bargaining and expanding the role of government in concertizing sectoral negotiations. I describe the problem to which these initiatives were the response - how the end of 'catch-up' growth made cooperative agreements more difficult to sustain - and explain why the response ultimately proved inadequate. My goal is to show that the perspective developed here is capable of explaining both why postwar institutions were initially so conducive to growth and why they ultimately broke down.

2

The model

2.1

Domestic institutions

Lancaster (1973), Grout (1984) and van der Ploeg (1987) model a dynamic game between capital and labour with a common general structure.9 Welfare is maximized when capitalists and workers both agree to defer current compensation in return for future gains. Workers moderate their wage claims in order to make profits available to enterprise and to make profitable their investment in capacity modernization and expansion. Capitalists restrain dividend payout in order to reinvest. Investment stimulates growth, raising the future incomes of both capitalists and workers. In the cooperative equilibrium in which both workers and capitalists exercise restraint, the costs of forgoing current consumption are dominated by the benefits of the future increase in incomes accruing to both. This cooperative equilibrium may be impossible to sustain, however, for the sequencing of events renders it time inconsistent. Consider the problem for labour created by uncertainty concerning subsequent investment. If investment requires liquidity, and liquidity requires profits, then workers must restrain wages now in order to make profits available to capitalists for investment later. Once the wage restraint has occurred, however, capitalists are best off if they renege on their agreement to invest, paying out profits as dividends instead. Since investment is no higher than if workers had failed to moderate their wage demands, labour has no incentive to exercise restraint. In this non-cooperative equilibrium, workers pursue wage increases, management pays out profits as dividends, and investment and growth are depressed. Even if workers can be assured of capital's willingness to invest, this is not a

44

Barry Eichengreen

complete solution to the problem. Unions may be able to recontract after investment has taken place. Once the investment has occurred, workers can renege on their agreement to restrain wages, seeking to capture the surplus instead. Since profits are not higher than if management had failed to invest, management has no incentive to plough profits into investment. Again, in the non-cooperative equilibrium, workers pursue wage increases, management pays out profits, and investment and growth lag. A contract that binds capitalists to invest profits and workers to exercise wage restraint overcomes the problem of dynamic inconsistency, rendering both groups better off. The social and economic institutions developed in Europe after World War II can be thought of as mechanisms to enforce this agreement.10 Institutions were developed to monitor the compliance of capitalists with their deferred contribution to the bargain and to disseminate evidence of non-cooperation; by reducing the likelihood that shirking went undetected, these mechanisms reduced the returns to doing so. Institutions were used to create bonds that would be lost in the event of reneging, effectively increasing the stakes and providing a further deterrent to shirking. By credibly committing capital to invest the profits made available by wage moderation, they provided labour with the incentive to be moderate. Institutions also deterred workers from appropriating the profits of firms that undertook investment Long-term contracts, social pacts between labour, management and government, and statutory wage and price controls are three mechanisms that could be used to precommit unions to wage moderation and thereby to induce management to invest. Unemployment, health and retirement programmes - the institutions of the welfare state, in other words - served as bonds that would be jeopardized if labour reneged. Centralization and concertation of sectoral wage negotiations further encouraged moderation on the part of unions. In so far as onefirm'searnings could pass through the capital market and finance another firm's investment, the benefits of wage moderation by one group of workers then accrued to other workers. Since the level of wages affected economy-wide determinants of investment like the interest rate, there was a need to coordinate wage demands across sectors to render a bargain to moderate wage claims attractive to each party to negotiations.l x Hence the need for institutions to centralize or concertize sectoral bargaining. On the employer side, any one firm contemplating investment had reason to worry that its decision to invest would encourage its workers to raise their wage demands in order to appropriate the profits thereby generated. But if wages were determined in economy-wide rather than at enterprise-level negotiations, an individual firm's investment decision no longer affected the wages it had to pay. In these circumstances, centralized wage negotiations led to a higher level of investment and, in so far as labour productivity was raised, to higher wages in equilibrium.12 2.2

International institutions

For deferring consumption to be worthwhile, investment has to be productive. For investment to stimulate growth, in other words, there has \o be a market for the goods produced by domestic industries whose capacity is augmented and whose efficiency is enhanced. Here the postwar expansion of trade was key. International

Institutions and economic growth

45

trade, and intra-European trade in particular, allowed countries to specialize in the production of goods in which they had a comparative advantage without regard to limits on the demand for those products existing at home. It allowed them to rely on cheap foreign supplies of raw materials and intermediate inputs that were costly to produce domestically. But the expansion of trade created further coordination and commitment problems. Restructuring along export-oriented lines was costly. Sinking the costs of reallocating resources along lines of comparative advantage could turn out to be an expensive mistake if one's trading partners reneged on their commitment to openness. Encouraging the expansion of steel production on the assumption that coal and iron ore could be imported from abroad could be a costly error if foreign supplies were not forthcoming. Augmenting the capacity of such industries would not pay if other countries ultimately refused to draw down their import tariffs on final goods. Before encouraging the rationalization of domestic production along lines of comparative advantage, governments had to be convinced that their partners' commitment to openness was permanent. Here again institutions solved these commitment and coordination problems. The European Coal and Steel Community (ECSC) created monitoring and surveillance technologies that guaranteed the French steel industry access to German coal, and the German industry access to French iron ore. A Joint High Authority monitored the compliance of participating countries to the terms of the agreement. The European Payments Union (EPU) coordinated the simultaneous move of European countries to currency convertibility for intra-European current account transactions and precommitted the participants to a sequence of trade liberalization measures. An EPU Managing Board was created to monitor the policies of member countries and to discourage them from reneging on their commitments. The participants contributed hard currency and credit to the EPU's central fund; access to these resources was contingent on their adherence to the terms of the EPU agreement, which served as an effective bond. Compared to unilateral convertibility, then, the payments union was a more credible commitment mechanism.13

3

The structure of domestic institutions

3.1

The nature of the bargain

That wage restraint and high investment were the dual cornerstones of the postwar settlement is evident in statements of the time. The Dutch case is prototypical. The Netherlands perceived itself as suffering from overpopulation (partly because of the return of expatriates from Indonesia), the solution for which was wage moderation and investment to enhance international competitiveness and raise living standards (Shonfield, 1965: 212). Between 1947 and 1954, consumer prices and the gross weekly earnings of adult male workers rose in lock step - by 32 and 33 per cent, respectively - this despite the fact that productivity increased by nearly 50 per cent between 1950 and 1954 alone, very considerably raising capital's share of national income (Flanagan et a/., 1983: 107).14 In Germany, trade unions observed 'significant wage restraint' throughout the 1950s in conjunction with the adoption

46

Barry Eichengreen

of investment-friendly policies designed to stimulate growth (Maier, 1984). Norwegian unions followed policies of wage moderation into the 1950s, in return for government policies attaching an overriding priority to capital formation. Even in the UK, hardly a paragon of labour/management harmony, contemporary observers were impressed by 'the wisdom, the moderation and sense of responsibility of the great bulk of the trade union movement' (to quote Sir Walter Monckton, Churchill's Minister of Labour, in 1954).15 This wage moderation was part of a bargain in which labour agreed to restraint now in return for more investment, faster growth and higher incomes later. In the Netherlands, the unions conceded that the fruits of all productivity increases in the first half of the 1950s should be used tofinanceinvestment.16 They allowed wages to lag behind productivity in the 1950s 'so that industry could earn profits which would pay for expansion and modernization of the productive apparatus' (from a union publication, cited in Windmuller, 1969:350-1). A clearer statement of a wage moderation-for-investment trade-off is hard to imagine. The movement extended beyond this one case, however. In Belgium, wage restraint was part of a Social Pact (Projet d'Accord de Solidarity Sociale) initialled in 1944, in which unions and employers agreed to seek means of enhancing the competitiveness and productivity of enterprise.17 Workers agreed to moderate their wage demands and to refrain from striking except as a last resort, in return for a management commitment to boost productivity. In the mid-1950s unions and employers concluded a series of'Productivity Agreements' in which workers agreed to link their wage demands to productivity increases in return for a management pledge to stimulate the latter.18 In the 1960s, as part of the programmation sociale, labour agreed to renewed wage moderation in return for agreement by industry to a programme of capacity expansion and the provision by government of investment subsidies and guarantees. In Norway, unions agreed to restrain wages in return for promises from government and management to limit distributed profits to acceptable levels (Esping-Andersen, 1985). The Labour government mobilized the populace around the 'Work for Everybody' programme, under which unions agreed to restrain wages in return for a pledge that profits would be ploughed back into capital formation.19 Price, profit and dividend controls, maintained through 1953-4, provided a guarantee that capital would keep to its part of the bargain. The government used profit taxes and other income sources to underwrite the highest investment rates in Europe. Labour embraced the bargain because it was promised higher future incomes and full employment. Industry acquiesced because it was promised cheap credit and wage restraint (Esping-Andersen, 1985: 216-19). In Austria, interest groups came together in a 'social partnership' whose goal, from the end of World War II to the late 1960s, was 'the creation of a favourable climate for growth by preventing an outbreak of inflation from uncoordinated and mutually inconsistent income claims by the various economic interest groups (Flanagan et aL, 1983: 63). Wage growth was moderate, fuelling the economy's relatively high investment rates. In Germany in the 1960s, as part of a programme of concerted action, 'the unions were urged to restrain their wage demands, not to puncture the entrepreneurs' improved profit expectations. Unions were promised a later settlement, which would include these delayed wage increases and restore

Institutions and economic growth

47

"social symmetry"' (Bergmann and Muller-Jentsch, 1975: 259). In other countries, attempts to cut such a bargain proved a failure. In the UK, Ireland, France and Italy, wage pressure was intense, squeezing capital's share of the national income and limiting the availability of domestic investment finance. Through the 1950s, investment ratios and economic growth rates were disappointing by the standards of northern European countries, where cooperative solutions were reached, and even by the standards of countries like France and Italy in the 1960s. 3.2

Commitment mechanisms

The immediate problem for postwar Europe was how to mobilize the funds to finance capital formation. International lending remained depressed; while it was possible to tap direct foreign investment flows from the United States, access to foreign capital was limited by the legacy of interwar default and the persistence of wartime controls. For growth it was therefore necessary that wages be moderated so that profits could be generated domestically to finance investment. Hence, workers had first to restrain wages in order to make profits available to capitalists for investment later. But once the wage restraint had occurred, capitalists could renege on their commitment to invest the profits, paying them out as dividends instead, leaving workers no reason to exercise restraint. And capitalists had no incentive to keep their part of the bargain in the absence of reassurance that workers would continue to exercise restraint in the future, appropriating the entire surplus. Workers and management thus confronted a prisoner's dilemma which could be resolved only through the introduction of institutional restraints on opportunistic behaviour. These institutions restrained such behaviour by disseminating information, monitoring compliance, and offering bonds. 3.2.1 Monitoring compliance and disseminating information One set of institutions monitored compliance and disseminated evidence of non-cooperation; by reducing the likelihood that shirking would go undetected, this reduced the returns to doing so. Workers were allowed to monitor management decisions relating to investment. Unions and employers' associations were encouraged to exchange information on wage and investment decisions through governmentsanctioned peak associations. The representation of labour unions on advisory and administrative committees of industry and government was made compulsory. German workplace co-determination, giving labour input into firms' investment strategies, provides a clear illustration of the operation of this mechanism.20 The 1951 Co-Determination Law mandated the appointment to the executive boards of all corporations of significant size a representative of labour, with the same rights as other members. By the late 1950s some 100firmshad labour representatives on their boards (Dahrendorf, 1959: 264-6). Streeck (1984: 147) argues that granting labour institutionalized influence on the management of the enterprise was a way of reassuring them that wage restraint would actually translate into investment. Works councils (required in all workshops with five or more employees) played a similar information-disseminating role in small German firms not covered by the Co-Determination Law. Further examples abound. In Austria, German-style wage moderation and high

48

Barry Eichengreen

investment were secured by regular consultation between representatives of labour, management and government (Katzenstein, 1984). In Holland, representatives of government, firms and workers sat together on PBOs (Publiek Rechtelijke Bedrijfsorganisatie) to develop common employment and investment policies for Dutch firms.21 In Norway, the Social Democrats introduced a system of Bransjerad (planning councils) and Produktionsutvalg (production committees) to 'promote democratic participation in matters of investment, planning and industrial organization'.22 In the Netherlands, the government used leverage acquired through the administration of price controls to inspect the books of individual companies, mainly regarding prices and costs, but on other matters as well. In Belgium, works councils were installed in every company with more than 100 employees under the provisions of the 1948 law on the 'Organization of Industry', and union and industry representatives sat together for the first time on the boards of public and semi-public industrial and financial institutions. Even France, which otherwise failed to put the institutional prerequisites for growth in place, made some progress in this one respect. Labour-management plant committees (comites d'enterprise) were required by law for all enterprises employing fifty or more workers, starting in 1945. Two members were entitled to attend the meeting of the board of directors of limited liability companies. Though the comites have been dismissed as ineffectual in shaping managers' production and investment decisions, to do so is to misunderstand their role. Never intended to give workers veto power over investment decisions, they simply provided a conduit for information regarding investment behaviour. An Act of 1946 required management to inform the comite and receive its opinion before finalizing investment decisions (ILO, 1950: 206). Limited liability companies had to inform the committee of the profits made by the undertaking, permit it to audit its accounts, and allow it to examine the record of discussions of the board of directors. Information relevant to the investment bargain was thereby disseminated.23 3.2.2 Bonding A second set of institutions locked in the bargain by creating 'bonds' that would be lost in the event of reneging.24 A variety of devices were utilized to achieve these ends. In Austria, for example,firmswere guaranteed raw materials and semi-finished products at submarket prices from public enterprises in return for their willingness to adhere to the terms of the bargain. Private business was given representatives on the boards of the state holding company to lend credibility to this arrangement (Kurzer, 1993: 35-6). Government subsidies for firms similarly functioned as bonds that would be forfeited in the event that capitalists failed to plough profits back into investment. In Germany, for example, subsidies for the steel and the aircraft industry were seen as part and parcel of the social market economy that provided a social safety net for workers.25 The tax and transfer system could also be used. The Austrian government threatened to levy tax penalties onfirmsthat failed to keep their part of the bargain. That labour possessed a powerful voice in postwar coalition governments right-wing parties having been discredited during the final years of the First Republic and the Nazi occupation - rendered this threat credible. Similarly, in the

Institutions and economic growth

49

late 1940s the Swedish government introduced regulations limiting the payments of dividends by public companies and taxing away nearly half of supernormal profits. An investment reserve scheme, established before the war but greatly expanded in the 1950s, 'invited' corporations to place as much as 40 per cent of their annual pre-tax profits into a closed public account, to be released with government approval. Business received substantial tax savings on such deposits. A clearer example of bonding is hard to imagine. The institutional initiatives enumerated above were all designed to bond capital, since in an environment of scarce liquidity thefirstproblem was to get management credibly to commit to invest, so that labour had the incentive to restrain wages and make requisite profits available. But these bonding devices were likely to suffice only if supplemented by mechanisms also locking in future as well as current wage restraint; otherwise management, fearful that an aggressive labour movement would appropriate future profits, would be tempted to disregard its forgone bonds and renege on its commitment to invest. A variety of postwar institutional initiatives can be understood as devices to bond labour. In Belgium, the first postwar government pushed through a scheme for social security in return for labour's adherence to the 1944 Social Pact (Dancet, 1988: 98). The welfare state was greatly extended between 1964 and 1969 (to entail expanded provision of health insurance, child and unemployment benefits, and centralized pensions), coincident with labour and capital's agreement to a new and more ambitious cooperative agreement (the so-called programmation sociale). In Norway, the government in the mid-1950s offered legislation improving work conditions, including vacations and the length of the working week, in implicit compensation for wage restraint (Schwerin, 1980: 84). In Sweden, the government's role in supporting the Rehn model of wage concessions for firms that succeeded in raising productivity was to protect workers against redundancies by providing active manpower policies entailing retraining, education, job placement services, and public job creation.26 The Austrian government agreed to extend tax and social insurance concessions to labour in return for its agreement to moderate wages.27 Governments surmounted problems of intergenerational equity by establishing pension schemes. Wage moderation now which translated into higher incomes later might benefit future generations at the expense of present ones, a fact which might cause those currently working to hesitate to defer their gratification. Governments therefore indexed pensions not just to changes in the cost of living, but to increases in the living standards of the currently employed. In Germany, state pension schemes were revised in the 1950s to 'ensure that persons retiring on a pension of a given money value should have the right to an adjustment in line with the increase in the general prosperity of the country, which was confidently expected to result from the rising productivity of those at work' (Shonfield, 1965: 92). 3.2.3 Coordinating mechanisms A third set of institutions coordinated bargains acrossfirmsand sectors, internalizing the externalities from wage moderation in one sector for investment and hence future wage growth in others.28 Either bargaining was centralized in the hands of a trade union federation and a national employers' association, or the government took an active role in the concertation of bargains reached by individual unions and

50 Barry Eichengreen

employers. Under these 'corporatist arrangements', the major labour and management associations enjoyed quasi-public status, and negotiations in different industries were coordinated under state auspices (see Bruno and Sachs, 1985; Newell and Symons, 1987). Bonding was important here as well: wage compression or 'solidarity' enticed sectoral unions to accept the loss of autonomy implied by centralized bargaining, while promises to provide private companies with inputs produced by public enterprises at submarket prices elicited the cooperation of employers. Thus, the Rehn model in Sweden made wage compression an explicit part of the bargain. In Holland the compression of wage differentials was a goal of the Board of Mediators from the immediate aftermath of World War II until the end of the 1950s; a skilled/unskilled differential of 10 per cent for weekly wages and 20 per cent for hourly earnings was maintained virtually unchanged to 1959. In Belgium, the progranimation sociale of the 1960s entailed a narrowing of regional and intrasectoral wage differentials and of disparities between men and women (Windmuller, 1969: 340; Dancet, 1988: 103-4). It is important to highlight two respects in which this framework differs from the recent literature on labour markets and macroeconomic outcomes. First, the present framework departs from the 'hump-shaped' model (Calmfors and Driffill, 1988), in which it is argued that both highly centralized and highly decentralized labour markets produce efficient outcomes. The argument here is that, while both highly centralized and highly decentralized structures may have facilitated adjustment to changing supply and demand conditions, competitive decentralized wage setting was ill-suited for internalizing the externalities for investment that spilled across sectors and over time. To the extent that such externalities prevailed, coordinated wage bargaining was required for efficiency. In the presence of externalities, competitive, decentralized markets did not suffice. Second, the term 'corporatism' is used differently here than in the recent literatures in both macroeconomics (e.g. Bruno and Sachs, 1985; Crouch, 1985) and comparative politics (e.g. Schmitter, 1981).29 Here it refers to the concertation of negotiations between labour and management by government. Those who follow the above-mentioned authors use it instead to refer to countries where labour is centralized and where there exists low shop floor autonomy. Here I refer to these factors as 'centralization'.30 This term as well is used differently than in the recent literature, where in practice it refers to the centralization of labour representation.3 * Here it refers instead to centralization on both the labour and employers' sides. 4

The evolution of domestic institutions

Authors like Olson (1982) emphasize the cleansing role of World War II in dissolving the quilt of interest groups and institutional restraints that had grown up in previous years and stifled growth. Their removal, in this view, freed the market to operate efficiently. The perspective I develop here is different. I emphasize continuity between pre- and postwar institutional arrangements. Postwar arrangements, rather than being created from scratch to fill a temporary institutional vacuum, were lineal descendants of earlier institutional structures. As I argue in more detail below, coordinating institutions are resistant of change. While the

Institutions and economic growth

51

disruptions of war and reconstruction afford more scope for change than do normal peacetime periods, this does not alter the fact that the scope of such change is necessarily incremental, implying continuity with the past.32 4.1

An overview of the historical dynamics

As Panitch (1979) and Maier (1984) remind us, efforts to institutionalize labourmanagement cooperation under state aegis can be traced to the late-nineteenth century. Protectionist responses to the crisis of 1873 in many European countries constituted a part of a political bargain between nascent interest organizations, the alliance of iron and rye in countries like Germany and France affording the most prominent example. With the rise of unionization, labour was introduced into discussions between producers' organizations. World War I was a watershed: it created excess demands for labour and enhanced the bargaining power of unions, conscious of the special vulnerability of governments and societies to work stoppages. Unions and management were brought together by government in an effort to conclude economy-wide wage negotiations that might head off labour unrest. Public officials used the authority of ministries of munitions to encourage this process without resorting to legislation (see Maier, 1984: 43). Labour's leverage diminished with the termination of hostilities and the re-emergence of unemployment. In some countries, new initiatives- the Stinnes-Legien Agreement in Germany, the NIRA in the USA, Popular Front labour policies in France, the Saltsjobaden agreement in Sweden - ensured continuity. Such frameworks were concessions to the labour movement by governments seeking to head off more radical alternatives. Frequently they were negotiated with the political arm of the labour movement, which had acquired a parliamentary presence. Maier suggests that these arrangements are more accurately characterized as 'supervised pluralism' (separate, decentralized negotiations conducted under broad procedural guidelines set down by government) than as economy-wide concertation.33 Centralized negotiations and encompassing organizations - 'state corporatism' to use Schmitter's (1979) phrase - were established only in Mussolini's Italy and Hitler's Germany.34 To minimize work stoppages and mobilize resources for the pursuit of war, between 1940 and 1945 many countries centralized bargaining between labour and capital under the heavy hand of government. Where postwar reconstruction was particularly difficult, these arrangements were allowed to persist into the postwar years. By the 1950s, however, reaction had set in. Governments withdrew, allowing labour and capital, often still federated into peak associations, to concentrate on bilateral bargaining. Prominent exceptions notwithstanding, intervention was limited to granting recognition and a representational monopoly to the leading interest organizations, using moral suasion to facilitate their cooperation, and posting bonds that would be lost in the event that any party reneged on the terms of its long-term commitment. In the 1960s, as bilateral cooperation between capital and labour became increasingly problematic, for reasons discussed below, governments intervened directly with statutory sanctions and controls.35 Maier (1984) argues that corporatist structures were especially precocious in small, open economies whose vulnerability to external disturbances encouraged the development of cooperative response mechanisms. Where wartime damage had

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been extensive, as in Norway, the case for government involvement in the economy was particularly compelling. Germany and Austria, as subjects of occupation, felt vulnerable for different reasons, but their response was similar. In such countries, sectoral unions were more willing to delegate authority to peak associations, while labour and management were willing to tolerate government guidance of negotiations (Esping-Andersen, 1985: 217). It might be added that the large-numbers problem that bedevils attempts to arrange cooperative solutions was less debilitating in smaller than larger European countries.36 4.2

Overall trajectories

Most countries experienced increases in centralization over the two postwar decades, as employers' associations were rebuilt and union membership expanded. The growing centralization of wage negotiations can be seen as a mechanism for preventing individual groups of workers from responding to additional investment by their particular employer, by escalating their wage demands in order to appropriate the surplus generated by that investment. That this danger had mounted with time reflected the decline of unemployment to extremely low levels by the mid-1960s and fading memories of high unemployment in the 1930s, which had worked to subdue labour militancy; hence the institutional response. In all countries but Portugal and the Netherlands, arrangements moved in more corporatist directions over time. In the cases of Norway and Austria this movement was slight, since the highly developed state of corporatism in the 1950s left relatively little scope for further articulation. In Portugal, the authoritarian Salazar regime applied a strong corporatist hand throughout the period, while the Dutch government, so heavily involved in bargaining at the beginning of the period, reduced its role over time. The growing involvement of government in the economy-wide concertation of sectoral negotiations can r5e seen as a way of supplementing efforts at centralization, with the goal of preventing individual groups of workers from appropriating any surplus generated by decisions to invest. A third direction taken by institutional developments in the 1960s was the expansion of the welfare state. In many countries, health, unemployment, retirement and training programmes were elaborated. Governments more aggressively pursued their commitment to policies of full employment. This can be seen as an attempt to provide new bonds for labour to contain the resurgence of labour militancy. 4.3

Recapitulation

The preceding sections have traced the evolution of institutions developed in Western Europe after World War II to coordinate, monitor, bond and enforce the compliance of economic interest groups with the terms of their bargain to moderate wage claims and boost investment. For reasons rooted in national histories and politics, European countries differed in the articulation and subsequent trajectory of such institutions. France, Italy, Ireland and the UK possessed neither the centralization nor the corporatization required to coordinate, monitor and enforce such bargains, though they moved in more corporatist directions over time. Danish and Belgian arrangements started out more centralized, though there too the initial, extent of

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corporatism was modest; they moved more quickly in the corporatist direction subsequently. The Netherlands, another country characterized by an intermediate degree of centralization, was initially highly corporatist and became less so over time. The role of government in supporting corporatist arrangements increased significantly in the more centralized German and Swedish economies, and modestly in the already highly centralized and corporatized Norwegian and Austrian ones.

5

The structure of international institutions

5.7

The nature of the bargain

For deferring consumption to be worthwhile, investment had to be productive. To put it another way, for investment to stimulate growth, there had to be a market for the goods produced by domestic industries whose capacity was augmented and whose efficiency was enhanced. Otherwise the terms of the domestic bargain would be rendered unattractive; if investment failed significantly to boost productivity and future incomes, workers and managers would be unwilling to defer current consumption for future gains. International trade, and intra-European trade in particular, allowed countries to specialize in the production of goods in which they had a comparative advantage without regard to limits on the demand for those products existing at home. By enhancing efficiency, this improved the intertemporal terms of trade between current and future incomes, encouraging wage restraint and investment. But efforts to expand trade had to surmount a further set of coordination and commitment problems. Restructuring a national economy along export-oriented lines was costly. Sinking the costs of reallocating resources along lines of comparative advantage could be an expensive mistake if one's trading partners reneged on their commitment to openness. Having incurred the costs of shifting resources into the production of exportable goods, countries mightfindtheir access to export markets blockaded, rendering their investments uneconomical. Before reorienting policy in this direction, governments therefore had to be convinced that their partners' commitment to openness was credible. This problem of collective action, though relevant to all European countries, was particularly pressing in the German case. Other European countries were particularly sceptical of its commitment to openness, given memories of the Schachtian policies of the 1930s and the Second World War (Berger and Ritschl, 1995). Germany had been Europe's dominant supplier of capital goods and the single largest demander of raw materials and consumer goods produced by other European countries. If it could not be relied on to supply the capital goods needed for the expansion and modernization of industry in other European countries, and to purchase the consumer goods and other merchandise which would be produced with that capacity, sacrificing efficiency for self-sufficiency would be the sensible strategy. Institutions which rendered credible Germany's commitment to intra-European trade could thus go a long way towards reconstituting the traditional pattern of comparative advantage and towards curing the dollar shortage (the balance of payments deficits of European countries vis-d-vis the USA, due mainly to their excess demand for capital goods).

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For Germany, recovery and growth required the consent of the occupying powers to the removal of controls on industrial production. Postwar policy-makers required in return that Germany be integrated into the European economy and that barriers to exit be erected to prevent that commitment from being reversed. German policy-makers required guarantees of their country's access to imported raw materials, industrial intermediates and foodstuffs in light of the prominence the Nazis had lent to Germany's dependence on foreign supplies. Institutional solutions to these commitment and coordination problems were provided by the European Payments Union and the European Coal and Steel Community. The ECSC provided monitoring and enforcement technologies guaranteeing national steel industries access to one another's coal and iron ore. The EPU entailed the establishment of institutions to monitor member country trade policies and the posting of bonds increasing the cost for any European country of reneging on its commitment. As an internationally coordinated initiative, it solved the 'after you Alphonse' problem discouraging unilateral steps towards convertibility. 5.2

Locking in intra-European trade

The effort to rebuild Europe's trade proved a remarkable success. The volume of Western European exports rose by nearly 9 per cent annum in the 1950s and 1960s. The exports of all Western European countries but the UK grew at rates in excess of 5 per cent, with those of West Germany and Italy expanding at a double-digit pace. The ability of European countries to exploit their comparative advantage heightened the efficiency of investment, contributing to the postwar growth miracle. In this development the European Payments Union played an important role. Participating countries were required to agree to a schedule of intra-European trade liberalization. A Code of Liberalization formalized their commitment. By February 1951, less than a year after the EPU went into effect, all existing trade measures were to be applied equally to imports from all member countries. Participants were required to reduce trade barriers by one-half initially, and then by 60 and 75 per cent. The share of quota-free intra-European trade was to rise to 90 per cent by the beginning of 1955. Countries failing to comply with this schedule, or employing policies to manipulate the terms or volume of trade in undesirable ways, could expect to be denied access to EPU credits. Operating the EPU required creating a set of institutions (the Organization for European Economic Cooperation (OEEC), which worked in tandem with the Bank for International Settlements) to monitor compliance and impose sanctions. Drawings on the system were embedded in a mechanism minimizing the likelihood that a country could use EPU credits to exploit its partners by remaining in persistent deficit. No conditions were attached to a country's drawings on its quota of 15 per cent of its intra-EPU trade. But additional credits could be obtained only if a country agreed to conditions set down by the EPU's Managing Board. Discussions were often initiated well before a country's quota was exhausted, and it was made clear that the provision of exceptional assistance was contingent on the country's early adoption of policies of adjustment. Officials of governments receiving exceptional credits were required to appear at meetings of the Board for questioning and to submit memoranda regarding their progress for its review.

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Moreover, US Marshall Plan administrators supported the EPU by providing $350 million of working capital to finance its operation. (In fact, the Economic Cooperation Administration and the State Department had to overcome the opposition of the Treasury and the US Executive Director to the IMF, who feared that the EPU would allow Europe to discriminate against US exports.) The fact that Europe and the EPU depended on Marshall aid reduced the likelihood that a debtor would renege on its agreement with the Managing Board and fail to take corrective action to eliminate its deficit. The provisions of Marshall aid and Europe's financial dependence on the USA allowed the United States to convince a reluctant UK to participate in the system rather than proceeding toward convertibility unilaterally (see Dickhaus, 1993).37 Indeed, for those concerned to construct a commitment technology, the EPU was preferable to unilateral current account convertibility, the other basis on which postwar Europe's trade might have been rebuilt. Convertibility was not technically infeasible, but, as a unilateral policy, it was too easy to reverse (Eichengreen, 1993a). It lacked the multilateral surveillance and conditionality that rendered the EPU an effective institutional barrier to exit. 5.5

Industrial self-sufficiency and national security

The ECSC further enhanced the credibility of Germany's commitment to openness by ensuring the French steel industry access to the Ruhr coal that was indispensable to its survival, and by providing German steel producers with guaranteed access to the iron ore of Lorraine. Coal and steel were viewed, rightly or wrongly, as essential to national security and to the rehabilitation of Europe's industrial base. As Pollard (1981: 86) put it, 'it had been precisely these industries which had become a focus of international hostility and national armaments and war-mongering'. By 1950 the inevitability that Allied control of German heavy industry would soon be terminated could not be denied. The question was whether Germany would use its industrial capacity benignly and allow other European nations free access to its products, or whether the rest of Europe would have to build up its self-sufficiency. In response to these dangers, the Schuman Plan of May 1950 proposed to create a common market in coal and steel. Its goal was to abolish protection in trade in coal, iron and steel among the six member states. The discussions culminating in the ECSC banned price discrimination between domestic and foreign customers. A Joint High Authority was created to monitor compliance with the terms of the agreement. Its decisions, within circumscribed limits, were binding on the national governments and private citizens of the partner countries. To render the High Authority accountable to its constituency and thereby lend it legitimacy, a Consultative Committee of industrialists, trade unionists, consumers and dealers was created, and a body of delegates from the parliaments of the member countries (the Common Assembly) was established with the power to vote 'no confidence' in the High Authority and thereby force its members to resign. Finally, a Community Court was established to adjudicate disputes between member governments, individual enterprises and the High Authority. Thus, by joining the Community, member states committed themselves to renouncing certain unilateral initiatives. As Gillingham (1995) puts it, the ECSC

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'was based on a new idea, supranationality. Membership required transference of sovereign powers to a new European authority.' It is hard to imagine a more effective barrier to exit.38

5.4 Extra-European institutions The EPU and the ECSC were just two of the institutional arrangements committing countries to openness and international trade. They were tailored to Europe's special economic and security needs, and they spoke to the historically specific fears aroused by the continent's experience in the period after World War I, when the commitment to openness had proved ephemeral. At the same time, they were buttressed by the global framework in which they were embedded, especially the General Agreement on Tariffs and Trade (GATT) and the Bretton Woods system. In contrast to the ad hoc tariff truce conferences of the 1920s, GATT was quickly recognized as an ongoing process. Even before completing one round of negotiations, signatories agreed to another. The repeated-game nature of their interaction mitigated against the temptation to engage in non-cooperative behaviour. The many GATT rounds, aimed at slashing tariffs, proved effective in dealing with the ever-present protectionist pressures' (Bhagwati, 1988: 41). Another important institutional innovation was to transfer tariff-setting authority from the US Congress to the Executive Branch, which was less susceptible to narrow constituency pressures.39 As epitomized by the Smoot-Hawley Tariff, US commercial policy had been dominated by Congressmen who proposed measures that afforded protection to industries in their districts without taking into account the negative externalities imposed on other districts. The 1934 Reciprocal Trade Agreements Act delegated authority to an executive with a national constituency more likely to take into account the external effects of district-specific trade policy measures. The executive was authorized to negotiate and implement pacts with other nations in which each agreed to cut tariffs on items of interest to the other by up to 50 per cent without further recourse to Congress. New centres of expertise like the State Department were thereby created which diluted the protectionist agenda with broader international economic and political considerations. Given US dominance of the postwar trading order and its leverage over multilateral trade negotiations, this lent impetus to the GATT process. Perhaps most importantly from the present point of view, GATT avoided conflicts between regional and global trade liberalization, conferring institutional blessings on discrimination in trade when pursued with the goal of establishing a regional customs union. Countries were allowed to offer one another intraregional trade preferences so long as in the course of doing so they did not raise barriers against imports from the rest of the world. This provision worked to the special advantage of Europe, where for historical reasons the scope for regional liberalization initiatives was greatest. The role in the early postwar years of the International Monetary Fund and the Bretton Woods system of pegged exchange rates should not be exaggerated. Efforts to have members establish par values and declare their currencies convertible produced little of more than symbolic value. Initially, foreign exchange rationing

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remained widespread. France experimented with multiple exchange rates. Devaluations were undertaken in 1949 and on other occasions without the prior consultation written into the IMF Articles of Agreement. Starting in 1950, Europe's international monetary relations were shaped by the EPU, not the Bretton Woods institutions. The strength of the Bretton Woods Agreement was its ability to prove compatible with specially tailored arrangements like the EPU. After 1958 and the termination of the EPU, the Bretton Woods system came into its own. For nearly a decade and a half, the international monetary system operated without a major crisis (Bordo, 1993). The UK's 1967 devaluation and revaluations by Germany and the Netherlands perturbed but did not disrupt the system. Exchange rate stability encouraged the expansion of trade. Large-scale private foreign lending resumed. Inflation, though accelerating in the 1960s, remained moderate by the standards of prior and subsequent decades. The import of the Bretton Woods system,firstas a structure into which the EPU happily fitted and then as the framework for Europe's international monetary affairs, was that it provided a nominal anchor that stabilized price expectations. So long as the USA remained committed to pegging the dollar to gold at $35 an ounce, and European countries remained committed to pegging their currencies to the dollar at declared par values, clear limits were placed on inflationary tendencies. Persistent high inflation in the USA would drive the American balance of payments into deficit and exhaust the country's gold reserves. Persistent high inflation in Europe would drive a European country's balance of payments into deficit and threaten the viability of its par value. Initially, ample US gold reserves and the dollar's role as a reserve currency relaxed the first of these constraints, while the maintenance of capital controls placed limits on the operation of the second. But while such factors relaxed the constraint on policy, they did not remove it. Hence, governments' investments in the Bretton Woods system of pegged exchange rates lent credibility to their stated commitments to the maintenance of price stability. The stability of price expectations under Bretton Woods in turn enhanced the effectiveness of macroeconomic stabilization policy, averting serious recessions and preventing cyclical declines in investment expenditure.40 So long as the pegged exchange rates of the Bretton Woods system remained credible, workers agreeing to a sequence of wage bargains did not have to worry that their nominal value would be inflated away. Any acceleration of inflation could be regarded as temporary, rendering compensating wage increases less urgent. Thus, when governments used Keynesian demand stimulus to counter a recession, the pressure of demand was less likely to translate into wage inflation and more likely to encourage production. Demand management policy proved effective. The consequent absence of serious recessions sustained investment at high levels.41 Indeed, the main difference in investment behaviour between the 1950s and 1960s and the interwar period was not that postwar investment rates were higher during expansions, but that governments succeeded in preventing investment from collapsing in recessions. This encouraged firms to contemplate sequences of related investment projects which would yield high returns if not interrupted by recessions. And the high returns on investment improved the terms of the trade-off between current and future consumption for workers and capitalists contemplating policies of moderation.

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Implications

Institutions like the EPU and the ECSC, buttressed by extra-European arrangements like the Bretton Woods system and GATT, solved commitment and coordination problems that had to be surmounted for intra-European transactions to be rebuilt and rapid growth to be sustained. Still, not all countries took equal advantage of the opportunities afforded by this new institutional basis for intra-European trade. The best counterexample is France, whose governments pursued policies that cloistered industry from international economic pressures until the 1960s. The OEECs Code of Liberalization anticipated removing three-quarters of quotas on private imports among the member countries and their dependencies by February 1951. While France temporarily reached this level in April of that year, the subsequent deterioration of its balance of payments led the government to reimpose quotas on all intra-European imports in February 1952. The OEECs 'minimum goal' of 75 per cent was only reached in February 1955 (Table 2.1), and even then a special 10-15 per cent 'provisional compensatory tax' was applied to most of the freed commodities to insulate French producers from import competition (Baum, 1958: 102-3).42 In manufacturing, imports accounted for only 8 per cent of domestic consumption as late as 1959. For half of all manufacturing industries thefigurewas less than 5 per cent. In thirteen of thirty-two industries, imports were essentially nil (Adams, 1989: 155). These low levels of import penetration reflected the relatively restrictive non-tariff barriers to trade maintained by France even during the EPU years. Only following the establishment of the European Common Market did import exposure rise, from 8 per cent of domestic consumption of manufactures in 1959 to fully 25 per cent in 1980, with most of the change occurring in the 1960s. The impact on domestic market conditions was profound: all French industries experiencing an increase in import penetration due to the establishment of the European Economic Community (EEC) saw their product prices fall in thefirstfive Common Market years. All industries with an increasing propensity to export saw their product prices rise (Adams, 1989: 172). A clearer example of restructuring along the lines of comparative advantage is hard to imagine. With this restructuring came a dramatic increase in the rate of French economic growth, plausibly reflecting higher returns on investment due to a greater tendency to invest along lines of comparative advantage, which in turn enhanced the incentive and hence the tendency to invest. 6

The decline of the postwar settlement

Eventually the Golden Age drew to a close. Output and productivity growth decelerated. Wages exploded, investment rates slumped, and the growth of trade no longer outstripped the growth of output to the same extent as in the 1950s and 1960s. The domestic and international settlements that had provided the basis for the postwar growth miracle ceased to function. A satisfactory explanation for the rapid growth of the Golden Age must also account for this subsequent deceleration. Afirstset of arguments is based on the idea that the postwar growth process contained the seeds of its own destruction. On the

Table 2.1. Intra-European trade: percentage liberalized at selected dates0 Country

30 June 30 June 30 June 30 June 30 June 30 June 30 June 30 June 30 June 30 June 30 June 30 June 1954 1952 1957 1950 1953 1955 1956 1959 1951 1958 1960 1961

Austria

53 56 55 53 58 47 — — 64 54 39 53 — 53 81 42 57

— 75 66 50 75 — — 41 75 76 51 83 — 75 85 63 90

— 75 75 68 — 77 — 41 75 100 75 100 — 75 88 63 46

36 87 92 76 — 90 (90) — 75 100 75 93 — 91 92 — 58

76 87 93 76 51 90 (90) 29 77 100 76 93 — 91 92 — 80

82 88 93 76 75 90 (95) 29 77 99 75 93 — 91 92 — 84

90 91 — 86 82 92 (95) 29 90 99 78 94 — 93 92 — 94

90 96 — 86 — 93 (95) 29 90 99 81 94 — 93 91 — 94

90 96 — 86 — 94 (95) 29 90 98 81 94 — 93 91 — 94

90 96 — 96 91 92 (76) 29 90 98 81 94 — 93 91 — 95

90 97 — 95 (97) 92 (76) 85 90 98 81 94 61 93 91 — 97

90 97 — 95 (99) 93 (72) 85 90 98 85 85 70 98 91 (52) 97

56

65

66

71

81

84

89

83

83

91

91

(94)

BLEU Netherlands Denmark France Germany (FR) Greece Iceland Ireland Italy Norway Portugal Spain Sweden Switzerland Turkey United Kingdom M e m b e r countries combined a

Percentage of private trade freed from quantitative restrictions. Base year is 1948, except for: Germany (FR) (1949), Spain (1950), Austria, Greece (1952), Turkey (1959), Iceland after 1960 (1958), and Benelux after 1957 (1953). In the case of Benelux, the percentages shown for 1959 and 1957 reflect the change in the base year rather than any effective change in liberalization. Source: Eleventh Annual Economic Review, Europe and the World Economy, Paris: OEEC, 1960, p. 185.

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domestic side, wage moderation was supported not just by centralized bargaining and corporatist arrangements, but by relatively elastic supplies of underemployed labour and memories of high unemployment in the 1920s and 1930s.43 The passage of time allowed memories of unemployment a generation before to fade, taking with them their restraining influence. At first, ample supplies of labour flooding into Germany from its East and into Holland from Indonesia encouraged docility on the part of their unions. Underemployed labour in the agricultural sector had similar effects in countries like Italy and France. But a decade and a half of rapid growth transformed Germany and the other countries of Western Europe from high- to low-unemployment economies, encouraging the unions to flex their muscles. A problem with this explanation is that it underestimates the market power of unions in many European countries. As early as the 1950s, supplies of skilled workers were inelastic to industries. Accounts are unanimous in ascribing market power to unions, aside from a few countries, such as Italy and France prior to 1960. Indeed, had elastic labour supplies stripped workers of market power, there would have been no need for institutions to lock in wage moderation once the growth process got under way, since wages would have been determined by competitive labour market conditions; there would have been no danger of wage rises designed to appropriate future profits to discourage investment. Many readily observed domestic institutions would have been without a clear rationale. On the international side, the success of GATT in stripping away tariff barriers may have encouraged governments to cultivate less transparent and tractable non-tariff barriers to trade with which the GATT process was less able to cope. The growing number of GATT signatories created a large-numbers problem hindering negotiations. The scope for the United States to encourage other countries to liberalize by allowing them to discriminate against it diminished hand in hand with declining US industrial predominance and Europe's catching up. While this explanation has appeal when applied to the 1980s, it is anachronistic to attribute mounting tensions on the international side in the late 1960s to the breakdown of the GATT process. The most important voluntary export restraints came later. US economic leverage, while in decline, was still considerable. The large-numbers problem cited by commentators on the Uruguay Round was not yet pressing. Although there may still be a sense in which the very success of the postwar growth miracle contributed ultimately to its downfall, the framework developed above, with its emphasis on institutions, points to five additional factors which together helped to ring down the curtain on the Golden Age. It directs attention to one of those five factors as possessing special importance. 6.1

Capture

An obvious place to start is Olsonian capture (Olson, 1982). Olson's argument is that the passage of time enables special interest groups to gain leverage over the operation of institutions and to turn them to their selfish ends. The new-installed union leaders of the postwar period, who initially identified with the workforce as a whole, may have come to favour senior workers at the expense of their junior counterparts as they themselves gained seniority, creating the insider-outsider

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problems that undermined the smooth operation of the labour market (Lindbeck and Snower, 1988). Governments initially able to use public programmes to bond unions and firms may have fallen prey to capture by the very agents whose behaviour they sought to influence, as the latter acquired knowledge of the workings of government bureaucracy. While this is an appealing story, the general formulation does not explain the timing of events - why the Golden Age of rapid growth drew to a close in the late 1960s or early 1970s - or their abruptness. Perhaps public institutions are especially susceptible to capture; if so, then the increasingly prominent role played by government in the operation of domestic institutions starting in the 1960s, as it sought to paper over cracks in the postwar settlement through the use of wage and price controls and direct intervention in labour-management negotiations, could have opened up avenues for capture where these had not existed before, thereby helping to explain the timing of events. Unfortunately, like other variants of the Olson thesis, this one does not easily lend itself to formal statistical tests. 6.2

The oil shocks

A second explanation for the end of the Golden Age emphasizes the oil shocks of the 1970s. A large literature addresses the question of whether these have the capacity to explain the productivity slowdown, generally reaching agnostic to negative conclusions.44 An institutional framework suggests a different perspective. By reducing even modestly the returns on investment (by raising the relative price of energy, or even just by making that price more variable and therefore requiring firms to diversify away the associated risks by investing in a wider variety of different kinds of equipment), the oil shock worsened the intertemporal terms of trade for workers offering wage concessions now in return for higher investment, productivity and incomes later. Thus, even a modest impact of the oil shock on the productivity of new investment could have tipped the balance for workers deciding whether to offer wage moderation now in return for higher incomes later, and thus had major implications for the level of investment and rate of growth. The problem with this explanation is in the timing. Thefirstoil shock came along in 1973, but the wage explosions that mark the breakdown of the postwar settlement were already evident at the end of the 1960s. The oil shocks might help to explain why the postwar settlement, once shattered, proved so hard to put back together, but they are less obviously a factor in explaining its downfall. 6.3

The breakdown of Bret ton Woods

A third potential explanation is the collapse of the Bretton Woods system of pegged but adjustable exchange rates. With the breakdown of Bretton Woods, not just inflation but the business cycle grew increasingly volatile.45 The elimination of par values removed a nominal anchor that had stabilized price expectations. With the commitment to par values removed, agents had no reason to regard an acceleration of inflation as temporary. When governments stimulated demand in the effort to offset a recession, this provoked compensating wage increases; aggregate demand policies therefore elicited inflation rather than stabilizing output. Governments

62 Barry Eichengreen

having lost the capacity to counteract incipient recessions, the business cycle and investment grew more volatile.46 The institutional perspective developed above points to channels through which this increased volatility could have depressed the rate of economic growth. Workers were willing to trade wage moderation now for higher incomes later, so long as they had confidence that sacrifices now would deliver investment, growth and higher incomes later. Recessions were an obvious threat to this confidence. Wage moderation might not succeed in stimulating investment if in the interim the level of activity, profits and the incentive to invest collapsed into a recession. As noted above, investment rates were higher in the 1950s and 1960s than they had been in the 1920s and 1930s not because those rates were significantly higher during expansion phases of the business cycle, but because serious recessions in which investment rates collapsed were successfully averted after World War II.47 So long as serious recessions were absent, the trade-off between wage moderation now and investment later remained attractive to European labour. Once the Bretton Woods nominal anchor was removed and Keynesian stabilization policy lost its power, allowing recessions to re-emerge, labour lost the incentive to keep its part of the bargain. The timing of events is suggestive: although the breakdown of the Bretton Woods system only took place in 1971-3, those events were widely anticipated, and the system was already showing signs of instability in the late 1960s.48 The limitations of this explanation are two. There is reverse causality: labour militancy developing for other reasons could have increased the responsiveness of wages to prices and the pressure of demand, implying that the change in labour market behaviour was a cause rather than a consequence of the breakdown of Bretton Woods. In addition, the view emphasizing the effectiveness of countercyclical stabilization under Bretton Woods may exaggerate the prevalence of such policies in Europe prior to the 1970s. In the 1950s Keynesian demand management policies were little used outside the UK. In Germany, to take one example, they were quite inconsistent with the prevailing ideology of ordoliberalism. In the 1960s they may have gained popularity in countries like France, but over wide portions of Europe they were still scarcely used. 6.4

Capital mobility

A fourth explanation for the end of the Golden Age is rising capital mobility. This is the factor whose particular importance is highlighted by the institutional framework of previous sections.49 Section 2 suggested that the postwar growth process had to surmount two problems of dynamic inconsistency. Thefirstwas that capitalists had to be precommitted to invest their profits in the future, so that workers would restrain their wage demands now and the liquidity would be made available to finance investment. The second was that workers had to be precommitted to moderate their wage demands later, so that capitalists would invest now in the expectation of reaping future profits. Institutions undertaking monitoring, informationdisseminating and bonding functions were developed with both of these problems in mind. It can be argued that the structure of the relevant institutions was predicated on limited international capital mobility. In a situation of limited capital mobility, it

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was possible, for example, to threaten the imposition of taxes on distributed profits at rates that would not be feasible when capital could evade them by moving abroad. As capital mobility began to increase in the 1960s, the bonding mechanisms of the 1950s therefore lost much of their effectiveness. Where wage moderation might once have guaranteed investment, international capital mobility now gave management the option of investing abroad rather than at home. Domestic workers no longer assured that wage moderation would translate subsequently into higher productivity and labour incomes had less incentive to be moderate. The problem with this explanation, advanced by Thelan (1991) and others, is that there exist equally compelling arguments working in the other direction. Capital's possession of an exit option, by providing investors with a credible threat, should have worked to encourage the acquiescence of labour. The knowledge that labour militancy might cause capital to move abroad was precisely the kind of information that should have induced labour to exercise restraint in order to prevent capital from exercising its exit option. Indeed, if capital was mobile inward as well as outward, wage restraint could induce foreign capital to flow in, augmenting the plant and equipment with which labour could work and eventually rendering it better off. Thus, it is still possible to use the capital mobility argument to explain why dividend payout rates might have increased and investment rates slumped in the 1970s. Capital was able to indulge its preference for consuming a higher share of profits without provoking wage demands sufficient to prevent the accrual of those profits, labour's militancy having been restrained by capital's exit option. What this hypothesis cannot explain, given that capital mobility should have exercised a restraining influence on labour militancy, is the simultaneous explosion of wage demands. 6.5

The end of catch-up

In the introduction to this paper, catch-up - the scope for exceptionally rapid expansion as European economies recovered prewar levels of output and closed the productivity gap vis-a-vis the United States - was offered as an alternative to institutional explanations for postwar Europe's growth. A different view is that the scope that existed for rapid growth during the catch-up period reinforced the institutions erected to solve commitment and coordination problems, and that once the catch-up phase passed, those institutional arrangements lost much of their effectiveness. Recall that at the centre of the institutional argument is a time-inconsistency problem. Workers and capitalists are both best off if they can agree to defer current consumption in return for future gains, which take the form of additional investment that results in higher productivity and income for all concerned, but neither is willing to agree to defer without an assurance that the other will do the same. Assume now a decline in the rate of return on deferring current consumption because, for example, the return on investment and the underlying rate of productivity growth both fall. The incentive for the parties to the agreement to resist the temptation to renege on its terms is correspondingly reduced. Institutions which

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were adequate to contain this temptation previously may no longer suffice, since the intertemporal terms of trade have changed. The end of the catch-up phase of postwar Europe's growth could have played precisely this role, by reducing the return on investment and weakening the incentive for capital and labour to adhere to their agreement to defer current consumption in return for now more meagre future gains. From this perspective, the scope for catch-up and the institutional arrangements developed to solve time-inconsistency problems following the war should be viewed as interacting positively with one another, rather than as competing explanations. The question then becomes why, if institutions were developed after World War II to solve the commitment and coordination problems that confronted the European economy at that time, it did not prove possible to reinforce them to meet these new circumstances. In fact, there was some institutional adaptation in the 1960s. Welfare state programmes to bond labour expanded greatly in the 1960s. Government acquired an increasingly prominent role in the operation of labour market institutions in many countries over the course of this decade. Growing use of statutory wage controls, concertation of sectoral negotiations, and direct intervention in wage bargaining are all characteristics of government policy in the 1960s that can be seen as a response to the need to deal with the second dynamic-inconsistency problem. But the increasingly prominent role of government was superimposed on existing institutions rather than superseding them. The underlying structures - craft versus trade unions, cohesive or fragmented trade associations, the degree of centralization of wage bargaining - changed only slowly. There are good reasons to expect socioeconomic institutions like those described in this paper to change only gradually. Institutional arrangements coordinate the actions of a large number of individual parties. It may not be in the interest of any one of those parties to modify existing arrangements unless the others can be made to go along, which poses formidable coordination problems in a decentralized setting. Even in a reasonably centralized market like Germany, where there are sixteen large sectoral unions and a matching number of sectoral employers' associations, it may be hard to get the social partners in any one sector independently to alter the timing and structure of their bargaining arrangements, if the cost is forgoing the coordination benefits provided by an established tradition of intersectoral pattern setting. As David puts it, 'Institutions generally turn out to be considerably less "plastic" than is technology.' (See David, 1993; Zysman, 1993.) In this light, the exceptional opportunity that is afforded by an extraordinary event like World War II is clearly evident. A wartime disruption which suspends the operation of normal peacetime institutions reduces the opportunity costs of coordinating a shift to new arrangements. That the most dramatic changes in domestic arrangements took place in countries like Norway, the Netherlands and Belgium, many of whose labour, management and government leaders were exiled, and who took the interlude as an opportunity to plan a wide-ranging package of institutional changes, is much more than a coincidence from this point of view. Yet what is remarkable given the extent of wartime dislocation is how durable early institutional arrangements remained. As section 3 shows, there was very considerable continuity between Europe's postwar institutions and the institutional developments

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of the interwar years and even the pre-1913 period. The exceptional circumstances of World War II and its aftermath may have provided an opportunity to adapt Europe's institutions to the special needs of postwar economic growth, but this could be done only where the departure from prewar arrangements was not too great.50 It is not surprising that, when in the 1960s circumstances again changed but without an event like World War II to interrupt the coordination functions of existing institutions, innovation was slow to come. 7

Conclusion

European economic growth in the quarter of a century that ended in 1973 outstripped growth in any period of comparable length before or since. The elements of Europe's growth miracle - wage moderation, high investment and rapid export growth - were delivered by a tailor-made set of domestic and international arrangements - on the domestic side, the social market economy; on the external side, international agreements and supranational institutions - that solved problems of commitment and cooperation that would have otherwise hindered the resumption of growth. Why then did growth slow after 1971? These exists a wealth of explanations, including the capture of socioeconomic institutions by special interest groups, the breakdown of the Bretton Woods system, the oil shocks of the 1970s and the rise in international capital mobility. While it is not possible to rule out these explanations, each of them has serious limitations. I therefore single out the role played by another factor: the interaction of postwar 'catch-up' with the sustainability of cooperative arrangements. The faster was growth, the greater was the willingness for workers and capitalists to defer current compensation in return for future gains. The period of rapid catch-up following World War II was therefore ideal for sustaining cooperative behaviour. As the scope for catch-up was spent, the incentive to renege on cooperative agreements was heightened, and agreements to cooperate broke down. Wage pressure intensified, investment slumped and the rate of growth was further depressed. Thus, whereas the beginning of the introduction to this chapter presented catch-up and institutional arrangements as two alternative explanations for postwar growth, my conclusion is that it would be more accurate to see them as complementary factors that reinforced one another. NOTES Prepared for thefinalconference of the Commission of the European Communities' Programme on 'Comparative Experience of Economic Growth in Postwar Europe', All Souls College, Oxford, December 1993. This chapter is part of a project on postwar recovery and growth in Western Europe, which receivesfinancialsupport from the National Science Foundation and the Center for German and European Studies of the University of California. It is an elaboration and extension of a short paper presented to the European Economic Association's Annual Meetings in August 1993, and published in the European Economic Review (June 1994). I thank Brian A'Hearn, Lisa Ortiz and Pablo Vasquez for research assistance, and Lars

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Calmfors, Paul David, Assar Lindbeck, Torsten Persson, Bob Powell, Gilles St Paul, Solomus Solomou, Rick van der Ploeg and Charles Wyplosz for helpful comments. 1 The unweighted average of the annualized growth rate of GDP per hour worked for eight European countries was 4.4. per cent in 1950-73 but only 2.4 per cent in 1922-37 and 2.3 percent in 1979-88. Calculated from Crafts (1992: table 1) and Boltho (1982: table 1.1). The contrast with recent years would be even more dramatic if the comparison were with 1973-88. 2 Note that the slopes of the regression lines in both of these figures differ significantly from zero at the 99 per cent level of confidence. Interestingly, when both effects are included in a single growth equation, the initial (1950) level of GDP per man-hour remains statistically significant, but not so the wartime and immediate postwar shortfall. 3 Crafts (1992) presents calculations of the growth bonus due to catch-up vis-a-vis the USA and spring-back to prewar levels for the same eight European countries, finding that purged of catch-up and spring-back, growth rates decelerated from 3.1 per cent in 1950-73 to 1.9 per cent in 1979-88. 4 The estimates of Maddison (1976) show the investment rate in Western Europe rising from 9.6 per cent in 1920-38 to 16.8 per cent in 1950-70. 5 See, for example, Crafts (1992: table 2). 6 As Shonfield (1965: 6) put it, The success of the modern capitalist society in reversing the pressures making for high consumption at the expense of investment is one of its outstanding achievements.' In the discussion that follows, I suggest that postwar policy-makers were especially concerned with the second, or supply-side, influence of wage restraint on investment. Moderate and slowly growing real wages can been seen as theflipside of the coin of the low and slowly rising real exchange rate that some authors (e.g. Boltho, 1982, 1993) emphasize as an element of Europe's postwar growth miracle. In simple open-economy macroeconomic models, in which domestic and foreign economies are completely specialized in the production of different goods that are imperfect substitutes for one another, there is a one-to-one correspondence between the real exchange rate and the relative real wage. 7 For an overview of the interwar situation in various European countries, see Maier (1975). A detailed and controversial analysis of the German case is Borchardt (1991). A few attempts to contrast the interwar and postwar situation are cited below. For example, Broad berry (1994) shows for the UK that wage pressure was more intense before than after World War II. 8 This emphasis on the postwar settlement and the institutions used to support it is not original with this chapter. Przeworski and Wallerstein (1982: 218) refer to such settlements as 'class compromise' and stress the need for capitalists to 'consent to institutions that would make it reasonably certain that wages would increase as a function of profits according to some rule'. Boyer (1988) uses the term 'Fordism' to refer to the cooperative structure of industrial relations and equitable division of productivity gains, in whose operation government played a prominent role, that existed in Europe after World War II. 9 Indeed, one might argue that the structure of the game can be traced back to Marx, if not earlier. 10 The notion that institutions can be used to create a credible commitment is prominent in the work of North and Weingast, among others. See North (1993) and North and Weingast (1989). 11 Otherwise a prisoner's dilemma situation may arise, in which any one sectoral

Institutions and economic growth 67

12 13

14 15 16 17

18 19

20 21 22 23 24 25 26 27

bargaining unit wishes to moderate its demands only if it expects others to do the same, but in the absence of an agreement to harmonize demands, no one unit has an incentive to be moderate. These possibilities are modelled by Hoel (1990). A more comprehensive treatment would analyse also the coming of the European Economic Community in the late 1950s, GATT and the Bretton Woods international monetary system. I leave these aside, given what is already an overlong paper. Starting in 1955, significant increases in real wages were granted; this can be seen as labour's reward for having kept its bargain in the immediate postwar years. Cited in Flanagan et al. (1983: 378-9). For details, see Abert (1969). In fact, wages jumped up following the armistice, but their growth was moderated subsequently. It was viewed as desirable to raise wages with the goal of stimulating demand, rather than lowering them to boost supply, because Belgian industry had survived the war largely intact, making capacity in the war's immediate aftermath much larger than in other European countries, which in turn had few resources with which to purchase Belgian exports. Cited in Beaupain (1983: 148). Starting in the 1960s, the peak associations of 'social partners' negotiated a series of 'social programming agreements' coordinating changes in wages and working conditions (Lorwin, 1954: 255). As Gruchy (1966:325) put it, 'Organized labour in Norway has accepted the goal of a high-investment, low-consumption economy with all that means for wage and other economic policies because organized labor approves the general economic objectives of the Norwegian Labor Party and the Norwegian Labor government. After the high-investment economy has been in operation for a number of years and the Norwegian economy has been converted from a relatively underdeveloped to a mature industrial economy, organized labor would then expect the government to shift back to the goal of a high-consumption, low-investment economy in which a high and expanding standard of living would be widely shared.' McCain (1989) provides a model of co-determination as a solution to a game between labour and management, where cooperation leads to higher investment. Ultimately, the need for political compromise scaled down the extent of the PBOs' power (Appels, 1986: 175). In the end, these failed to retain the full decision-making power envisaged by their architects (Esping-Andersen, 1985: 218). The committee has therefore the most complete information and is directly informed as to the management of the undertaking' (ILO, 1950: 211). On bonding, see Schelling (1960). For elaboration of this argument, see Appels (1986). The USA and its allies acceded to these policies, of course, because they supported American Cold War aims. The model was named after Gosta Rehn, the Swedish labour movement economist. For details on the model, see Esping-Andersen (1985: 229-31). The UK is another case where it might be argued that the extension of the welfare state can be seen as an attempt to provide this bonding function. In his wartime pamphlet, How to Pay for the War, Keynes had urged the government to adopt not only a compulsory savings scheme, but also a more generous national minimum, to be extended through the provision of family allowances. Though Keynes's scheme proved too ambitious for the Treasury to swallow, the

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31 32 33 34 35

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Barry Eichengreen extension of family allowances following the war can be seen as a quid pro quo for wage restraint. Exactly this point can be found in Elder's (1982) article on Sweden. Describing the situation from the mid-1950s through the 1960s, he writes, 'in general the nature of the collective-bargaining arrangements in Sweden made it simpler than in many other countries to reach well-founded investment decisions. Highly centralised and self-disciplined organisations on either side of the labour market helped ensure that commitments once entered into would not be reneged upon' (1982: 66). Similarly, authors differ in referring to structural corporatism (the organization of conflicting interests into a limited number of functionally differentiated organizations controlled or recognized by the state) and functional corporatism (the institutionalized participation of private interest organizations in public policy), and to sectoral and macroeconomic (economy-wide) corporatism. As will become apparent, my emphasis here is on structural macroeconomic corporatism. In line with this distinction, Gennard and Wright (1978) contrast countries like Sweden where a relatively high degree of centralization allowed intersectoral harmonization to proceed with only indirect guidance from government, with countries like France and the Netherlands, where the more decentralized nature of the government required a more forceful government hand. This point is argued at length by Thelan (1994), who points to some notable exceptions. As van Waarden (1993) notes, such a perspective implies that war, rather than destroying existing interest organizations, may actually heighten the concentration of influence in them. The Mond-Turner talks in the UK might be cited as an exception, but it is questionable whether they had significant effects of an enduring legacy. Other examples that might be cited include Vichy France, Portugal under Salazar and Spain under Franco. This generalization also neglects the importance of government arbitration of private negotiations in countries like Germany. Though such public support initially sustained the operation of corporatist institutions, it also widened the scope for capture, ultimately undermining the efficacy of corporatist arrangements. I develop this last point below. In the exceptional cases, such as the Netherlands, government intervention had been extensive from the start. Hence, there was little scope in the 1960s for supporting corporatist arrangements by broadening the role of government. It is no surprise that Dutch corporatism displayed widening cracks from the early 1960s. Thus, Ingham (1974) argues that centralization is easiest in 'relatively small-scale societies which export a large part of their manufactured goods', since these tend to have a low level of 'industrial differentiation' and a high level of industrial concentration (see p. 42 and passim). Roberts (1958: 119 and passim) makes this same argument for Holland. The UK objected to endowing the EPU with authority over the blocking of accumulated sterling balances and resisted the creation of a powerful Managing Board. The same terminology is used by Meade et al. (1962). The contribution of the ECSC to the genesis of the European Economic Community remains a debated issue. I do not take up the origins and role of the EEC in this paper. These arguments are most clearly elaborated in Pastor (1980) and Lohmann and O'Halloran (1993).

Institutions and economic growth 69 40 The argument that follows is drawn from Eichengreen (1993b). 41 For evidence, see Alogoskoufis and Smith (1991). 42 As Sheahan (1963: 233-4) put it, 'Practically every OEEC meeting on trade liberalization up to the end of the 1950s featured a good deal of special criticism of French import restrictions. It was not merely that tariffs on imports of manufactured goods averaged unusually high, or that the percentage of trade allowed to enter without quantitative controls was unusually low, but that the small areas of competition permitted were restricted to those few industries in which French firms were able to hold their own anyway.' 43 On the elastic labour supply argument, see Postan (1964), Kaldor (1966) and Kindleberger (1967). 44 See Griliches (1988) for a survey of the relevant literature. 45 The contrast is especially pronounced if one compares the period of Bretton Woods convertibility (1959-70) with the post-Bretton Woods years. See Bordo (1993). 46 Alogoskoufis and Smith (1991) provide evidence of differences in the time-series process generating inflation before and after Bretton Woods. Eichengreen (1993b) shows that the same shift in time-series process is evident in the behaviour of inflationary expectations, and develops the argument of this paragraph concerning the effectiveness of countercyclical stabilization policy. 47 Boltho (1982) notes how there was no year between 1945 and 1971 when the real GNP of Europe as a whole fell by as much as 1 per cent. 48 The persistence of inflationary impulses and inflationary expectations was already trending upwards prior to the breakdown of the system. 49 Kurzer (1993) also emphasizes the implications of capital mobility for the changing operation of Western European institutions, but the perspective she adopts is different from the one utilized here. Although explaining why capital mobility increased in the 1960s is beyond the scope of this of this paper, I would mention four factors: first, the inevitable decontrol of the European economies following the exceptional period of heavy government intervention during and immediately following World War II; second, the restoration of current account convertibility at the beginning of 1959, which increased the scope for capital mobility through leads and lags; third, technological change which rendered controls on capital movements increasingly difficult to enforce; and fourth, the rise of competingfinancialcentres, which created a free-rider problem in which national policy-makers had an incentive to cheat on international understandings to maintain controls in the hope of acquiring increasing amounts of financial business from abroad. 50 Thus, by way of counterexample, in the UK, a country which had never possessed strong industrial unions or cohesive employers' associations, the attempt to adapt domestic institutions to the new imperatives of the postwar period proved a failure. REFERENCES Abert, J.G. (1969) Economic Policy and Planning in the Netherlands, New Haven,

CT: Yale University Press. Abramovitz, Moses (1986) 'Catching up, forging ahead, and falling behind', Journal of Economic History, 46, pp. 385-406.

,

Adams, James (1989) Restructuring the French Economy, Washington, DC: The Brookings Institution.

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Alogoskoufis, George and Ron Smith (1991) T h e Phillips curve, the persistence of inflation, and the Lucas critique: evidence from exchange rate regimes', American Economic Review, 81, pp. 1254-75. Appels, A. (1986) Political Economy and Enterprise Subsidies, Tilburg: Tilburg University Press. Barnett, Corelli (1986) The Audit of War, London: Macmillan. Baum, Warren C. (1958) The French Economy and the State, Princeton, NJ: Princeton University Press. Beaupain, Therese (1983) 'Belgium: collective bargaining and concertation system inhibited by economic crisis and government', in Solomon Barkin (ed.), Worker Militancy and its Consequences, New York: Praeger. Berger, Helge and Albrecht Ritschl (1995) 'Germany and the political economy of the Marshall Plan, 1947-1952', in Barry Eichengreen (ed.), Europe's Postwar Recovery, Cambridge: Cambridge University Press. Bergmann, Joachim and Walther Muller-Jentsch (1975) T h e Federal Republic of Germany: cooperative unionism and dual bargaining system challenged', in Solomon Barkin (ed.), Worker Militancy and its Consequences, 1965-15, New York: Praeger. Bhagwati, Jagdish (1988) Protectionism, Cambridge, MA: MIT Press. Boltho, Andrea (1982) 'Growth', in Andrea Boltho (ed.), The European Economy: Growth and Crisis, Oxford: Oxford University Press. (1996) 'Convergence, competitiveness and the exchange rate', in N.F.R. Crafts and G. Toniolo (eds.), Economic Growth in Europe since 1945, Cambridge: Cambridge University Press. Borchardt, ICnut (1991) Perspectives on Modern German History and Policy, Cambridge: Cambridge University Press. Bordo, Michael D. (1993) T h e Bretton Woods international monetary system: an overview', in Michael D. Bordo and Barry Eichengreen (eds.), A Retrospective on the Bretton Woods System, Chicago, IL: University of Chicago Press. Boyer, Robert (1988) 'Wage labour relations, growth and crisis: a hidden dialectic', in Robert Boyer (ed.), The Search for Labour Market Flexibility: The European Economies in Transition, Oxford: Clarendon Press. Broadberry, Stephen (1994) 'Employment and unemployment', in Donald McCloskey and Roderick Floud (eds.), The Economic History of Britain Since 1700,2nd edn, Cambridge: Cambridge University Press. Bruno, Michael and Jeffrey Sachs (1987) The Economics of Worldwide Stagflation, Cambridge, MA: Harvard University Press. Calmfors, Lars and John Driffill (1988) 'Bargaining structure, corporatism and macroeconomic performance', Economic Policy, 6, pp. 14-61. Crafts, N.F.R. (1992) 'Institutions and economic growth: recent British experience in an international context', Western European Politics, 15, pp. 16-38. Crouch, Colin (1985) 'The conditions for trade unions' wage restraint', in Leon Lindberg and Charles Maier (eds.), The Politics of Inflation and Economic Stagnation, Washington, DC: The Brookings Institution. Dahrendorf, Ralf (1959) Class and Class Conflict in Industrial Society, London: Routledge and Kegan Paul. Dancet, Geert (1988) 'From a workable social compromise to conflict: the case of Belgium', in Robert Boyer (ed.), The Search for Labour Market Flexibility: The European Economies in Transition, Oxford: Clarendon Press. David, Paul A. (1993) 'Why are institutions the "carriers of history"?' unpublished manuscript, Stanford University, CA. Dickhaus, Monika (1993) T h e European Payments Union', forthcoming in

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Richard Griffiths (ed.), Explorations in OEEC History.

Eichengreen, Barry (1993a) 'A payments mechanism for the former Soviet Union: is the EPU a relevant precedent?', Economic Policy, 17, pp. 310-53. (1993b) 'Epilogue: three perspectives on the Bretton Woods system', in Michael Bordo and Barry Eichengreen (eds.), A Retrospective on the Bretton Woods System, Chicago, IL: University of Chicago Press. Elder, Neil (1982) 'Continuity and innovation in Sweden in the 1970s', in Andrew Cox (ed.), Politics, Policy and the European Recession, London: Macmillan.

Esping-Andersen, Gosta (1985) Politics Against Markets, Princeton, NJ: Princeton University Press. Flanagan, Robert, David Soskice and Lloyd Ulman (1983) Unions, Economic Stabilization and Incomes Policies, Washington, DC: The Brookings Institution. Gennard, John and Michael Wright (1978) 'Incomes policy', in Derek Torrington (ed.), Comparative Industrial Relations in Europe, Westport, CT: Greenwood

Press. Gillingham, John (1995) The European Coal and Steel Community: an object lesson?', in Barry Eichengreen (ed.), Europe's Postwar Recovery, Cambridge: Cambridge University Press. Griliches, Zvi (1988) 'Productivity puzzles and R & D: another nonexplanation', Journal of Economic Perspectives, 2, pp. 9-21.

Grout, P.A. (1984) 'Investment and wages in the absence of binding contracts: a Nash bargaining approach', Econometrica, 52, pp. 449-60. Gruchy, A.G. (1966) Comparative Economic Systems, Boston, MA: Hough ton Mifflin. Hoel, K. (1990) 'Local versus central wage bargaining with endogenous investments', Scandinavian Journal of Economics, 92, pp. 453-69.

Ingham, G.K. (1974) Strikes and Industrial Conflict, London: Macmillan. International Labour Office (1950) Labour-Management Co-operation in France,

Geneva: ILO. Kaldor, Nicholas (1966) Causes of the Slow Rate of Economic Growth of the United

Kingdom, Cambridge: Cambridge University Press. Katzenstein, Peter (1984) Corporatism and Change: Switzerland, Austria and the

Politics of Industry, Ithaca, NY: Cornell University Press. Kindleberger, Charles P. (1967) Europe's Postwar Growth, New York: Oxford University Press. Kurzer, Paulette (1993) Business and Banking: Political Change and Economic

Integration in Western Europe, Ithaca, NY: Cornell University Press. Lancaster, Kelvin (1973) 'The dynamic inefficiency of capitalism', Journal of Political Economy, 81, pp. 1092-110. Lindbeck, Assar and Denis Snower (1988) The Insider-Outsider Theory of Unemployment, Cambridge, MA: MIT Press. Lohman, Susanne and Sharyn O'Halloran (1993) 'Divided government and US trade policy', unpublished manuscript, Stanford University and Columbia University. Lorwin, V.R. (1954) The French Labor Movement, Cambridge, MA: Harvard University Press. Maddison, Angus (1976) 'Economic policy and performance in Europe, 1913-1970', in Carlo Cipolla (ed.), The Fontana Economic History of Europe, vol. 2, London:

Fontana. Maier, Charles S. (1975) Recasting Bourgeois Europe, Princeton, NJ: Princeton University Press. (1984) 'Preconditions for corporatism', in John Goldthorpe (ed.), Order and Conflict in Contemporary Capitalism, New York: Oxford University Press.

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McCain, Roger A. (1989) 'Codetermination, collective bargaining, commitment, and sequential games', in Hans Nutzinger and Jurgen Backhaus (eds.), Codetermination, Berlin: Springer-Verlag. Meade, J.E., H.H. Liesner and SJ. Wells (1962) Case Studies in European Economic Integration, London: Oxford University Press. Newell, Andrew, T. and James Symons (1987) 'Corporatism, laissez-faire and the rise in unemployment', European Economic Review, 31, pp. 567-602. North, Douglass C. (1993) Institutions and credible commitment', Journal of Institutional and Theoretical Economics, 149, pp. 11-23. North, Douglass C. and Barry Weingast (1989) 'Constitutions and commitment: the evolution of institutions governing public choice in seventeenth century England', Journal of Economic History, 49, pp. 803-32. Olson, Mancur (1982) The Rise and Decline of Nations, New Haven, CT: Yale University Press. Panitch, Leo (1979) T h e development of corporatism in liberal democracies', in Philippe C. Schmitter and Gerhard Lehmbruch (eds.), Trends Toward Corporatist Intermediation, Beverly Hills, CA: Sage. Pastor, Robert (1980) Congress and the Politics of US Foreign Economic Policy, Berkeley, CA: University of California Press. Pollard, Sidney (1981) The Integration of the European Economy Since 1815, London: Allen and Unwin. Postan, M.M. (1964) An Economic History of Western Europe 1945-1964, London: Methuen. Przeworski, Adam and Michael Wallerstein (1982) 'The structure of class conflict in democratic societies', American Political Science Review, 76, pp. 215-38. Roberts, B.C. (1958) National Wages Policy in War and Peace, London: George Allen and Unwin. Schelling, Thomas (1960) The Strategy of Conflict, Cambridge, MA: Harvard University Press. Schmitter, Philippe C. (1981) Interest intermediation and regime governability in contemporary Western Europe and North America', in Suzanne Berger (ed.), Organizing Interests in Western Europe, Cambridge: Cambridge University Press. Schmitter, Philippe C. and Gerhard Lehmbruch (1979) Trends Toward Corporatist Intermediation, Beverly Hills, CA: Sage. Sheahan, John (1963) Promotion and Control of Industry in Postwar France, Cambridge, MA: Harvard University Press. Shonfield, Andrew (1965) Modern Capitalism, Oxford: Oxford University Press. Streeck, Wolfgang (1984) Industrial Relations in West Germany, London: Heinemann. Thelan, Kathleen (1991) Union of Parts: Labor Politics in Postwar Germany, Ithaca, NY: Cornell University Press. (1994) 'Beyond corporatism', forthcoming in Comparative Politics. van der Ploeg, Frederick (1987) 'Trade unions, investment and employment: a non-cooperative approach', European Economic Review, 31, pp. 1465-92. van Waarden, Frans (1993) 'Introduction: crisis, corporatism and continuity', in Wyn Grant, Jan Nekkers and Frans van Waarden (1993) Organising Business for War, New York: Berg. Windmuller, J.P. (1969) Labor Relations in the Netherlands, Ithaca, NY: Cornell University Press.

The varieties of Eurosclerosis: the rise and decline of nations since 1982 MANCUR OLSON

1

Introduction

Valuable as they are, conventional economic models have not succeeded in explaining the great differences in economic performance in different countries or historical periods. The 'old' growth theory is called into question by the absence of the convergence in per-capita income levels across the globe that it leads one to expect. The 'new' growth theory readily accommodates continuing differences in per-capita incomes across countries, but does not yet provide much insight into why the particular countries that became rich were the ones that grew. Neither does it explain why a few poor countries have led the world in economic growth at the same time that the poor countries as a whole have not been catching up. In a book, The Rise and Decline of Nations,1 some article-length publications that foreshadowed it, and some subsequent papers and publications that focused on Eastern Europe and on the Third World,2 I presented a theory that combines the insights of familiar neoclassical economic models with a model of collective choice. The model of collective choice enables the theory to comprehend certain aspects of political and organizational life. The theory succeeds in explaining the most dramatic and puzzling variations in economic performance across countries. The present chapter will differ from the aforementioned book and articles in two ways. First, this chapter will attempt to show how the same fundamental forces that influence economic performance everywhere show up in a very different forms in countries with different initial conditions. Even when one considers only the related and similar societies of Western Europe, the institutional and historical differences across countries not only have a significant independent effect on outcomes, but they also make the same fundamental forces take on a totally different appearance. Just as a change in temperature can turn water into ice or steam, so international differences in institutions can make a single, general force operating in different countries appear to be a variety of unrelated phenomena. This chapter will show that some apparently unrelated developments in Europe are, in fact, manifestations of the same process. 73

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Second, the analysis will focus only on economic growth since Rise and Decline was written. Any theory should be able to explain data beyond the data from which it was derived. Obviously, I could not have known, when writing the book, about developments that occurred after the book was published. Thus the theory could not possibly have been adjusted to take account of the developments that are the focus of the present study. Since my discussion will not be comprehensible unless the reader has some knowledge of the theory developed in prior works, section 2 outlines some of the ideas from prior publications that will be used and tested in this essay. Readers who know both Rise and Decline and my subsequent papers on the Communist and post-Communist societies can skip this section. 2

A recapitulation of the theory

The theory begins with collective action - concerted efforts to lobby the government or to combine in the marketplace to influence prices and wages. Such action occurs through professional associations, labour unions, farm organizations, trade associations, and oligopolistic collusions of firms in concentrated industries. The benefits of the governmental favours and the monopolistic or monopsonistic prices or wages obtained by organized action go to everyfirmor individual in some group or category, a tariff or tax loophole favours every firm in some industry or group, and cartelization raises the price or wage for every seller of a good. It follows that any sacrifice an individual makes to support a lobby or cartel for his group will benefit others as much as himself. A group with a common interest will be able to overcome this collective good problem only if it has the advantage of small numbers or is blessed with access to 'selective incentives'. The advantage of small numbers is clearest in a concentrated industry containing only a few largefirms.If there are twofirmsof the same size in an industry, each firm will obtain half of the benefit of any action in the interest of the group. Even though eachfirmmust bear the whole cost of whatever it does for this group of twofirms,its large share of the benefit will often be sufficient to give it an incentive for some unilateral action in the interest of the group. If there are, by contrast, a million individuals in a group with a common interest, a representative individual in the group will receive only a millionth of the benefits of any action he or she takes in the interest of the group. Each individual will still have to bear the whole cost of whatever he or she does in the interest of the group. As these examples make obvious, the incentive to act in the interest of the group must be less in large than in small groups, and in really large groups, the incentive for an individual to engage in spontaneous collective action is vanishingly small. When a large number of people share a common interest, they will be able to act collectively to serve this interest only if they have 'selective incentives'. A selective incentive is a reward or punishment that, unlike the benefits of the collective good itself, selectively apples to individuals according as they do or do not contribute to the provision of the collective good, and therefore gives the individuals an incentive to act in the group interest. Probably the best-known selective incentives are the closed shop, the union shop and the coercive picket line - those who do not share the costs of the collective action are threatened with loss of a job or are subject to social

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or physical intimidation. Though the selective incentives used by other kinds of large organization for collective action are usually less conspicuous, they are no less important.3 Since collective action is difficult and problematical, it usually takes quite some time before a group can engage in collective action, even when it has small numbers or the opportunity to devise selective incentives. The bargaining that is required for those in small groups to organize or collude with full effectiveness often takes a while. Organizing large groups is incomparably more difficult and time consuming. It is only in the fullness of time that many groups will have had the able leadership and the favourable circumstances needed to organize for collective action. 2.1

The incentives facing organizations for collective action

What difference does it make for the prosperity of a society how many groups, and what kinds of group, are organized for collective action? The answer is evident when we look at the incentives that organizations for collective action face. The constituents of any organization that represents only a narrow segment of the society will virtually always be better off if the organization shifts the distribution of income in the society in their favour. An organization for collective action can shift the distribution of income in the society in its favour through lobbying for special-interest legislation - for subsidies, tariffs, tax loopholes or regulations that limit entry and competition. It can shift the distribution of income in its favour by selling less and charging more for it - that is, by collusion or cartelization. In general, special-interest legislation and monopolistic combination make an economy less productive than it would have been, and the constituents of an organization for collective action will share the losses. But an organization for collective action that represents only a narrow segment of the society will bear only a minuscule share of these losses. A special-interest organization whose constituents earn 1 per cent of the national income will, on average, bear only 1 per cent of the loss in national output that occurs because of the inefficiency its activities bring about. But the special interest obtains the whole of the amount redistributed to it. Thus it pays our hypothetical special-interest group to seek to redistribute income to its own members, even if this redistribution reduces the national income by up to 100 times the amount redistributed. Therefore, organizations that represent only a minute percentage of an economy's income-earning capacity are really 'distributional coalitions' - coalitions whose purpose is to redistribute more of society's income to themselves. If an organization for collective action encompasses a large part of the income-earning capacity of a country, its incentives are very different. This is immediately evident if one considers an organization that represents, say, half of the income-earning capacity of a society; its clients will on average obtain one-half of any increase in the national income that it brings about, and bear half of the social loss that results from redistributions to itself. There have been such encompassing interest organizations in Austria, Norway and Sweden, and to a lesser extent in Germany and Japan. The concept of the encompassing interest applies to many different types of situations, offices and individuals. A dictator has an encompassing interest in any

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domain which he securely controls: his tax receipts, which will increase with the productivity of his country, give him this encompassing interest.4 Though a large organization cannot usually optimize as effectively as a single individual, a large and well-disciplined political party, such as the Conservative Party in Great Britain or the Social Democratic Party in Sweden, also has an encompassing interest. So does a president in strong-presidency countries like France and the United States; a president normally needs majority support to be re-elected, and a majority is an encompassing constituency. Some of the conclusions of the present argument hinge on this concept of the encompassing interest, and much of the latter part of this essay is devoted to an analysis of the dynamics of encompassing special-interest organizations. 2.2

Testable implications of the theory

The ideas that have just been evoked can explain the most striking anomalies in modern economic growth. We have seen that organizations for collective action with narrow constituencies have uniquely perverse incentives, and that it takes a long time before a society accumulates many organizations for collective action. Revolutionary upheavals, totalitarian repressions and foreign occupations destroy organizations for collective action. In any brief interval of stability, few if any groups can overcome the difficulties of collective action. By contrast, in a long-stable society, many groups will have overcome these obstacles. Once these organizations have worked out the selective incentives or agreements needed for collective action, they rarely disappear unless they are violently repressed. Thus only long-stable societies are thick with organizations for collective action. Distributional coalitions are, if my argument is correct, uniquely harmful to economic efficiency and dynamism. It follows that societies that set up a good legal order, after a catastrophe has destroyed organizations for collective action, will, for a time, grow extraordinarily rapidly. Similarly, long-stable societies ought to grow much less rapidly than societies that are in other respects comparable. Thus we can test the theory by asking whether it fits the facts about economic performance in different countries. The society that has had the longest period of stability and immunity from invasion and institutional destruction is Great Britain. As the theory predicts, Great Britain for most of the postwar period has also had the 'British disease' - the poorest economic performance of the major developed democracies. The economic miracles of Germany and Japan after World War II are also consistent with the argument. In Italy, the institutional destruction in World War II, while considerable, was less complete than in Germany and Japan. The economic miracle in Italy, though there definitely was one, was correspondingly somewhat shorter and smaller than those in Germany and Japan, and this again is in accord with the theory. With appropriate elaboration,5 the aforementioned theory also explains the general pattern of regional growth in the United States since World War II. Consider also the most remarkable examples of economic growth in previous centuries: the growth of Germany after the Zollverein or customs union was established in 1834 and after German unification was completed in 1871; the growth of Japan after the Meiji Restoration of 1867-8; the growth of the United States in the

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nineteenth century; the growth of Holland during its Golden Age in the seventeenth century; the growth of Britain during the Industrial Revolution from about 1760 to about 1840; and the commercial revolutions in England and France in the sixteenth century. All of these cases illustrate what I called 'jurisdictional integration': in each case, a wider market was created within which there was at least internal free trade, and at the same time a new jurisdiction or government was established that could be influenced only by lobbies that were of a larger scale than most of those that had influenced the parochial jurisdictions that existed before. After the creation of a much larger jurisdiction and the wider market, there was in every case rapid economic growth. Jurisdictional integration undercut the guilds and other special-interest groups of the day. A detailed examination reveals that not only the speed of development after the jurisdictional integration, but also its organizational features and regional patterns, are consistent with the theory, as is much of the subsequent literature.6 2.3

Generalizing the theory for Communism and the transition

Though Rise and Decline said nothing about the Soviet-type countries, the theory in it was soon generalized to cover these societies and then later to deal with the transition from Communism.7 Under Soviet-type dictatorships, there was, of course, no freedom of organization, so there were no formal lobbying organizations, independent labour unions or other explicitly cartelistic organizations. Thus it might seem that under Communism there could not have been any collective action that impaired economic performance. I claim that, in fact, the dictator in a Soviet-type system is utterly dependent for information on bureaucratic competition among the subordinates in individual industries and enterprises, and that the subordinates in each industry and enterprise can, if they covertly collude, distort the informationflowgoing tp the centre in ways that enable them to obtain surplus resources that serve their own interests. Thus covert collective action ultimately creates innumerable nomenklatura collusions and, in fullness of time, this devolution reaches the point where large enterprises and industry associations are as much insider lobbies and monopolies with vested interests as they are instruments of production to serve the Communist regime. Each collusion, enterprise and industry has so small a stake in the productivity of the society as a whole that each tends to ignore its impact on the society. In this the individual collusions and enterprises are very different from the general secretary of a Communist country, who has an encompassing interest in the productivity of his domain and therefore a motive to make it as productive as possible. Thus, in the absence of organizationally destructive events like China's cultural revolution, the theory predicts that the economic performance of stable Soviet-type societies deteriorates over time. Since the enterprises and industries are not destroyed by the transition to democracy, but are, on the contrary, given a new freedom to lobby for their sectional interest, this problem is magnified during the transition. Since the focus here is on Western Europe, I will not discuss the other testable predictions of the theory for Soviet-type and transitional societies, and will return to developed democracies.

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Better economic understanding as the antidote

The theory argues that it is mainly narrow as opposed to encompassing organizations that repress economic growth. Each narrow special-interest organization represents only a tiny minority of the population. I can therefore, in any democracy, easily be outvoted. A special interest can get its way only because most of the society does not notice or understand what is happening. Thus Rise and Decline emphasized the quality of economic thought and the extent of economic literacy. It argued that, if societies came to understand and believe the argument in Rise and Decline, the predictions in the book would be refuted. Since both the level of economic understanding and the density of organizations for collective action are important determinants of economic performance, each needs to be kept in mind in any attempt to trace the influence of the other. A country may grow faster or slower than would be expected from the density of organization for collective action because its understanding of the problem - and of what is required for an efficient and dynamic economy - is better or worse than in comparable countries. It is even conceivable that societies with more serious cases or less opaque forms - of institutional sclerosis apprehend the problem more quickly than other societies.8 This means that, in analysing economic growth since 1982, we must keep both the character of collective action and the prevailing economic ideas in a country in mind. 3

Economic growth since Rise and Decline

Some of the best evidence in support of the theory that has been outlined above comes from the Communist and formerly Communist countries. In the early postwar period, the Communist countries grew relatively rapidly. But as time went on they suffered a gradual and continuing deterioration in their growth rates, in spite of their continued opportunities for fast catch-up growth. It was only after a long period of relative decline that Communism collapsed. The sharply contrasting consequences of the defeat of Fascist and Communist regimes fits the theory especially nicely. Whereas the defeat of Fascism destroyed most organizations for collective action, the defeat of Communism gave the lobbies of large enterprises and industry associations the opportunity to use their political muscle openly. The defeat of Fascism was followed by economic miracles in all of the formerly Axis countries, but the defeat of Communism has so far often been followed by even poorer performance than under Communism. The only Communist or once-Communist country that has enjoyed an economic miracle is the one that suffered the cultural revolution (and after this revolution China was ruled by a pragmatic dictator with an encompassing interest in a productive domain). This is indeed the exception that proves the rule. But the focus here is on the West, so I turn to the less dramatic changes that have occurred in the developed democracies. A most interesting pattern of gradual change through time has been evident in the countries whose Fascist regimes were defeated in World War II. The logic of the argument in Rise and Decline implied that, as time went on, the same accumulation of organizations for collective action that had troubled the long-stable English-speaking countries would, if these countries remained stable, also continue to occur in

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Germany and Japan. This prediction was made explicitly: The theory here predicts that with continued stability the Germans and Japanese will accumulate more distributional coalitions, which will have an adverse influence on their growth rates/9 The same argument was made separately with respect to Italy. Germany and Italy were already, when Rise and Decline was being written, experiencing some reduction in relative growth rates, but at that time this relative decline had not attracted much attention outside of those countries. The almost universal forecast at that time was that the Japanese economic miracle would continue. By now it is beyond dispute that the Japanese as well as the German and Italian economic miracles are over. In the 1950s and 1960s, real per-capita incomes of Germany and Japan grew more then three times as fast as those of the UK, the USA, Ireland, Australia and New Zealand. Since 1980 the average rate of growth of per-capita income in the English-speaking OECD countries has been as great as, and often even greater than, that of Germany and Japan. Rise and Decline also argued that there was some institutional destruction in the continental countries that were under Axis occupation during World War II, and that many distributional coalitions in France and in some of the other previously protectionist countries were rendered ineffective by jurisdictional integration as the initial six countries created the Common Market. The jurisdictional integration due to the formation of the Common Market gave the six original members some growth advantage, for a period of time, over the long-stable English-speaking OECD countries. Again, the theory in Rise and Decline predicted that, with continued stability in the Common Market countries, the growth-enhancing effects of the jurisdictional effects would gradually wear off as new patterns of collective action accumulated. Again, this is what seems to have happened. In the 1960s per-capita incomes in France, Italy, Belgium and the Netherlands all grew at more than 4 per cent per year, whereas the English-speaking OECD countries grew at far slower rates. Since 1980, by contrast, these countries have grown no faster - and sometimes slower than the English-speaking OECD countries. Countries with the most encompassing interest organizations have also slowed down over time. In the 1950s and 1960s Sweden, in spite of its already relatively high level of per-capita income, grew faster than the English-speaking countries. The growth rates of Austria, Norway and (as we already know) West Germany were also well ahead of those of the English-speaking countries. In the 1980s (and especially the 1990s) Swedish economic growth has fallen far behind that of the English-speaking countries, and that is also true of most of the other European countries that had enjoyed relatively encompassing interest group structures. Whether we look at the growth rates of the Communist countries, or at Germany, Japan and Italy, or at the continental countries that were occupied by the Nazis in World War II, or at countries like Sweden that have had encompassing interest-group structures, we see that the changes are not only in the direction predicted by the theory, but also have the gradual character that would be expected from a sclerotic institutional accumulation. Nonetheless, even though the aggregate evidence on national growth rates that has emerged since 1982 is certainly supportive of the theory, this aggregate evidence by itself is by no means compelling. As we know, economic growth is influenced by

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many different factors. It is obviously possible that other factors that influence growth rates could have explained the observed pattern, and that the conformity with the theory in Rise and Decline is spurious. There is also another and more intriguing possibility. We recall that, if the theory in Rise and Decline were generally understood and accepted, the predictions of theory would necessarily be refuted, and, more generally, that the intellectual climate influences choices about economic policy and is therefore extremely important. It is possible that the countries that suffered the most (or suffered in the least opaque ways) from special-interest cartelization and lobbying would be more susceptible to analyses of the problem, and come to have a bit more of an apprehension of it, than societies that had suffered less (or in ways that were harder to understand). At least if the issue is explicitly discussed, the degree of understanding of the damage done by distributional coalitions could be, at least to some extent, endogenous. Rise and Decline pointed out that two countries that had suffered extraordinarily severe institutional sclerosis, not only because of their long-standing stability, but also because of their small size and then-exceptional propensities to industrial protectionism (the opposite of jurisdictional integration) were Australia and (especially) New Zealand. Interestingly, Labour governments in both New Zealand and Australia have undertaken widespread market-opening and deregulatory reforms that seem greatly to have weakened special-interest organizations on the business side. As might be expected, these Labour parties, dependent in part on support from labour unions, have not taken the same strong stand against cartelization in the labour force. Similarly, the deregulation of the thoroughly cartelized and lobby-intensive industries such as airlines, trucking, telephone and railroads in the United States, mainly during President Carter's Democratic administration, owed something to the conspicuous economic irrationalities that special-interest pressures had brought to these industries. The beginnings, during the Callaghan Labour government in the UK, of a reliance on limiting the money supply rather than only on incomes policies to restrict inflation, could be interpreted in a similar way. Despair, even in the British Labour Party, about the UK's anything-but-encompassing trade unions also led a substantial part of the Labour leadership to leave that party and create a new political party. This step - which was all the more extraordinary because the British electoral system makes the defeat of any third party almost inevitable - could also be analysed as a response to the severity of institutional sclerosis in the UK: as we know, the phenomenon there has been prolonged and serious enough to come to be called the 'British disease' and this surely generated some demand for cures, even if they should be painful. Thus, in the same way, Thatcherism can also be taken to be endogenous - even as the mirror image of the Labour or left-inspired reforms in New Zealand and Australia. Just as the reforms inaugurated by the Labour governments of the South Pacific focused disproportionately on reversing the losses arising from cartelization and lobbying by business, naturally the Thatcher government focused on limiting the harm done by the special-interest groups that were linked with the left: the labour unions, which are also the most visible part of the special-interest iceberg. Intriguing as the foregoing possibility of endogenous response to institutional

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sclerosis is, I must emphasize that I have not been able to undertake the multicountry study of political, economic and intellectual history that would be needed to know how much truth it contains. The more important point for now is that no monocausal explanation of complex historical developments can be correct, including any such explanation drawn from the theory that I have offered. A series of factors that are not accounted for by the theory in Rise and Decline could have made the observed pattern of growth rates since 1982 spuriously consistent with the theory. Some of these other factors could even have operated in such a way as to generate the gradual character of the observed changes. There is some additional evidence in the economic literature on continental and Nordic Europe in the 1980s and 1990s. In a series of papers and lectures starting in 1976, and in Rise and Decline, I used the phrases 'institutional sclerosis' and 'institutional arthritis' to label the process that my theory predicted.10 Thus there is perhaps a little support for my argument in the emergence, in continental Europe in the 1980s, of the term 'Eurosclerosis', which I have borrowed for the title of the present paper. The German economist Herbert Giersch appears to have coined the term, which also has currency in the popular press, and Asaar Lindbeck gave sustained attention to the increasing sclerosis in continental and Nordic Europe in 1982.11 In Sweden, Stahl and Wikstrom have used the more targeted label of 'Suedosclerosis' in the title of a recent book, and this coinage also appears to be spreading.12 Though the economists who use the sclerotic analogy all have somewhat different emphases, the varied accounts nonetheless resonate with each other and with the argument here. Many expert observers with detailed knowledge of the economies of Germany, Sweden and continental Europe find an economic inflexibility and an irrationality in economic policy that they deem to be increasingly serious. There were few if any comparable complaints on the continent in the early postwar period - there is apparently a widely observed accumulation of distortions with social ageing. 4

Distinctive institutions and common processes

Those who are sceptical about whether there are any general principles governing economic growth in countries with very different institutions and histories will want to question whether the general model in Rise and Decline and its collateral works can be reconciled with the great institutional and historical differences across countries. Thus I face the challenge of showing how the general theory could be true, given the significance that the idiosyncratic characteristics of each country can have for economic growth. But this challenge is also an opportunity. The institutional and historical differences across countries can also be used to test, in a different way, whether the argument in Rise and Declinefitsthe facts of experience. If we agree about the important special institutional and historical features of a country, and if it is also clear how the general theory, if true, should be manifest in a country with those special institutional or historical characteristics, then we can test to see if exactly this manifestation is in fact observed. If the general principle shows up in the theoretically predicted way in each of a number of very different institutional and historical settings, then that provides additional evidence that the principle is true.

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Just as we know that a fluid is water when we know the temperatures at which it freezes and turns to steam, so we can have more confidence in a theory if the sclerotic processes vary across countries in a way that is consistent with that theory. In testing the argument in this way, it will be convenient to distinguish different classes of cases. Some of these classes have been analysed elsewhere and will only be mentioned here. Another class of cases is sufficiently straightforward that it can be evoked in a couple of paragraphs. Afinalclass, the Nordic-Teutonic class, is more complex and will require a more elaborate analysis. Most of the rest of this paper will be devoted to dealing with this last type of sclerosis, but I shall touch first on those cases that can here be dealt with more briefly. 4.1

Anglo-American

The sclerotic process that manifested itself in the developed English-speaking countries has already been analysed in Rise and Decline, so it is now only necessary to give it a separate name. It can conveniently be called the 'Anglo-American* or (since it covers the developed democracies that were once part of the British Empire) the 'English-speaking' form. The way in which the hyper-pluralistic organizational structures and collusional patterns evolve in the Anglo-American type of context has also been described elsewhere, and thus can readily be compared with the other patterns of evolution that will be referred to or described in the rest of this chapter. 4.2

Mercantilistic

Most of the countries of the Third World constitute another class of cases. The less developed countries have poor transportation and communication systems that, in combination with the difficulties of collective action, normally make organization of rural interests impossible. Their governments tend to be influenced disproportionately by organized small-group interests in the major urban areas, and especially in the capital city. These organized interests gain from protection and subsidies to activities in which most of the Third World countries do not have a comparative advantage. Because of this, they suffer from what I call a 'perverse policy syndrome'. Since I have dealt with this class of cases in Rise and Decline and in some articles,13 I will say no more about it here. Since Adam Smith first dealt with this class of cases (in analysis of pre-industrial Europe in the Wealth of Nations) and diagnosed it in a similar way, let us use his term, 'mercantilism', to label this form of sclerosis. 4.3

Red devolution

This form of institutional sclerosis has also been dealt with elsewhere.14 The types of special-interest collusion that the theory predicts will emerge in societies without freedom of organization and with a Soviet-type economic organization are, of course, dramatically different from those that are predicted to emerge in the developed democracies with market economies. Most of the specific features that the theory predicts will characterize the evolution of Soviet-style societies are also different from those that characterize the sclerotic process in democracies with market economies. Because the Soviet-type societies lack various countervailing

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and corrective forces that characterize the market democracies, they develop a more severe sclerosis than Western societies do. 4.4

Healing-of-divisions sclerosis: southern Europe

Societies differ in the degree to which they are divided over fundamental beliefs. Though there are divisions about government policy in all societies, in some there are also intense disagreements about what fundamental principles should govern the organization of society. The dangers and disadvantages for a society of intense divisions about fundamental issues are well known. Societies that are deeply divided are less stable, and this instability not only directly endangers these societies, but also generates uncertainties that reduce business confidence and especially limit the inflow of foreign investment. What is not so widely understood is that social divisions can also favour economic growth by inhibiting some collective action that reduces social efficiency and dynamism. If collective action is to occur, there must be some limit to the intensity of divisions among those who would engage in collective action. Collective action by definition requires cooperation and concerted effort. Normally, cartelization and collusion to fix prices and wages can occur only if everyone in some industry, craft or occupation is willing to go along with it. A cartel cannot monopolize the supply of any type of good or labour if any suppliers who can supply a large part of total demand refuse to cooperate. This is one of the reasons why organizations for collective action prefer to have a socially homogeneous membership. By and large, the most seriously divided societies in Europe in the early postwar years were the societies that had simultaneously large numbers of Roman Catholics and large Communist Parties: the Mediterranean societies, especially Italy and France. No doubt these societies suffered some loss of foreign investment and some capital flight and other problems because of the uncertainty and tension arising from their social divisions. In general, the social divisions in these societies did not prevent collusion or cartelization among large private firms, since almost all of those who owned or managed substantial private firms were anti-Communist. Since the Communists were never in the central government, the state-owned firms also were not under Communist management (though in Italy apparently there were systematic disagreements at a more encompassing level about some matters between the often left-Catholic-managed government-owned firms in INTERSIND and the privately owned firms in CONFINDUSTRIA).15 So generally the southern European societies, especially in the years before the Common Market, had many powerful trade associations, cartels and oligopolistic collusions. The social divisions did, however, work against effective cartelization of the labour force in the early postwar years. There were separate Communist, Catholic and socialist unions, and these unions were often in conflict not only in the society at large, but also in particular industries, crafts and enterprises. These divisions made it much more difficult for unions to obtain the powerful selective incentives needed to build up stable dues-paying memberships and large strike funds - that is, they worked against closed shops and other forms of compulsory membership. Union dues and union density tended to be lower in southern Europe than in the UK,

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Scandinavia or Germany. (Interestingly, as the present argument would predict, the religious-ethnic division in Northern Ireland is said to have made labour unions at times less strong there than in other parts of the United Kingdom.) The competing unions in each workplace also sometimes negated each other. The social divisions, and each group's fear of being permanently repressed, worked against the solidarity needed for strikes that could outlast employers. The labour unions in the southern European countries were able to stage conspicuous demonstrations, and they could often organize brief strikes, even in the early postwar period. They made the left-wing forces in politics more important than they would otherwise have been. For the most part, however, the societies that were most sharply divided between Catholics and Communists did not have what in the United States has been called 'business unionism'. That is, they did not have unions whose members shared a consensus about the acceptability of the existing social order and thus were able to focus single-mindedly on obtaining the strike funds and control over the workforce needed for effective cartelization of the supply of labour in somefirm,craft or industry. At the same time, the unacceptability to the majorities of a Communist Party in the governing coalitions (until President Mitterrand in France organized a coalition with the Communists that left them impotent) meant that the Communists did not have as large an effect on economic policy as might be expected from their numbers. Thus there are some respects and circumstances in which, paradoxically, 'Communism is good for capitalism'. This paradox should not be overdrawn. The southern European societies were endangered and, in some important respects, damaged by their deep divisions over Communism, Catholicism and what constitutional order should be chosen. Their ideological-religious division could not have had any large impact on the cartelization of firms, and these societies appear to have lost a good deal from that type of cartelization. Still, there can be no doubt that there is an important and neglected element of trjath in the paradox. The foregoing argument about social divisions applies mainly to the early postwar period in France and Italy. The divisions over the constitution of society in southern Europe diminished greatly even before the collapse of Communism. With the collapse of the Soviet-type societies, both Communism and fear of Communism have nearly disappeared. The logic of the theory leads one to expect to see certain special features in the sclerotic process in postwar southern Europe. Cartelization of labour markets would be expected to proceed more slowly than it would otherwise have done. The political focus of labour unions would be relatively larger and the cartelistic element somewhat smaller than in societies of lesser social divisions. The healing of divisions would make the devolution of these societies resemble the English-language and north European societies more as time goes on. As social divisions heal, these societies would reap a direct gain from improved confidence in the investment climate. They would also lose from an increasing institutional sclerosis. In short, the ageing process in southern Europe would, by the logic of the argument, tend to be accompanied by a healing of social divisions that would bring diverse social benefits at the same time that it brings new types of damage from cartelistic collective action.

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The devolution of encompassing interest organizations: northern Europe

As we recall, our basic logic implies that, if an organized interest is sufficiently encompassing, it will not have an incentive to engage in the anti-social behaviour that a narrow special-interest group has. A disciplined labour union or employers' association that represents, say, 50 per cent of the income-earning capacity of a country will, on average, bear half of any losses it imposes on society. Thus it will cease any redistribution to itself when the marginal social losses that result from this redistribution are twice as large as its gain at the margin from the redistribution. It will have no incentive to engage in the extremely anti-social redistributions that are advantageous for a group that represents only a narrow interest, such as an industry or occupation. Indeed, it has been proven elsewhere16 that if an interest is sufficiently encompassing - if it is a 'super-encompassing' interest - then self-interest, paradoxically, keeps it from taking any redistribution whatever from the rest of society, and motivates it to provide socially optimal supplies of public goods. In a few (mostly small and homogeneous) societies, encompassing interest organizations were created by quasi-constitutional settlements utilizing, among other things, the power of government (or of occupation authorities). In Sweden, the encompassing arrangements were worked out before World War II and (since Sweden was not occupied or even a combatant in the war) continued unbroken through the war. In the case of Norway, Austria and Germany, these arrangements date from after the war. At the beginning, in the cases of Norway and Sweden, and certainly of Austria, it was at most a moderate exaggeration to say that there was only one big union that represented all manual workers and only one big employers' organization representing all substantialfirms.This was never true in Germany, but that country's structure of labour unions and business organizations was nonetheless relatively encompassing, especially by the standards of the English-speaking countries. As the foregoing logic would suggest, the countries with encompassing interest organizations worked very well in the 1950s and 1960s. But as time has gone on, their economic performance has deteriorated considerably and, in the case of Sweden, dramatically. This raises the question: how do societies with encompassing interest organizations change over time? When I was writing Rise and Decline, I had no idea what governed the evolution of such organizations, so that book is cautious and agnostic about how such organizations would work out in the long run. But, as I realized when writing some later articles on this subject,17 the logic of the matter is so clear that I ought to have seen it from the start. Though encompassing political parties and offices in certain types of electoral system can remain encompassing for indefinitely long periods, encompassing interest organizations, such as business organizations and labour unions, are eventually bound to devolve, implicitly or explicitly, into narrow special-interest groups. The underlying logic can best be understood by comparing the incentives that face political parties in countries with electoral rules that generate two-party systems, with the incentives facing organized groups in some other situations. In elections such as those for the House of Commons in the United Kingdom, or in presidential elections in France or the United States, the candidate with a plurality -

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the 'first past the post' - wins. There is no reward for the party that represents a block of voters but never comes infirst.Therefore, though small parties can thrive under proportional representation, there is no incentive under winner-take-all electoral rules to set up political parties to serve the interests of thefirmsin any one industry, or the workers in any one occupation, or any other group too small to have a chance of coming infirst.As has long been known from Duverger's Law, in such electoral systems there is a tendency towards a two-party system. Thus encompassing political parties in countries with plurality-winner electoral systems can last indefinitely. The situation over the long run is dramatically different for encompassing interest organizations such as employers' associations or labour unions. Lobbying and cartelistic organizations do not need a majority or even a plurality of the society to profit from collective action. All a collusion or cartel needs is control over the supply in a single market. All a lobby needs is enough resources to hire a lobbyist, or to make campaign contributions, or to provide enough campaign workers to make a difference in crucial districts, and so on. A trade association offirmsin a particular industry, or the union that represents the workers in a single craft or industry, will normally be large enough to have significant lobbying power, even if the members of the organization in the aggregate obtain only a minute share of the national income. They are therefore in a very different situation from a political party in a country with electoral rules that favour a two-party system. To understand the decisive significance of this for the evolution of encompassing organizations, we begin by assuming an ideally encompassing system with one encompassing labour union representing all workers and one encompassing organization representing all of business. A union representing all workers in the country, if it acts in the best interests of its clientele, strives in the labour market to obtain the highest possible real wages for workers as a whole. The highest possible incomes for workers in this society will be attainable only if the economy is efficient, which it will not be if workers in particular occupations have monopolistic wage levels. Thus an encompassing labour union representing all workers would work for uniform wage levels for each skill level throughout the economy. An encompassing union will often maximize the real incomes of its constituency by using its political power to obtain some income redistribution through government to the income categories in which its membership mainly falls. But it cannot serve its membership by seeking special protection or subsidies for workers in particular industries or occupations: industry-specific and occupation-specific favouritism will reduce the efficiency and dynamism of an economy. In the same way, an encompassing business organization will best serve its clients by opposing any industry-specific orfirm-specificprotection or subsidies, unless they repair specific market failures, and it will also resist any efforts to block entry into any industries, including especially those that have come to have unexpectedly high profits. Consider now an individual industry or occupation in the domain of an encompassing business organization or labour union. Even if the encompassing entity represents business as a whole or labour as whole perfectly, an individual industry or occupation will obtain additional gains if it wins special-interest legislation or a monopoly price or wage for itself. Though special-interest legislation

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and cartelistic prices or wages for an industry or occupation are contrary to the interests of the encompassing constituency as a whole, they are still advantageous for a narrow interest within it. Remember that, so long as an industry or occupation earns only a tiny percentage of aggregate income, it will bear only a tiny share of the social losses from the distortions brought about by a redistribution to itself, but will receive all of the redistribution. Thus, no matter how well an encompassing organization serves the encompassing constituency in which a given industry or occupation falls, industry-specific or occupation-specific lobbying or cartelization can obtain something extra. Since the amount that an encompassing interest group will redistribute to its members is, as we found earlier, limited by its encompassing interest, whereas there is almost no limit to the amount of redistribution that is advantageous for a narrow interest, the activities of the narrow interest will normally be worth much more to its beneficiaries than the activities of an encompassing organization. Paradoxically, this

is true even though many if not all of the narrow interests would have been better off if there had been no special-interest favouritism or cartelization by any group! The reason is that, when the number of narrow interests is large, so the narrow groups do not interact strategically, predation by one narrow group does not affect the likelihood of predation by another. Thus the unilateral action of each group takes no account of the losses to them all from their actions in the aggregate, so they continue with anti-social action even if all of them would have been better off if there had not been any such action. Unexpected developments that bring large gains or losses to thefirmsor workers in a given market can often provide exceptional openings for cartelization or subsidy.18 As a society with encompassing organizations matures, more of its firms and workers will have found themselves in exceptional circumstances where the rewards from abandoning or opposing the encompassing organizations are unusually great. A political entrepreneur who promotes an organization that obtains a surplus by organizing collective action for a narrow group can consume part of it him or herself. Therefore, whenever the firms or workers in an industry or occupation have the small numbers or access to selective incentives that make collective action possible, there is always an incentive to organize for collective action, whether or not the industry or occupation is already represented by an encompassing organization. Nevertheless, it takes a long time before a society comes to have a large number of narrow cartelistic and lobbying organizations. Whether an encompassing organization already exists or not, each industry, occupation or other narrow group must overcome the difficulties of collective action in order to organize. This process slows down the devolution of societies with encompassing interest organizations. On the other hand, the foregoing logic - and especially the logic that shows that it pays narrow interests to redistribute much more than any encompassing organization would - implies that the branch organizations of an encompassing business or labour organization have a powerful incentive to push for the interests of their own branch, even when this is very harmful to the interests of the membership of the encompassing organization as a whole. As subordinate units gain autonomy, and as separate industry or occupational caucuses are formed, an encompassing organization

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will tend to become merely a clearinghouse for the separate interests of its subordinate parts. It might seem that the problem of insubordinate branches and independent coalitions could be controlled by appropriate by-laws for the encompassing interest group, or by government legislation or policies that discourage independent action by branches or other non-encompassing organizations. Corporatist societies such as Fascist Italy and Franco's Spain did that with great severity. In political science and sociology, there are advocates of corporatism (or, as it is now sometimes called, neo-corporatism), and some of them propose government licensing or other devices to give a monopoly to corporatist pressure groups in democratic societies. The governments of some democracies have discouraged independent associations and favoured established encompassing interest organizations in other ways as well, and this has delayed their devolution. But governmental edicts, at least in democracies, cannot permanently prevent the devolution of encompassing interest organizations. There is no way that corporatist legislation in a democracy can prevent a branch of an encompassing organization from pressuring the leadership of an encompassing organization on behalf of the branch's narrow interest. The branch can always press for the right to obtain a monopoly price or wage for itself, or lobby within the encompassing organization to make it support special-interest legislation for the branch. This branch advocacy is bound to have some effect in the long run. The way to get elected to the leadership of an organization is to gain the favour of influential constituents. The leaders of branch units are accordingly important in determining who comes to lead an encompassing interest organization. The leaders of branch units often have an incentive to insist that only those candidates for central office that agree to allow them to set prices or wages separately in their own market, or who promise to support special-interest legislation for those in this market, will receive the branch's support. Those subgroups of an encompassing organization that are not already separately organized in branches can, if they have small numbers or if'selective incentives' can be found, organize a caucus or lobby within the encompassing organization to pressure it to serve the sectional interest at the expense of the encompassing interest. In the long run, how could a democratic society prevent subsets of members of an encompassing organization with a legal monopoly of representation from being controlled in large part by internal lobbies working on behalf of internal subgroups? Even if a democratic government stipulates that only specified organizations are allowed to petition the government, how in practice could it prohibit the creation of internal caucuses or organizations to lobby internally to change the policies of any legally established encompassing lobby? The logic that has just been discussed seems to fit some developments in the Nordic and Teutonic economies. Some observers of Norway and Sweden have emphasized developments that are completely consistent with the logic that I have just set out. Lash has argued, from a Marxist and sociological perspective, 'that there is a long-term trend toward decentralization of Swedish industrial relations'.19 The Swedish economist Assar Lindbeck has argued (personal communication) that the actual policies of encompassing organizations in Sweden have apparently often

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been dictated by relatively small subsets of the membership with special interests; government bail-outs of Swedish shipbuilding were not in the interest of Swedish labour as a whole, but the big union, the LO, presumably at the behest of its constituent units in the shipbuilding industry, favoured such subsidies. Gudmund Hernes has described, in compelling detail, a large number of situations in both Norway and Sweden where once-encompassing interest organizations have been undone by breakaway organizations, by assertive subunits, or by new organizations for collective action.20 No doubt there continue to be significant episodes of encompassing behaviour in some interest groups in Austria, Norway, Sweden, Germany and some other countries. This behaviour has had no counterpart in narrow distributional coalitions. But, as I argued in articles published in 1986,21 we should expect to find fewer examples of encompassing interest group behaviour as time goes on. Though some additional supporting evidence has emerged since then, it remains to be seen whether this prediction will be borne out in the long run. We also need to test the foregoing argument about the devolution of encompassing organizations against evidence on economic performance. Economic growth has gradually been slowing down in all of the pertinent countries, and the deterioration in Swedish economic performance in the last few years has been especially striking. Though this is consistent with the theory in Rise and Decline, that book argues that monocasual theories are wrong and that any complex reality is multicasual; there may well be other factors that account for the apparent consistency of the growth data with the theory. For example, the countries in which encompassing organizations have been devolving tend to have much above average levels of egalitarian or welfare state income redistribution; the exceptionally high levels of income redistribution in Sweden are especially well known, and in the 1950s West Germany redistributed as high a proportion of its income through welfare state programmes as any country in the world. Probably the single best-known explanation of the general deterioration in economic performance in the Nordic and Teutonic economies is that it is due to the magnitude of their programme for egalitarian income redistribution and their correspondingly high tax rates. As we shall see, this extensive redistribution may not be independent of the present argument, but we must nonetheless be wary of the possibility that the economic slowdown is due not to the devolution of encompassing organizations, but to inefficiencies arising from the extensive egalitarian redistributions of income in these societies. Similarly, the severe depression of the Swedish economy in the last couple of years is almost certainly partly due to various macroeconomic mistakes and disequilibria that are in some degree independent of the argument offered here. Therefore, because so many different casual factors are involved, we cannot know, until much more detailed research has been done, how well the available evidence fits the theory. The high level of egalitarian income redistribution in the countries with devolving encompassing interest organizations raises at least three questions. First, why have these countries, and especially Sweden, chosen a more egalitarian redistribution of income than other countries? Second, in view of the huge divergence between marginal private and marginal social returns arising from the

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large welfare state subsidies and taxes, why have these countries done as well as they have? Third, why has the Swedish economy performed worse than the other countries in this category? With respect to why there has been so much income redistribution, other factors may be more important, but I have hypothesized that the early postwar success with encompassing interest organizations led to overconfidence and to 'overshooting',22 especially in the case of Sweden.23 The successful economic performance at the same time that there was a substantial level of income redistribution persuaded many people that very much larger levels of income redistribution could be undertaken with little social cost. Since the deadweight losses from income redistribution almost certainly rise more than linearly with the magnitude of the redistribution, and are multiplied by the distortions from special interest, the overshooting tended to have much higher costs than its advocates expected. On the question of why the countries in this category have managed as well as they have, I have argued elsewhere that 'explicit income redistribution' to low-income people brings about, for several neglected reasons, lower deadweight costs and much less retardation of innovation than the 'implicit income redistribution' in the form of protection, regulation and cartelization that is normally brought about by narrow special-interest groups.24 Therefore, in the early postwar period before their encompassing organizations had devolved much, Sweden and the other countries with encompassing organizations had relatively less deadweight loss from income redistribution in relation to other countries than might have been expected. This helps to explain why Sweden and the other Nordic and Teutonic countries worked as well as they did for so long. On the third question of why Sweden is lately doing worse than the other countries with devolving encompassing organizations, we must remember that none of the other countries, because of their participation or occupation in World War II, have any encompassing organizations with continuity from before World War II. But Sweden does - the 'Swedish model' or 'middle way' has enjoyed continuity (and great international visibility) since the 1930s. Thus the country in which the devolution of encompassing interest organizations has apparently gone on the longest is not only a country that seems to have started overshooting with the welfare state relatively early, but also the country where this devolution has brought about the greatest deterioration in economic performance. 4.6

Different beginnings, similar endings

When one puts the devolution of encompassing interest-group organizations in perspective, the parallel with the Anglo-American or English-speaking sclerotic processes becomes clear. Just as political entrepreneurs have an incentive to organize narrow organizations for collective action in a society without any such organizations, so they have an incentive to create such organizations - or to establish them by breaking off from larger organizations - in a system of encompassing organizations. In both situations, the political entrepreneurs must overcome the great difficulties of collective action, so they will not be able to create many organizations for collective action quickly. But some groups have the small numbers or the access to selective incentives needed for organization, and will, in a

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stable society, eventually succeed in organizing. When thefirmsor workers in some industry or occupation are separately organized, either by the creation of a new organization or by breakaway from an encompassing organization, they have an incentive to use cartelistic and lobbying power to shift the distribution of income to their advantage, and to do this even if the deadweight costs to society are large in relation to the amount they gain. This is true no matter how well the unorganized society or the society with encompassing organizations works. So the political entrepreneur's incentive to establish narrow coalitions for collective action is the same both in unorganized societies and in those starting with ideal encompassing organizations. Though I did not realize this when I wrote Rise and Decline, encompassing organizations may delay - but they cannot by themselves prevent -the emergence of narrow special interests. The result in the long run, if we abstract from any differences across societies in how well they understand the problem, is likely to be much the same whether societies set up encompassing organizations or not. In 1970 Sweden was substantially ahead of the UK, for example, in per-capita income, even though it started modern economic growth much later and had a similarly high level of organization for collective action. Its superior performance surely owed something to the fact that its organizations for collective action were encompassing rather than narrow. But there is no reason whatever to suppose that the societies that have had highly encompassing organizations will stay in front. On the contrary, unless they come to have a better appreciation of the problem than other countries, they seem destined to operate more like societies with narrow organizations for collective action as time goes on. 5

Distinctive institutions and inescapable logic

If the foregoing analysis of 4healing-of-divisions sclerosis' and of the 'devolution of encompassing interest organizations' is read along with other publications on the sclerotic processes in Soviet-type societies, on Third World mercantilistic environments, and on the sclerotic process in the English-language countries, it becomes clear that, important as the differences in the structure of interest organizations across societies are, the similarities in the sclerotic process are nonetheless more fundamental. Encompassing organizations and social divisions are conspicuous, but the inconspicuous accumulation of industry-by-industry and occupation-by-occupation lobbying and collusion is likely to be more telling in the long run. The healing of social divisions and the devolution of encompassing organizations tends to make the continental European societies resemble the English-speaking countries more as time goes on. Important as the institutional and historical differences across societies are, they cannot alter the laws of logic. The logical principle that organized interests, when they have the capacity to influence or control coercive power, have incentives to act in anti-social ways if they have only a narrow or minuscule stake in society, but incentives to act in less harmful and sometimes even socially beneficent ways when they have a sufficiently encompassing stake, applies to all societies. So does the logic of collective action: it is only small groups and those with access to selective incentives than can organize for collective action in any society. Thus groups like

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consumers, taxpayers and the poor are not organized in any society, but in all societies more of the groups with the potential for collective action organize as time goes on. The two logical principles on which the present theory is based are manifest in different forms in different types of society, but they are always (along with other important factors in this complex and multicausal world) evident. The diverse manifestations of the theory in different types of society indicates that the theory has not only parsimony and explanatory power, but also what the nineteenth century scientist William Whewall called 'consilience': the capacity to explain quite diverse phenomena. The foregoing analysis shows that, though a society cannot preserve an encompassing interest-group structure over the very long run, encompassing political parties can be viable indefinitely with the right electoral rules. Thus the logic of encompassing interests argues for electoral rules that discourage small political parties and, ideally, even promote two-party systems. In the United States, where the problem is the weakness of political parties rather than their number, it is institutional rules that make the political parties stronger and more responsible that are needed. The most important implication of the analysis, however, is that the only real solution is for societies to acquire a better understanding of economics and of the present argument. The problem, even in the societies that once had only encompassing interest organizations, is small organized minorities. Each of these tiny minorities will easily be defeated if the public wises up. No historical process that is understood is inevitable. NOTES I am grateful to the US Agency for International Development for support of my research through the Center for Institutional Reform and the Informal Sector (IRIS) at the University of Maryland. This support has facilitated my development of the general theory used here and particularly its application to the formerly Communist countries and the Third World. I have also benefited from a travel grant from the Thyssen Stiftung, and from helpful criticisms by Christopher Bartlett, Carol Kaplan, Nicholas Crafts, Lars Jonung and R.C.O. Matthews. 1 New Haven, CT, and London: Yale University Press (1982). 2 The devolution of centrally planned economies' (with Peter Murrell), initially presented in tentative form to various audiences in the mid and late 1980s and published in the Journal of Comparative Economics, 15, pp. 239-65 (1991); The logic of collective action in Soviet-type societies', Journal of Soviet Nationalities, 1(2), (1990), pp. 8-33; The exploitation and subsidization of agriculture in the developing and developed countries', in Agriculture in a Turbulent World Economy: Proceedings of the Nineteenth International Conference of Agricultural Economists, held at Malaga, Spain, 26 August-4 September 1985, edited by Allen Maunder and Ulf Renborg (Brookfield, VT: Gower, 1986); The hidden path to economic development', in Christopher Clague and Gordon Rausser (eds.), The Emergence of Market Economies in Eastern Europe (Oxford: Blackwell, 1992). 3 The logic of the foregoing argument is demonstrated in The Logic of Collective Action (Cambridge, MA: Harvard University Press, 1965). The findings of much of the best subsequent literature on the topic are cited in Russell Hardin, Collective Action (Baltimore, MD: Johns Hopkins University Press, 1982) and in

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Todd Sandier, Collective Action (Ann Arbor, MI: University of Michigan Press, 1992). 4 The concept of encompassing interests has only been extended to dictatorships and analysed in a formal way since Rise and Decline was published. See, for example, Martin C. McGuire and Mancur Olson, Jr, 'Dictatorship, democracy, and the provision of public goods', Department of Economics and IRIS, University of Maryland, December 1990; The economics of autocracy and majority rule: the invisible hand and the use of force' (IRIS, University of Maryland and University of California, Irvine, 1994'; forthcoming in Journal of Economic Literature); Mancur Olson, Jr, 'Autocracy, democracy and prosperity', in Richard J. Zeckhauser (ed.), Strategy and Choice (Cambridge, MA: MIT Press, 1991); 'Dictatorship, democracy and development', American Political Science Review, 87 (3) (September 1993), pp. 567-76. 5 See 'The South will fall again: the South as leader and laggard in economic growth', Southern Economic Journal, 49 (April 1983), pp. 917-32. 6 See, for example, Kwang Choi, Theories of Economic Growth (Ames, I A: Iowa State University Press, 1983); Richard Vedder and Lowell Galloway, 'Rentseeking, distributional coalitions, taxes, relative prices, and economic growth', Public Choice, 51 (1) (1986), pp. 93-100; Steve Chan, 'Growth with equity: a test of Olson's theory for the Asian Pacific-Rim countries', Journal of Peace Research, 24 (2) (1987), pp.135-49; Erich Weede, 'Catch-up, distributional coalitions and government as determinants of growth and decline in industrial democracies', British Journal of Sociology, 37 (1986), pp. 194-220; Jan-Erik Lane and Svante Ersson, Comparative Political Economy (New York: Pinter, 1990); Todd Sandier, Collective Action: Theory and Applications (Ann Arbor, MI: University of

Michigan Press, 1992); Jonathan Rauch, Demosclerosis (New York: Times Books, 1994); and many of the contributions in the following collections of assessments and tests of the Rise and Decline of Nations: Dennis C. Mueller (ed.), The Political Economy of Growth (New Haven, CT: Yale University Press, 1983); International Studies Quarterly, 27 (1983); Scandinavian Political Studies, 9

(March 1986). , 7 See the citations in note 3 and in my forthcoming book on Capitalism, Socialism and Dictatorship. 8 This possibility, and the role of economic ideas generally, is discussed in 'How ideas affect societies: is Britain the wave of the future?' in Ideas, Interests and Consequences (London: Institute of Economic Affairs, 1989), also republished in The LSE Quarterly, Winter, 1989. 9 Rise and Decline, p. 76.

10 In 'The political economy of comparative growth rates', in US Economic Growth, vol. 2, Joint Economic Committee, Congress of the United States, Hearings of the Joint Economic Committee for November 10, 1976, pp. 105-12; and 'Comment', in Thomas Wilson and Andrew Skinner (eds.), The Market and the State: Essays in Honour of Adam Smith (Oxford: Oxford University Press, 1976), pp. 105-12. There was an international conference in December 1978, at the University of Maryland, to assess and criticize an early draft of Rise and Decline. Though that 1978 draft and some of the papers of commentary presented at that conference were circulated widely, the proceedings of this conference were published only later in Dennis Mueller (ed.), The Political Economy of Growth (New Haven, CT: Yale University Press, 1983). My use of the term 'institutional sclerosis' in the 1978 paper is on pages 35 and 46-9 of that book, and other participants in the conference, such as K. Choi (pp. 57-78), J.-C. Asselain and C. Morrison (p. 158) and D. Mueller (p. 268) also used the term to label my argument.

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11 Herbert Giersch, 'Gegen Euro-Sklerose', Die Wirtschaftswoche, 33 (12 August 1983), and 'Eurosclerosis', Institut fur Weltwirtschaft Discussion Paper No.l 12 (1985). See also the Financial Times (11 September 1984) and Time (30 January 1984). Lindbeck's essay is The emerging sclerosis in the Western economies' (Institute for International Economics, University of Stockholm, 1982). 12 Ingemar Stahl and Kurt Wickman, Riv bostadspolitiken (Stockholm: SNS, 1992). 13 The exploitation and subsidization of agriculture in developing and developed countries', op. cit., and 'Space, agriculture and organization', American Journal of Agricultural Economics, 67(5) (December 1985), pp. 28-37. 14 Peter Murrell and Mancur Olson, The devolution of centrally-planned economies', Journal of Comparative Economics, 15 (1991), pp. 239-65. 15 I am thankful to G. Toniolo for helpful criticism on this point. 16 Martin C. McGuire and Mancur Olson, Jr, The economics of autocracy and majority rule: the hidden hand and the use of force' (IRIS, University of Maryland and University of California, Irvine, 1994; forthcoming in Journal of Economic Literature). 17 'A theory of the incentives facing political organizations: neo-corporatism and the hegemonic state', International Political Science Review, 1 (2) (April 1986), pp. 165-89; and 'An appreciation of the tests and criticisms', Scandinavian Political Studies, 9 (1) (1986), pp. 65-80. 18 The workers in a line of work that is enjoying a boom will gain the most if they receive not only the wage premia that firms want to offer to attract additional labour, but also the far higher increases that come from blocking entry into the booming line of work, or making the wage so high that there is little or no employer demand for additional workers. During the oil boom, the Norwegian helicopter pilots that served the oil rigs in the North Sea could make themselves far better off by demanding the exceptional rises their employers could afford than by sticking with the policy of the encompassing labour union. When an unexpectedly large devaluation of the Swedish krona once made some manufactured exports exceptionally profitable, the Swedish engineering union decided to abandon centralized wage bargaining. Clearly, the encompassing interest of workers as a whole is normally best served by allowing those in other sectors to move into the booming lines, thereby expanding the workforce that is too small and making wages higher than they would otherwise be in the areas that were not so lucky. Similarly, when adverse shocks reduce the demand for, say, shipbuilding labour, the workers in this industry have an incentive to demand subsidies for the industry in which they work. By contrast, workers as a whole lose when a society maintains uneconomic industries that cannot cover their costs without protection or other subsidies. Obviously, there are exactly parallel arguments showing similar conflicts of interest between the firms in a booming or declining industry and the owners of capital as a whole. 19 S. Lash, The end of neo-corporatism? The breakdown of centralized bargaining in Sweden', British Journal of Industrial Relations (July 1985), pp. 215-39. 20 Acta Sociologica, 34 (4) (1991), pp. 239-60. 21 'An appreciation of the tests and criticisms', op. cit:, and The incentives facing political organizations', op. cit. 22 See Assar Lindbeck, 'Overshooting, reform and retreat of the welfare state', De Economist, 142 (1994), pp. 1-19. 23 This is argued in my 'Devolution of the Nordic and Teutonic economies', American Economic Review (May 1995). 24 This and other arguments that bear on the present problem are set out in my book, How Bright are the Northern Lights? Some Questions about Sweden (Lund, Sweden: Institute of Economic Research, Lund University Press, 1990).

4

Why the 1950s and not the 1920s? Olsonian and non-Olsonian interpretations of two decades of German economic history KARL-HEINZ PAQUE

1

Introduction

A major puzzle of German economic history in the twentieth century is the fact that the records of the two postwar decades have been so vastly different - a fast and sustained growth leading to full employment in the 1950s, a slow and rather volatile expansion with persistent unemployment in the 1920s. To explain this puzzle, Mancur Olson and some other prominent scholars - notably the economic historians Knut Borchardt and Harold James - have advanced a theory of institutional discontinuity: in essence, they claim that the Weimar Republic of the 1920s suffered from some major institutional weaknesses which gave interest groups a much strong influence to pursue their distributional objectives than was to be the case in the different institutional environment of the later Bonn Republic.1 In fact, Mancur Olson himself has regarded German economic history as a most important piece of empirical evidence in favour of his celebrated theory of the rise and decline of nations. In this sense, the German case delivers more than just another string of idiosyncratic national history; it is rather a paradigmatic playground for testing one of the most elegant and parsimonious growth theories advanced in the last few decades. This chapter is no more than a critical note on this 'Olsonian interpretation' and an attempt to offer an alternative view that takes the role of interest groups seriously without running into conflict with the basic facts of history. In section 2,1 argue that the major premise of the Olsonian interpretation - the existence of a relatively sharp institutional break between the Bonn and the Weimar Republics concerning the role of distributional coalitions - is untenable. In section 3,1 outline the skeleton of my own interpretation of the puzzle, which may be called a theory of corporatist rigidity under different conditions of unanticipated trade integration and productivity growth. 95

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An Olsonian interpretation of the two postwar records

An Olsonian account of West German economic history after World War II as against the background of the Weimar economy can be summarized in basically three propositions: 1. Through Nazi dictatorship and wartime physical and social destruction and the subsequent Allied occupation of the country, the traditional network of distributional coalitions in Germany was fatally weakened in the decade or so after the war, so that the economy could for a while grow unburdened by the static and dynamic efficiency losses induced by institutional sclerosis. 2. To the extent that the distributional coalitions reappeared early on, they did so in a much more encompassing form that helped to prevent a persistent divergence between the respective coalitions' and society's interests. 3. Over time, the economy was gradually subjected again to the growth-impeding network of distributional coalitions which typically gain ground in stable societies; thus, after all, the German miracle began to fade from the 1960s on. 2.1

A liberation from interest groups?

Any serious discussion of the role of World War II as a historical watershed of whatever kind must first recognize the fact that, in its most fundamental legal, political and economic characteristics, the Bonn Republic as it emerged through the re-establishment of a market economy in 1948 and a parliamentary democracy in 1949 was a descendant of the Weimar Republic of 1919-33. This is not to say that there may not have been substantial differences between the two, which may also matter in the sense of Olson's theory; it is to say, however, that the basic point of reference and even the starting point for deliberate deviations were the Weimar institutions. In this sense, both the Nazi period and the Allied occupation, with their systems of administrative control of political and economic life, were pauses though very different ones - in an otherwise continuous tradition. Both left traces that changed the track of German society for good; but for neither can it be claimed that they influenced the institutional framework of later West Germany more than the 'hysteretic' shadow of the Weimar Republic did. After all, the great institutional transformations in Germany had happened at earlier times: politically from autocracy to democracy towards the end of World War I, legally to a modern Rechtsstaat with an elaborate national system of codified private and public law in imperial times, economically towards a 'corporatist' industrial society with a prominent role for collective bargaining in the early 1920s. Thus there was never really an institutional void that had to befilledwith newly invented laws. For the Allies and the Germans after the war, it was more a question of whether, when and to what extent the pre-Nazi regime would be reimplemented, and which particular changes would have to be made to avoid some of the unfortunate developments of the Weimar period. In this respect, it is the period of Allied occupation from May 1945 until the economic liberalization in June 1948 and the election to thefirstfederal parliament

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in September 1949 that deserves careful examination. Taking a bird's-eye view of this period, it is remarkable how much leeway for collective action the Allies always excluding the Russians in the eastern zone - left to newly founded or refounded German interest groups, and how strongly these organizations represented their traditional pre-Nazi interests. Politically, this can be explained by the specific aims of the Allied forces: after a virtually complete standstill of German political and economic activities in mid-1945 right after the end of World War II, the country was simply to be put to work again, and this was to be done without reactivating a Nazi influence; for this purpose, the extensive use of personnel and expertise of pre-Nazi vintage and origin was obviously indispensable, and the price to be paid in terms of a resurgence of lobbies, coalitions and collusions was viewed to be bearable as long as no overly centralized German organization could challenge the Allies' internal enforcement power. In the light of Olson's theory, three types of organization stand out in importance as distributional coalitions: unions, political parties and business associations. All three re-emerged early with ideas, ideologies, practical purposes and personnel that were in full continuity with Weimar times.2 Most important is the case of the unions. Due to their consistent opposition to the Nazi regime, the unions were viewed very favourably by the Allies - above all, by the union-friendly British Labour government - and they were accepted as an important pillar of a new German economy and society. On a local level, constituent meetings of unions took place as early as summer 1945, and a conference of union deputies of the British zone (which included the industrial heartland of the Rhine/Ruhr valley) was held in December 1945. At this conference, the basic principles of organization of unionism in Germany were laid out in a first statute, which was approved by the British in January 1947. In the American zone, the development was a bit slower and a bit more decentralized - no genuine zone-wide organization was permitted to operate but except in Bavaria, all major industrial unions were established in these regions in the course of 1946 (in Bavaria not before spring 1947). Interzonal conferences of unions were held regularly from December 1946 on. In addition, union membership grew very fast: in the first full year of its existence (1950), the DGB had 5.5 million members - two years later about 6 million - which amounted to a higher density rate than at any time up to the present.3 In short, at least with respect to the quality and the degree of organization, it is difficult to uphold the view that German unions were in any sense weak for more than a very brief initial period of Allied occupation. In a much more narrow sense, however, the unions were handicapped by a very mundane event: the virtual destruction of their strike funds through the currency reform of June 1948. For a while - maybe something like one or two years - most unions were simply notfinanciallypotent enough to carry out any major strike, and that may well have contributed substantially to a rather smooth working of the bargaining process and relatively modest wage settlements (see Giersch et al, 1992: 73). However, this morefinancialconstraint falls well short of any more fundamental weakness of the unions' position that could help to explain a larger chunk of the beginning West German economic miracle of the 1950s. After all, with unions being organizationally strong, one might have expected sharp wage increases and labour conflicts as soon as the strike funds werefilledagain, and this obviously did not happen.

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Encompassing unions?

Historically, there were three major attempts of the unions after World War II to make their organizations more encompassing in the Olsonian sense. The first and most radical one was to establish one 'central union' (Zentralgewerkschaft), comparable to the Swedish LO, that was supposed to carry out wage negotiations on a nationwide basis in the future. These efforts failed because of Allied resistance to any such large-scale concentration of power in whatever hands. Recognizing the Allied veto as insurmountable, the union leaders settled for the construction of autonomous industry unions under one umbrella organization, which later became the DGB. Like its predecessor in the Weimar Republic, the ADGB, the new umbrella organization did not in general have a mandate to conclude wage agreements, so the actual economic clout remained with the industry unions, among them the large metalworkers' union (IG Metall, the largest industrial union in the world), which was to play a dominant role as a pacemaker in the mostly annual bargaining rounds during the following decades. Like the ADGB in the Weimar Republic, the DGB grew into the political arm of the union movement, coordinating general aims and targets without interfering in actual bargaining matters. Hence, in this respect, the discontinuity with earlier times appears to be not very significant. The second attempt was to replace the Weimar-type crafts-based unions by strictly industrial ones. In this sense the union leadership was fully successful, and not much controversy arose about this shift of organizational principles (see Hemmer and Schmitz, 1990: 27-8). The main reason for the smooth transition was that, in the early 1930s, there had already been a consensus on the necessity of this kind of reform, but the rise of Hitler and the subsequent suppression of the union movement prevented its being realized. Atfirstglance, this postwar reform seems to be a far-reaching step in the Olsonian sense towards a more encompassing representation of interests (see Olson, 1982: 49). However, the extent of the organizational innovation should not be overrated because major branches of industry had adopted a factual industry organization of labour for a long time. For example, metalworkers, who at times made up 30 per cent of all union members in the Weimar Republic, were organized in the German Metalworkers' Union (the predecessor of IG Metall and already at that time the largest single industrial union in the world), which was founded in 1891 as an industrial union and which carried out its collective bargaining consistently on an industrial basis. Of course, the backbone of this union (as of all others) was skilled workers, who made up about two-thirds of the membership, but actual negotiations covered all skill groups, including unskilled and semi-skilled workers.4 Formally, there were still many different craft associations or unions within the industry, but they were usually united under special cartel arrangements (e.g. in the branches related to metal manufacturing, the Metalkartell), which explicitly delegated their right to conclude collective agreements to the German Metalworkers' Union. Apparently, they no longer played any significant role in collective bargaining.5 Hence, after all, the gap between the Weimar and the Bonn collective bargaining culture was probably much narrower than, say, between the traditional crafts-based British and the German system, be it of the Weimar or the Bonn variety. The third attempt was to absorb various smaller unions of different ideological

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standings - notably the more conservative Christian and the tiny liberal ones - as well as the union of white-collar workers in the mainstream of the DGB. In the end, after painful deliberations, this attempt failed mainly because the large DGB quickly developed an identity of blue-collar worker representation with strong political sympathies for reformist socialism, i.e. in the range of the German party system, for social democracy.6 Hence, just like in the Weimar Republic, the union movement remained split, although it is fair to say that the relative weight of the dominating blue-collar umbrella organization, the DGB, was becoming even more decisive than it had been in Weimar times with respect to the ADGB. To sum up, there were certainly trends towards a more encompassing union organization in the early postwar period, but it is hard to see anything revolutionary in them. They appear to be more like thefinalconclusion of developments that had been well under way in the Weimar Republic. In any case, there was no sharp 'Olsonian' discontinuity that may explain a dramatic shift from aggressive wage demand based on narrow group interests towards moderation in the interest of the whole economy. Note that there was in fact one institutional change in the legal framework of collective bargaining from Weimar to Bonn which was probably much more important that the marginal shifts of union organization: the end of compulsory arbitration.7 Whereas, in the Weimar framework, an industrial dispute could be settled by a rather complicated procedure which culminated in compulsory arbitration under the auspices of the Federal Ministry of Labour, the new law on collective bargaining of 1949 did not contain any such provisions of state intervention in industrial disputes. Again, the explicitly wide interpretation of private bargaining autonomy was a consequence of the bad Weimar experience with this system. Instead of being used as an instrument of last resort, it actually removed the pressure for agreement from the parties and thus induced them to carry on with maximalist positions and to speculate on the arbitration's likely bias. In all major industries, at least half of the 'agreements' in the later years of the Weimar Republic were implemented via compulsory arbitration (Hartwich, 1967:418-20).8 Industrial relations remained bad, not least because most compulsory agreements were explicitly disapproved by one party, in the majority of cases the employers' side, and sometimes even by both parties. It is important to realize that the removal of compulsory arbitration and its likely consequences are outside the scope of Olson's theory. If anything, his theory would predict them to have a negative impact on growth because they dissolve the link between the behaviour of distributional coalitions and the public interest via government intervention. 2.3

Worsening distributional sclerosis over time?

If it is difficult to defend the view that there was a wholesale demise of distributional coalitions after World War II, it is equally difficult to identify an Olsonian process of sclerosis thereafter: once established, interest groups were able to lobby for their purposes just as well in the early 1950s as in later decades.9 This is particularly obvious for unions because the framework of collective bargaining remained remarkably constant over time: there were only very few labour law extensions and

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court decisions specifying the conditions of strikes and lockouts, and these were due to technical progress and the ever more perfect logistics of firms. At any rate, these changes cannot remotely explain the vast variations in wage behaviour between the 1950s and the 1980s on the one hand - with a persistent decline of real unit labour costs, but different unemployment records - and the first half of the 1970s on the other, when labour costs rose sharply and aggravated the labour market plight. 3

A non-Olsonian mode of interpretation

By its very logic, a non-Olsonian interpretation of the German economic performance of the 1920s and the 1950s has to be based on a twin pair of assumptions: (1) that the relevant institutional framework remained by and large unchanged between the two periods, and (2) that there are forces external to this constant institutional framework which can be made responsible for the difference of economic performance in the two periods. 3.1

Collective bargaining and unemployment inertia

Focusing again on the system and practice of collective bargaining as one central element of the relevant institutional structure, one may say that a simple monopoly union or a bargaining model can do a reasonably good job in portraying the main features of wage determination both in the Weimar and in the Bonn economy. A typical characteristic of these models is that they imply a stable long-term relationship between the level of the real wage and the level of unemployment. This means that - unlike in a Phillips curve world - a once-for-all rise in unemployment has no long-run depressing effect on real wage growth, so there is no self-correcting mechanism to bring unemployment back to a prior 'natural' level. Thus unanticipated shocks to labour demand have strong persistence effects which tan be explained in the last resort by the working of insider interests of the incumbent employed labour force vis-a-vis unemployed outsiders.10 It is important to realize that these models have in principle symmetrical implications with respect to 'good times' and 'bad times', depending on which way the unanticipated shock goes. If, for example, there is a series of unanticipated positive supply shocks - say, labour productivity or the terms of trade following a stochastic trend, but with a few successive random changes with a positive sign then there may be a non-inflationary expansion for a longer period of time (provided, of course, there is a sufficiently large labour surplus to be re-employed). Hence, in such a framework, the issue of the different output and employment growth performance of the 1920s and the 1950s comes down to the question of whether there was a sequence of unanticipated positive shocks in the latter which was lacking in the former period. Note the important fact that our non-Olsonian framework takes the institutions of collective bargaining very seriously as an element of what might be called 'passive rigidity' in the system - unlike Olson, who interprets them as a factor of 'active sclerosis'. In an Olsonian setting, the gradual cartelization of the labour market leads to an equally gradual strangling of market-type adjustment mechanisms; it thus turns a good world into a bad one, and an abrupt decartelization turns a bad

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world back into a good one. In our non-Olsonian setting, the cartelization amplifies economic performance: in terms of employment growth, it makes good times better and bad times worse. Note also that this non-Olsonian concept of passive rigidity need not be confined to the labour market, but may re-emerge in other types of cartelization as well - basically in all areas which Olson (1982) touches upon. For instance, a series of positive supply shocks to industry may ease structural change between the primary and the secondary sector of an economy so as to make part of farmers' protectionism pointless because many farmers voluntarily leave agriculture to accept emerging well-paid jobs in industry. Just as Olson developed a general theory of active sclerosis, so one may draw the outlines of a theory of passive rigidity that helps to account for many phenomena of social and economic life. However, this kind of theory can never be complete because it explains only why the system has no strong capacity to absorb particular positive or negative shocks. One still needs an answer to the question of why these shocks came about or did not come about in the first place. 3.2

External forces

Giersch et al. (1992: section 3.A.3) and Paque (1994: section 3) have shown that there is considerable empirical evidence for interpreting the West German 'economic miracle' of the late 1940s and the 1950s as a long sequence of positive, unanticipated productivity and terms of trade shocks, which, by turning outsiders into insiders in the labour market, made unit labour costs fall in real terms over a full decade. Only in the very early postwar years were these shocks the immediate effect of a genuine reconstruction in the sense of a very high profitability of (mostly repair) investments in a war-damaged industrial capital stock. From the early 1950s on, they must rather be regarded as the consequence of the extremely rapid integration of the West German economy into an international division of labour, which assigned an ever more prominent place to intra-European, intra-industry trade. With its traditionally strong manufacturing industries, notably in the production of investment goods and in chemicals, the West German economy was particularly well placed to take full advantage of this intensification of trade links. Given the large supply of skilled and highly mobile workers that had been added to the West German labour force through the postwar influx of ethnic Germans from Eastern Europe, the export-led expansion of manufacturing did not meet hard supply constraints and could thus turn into a genuine ^industrialization of the economy, with the share of industry in total employment increasing until the early 1960s, which was an unusual phenomenon for a highly developed industrial country, even at that time.11 Concerning the difference between the 1920s and the 1950s, the question thus becomes: why did a series of positive shocks happen in the 1950s and not in the 1920s? To be sure, recent research in the wake of the so-called Borchardt controversy12 has shown that, by international standards, the German productivity growth performance of the 1920s was not bad at all, and that, towards the end of the decade, a large part of the shares in international markets that had been lost in the course of World War I and its inflationary aftermath was regarhed by German firms. While the evidence is not without ambiguities,13 it does indicate that the German economy was well on its way to resuming its proper place in the international

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division of labour. Even before the Great Depression, however, the unemployment rate was stuck around 8 per cent, not far off the scale of the 1980s. Although not bad by other standards, productivity growth was apparently not powerful enough to surpass the prior expectations that underlay collective wage agreements. Hence we are still left with the question: why did such a formidable series of (unanticipated) positive shocks from trade integration occur only in the 1950s and not twenty years earlier? In actual historical sequence, it was of course the Great Depression and its consequences, notably the subsequent Nazi autarky policy, which definitely stopped the further reintegration of Germany into world markets. As it happened, the Great Depression was first and foremost a gigantic macroeconomic accident originating in the United States, and hitting the German economy particularly hard because of its high dependence on short-term transatlantic capital flows, which in turn were an indirect consequence of a whole bunch of complex unresolved political issues going back to the ill-designed and ill-fated Versailles treaty.14 One can hardly deny that the breakdown of international coordination and the resort to protectionist means in the course of the Great Depression destroyed an international division of labour and a network of international trade relations which had been beneficial to its participants and which was per se not doomed to fail. If this is so, however, it is legitimate counterfactually to assume away the Great Depression and ask what might have been the path of economic history if this most unfortunate macroeconomic event had not taken place. Was there a realistic chance for an export miracle in the style of the 1950s? Probably not, at least not in the near future after 1929. The reasons lie in what might be called a lack of trade potential in technology and a lack of cooperative spirit in international politics. Technologically, there was no general backwardness in continental Europe and, for that matter, in Germany vis-a-vis the United States in all industrial branches, but there was a very differentiated pattern, with Germany still having the lead in chemicals and electrical engineering, but clearly lagging behind in those branches like vehicle production where the revolutionary productivity advances through the innovation of the assembly line and related production techniques had been made in the United States during the 1920s. While these techniques were increasingly applied in Germany as well, the country was probably still some way off the threshold level at which production costs fall so low that a mass market for middle-class income earners emerges, with all the backward and forward linkages that the production of vehicles implies. After all, the American car industry had already produced an impressive 4.5 million passenger cars in its first peak production year of 1929, which translates into an annual supply of 37 cars per thousand inhabitants, a level not reached in France and Germany, the main continental European car-producing countries, until the early 1960s. Behind this assessment, there is the implicit idea that waves of productivity improvements in the course of a rapid process of integration, which goes along with a rapid rise in intra-industry trade, require the passing of some threshold levels of technological implementation and of income levels of the population before a mass market and the means to supply it can simultaneously develop. It is doubtful whether these conditions were already prevailing in Europe in the early 1920s. Politically, Europe in the 1950s enjoyed the decisive advantage of being subject to

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a 'trade hegemon', the United States, which had a strong interest in free trade both across the Atlantic and, for reasons of economic and political stability, within Europe itself (see Giersch et a/., 1992:95-105). Again, in this respect, the experience of World War II and the subsequent Cold War provided an almost ideal background to overcome traditional political frictions. A much more realistic ex-post scenario as an alternative to the Great Depression is probably that Germany would have continued its reintegration into the world economy at about the pace of the late 1920s, reaching and then surpassing the prewar export share some time in the mid-1930s. However, in such a scenario, there would have been no inherent mechanism to reduce unemployment substantially below the level inherited from the late 1920s. Without the wartime backlash, this moderate growth might even have accelerated later, say, in the 1940s, by which time the continental European countries would have gradually grown into the threshold range of technology and income, where the 'expected' cumulative process of mechanization and motorization of their economies would have set in. Again, to the extent that the relevant productivity advances would have been unanticipated, there would have been a decline in unemployment. However, given the assumed continuity of institutions, the degree of unanticipation would probably have been much less pronounced than it turned out to be in the actual history of the 1950s. Hence, while the productivity level may end up to be the same in this counterfactual world as it actually was in reality - once all transitory disturbances like wars and subsequent periods of 'reconstruction' or 4catching-up' have run their course - the long-term persistent changes in the equilibrium unemployment rate would have been much more moderate.15 Admittedly, all this is highly speculative - more so than professional historians might find acceptable. However, it should at least suggest that the future path of research into the causes of the rise and decline of economies or even nations may well lead in a direction which is slightly different from Olsonian thinking.

NOTES This chapter draws heavily on a CEPR discussion paper by the author (Paque, 1994). In that paper, all the major lines of reasoning of this chapter are presented in a much more extended form, and additional quantitative evidence on the main points is given. 1 See Olson (1982, 1987) which are in essence applications of Olson's theory of collective action as advanced in Olson (1965). For a brief summary account of Olson's theory as applied to economic growth and some conceptual difficulties it encounters, see Paque (1993b: 1-4). In more detailed analyses of the Weimar economy, some major ideas of Olson have been taken up by James (1986) and Borchardt (1990), although these authors do not engage in an explicit comparison of the post-World War I and II periods. Implicitly, however, they do assume some major institutional discontinuity between Bonn and Weimar because otherwise they would not be able to account for the difference in the relevant economic records. 2 For an authoritative historical account of the resurgence of these organizations after World War II, see Eschenburg(1983:171-218). For a summary evaluation of the re-emergence of business associations and political parties in the light of

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Olson's theory, see Paque (1994: section 2). 3 In 1950-2, about 38-9 per cent of all employees were organized in the DGB, a share that gradually declined to roughly 30 per cent by the mid-1960s and - after a sharp rise in the early 1970s - levelled off at about 33 per cent. If the union of white-collar workers (DAG) and the small Christian unions are included, the density rate was somewhat higher throughout, with about the same intertemporal pattern. For statistical details, see Hemmer and Schmitz (1990). In the Weimar Republic, the density rate reached a peak of about 33 per cent in 1920-2, but declined sharply after the stabilization crisis of 1923/4 to reach a low of 15 per cent in 1925. By 1929, it had risen again to 22 per cent. Even if (low-unionized) agricultural employment is excluded, the density rate in the period 1925-9 never surpassed one-third. (Own calculations based on trade union membership data by Moses (1982: vol. II, 512) and employment data by Hoffmann (1965:205-6).) 4 For details, see Hartwich (1967: 70-2). 5 For details of the structure of organization of metalworkers in one important regional bargaining district, the metropolitan area of Berlin, see Hartwich (1967: 65-70). 6 After a brief period of merger with the DGB, the Christian unions split off in the early 1950s as they did not recognize their more conservative stance sufficiently represented in the official union position. As to white-collar workers, a separate nationwide union (the DAG) was founded in 1949 after unsuccessful negotiations with the DGB. 7 In all other respects - including, for example, special provisions concerning the possibility of declaring a collective agreement generally binding under specific circumstances - the legal frameworks for collective bargaining in the Weimar and Bonn Republic are remarkably similar. See Paque (1993a). 8 For a detailed account of the Weimar experience with compulsory arbitration, see Bahr (1989). 9 As early as 1954, the renowned German historian Theodor Eschenburg held a much celebrated public lecture series entitled 'Herrschaft der Verbande' (later published as Eschenburg (1955)) in which he described and criticized the strong influence of organized interests in public decision making on the political and administrative level. 10 On monopoly and bargaining models of unionism in general, see Farber (1986), Oswald (1986) and Calmfors (1990); by now classical insider/outsider models had been developed by Blanchard and Summers (1986) and Lindbeck and Snower (1986). On their being quite realistic descriptions of the German labour market and industrial relations in the 1920s and 1950s, see in detail Paque (1994: section 3). 11 For a detailed descriptive account of this non-inflationary process of expansion, (see Giersch et al, 1992: section 3.A), where it is also argued on the basis of casual empirical evidence that there was a strong and persistent tendency in the public to underestimate the growth dynamics of this process until well into the late 1950s; hence the trend path of growth can reasonably be regarded as unanticipated. 12 Notably Balderston (1993). The main Borchardt hypothesis that the economy of the Weimar Republic suffered from inherent supply-side deficiencies - above all, a badly working institutional framework - was developed and expounded in Borchardt (1979, 1990); major contributions apart from Balderston (1993) have been made by Holtfrerich (1982, 1983), James (1986) and Ritschl (1990); Kruedener (1990) presents a useful collection of essays on the major issues of the controversy.

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13 For details, see Paque (1994: sections 1 and 3). 14 See, among others, the accounts by Aldcroft (1977) and Kindleberger (1973). 15 There may, of course, be many more differences in details between our counterfactual scenario and the real world. For example, without World War II, there would not have been a footloose labour supply of refugees in western Germany, but rather a larger share of agricultural in total employment. To the extent that agricultural workers would be less ready to leave their land and to search for industrial jobs than the refugees in actual history, the process of reindustrialization would have been more protracted than it actually was in the 1950s. REFERENCES Aldcroft, D.N. (1977) From Versailles to Wall Street, London: Allen Lane. Bahr, J. (1989) Staatliche Schlichtung in der Weimarer Republik, Berlin: Colloquium. Balderston, T. (1993) The Origins and Course of the German Economic Crisis 1923-1932, Berlin: Hande & Spener. Blanchard, O. and L.H. Summers (1986) 'Hysteresis and the European unemployment problem', NBER Macroeconomics Annual, 1, pp. 15-78. Borchardt, K. (1979) 'Zwangslagen und Handlungsspielraume in der groBen Wirtschaftskrise der friihen dreiBiger Jahre: Zur Revision des iiberlieferten Geschichtsbildes', in Bayerische Akademie der Wissenschaften Jahrbuch 1979, Munich. (1990) 'A decade of debate about Briining's economic policy', in Kruedener (1990). Calmfors, L. (ed.) (1990) Wage Formation and Macroeconomic Policy in the Nordic Countries, Oxford: Oxford University Press. Eschenburg, T. (1955) Herrschaft der Verbdnde?, Stuttgart: Deutsche Verlags-Anstalt. (1983) Geschichte der Bundesrepublik Deutschland, Volume 1: Jahre der Besatzung 1945-1949, Stuttgart: Deutsche Verlags-Anstalt. Farber, H.S. (1986) T h e analysis of union behaviour', in O. Ashenfelter and R.G. Layard (eds.), Handbook of Labour Economics, vol. 2, Amsterdam. Giersch, H., K.-H. Paque and H. Schmieding (1992) The Fading Miracle: Four Decades ofMarket Economy in Germany, Cambridge: Cambridge University Press. Hartwich, H.H. (1967) Arbeitsmarkt, Verbdnde und Staat 1918-1933, Berlin: Walter de Gruyter. Hemmer, H.-O. and K.T. Schmitz (1990) Geschichte der Gewerkschaften in der Bundesrepublik, Cologne: Bund-Verlag. Hoffmann, W.G. (1965) Das Wachstum der deutschen Wirtschaft seit der Mitte des 19. Jahrhunderts, Berlin, Heidelberg, New York: Springer. Holtfrerich, C.-L. (1982) 'Alternativen zu Briinings Wirtschaftspolitik in der Weltwirtschaftskrise?', Historische Zeitschrift, 235, pp. 605-31. (1983) 'Zu hohe Lohne in der Weimarer Republik? Bemerkungen zur BorchardtThese', Geschichte und Gesellschaft, 10, pp. 122—41. James, H. (1986) The German Slump, Oxford: Clarendon Press. Kindleberger, C.P. (1973) The World in Depression, London: Allen Lane. Kruedener, J. Baron von (ed.) (1990) Economic Crisis and Political Collapse: The Weimar Republic 1924-33, New York, Oxford, Munich: Berg. Lindbeck, A. and D. Snower (1986) 'Wage setting, unemployment and insider-outsider relations', American Economic Review, 76, pp. 235-9. Moses, J.A. (1982) Trade Unionism in Germany from Bismarck to Hitler 1869-1933, Vols. I and II, London: Priorr

106 Karl-Heinz Paque Olson, M. (1965) The Logic of Collective Action: Public Goods and the Theory of

Groups, Cambridge, MA: Harvard University Press. (1982) The Rise and Decline of Nations: Economic Growth, Stagflation and Social

Rigidities, New Haven, CT, London: Yale University Press. (1987) 'Some questions about the Weimar republic and possible parallels to the developed democracies today', in P. Koslowski (ed.), Individual Liberty and Democratic Decision-Making, Tubingen: J.C.B. Mohr (Paul Siebeck). Oswald, A. (1986) The economic theory of trade unions: an introductory survey', in L. Calmfors and H. Horn (eds.), Trade Unions, Wage Formation and Macroeconomic

Stability, Basingstoke: Macmillan. Paque, K.-H. (1993a) 'Germany: living with tight corporatism', in J. Hartog and J. Theeuwes (eds.), Labour Market Contracts and Institutions: A Cross-National

Comparison, Amsterdam: North-Holland. (1993b)'How clean was the slate? Some notes on the Olsonian view of the postwar German economic miracle', Kiel Working Paper No. 588, Kiel: Institut fur Weltwirtschaft. (1994) The causes of slumps and miracles: a critical evaluation of Olsonian views on the German economic performance in the 1920s and the 1950s', CEPR Discussion Paper No. 981. Ritschl, A. (1990) 'Zu hohe Lohne in der Weimarer Republik? Eine Auseinandersetzung mit Holtfrerichs Berechnungen zur Lohnposition der Arbeiterschaft 1925-1932', Geschichte und Gesellschaft, 16, pp. 375-402.

5

Convergence, competitiveness and the exchange rate ANDREA BOLTHO

1

Introduction

Recent years have seen a burgeoning literature on the issue of why countries' per-capita income levels converge (or do not, as the case may be). This topic is hardly new, of course, and much of the present research is merely rediscovering arguments that had long been known (the advantages of relative backwardness, the role of skills, the importance of investment or of learning by doing, etc.). There is, however, one feature of the older literature which recent writings have hardly exploited: that is, the role which government intervention (through, for instance, macroeconomic, industrial or exchange rate policies) could play in promoting growth. This neglect is understandable. In the context of the dominating orthodoxy, industrial policies can only lead to inferior outcomes, while macroeconomic and exchange rate policies, when not instantly ineffective, must be so in the medium term. Similarly heretic, and hence ignored, are approaches of the 'export-led growth' variety which dare to suggest that demand factors may contribute to longer-run growth differences. Yet, just a cursory look at the economic history of the OECD countries since World War II suggests that the role of demand and policies cannot be ignored, notably in the 1950s (witness the importance that many attribute to the indicative planning of France, to the investment subsidies of Germany, to the industrial policies of Japan, and so on). In particular, policies may have influenced one area that seems crucial for an understanding of the convergence process, that of international competitiveness. Traditional approaches usually view the latter as an entirely endogenous function of the growth process itself. Should competitiveness have an exogenous (e.g. policy-determined) component, however, then the convergence process may, in part at least, be explained by forces other than the usual supply factors advanced in the literature. The text that follows, by looking at one such (partly) exogenous force - the exchange rate - tries to see to what extent devaluations of the currency can generate not only short-term improvements in price competitiveness, but also longer-term improvements in non-price competitiveness. This is done in the context of Western 107

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Europe's 'Golden Age', a period in which convergence was rapid and exchange rates were, at times, allowed to vary. After a methodological introduction to the issue in section 2, Europe's overall experience is surveyed in section 3 and briefly contrasted with that of the interwar period. Section 4 considers in somewhat greater detail the economic histories of Germany and Italy in the 1950s, and those of France and Spain in the 1960s. Thefinalsection summarizes the main arguments and provides what turn out to be some rather inconclusive conclusions! 2

Competitiveness and the exchange rate

The proposition that catch-up in per-capita incomes implies a high degree of competitiveness would seem to be almost self-evident for the open economies of postwar Europe. Converging on a richer country means growing relatively rapidly; above average growth, in turn, usually leads to high import penetration; external constraints (be they imposed by a fixed exchange rate system and/or policy unwillingness to countenance rising external indebtedness) therefore require a parallel expansion in exports and/or in import-substituting capacity.1 In either case the country must be able continually to preserve the international competitiveness of its tradable sector. Much less obvious are the conditions that lead to such a state of high competitiveness. Standard demand theory might suggest that this should be a function of differences in relative costs or prices between countries. Yet, international monetary theory usually argues, with some plausibility, that differences in price competitiveness occur only in the short run (e.g. because of differential inflation rates or exchange rate changes). Over the longer run, however, prices are unlikely to vary much across countries because purchasing power parity re-establishes itself. By default, therefore, longer-run cross-country differences in competitiveness are attributed to so-called non-price factors. Partly, perhaps, because such factors are very difficult to quantify, their explanation has usually been left fairly vague. Overall, however, the consensus is that they are largely a function of the supply side, a consensus that embraces writers as different as Kaldor and Krugman. Thus, the former explains high income elasticities of demand for a country's exports in terms of'the innovative ability and adaptive capacity of its manufacturers' (Kaldor, 1981:603). The latter, on the other hand, explains the same phenomenon via a model in which, thanks mainly to the operation of scale economies, 'fast growing countries expand their shares of world markets . . . by expanding the range of goods that they produce' (Krugman, 1989: 1039). And some empirical backing is provided for these views by results that link longer-run changes in export and import market shares to technological and investment variables, rather than to price or cost competitiveness (Fagerberg, 1988). While all this sounds eminently plausible, it is not very helpful for policy-making purposes. As so often in the growth literature, the outcome seems to boil down to virtuous (or vicious) circles - rapidly growing countries enjoy high competitiveness which reinforces their rapid growth, and vice versa. Models of export-led growth had, long ago, come to similar conclusions (Beckerman, 1962). The interesting policy-oriented question is whether tools exist that could improve the performance of a country's tradable sector and allow an entry into such a virtuous circle.

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Endogenous growth theories do, of course, suggest a number of variables that might contribute to international competitiveness and hence to rapid growth (e.g. investment in R & D, in human capital or even in infrastructures), but the empirical backing for these theories is, as yet, very weak. In any case, for the developed market economies of Western Europe, in which spending on R & D is usually subsidized and human capital or public infrastructure levels are already relatively high, such a list is not particularly helpful. And the number of remaining instruments may be limited. Industrial policy could be a potential candidate, but it is one that has increasingly received a bad press, East Asia's apparent successes notwithstanding. Alternatively, one could select the exchange rate. This may sound paradoxical. It was argued above that relative prices are unlikely to alter in the longer run. Hence currency devaluations, for instance, can have only temporary effects, as is the case, more generally, for monetary policy changes. Indeed, this view of neutrality is embedded in standard international economics textbooks (e.g. Krugman and Obstfeld, 1988). Output and employment may be temporarily boosted by devaluation, but ultimately everything returns to its 'natural' level except for prices, which end up permanently higher. Yet, just as money neutrality may not be quite as axiomatic as standard theory suggests, similarly exchange rate changes may, after all, have more than merely temporary effects, even if one accepts that any price advantage is eventually eroded by higher inflation. Thus, according to one (non-orthodox) school of thought, the short-run improvements in price competitiveness conferred by devaluation could well be more than swamped in the longer run by devaluation-induced worsenings in non-price competitiveness. These would arise, inter alia, from a shift in production towards price-sensitive goods that are less likely to be in high demand on world markets, from a slowing down in resource reallocation away from low value-added activities, now that the latter have been given a temporary lease of life, and from the protection-like effects on X-inefficiency and on the dulling of competitive pressures that could follow from a devaluation. Taken to their logical conclusions, such views would imply that currency appreciation rather than depreciation might be the road to longer-run competitiveness. An alternative (and equally non-orthodox) view is, however, also plausible. At the microeconomic level it has recently been suggested that the presence of sunk entry costs in imperfectly competitive industries may lead to persistent effects on competitiveness coming from transitory (if large) exchange rate changes (Baldwin, 1988). Once foreignfirms,for instance, have entered domestic markets in the wake of home currency appreciation, 'they will find it profitable to remain in [these] markets even at a lower exchange rate' (Baldwin and Krugman, 1989: 635). Conversely, 'once...firmshave abandoned markets, a mere return of the exchange rate to the former level will not be enough to make the expensive recapture of these markets worthwhile' (Baldwin and Krugman, 1989: 635-6). And there may be more to changes in currency values than these effects on the numbers of firms that are present in a market. Each individual firm's non-price competitiveness may also be raised, since a depreciation of the exchange rate almost inevitably generates higher profits. While these profits could, of course, be squandered in high dividends and/or high salaries, they could, alternatively, be used to raise capacity, to launch advertising campaigns, to improve product quality, to

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finance R & D spending, etc. As was rightly said in a similar context: 'relative selling effort and availability determine relative sales. Selling effort and availability [in turn] are greatest when the seller has the resources, which means the biggest . . . profits' (Brown, 1979: 8). If the short-term opportunities that devaluation provides, in the form of such higher profits, are seized upon, then arguably, by the time the price advantage has evaporated,firmscould still find themselves more competitive than before. Similarly, there may also be macroeconomic channels of transmission. Models of export-led growth, for instance, have long suggested that an undervalued exchange rate could have beneficial effects that went beyond a short-run boost to exports and the balance of payments. Thus, higher exports could stimulate investment via the accelerator, while a favourable current account could allow governments to follow more expansionary policies. Both these trends might further add to investment by raising business confidence (Beckerman, 1962; Lamfalussy, 1963). The virtuous circle could then be completed by a supply response in the form of scale economies and more rapid productivity growth, which would perpetuate the competitive advantage (Cornwall, 1977). In other words, what is being proposed is another version of what has recently been called hysteresis and was, earlier, known as path-dependence - the idea that temporary shocks may have more than merely temporary consequences. For appreciation this has often been argued in the recent past: 'If the level of... productivity depends on past levels of output, then a fall in output today, due to, say, a loss in competitiveness, will lower productivity in the future and reduce supply' (Bean, 1988: 59). A similar mechanism in reverse could also apply to depreciation, with higher profitability generating longer-run beneficial effects through higher exports, capital formation and productivity growth. In principle, as with any investment, one might expect that diminishing returns would set in to 'investment in exporting', but learning by doing and the displacement of foreign rivals could offset such tendencies and raise the growth rate of exports (or of import substitutes) over a prolonged period. 3

Western Europe in the 'Golden Age'

Whether the hysteresis effects suggested in section 2 can be detected in practice is more difficult to determine. The following few paragraphs will look at Western Europe's experience in the 1950s and 1960s, a period that would seem ideal for testing the approach. For one thing, these were years during which convergence in per-capita income and productivity levels was very rapid. Between 1950 and 1970, for instance, labour productivity grew at more than A\ per cent per annum in countries such as France, Germany, Italy and Spain, but at only 2 per cent per annum in the United States. More importantly, these were thefixedexchange rate years of the Bretton Woods system, in which parity changes did occur but were, on the whole, few and far between. If devaluation of the currency is to have favourable longer-term effects, it would seem that pegged systems offer far more opportunities than floating ones. In the latter, the likelihood of strong supply responses may well be limited if, as has been the case since the early 1970s, the persistence of real exchange rate changes is in doubt.

Convergence, competitiveness and the exchange rate

111

Experience of floating so far suggests that all major currencies have risen and fallen in real terms, and often by large amounts and in quick succession. In such circumstances, the response of risk-averting firms to sudden depreciations that are likely to be viewed as temporary may be a quick attempt to increase sales, but not a commitment to a long-run switch into tradable production. The short-run apparent price elasticities could actually be somewhat higher as a result of such behaviour than they would have been in a more predictable exchange rate environment, but the longer-run ones would be lower. Conversely, in the Bretton Woods days a devaluation of the currency would probably have been viewed by most firms as conferring a semi-permanent competitive advantage, particularly in circumstances in which labour markets were stillflexibleand money illusion was widespread. This, in turn, could have led to long-term changes in strategy as firms reallocated not only production, but also investment, to the more profitable export and import-competing activities. If this had indeed been the case, one would expect to see exchange rate changes affecting the growth performance of various European countries in these two decades. The first, and very simple, procedure followed to test for this hypothesis was to begin by establishing which major forces accounted for convergence during the period and then to see whether the exchange rate was able to throw light on the behaviour of any of these major forces. Differential productivity growth rates in this sample of relatively developed economies have traditionally been explained in terms of two main variables. The first one, known since time immemorial, is the advantage of relative backwardness. The second one, which also has a relatively long history (e.g. Hill, 1964) is the importance of investment and, particularly, of investment in machinery and equipment (De Long and Summers, 1991). Indeed, these two variables seem to be the only ones that are consistently robust in the econometric literature, irrespective of sample size and period investigated, according to a recent thorough examination of the issue (Levine and Renelt, 1992). The evidence for Western Europe in the 1950s and 1960s confirms these findings. Initial productivity levels and investment ratios in machinery and equipment throw a good deal of light on the productivity growth experience of this period.2 Indeed, if the sample of countries is enlarged to encompass the United States and Japan, the estimated relationship improves further, with almost 98 per cent of the variance in productivity growth rates 'explained' by catch-up factors and investment efforts. It may be interesting to note that this seems not to have been the case in the interwar period when, admittedly on the basis of a very imperfect data set and of a smaller country sample, no relation whatsoever is found between these various variables. If the exchange rate matters, it should presumably have some impact on the investment ratio. To see whether this was the case, a set of nominal and real effective exchange rate indices was constructed from 1950 to 1970, using weights derived from the IMF's 'Multilateral Exchange Rate Model' (Artus and McGuirk, 1981) for all the eighteen OECD countries which that model covers. The effective exchange rate index that was derived considers the various bilateral nominal rates; the real one deflates these with wholesale prices.3 Unit labour costs would, no doubt, have been preferable, but these were not available for all the countries considered here. Equally, an earlier set of weights might have been more appropriate (the one used

112 Andrea Boltho

here, based on 1977 tradeflows,seems to give too much importance to, for instance, Japan), but again this seemed not to be available. Linking, in a very simple way, the investment share to an accelerator variable and to the real exchange rate index that had been derived gave totally insignificant results.4 At this level of aggregation, in other words, it would appear that exchange rate effects on investment, and hence on income convergence, cannot be detected. While this may, prima facie, seem surprising, it should not be forgotten, from the discussion in section 2 above, that the impact of longer-run exchange rate changes on investment and non-price competitiveness need not necessarily be favourable, so that a nil result for this sample of countries may not, after all, be that unexpected. A more appropriate procedure might thus be one that looked at single countries' experiences in somewhat greater depth. This has been done fairly exhaustively in the case of the United Kingdom. Studies of the 1967 parity change have, for instance, provided favourable assessments (for a survey, see Tew (1978)). Similarly, there is tentative evidence suggesting that the pound's sharp appreciation in 1978-81 had long-run negative effects on British exports (Bean, 1988), as may also have been the case for the uncompetitive exchange rate that the UK chose in 1925, at the time of its return to the pre-World War I gold parity. Yet, such conclusions have been questioned in a broader examination of the country's longer-run history of currency changes, which has suggested that postwar depreciations on balance worsened rather than improved non-price competitiveness (Thirlwall, 1980). Indeed, a more detailed econometric investigation has shown this to have been the case for the machine tools branch in the 1970s (Brech and Stout, 1981). The text that follows will eschew the conflicting evidence on the United Kingdom's experience and concentrate, instead, on some other countries that through the period under review showed very rapid convergence and either recorded low values of the exchange rate at the beginning, or consciously devalued their currencies at some time or other during the 'Golden Age'. An indication of where Western Europe's currencies may have stood at the outset is provided by Table 5.1, which shows various estimates of purchasing power parities vis-d-vis the United States in 1950 (following, therefore, the sharp devaluations of late 1949). Data are provided both on an absolute and on a relative basis (vis-a-vis 1938). While the latter year may not have been one of full payments equilibrium, a selective reading of the literature suggests that it may not have been too far from it either.5 The overwhelming impression the table conveys is that, vis-d-vis the United States at least, most European countries had acquired at the time a significant competitive price advantage (the major exceptions being Belgium, Switzerland and possibly France).6 Thisfindingstands in sharp contrast to the experience that followed World War I. The parities that were fixed in the 1920s, at different dates for different countries, seem often to have been above what a simple purchasing power parity rule might have suggested. Table 5.2 provides a tentative comparison of where real exchange rates may have stood in the mid-1920s and in 1950 relative to the prewar levels, on the basis of wholesale price developments. While, as mentioned above, virtually every Western European economy seemed competitive vis-d-vis the United States in 1950, very few looked similarly competitive a quarter of a century earlier. Moreover, activity in Western Europe in the early 1950s received a further boost

Convergence, competitiveness and the exchange rate 113 Table 5.1. Indicators of European competitiveness, 1950 Absolute competitiveness Cost of tradable basket0 (USA = 100) France Germany Italy United Kingdom Spain Austria Belgium Denmark Netherlands Norway Sweden Switzerland Mean

85 87 83 81 _ 89 83 76 82 83

Relative competitiveness (relative to USA) GDP

deflator 97 52 82 62 67 115 78 66 63 72 94 77

Wholesale Export Unit lab. prices prices costs (1938 = 100) 114 101 (80) 53 (70) 106 73 (87) 72 57* 72 112 85 75 58 77 100 78

79 71C 107 85 100 94 96 125 98

_ _ -

a

Obtained by averaging the United States and own country basket figures shown in the original source. b 1936 = 100. c 1937 = 100. Sources: Armstrong et al (1991); Gilbert and associates (1958); Triffin (1957); United Nations, Statistical Yearbook, 1954; United Nations Economic Commission for Europe, Economic Survey of Europe in 1951, Geneva, 1952, and Economic Survey of Europe Since the War, Geneva, 1953; US Department of Commerce, Long Term Economic Growth: 1860-1965, Washington, DC, 1966.

from the Korean War. Conversely, the achievement of afixedparity in the 1920s had been preceded (or accompanied) in a number of countries by domestic deflation aimed at reducing wages and prices to levels compatible with the new exchange rate. This had clearly been the case in Italy (Toniolo, 1980) and the UK (Lewis, 1949), and had probably also been true of the Netherlands, Norway, Sweden and Switzerland (Eichengreen, 1989). The debilitating effects of such deflations in some countries, combined with the lack of competitiveness in these and many others, may provide yet another reason for why Europe's growth experience after World War I was so much less successful than the one that followed World War II (Boltho, 1982b). Returning to the period under examination, the greatest degree of undervaluation in 1950 is that seen for Germany, an undervaluation that probably reflected the choice of a favourable exchange rate in spring 1948 (when Germany's economic situation still looked extremely precarious), and the subsequent devaluation of September 1949. This state of affairs hardly changed through the following decade, in view of the stability of the real exchange rate indicator shown in Figure 5.1. While

114 Andrea Boltho Table 5.2. Selected indicators of European competitiveness, 1920s and 1950 Relative to United States Wholesale prices Mid-1920sa (1913 = 100) France Germany Italy United Kingdom Spain Austria Belgium Denmark Finland Netherlands Norway Sweden Switzerland Czechoslovakia Hungary Mean

87 94 105 120 91 111 97 103 113 112 106 107 114 105

1950 (1938 = 100) 101 53 73 72 57* 72 112 85 — 75 58 77 100 78

a

The years chosen depend on when the country stabilized its exchange rate. For each country, the figure shown is an average of the real exchange rate in two years - the year of stabilization and the year immediately following it (e.g. in the French case, 1926 and 1927). b 1936 = 100. Sources: League of Nations, International Statistical Yearbook (various issues); Svennilson (1954); United Nations, Statistical Yearbook, 1954; United Nations Economic Commission for Europe, Economic Survey of Europe in 1951, Geneva, 1952; US Department of Commerce, Long Term Economic Growth: 1860-1965, Washington, DC, 1966.

Italy's starting advantage seems no more pronounced than that of the rest of Europe, Italy's real exchange rate dropped significantly in the early 1950s (Figure 5.2), and remained low throughout the decade. This reflected a very low rate of price inflation (wholesale prices fell by nearly 1 per cent per annum between 1951 and 1960, the sharpest decline in the OECD area), helped by both subdued wage developments and rapid productivity growth. In addition, two further rapidly growing countries (France and Spain) devalued in the late 1950s, in contrast to their experience in the 1930s. At the time, defence of the currency had been an obsessive aim of the authorities (Lewis, 1949; Fontana and Nadal, 1976). In the 1950s, on the other hand, such monetary orthodoxy was jettisoned when both countries opened their very protected economies to the forces of international trade. The competitive advantages that were acquired thanks to

Convergence, competitiveness and the exchange rate

95 1950

1955

1960

1965

115

1970

Source: Author's calculations using IMF data.

Figure 5.1 Effective and real exchange rate: Germany, 1950-70 (1950 = 100) 110 i

105 -

80 1950

1955

1960

1965

Source: Author's calculations using IMF data.

Figure 5.2 Effective and real exchange rate: Italy, 1950-70 (1950 = 100)

1970

116

Andrea Boltho

120 -

Effective ER Real ER

110 -

100

90 -

1950

1955

1960

1965

1970

Source: Author's calculations using IMF data.

Figure 5.3 Effective and real exchange rate: France 1950-70 (1950 = 100)

parity changes were then maintained, particularly in the French case, through most of the following decade (Figures 5.3 and 5.4). For these four countries, prolonged periods of low real exchange rates could have led to higher investment and structural transformation. Some inkling that this may have been the case is provided by a re-estimation of the simple econometric link between investment ratios, output growth and the exchange* rate, unsuccessfully tried above for the full sample of countries. Limiting coverage to France, Germany, Italy and Spain, it would now appear that exchange rate depreciation did raise investment shares.7 This is, however, far from conclusive proof of anything. Slight changes in periodization or in the definition of the real exchange rate variable could provide different outcomes. And even if the results were robust to somewhat different specifications, there is no insurance that the (relatively small) favourable effect that the exchange rate seems to have had on investment necessarily improved longer-run non-price competitiveness. Hence the need for a somewhat more detailed analysis of the four countries' experience. 4

Country experience

The present section looks at selected episodes of the postwar economic history of the four countries chosen above. In the German and Italian cases in the 1950s, the emphasis is not so much on nominal parity changes in 1949, since these were relatively modest,8 but on the low real exchange rate levels that seem to have prevailed in the decade. For France and Spain, on the other hand, the accent is on the sharp devaluations of the late 1950s.

Convergence, competitiveness and the exchange rate

601950

1955

1960

1965

117

1970

Source: Author's calculations using IMF data.

Figure 5.4 Effective and real exchange rate: Spain, 1950-70 (1950 = 100)

4.1

Germany and Italy

For Germany and Italy, despite obvious differences in maturity and industrial structure, the 1950s were in many ways a period of relatively similar 'miracles'. Both countries saw rapid output growth, rising investment propensities and sharp increases (particularly in Germany) in their shares of the world market for manufactured goods. And for both countries the explanations provided for this 'success story' are broadly similar - the combination of an elastic supply of labour and of cheap imports of American technology generated relatively high profits; these, in turn, stimulated investment and productivity growth. The interesting issue in the present context is to see to what extent external developments contributed to this virtuous circle. Despite the evidence of Table 5.1, there seems little acknowledgement in the literature that Germany's exchange rate level in 1950 was particularly favourable. Indeed, the Bizonal authorities apparently thought that the rate which had been agreed upon in 1948 was too high (Erhard, 1954). Despite the subsequent devaluation of 1949, there is a hint in the literature that suggests the presence of an overvalued exchange rate in the 1950s (Giersch et a/., 1992: 95). Yet, the evidence of mounting trade surpluses through that decade later convinced many that the currency had been clearly and increasingly undervalued (Gatz, 1963; Borchardt, 1967; Hardach, 1976). And such a conclusion is indirectly corroborated by the numerous interpretations of the period which suggest that both growth and cyclical upswings in these years were export-led (Michalski, 1970; Hennings, 1982; Giersch et al, 1992). This is even truer for Italy. Here, too, there seems to be little reference to the appropriateness or not of the 1950s nominal exchange rate, but there is virtual

118 Andrea Boltho

unanimity in acknowledging that the real exchange rate fell significantly in the 1950s, thereby stimulating exports (D'Antonio, 1973; Fua, 1981). And this has led a number of authors to argue that Italy too benefited from an export-led growth mechanism (e.g. Stern, 1967; Graziani, 1979; for a dissenting voice, see Rey, 1982). Yet, neither country was subject to revaluation pressures through the 1950s, in contrast to the many such pressures that were exerted in the 1920s, particularly in the Italian case, to restore parities to an overvalued rate. The stance of demand management policies may have helped. Fiscal policy was relatively orthodox, but there seems to have been little pressure to follow tight monetary policies. While both the Bundesbank and the Bank of Italy were, of course, concerned with inflation, modest wage rises, consequent upon the already mentioned elastic labour supplies, allowed a monetary stance that can be described as accommodating. The average annual growth rates of broad money supply from 1952 to 1960 were 16.6 per cent in Germany and 14.3 per cent in Italy (Budd and Dicks, 1982), as against rises in nominal GDP of only 9.3 and 8.2 per cent per annum respectively. Looking at overall performance in the 1950s, it is likely that in both countries a low exchange rate was an important ingredient in the virtuous circle of strong competitiveness, high investment, rapid productivity growth and scale economies, leading to even stronger competitiveness and more confident expectations. By the early 1960s, however, this price-cost advantage had begun to wane (Figures 5.1 and 5.2). In Germany it was appreciation of the currency, as well as a tighter labour market, that eroded some of the economy's external competitiveness; in Italy it was the effects of overheating in 1962-3. In both countries growth decelerated and inroads on foreign markets slowed down (Table 5.3). Arguably, however, the advantages conferred by earlier real depreciation had become permanent. After all, export market shares were not lost, and German and Italian competitiveness remained strong. To see whether these impressionistic observations can be confirmed, Table 5.4 presents indices of'revealed comparative advantage' (RCA) for the two countries in a number of product groups at the outset and end of the period under review.9 Data are shown for several broad SITC categories and for a subset of goods called 'growth commodities', which consists of twelve products (chosen at the three-digit SITC level) of the chemical, machinery, and transport and equipment industries whose share in OEEC exports grew fastest in the years 1954-61 (NIESR, 1963).10 Evidence of increasing RCAs in this group, as well as in the broader SITC categories 5 and 7, would presumably suggest that the two countries had moved 'up-market' in the period, thus making subsequent real appreciation easier to resist. As they stand, the changes between the 1950s and the 1960s show a clear improvement in Italy's RCAs from a relatively low starting point (particularly in the machinery branch) and a consolidation by Germany in a number of growth sectors. For both countries the impressionistic verdict presented above would seem to be confirmed - non-price competitiveness is likely to have improved in a period in which price competitiveness was strong. Yet, even this relatively innocuous conclusion need not be fully warranted. For one thing, the benefits of a low real exchange rate have been subject to fairly radical criticisms in both countries - whatever advantages export-led growth may have bestowed in terms of output, employment and the balance of payments, it also led to

Convergence, competitiveness and the exchange rate

119

Table 5.3. Changes in selected macroeconomic indicators: Germany and Italy, selected dates (%) Germany

G D P growth 0 Manufactured exports share* Machinery equipment investment share c Profit share: manufacturing sector0" Profit share: corporate sector0*

Italy

1951-2

1960-1

1951-2

1961-2

to

to

to

1960-1

1969-70

1960-1

to 1969-70

7.5 8.8

4.5 0.8

6.0 1.8

5.8 1.9

2.0 —9.9* -3.2e

2.0 —6.9 -6.4

2.0 — 4.0* 4.8 e

-0.9 —2.1 -0.1

0

Average annual percentage charges. In the exports of the eleven largest industrialized exporters. c In constant price G D P . ^In value added. * 1954 to 1960-1. Sources: Armstrong et al. (1991); M a d d i s o n (1991); N I E S R , Economic b

Review

(various issues); OECD, National Accounts of OECD Countries, 1950-68, 1953-69 and 1960-71. Table 5.4. Indices of revealed comparative advantage: Germany and Italy, selected dates Germany Primary products (0-4) Manufactures (5-8) of which: Chemicals (5) Machinery, etc. (7) 12 'growth products'0

Italy

1951-2

1960-1

1951-2

1960-1

0.51 1.29

0.37 1.28

0.93 1.06

0.87 1.07

1.64 1.32 1.60

1.38 1.45 1.43

0.92 0.76 0.83

0.93 0.95 0.91

0

For composition, see Statistical Appendix. Note: Figures in brackets refer to SITC categories. Sources: OEEC, Statistical Bulletins - Foreign Trade (Series II, III and IV).

a distortion in resource allocation whose longer-term structural effects were unfavourable. Thus, in Germany, it has been argued that the low exchange rate led to an 'oversized manufacturing sector' (Giersch et ai, 1992: 222). In the longer run this was untenable, and the country was forced into too rapid a phase of deindustrialization once the currency rose in the 1970s. Fluctuations in output shares, in other words, were magnified with, arguably, negative consequences for welfare. As for Italy, a low exchange rate favoured the manufacturing North at the expense of the more agricultural South. By exacerbating industrial and regional

120 Andrea Boltho

dualism, this paved the way for some of the difficulties the country experienced in the later 1960s (Graziani, 1979). Be this as it may, it can also be plausibly argued that the two countries' transformations owed more to forces other than low real exchange rates. In Germany's case, for instance, the view has been put forward that the weight of history mattered most - Germany's industrial structure had already, before the war, been heavily concentrated on investment goods. Events in the 1950s may have merely represented a return to earlier patterns of production and penetration of world markets (Altvater et al, 1980). More importantly, perhaps, the period of low real exchange rates coincided in both countries with a period of significant trade liberalization. Italy, for instance, eliminated its quantitative, trade barriers very rapidly - thus, by 1952 it was, with Portugal, the only OEEC country to have fully liberalized intra-European trade (Table 5.5). Liberalization vis-a-vis the dollar area was somewhat slower and Italy's tariffs remained high in the decade, but the Messina treaty, signed in 1955, was a clear signal of impending tariff dismantling. Germany, similarly, had lifted quota restrictions from 90 per cent of its intra-European trade by 1953 and of its dollar-area trade by 1956, well ahead of the rest of Europe. In addition, it was also aggressively engaged in unilateral tariff reductions through most of the 1950s (Giersch et al, 1992). That this opening to international trade may have mattered seems indirectly confirmed by the evolution of profitability in both countries (Table 5.3). A striking feature of the period is the less favourable movement of the profit share in the manufacturing sector if compared to that of the corporate sector as a whole, despite the currency's undervaluation. Overall profit shares decline sharply in Germany in the 1950s, but the fall in the open industrial sector is well above that of the more sheltered rest of the economy, in marked contrast to the relatively uniform trends of the 1960s. Similarly in Italy, the manufacturing sector's profitability is significantly weaker in the 1950s relative both to the profitability of the overall corporate sector and to developments in the 1960s. In other words, the improvements in the two countries' international competitiveness that have been noted above may, after all, have been prompted just as much, if not more, by the coming down of protectionist barriers as by the low real exchange rates of the period. Indeed, a number of observers have argued that the spur to modernization provided by trade liberalization was a powerful stimulant to investment and competitiveness in both Germany and Italy (e.g. Giersch et al, 1992; Ackley, 1979). 4.2

France and Spain

Not unlike Germany and Italy in the 1950s, France and Spain in the 1960s also shared some similarities. France saw a 'profound renovation' (Fohlen, 1976: 114), while Spain witnessed 'true industrialisation' (Fontana and Nadal, 1976: 522). In both countries, growth was more rapid than in the previous decade, there were gains in market shares abroad, and ratios of investment to output rose, when they could be expected to fall, at least in France (Carre et al, 1982) (Table 5.6). Yet, in contrast

Convergence, competitiveness and the exchange rate

121

Table 5.5. Trade liberalization in OEEC countries, 1952-8 (% of imports freed from quota restrictions; end years)

Intra-OEEC trade Germany France Italy OEEC average Trade with dollar area Germany France Italy OEEC average

1952

1954

1956

1958

81 0 100 65

90 65 100 83

92 82 98 89

91 90 98 89

a

90 11 39 61

85 51 68 72

0 0 0 11

54

0° 24* 44*

a

End-September 1954. Sources: OEEC, Annual Reports of the OEEC (9th, 10th, 12th).

Table 5.6. Changes in selected macroeconomic indicators: France and Spain, selected dates (%) France 1950-1 to 1957-8 G D P growth 0 Manufactured exports share 6 Machinery and equipment investment sharec Profit share: manufacturing sector** Profit share: corporate sector^ a

Spain 1957-8 to 1967-8

1954 to 1957-8

1957-8 to 1967-8

4.5 -1.7

5.2 0.3

5.8 -

6.2 0.3

1.2

2.1

1.5

4.7

-6.2'

-1.1 2.7/

-0.6/

-4.6e

2.3

Average annual percentage changes. In the exports of the eleven largest industrialized countries. c In constant price GDP. **In value added. e 1954 to 1960-1. /Inverse of adjusted wage share in GDP. Sources: Armstrong et al. (1991); EEC, European Economy, no. 54, 1993; Maddison (1991); NIESR, Economic Review (various issues); OECD, National Accounts of OECD Countries, 1950-68 and 1953-69; UN, Monthly Bulletin of Statistics (various issues). b

122 Andrea Boltho Table 5.7. Indices of revealed comparative advantage: France and Spain, selected dates Spain

France Primary products (0-4) Manufactures (5-8) of which: Chemicals (5) Machinery etc. (7) 12 'growth products'0

1957-8

1967-8

1961

1967-8

0.91 1.02

1.04 1.00

2.40 0.43

2.16 0.64

1.12 0.73 0.61

1.18 0.83 0.84

0.62 0.12 0.18

0.67 0.39 0.34

fl

For composition, see Statistical Appendix. Note: Figures in brackets refer to SITC categories. Sources: OEEC, Statistical Bulletins - Foreign Trade (Series II, III and IV); OECD, Foreign Trade Statistics (Series B and C).

to the German and Italian experiences, these developments seem to have owed less to elastic labour supplies and subdued wage developments. Low population growth in France and emigration in Spain meant that the industrial areas of the two countries were experiencing conditions approaching full employment (Merigo, 1982; Sautter, 1982). It is tempting, therefore, to advance the devaluations of 1957-8 in France and of 1959 in Spain as possible important causes of subsequent developments. Both devaluations were triggered off by earlier inflationary developments, both were accompanied by sharp absorption-reducing policies, and both led very quickly to current account improvements and pronounced rises in investment. It is true, however, that both countries found themselves forced to devalue again towards the end of the decade. Spain followed the UK in October 1967, after its mid-1960s boom had led to generalized overheating, while France devalued in 1969, not long after the May 1968 events. Though neither of these two inflationary episodes can be directly linked to the earlier devaluations, they still raise the issue of how temporary were the advantages that these parity changes conferred. For France, the literature on the devaluation is, on the whole, sceptical about its favourable impact. Some argue that price advantages had already been lost by 1964 (Carre et al., 1982), something that Figure 5.3, however, does not fully confirm. Others point, instead, to the lack of a strong investment response in the tradable sector (Mistral, 1975). All lament (in predictable French fashion), the continuing presence of an unfavourable taux de couverture in manufactured goods (i.e. a trade deficit), often forgetting that this was associated with an acceleration in output growth. For Spain, the judgement would seem to be that the immediate response to devaluation had been favourable (OECD, 1966; Martinez Serrano et al., 1982), but that subsequent demand-pull inflation undid much of the initial gains (Anderson, 1970). In an attempt to go beyond, Table 5.7 replicates the RCA information already provided above for Germany and Italy.11 It is interesting to note how relatively underdeveloped the export structures of both countries were at the outset. France's

Convergence, competitiveness and the exchange rate

123

Table 5.8. Indicators offoreign trade changes: France and Spain, selected dates (%) 1950-1

1957-8

1967-8

38.0 17.5 1.9U

35.9 23.6 2.6

13.4 42.2 5.9

(18.6) (20.3) -

13.7 29.0 3Ab

12.5 30.2 6.7

France

Share of exports to franc area Share of exports to EEC 6 Share of manufactured imports in GDP Spain Share and Share Share

of exports to African possessions Latin America of exports to E E C 6 of manufactured imports in G D P

a

1954. M961. Sources: OECD, Statistical Bulletins - Foreign Trade (Series I and IV), Foreign Trade Statistics (Series A and B) and National Accounts of OECD Countries, 1950-58 and 1953-69; Annuario Estadistico de Espana (various issues).

RCAs in both SITC 7 and the twelve 'growth products' were, in 1957-8, below those of Italy in 1951-2. As for Spain, its manufactured exports were virtually absent from world markets. Over time, there is a clear improvement in both countries' RCAs in what can be called the 'growth areas' (in France's case there is also an improvement for primary products, totally concentrated, of course, in agriculture). In fact, these figures probably underestimate the transformation of the two countries' tradable sectors. Spain was able to make its first entry on the world markets for manufactures, strongly helped in this by an overflow of foreign direct investment, while France radically changed the geographic structure of its exports. Since the Great Depression, the country had concentrated its sales abroad on the protected markets of the franc area (Table 5.8). In the space often years, it succeeded in massively reorienting its exports towards the EEC. Even if some felt that the changes in France's RCAs were not sufficient (INSEE, 1974), the data shown in Table 5.8 would seem to provide a very clear indication of a structural improvement in the country's competitiveness. Yet, devaluation may not have been the only cause of these developments, since France in 1958 and Spain in 1959 also saw massive programmes of market opening. Indeed, it is likely that the devaluations were an integral part of the trade liberalization packages - industry, as well as labour, would probably have baulked at the prospects of a sharp decline in protectionism in the absence of some compensating measures. France, which had been slow in implementing trade liberalization until then (Table 5.5), now entered the Common Market and dismantled all its tariffs vis-a-vis the EEC countries between January 1959 and July 1968. As for Spain, it abandoned the virtually autarkic model of development that it had followed since the early 1940s. Before 1959, up to 90 per cent of imports had been subject to quantitative restrictions. This share had fallen to 30 per cent by 1966 (Wright, 1977), although

124 Andrea Boltho

effective tariff protection remained high in the decade (Martinez Serrano et a/., 1982). And as in Germany and Italy, manufacturing profits in France fared much less well in this decade than in the 1950s relative to total corporate sector profits. For Spain a very rough indicator of overall profits also suggests a worsening. Similarly to Germany and Italy, therefore, changes in international competitiveness in France and Spain coincided with, and may well have been prompted by, the opening to foreign competition, as indeed is argued by a number of writers (Carre et al., 1982; Lieberman, 1982). Two relatively protected economies abandoned their semi-autarkic ways, allowed much greater import penetration, and at the same time were able to improve the commodity and country composition of their exports. Whether the primary stimulus of this conversion came from devaluation of the currency or from the opening to free trade is unresolved. Yet, a glance at Figures 5.3 and 5.4 suggests that liberalization may have played a greater role. By the mid-1960s France's real exchange rate (while well below 1957) had returned to its (not very competitive) 1950 starting point. As for Spain, the peseta's real value had virtually jumped back to its (equally non-competitive) pre-devaluation levels. 5

Conclusions

The preceding pages have explored the possibility that the rapid growth experienced by several Western European countries in the 1950s and 1960s may have been partly linked to their exchange rate developments. In particular, the chapter has tried to investigate, in an admittedly very informal and ad hoc way, the hypothesis that devaluation of the currency, in addition to conferring well-known, but ultimately short-lived, cost and price advantages, may also improve longer-term non-price competitiveness. The evidence provided for Germany and Italy in the 1950s, and France and Spain in the 1960s, predictably perhaps, does not really allow a clear-cut answer to this question. All the four countries surveyed did benefit from relatively favourable exchange rates through some of the period - Germany thanks mainly to the postwar fixing of the Deutschmark at what turned out to be a very low level; Italy in the wake of subdued domestic wage and price developments; France and Spain following deliberate and relatively large devaluations of their currencies. All four countries also experienced rapid output and investment growth as well as rising export market shares in the period during which their real exchange rates remained low. More tellingly, all four countries also went through significant structural transformations. Changes in indices of revealed comparative advantage for products that experienced very rapid growth on world markets suggest, for instance, that improvements in non-price competitiveness were widespread, particularly in Italy. Equally strikingly, France was able sharply to restructure the geographic composition of its sales abroad, away from largely protected and slow-growing overseas markets to the much more dynamic and competitive Western European outlets. All this may suggest that, by the time the advantages of low real exchange rates had been eroded (be it by appreciation in Germany or by accelerating wage and price inflation in France, Italy and Spain), these countries found themselves in a stronger position than they would otherwise have achieved. A low real exchange rate, in other words, may have had more than merely transitory effects.

Convergence, competitiveness and the exchange rate

125

Yet, however plausible such a conclusion may sound, it need not be fully warranted. One important feature of the four countries' experiences at the time at which they gained high competitiveness was an extensive programme of trade liberalization. For Germany and Italy, this coincided with the general freeing of intra-OEEC exchanges in the 1950s, but both Germany and Italy seem to have gone faster down the liberalization road than other countries. For France and Spain, liberalization was an essential component of the late 1950s devaluation packages, and led to a sharp opening in economies that, until then, had followed highly protectionistic or even semi-autarkic policies. In standard economic theory, trade liberalization would hardly be expected to generate longer-run growth effects. Freer trade leads to well-known, but merely static gains in welfare. When translated into GDP equivalents, these often turn out to be pitifully small - not quite 0.2 per cent of EEC GDP, for instance, following the completion of the Common Market (Balassa, 1974). Yet, just as devaluation may have more than a transitory impact, so too could trade liberalization. Thus, estimates which allow for scale economies and increased competitive pressures suggest that the formation of the EEC may have raised Community GDP by 3 to 6 percentage points (Owen, 1983). And the new 'growth economics' states that further, and even greater, gains are possible because of induced higher investment (Baldwin, 1989). It would seem plausible, therefore, to argue that both devaluation and trade liberalization can provide longer-term favourable effects on economic growth. The 'warm blanket of protection' which a devaluation provides may stimulate profits and investment, rather than retard structural change. Similarly, the 'cold shower of competition', rather than hurting investment through its squeeze on profits, may raise efficiency and force firms to step up investment. Most probably, in the circumstances of the time, the two favourable effects worked hand in hand - rising external pressures dictated the need for structural change,while low real exchange rates provided the funds with which this structural change could be financed. If this is so, some conclusions can perhaps be drawn. First, a combination of currency devaluation and trade liberalization, such as occurred in the four countries examined here, may, in many ways, be optimal. At the political level, it facilitates the acceptance of market-opening packages (as suggested by the French and Spanish examples of the late 1950s). Without devaluation it may be very difficult to persuade industrial and trade union lobbies to accept a lowering of protective barriers.12 And at the economic level, a joint package supplies three crucial ingredients for the success of the tradable sector: increased competition (which devaluation alone does not provide), increased profits (which liberalization alone does not provide), and increased opportunities both at home and abroad.13 Second, the (partial) successes which the exchange rate instrument may have had in ensuring structural change were perhaps limited to the particular period under consideration. One reason for this is to be found in the international monetary and trading conditions of the time. These allowed for occasional parity changes, in contrast to much of the interwar period and to the post-1973 world, when floating was more prevalent. In addition, they also made for a rapid process of trade liberalization that was very different from the trade wars that prevailed in the 1930s, and even from the 'creeping protectionism' of the post-1973 years. Finally, United

126 Andrea Boltho

States hegemony in the 'Golden Age' allowed a form of free-riding behaviour in both Europe and Japan. Undervaluation of major currencies would not have been possible for long in the interwar years and is similarly unlikely today. It was feasible in the very special conditions of the Bretton Woods system, given the 'benign neglect' with which the United States viewed its balance of payments developments. These two conclusions, in turn, have an important implication for policy. Devaluing so as to ensure export-led growth may have been a viable strategy provided it was accompanied by market-opening measures and taken in an environment of quasi-fixed exchange rates. In today's Europe, however, most trade barriers (outside agriculture) have fallen to very low levels, and efforts at trade liberalization, such as those of the 1992 Programme or of the Uruguay Round, are much smaller in scope. Similarly, greater currency flexibility is likely to have diminished the investment response to what are now often seen as merely transitory changes in real exchange rates. In other words, longer-run effects on competitiveness stemming from temporary exchange rate changes (or from radical market opening) may be much less likely at present than they were in the 'Golden Age'.14 Devaluations may still, of course, be indispensable to restore purchasing power parity following nominal shocks. They can also provide a welcome shot in the arm (as they seem to have done in 1993 in both Italy and the UK). They may even lead to prolonged periods of price or cost competitiveness, as suggested by Belgian experience since the franc's downward realignment of 1982, but their effects in altering non-price competitiveness may be much less secure.

Statistical Appendix Data for regressions: 1950 and 1970 GDP and employment data for twelve European countries were obtained from Maddison (1991); 1950 GDP data for Spain and Ireland came from Maddison (1989) and were linked to OECD statistics (from OECD, National Accounts, 1960-1990) to obtainfiguresfor 1970. Spanish and Irish employment data for 1950 and 1970 came from OECD, Manpower Statistics and Labour Force Statistics (various issues). Productivity growth was derived by dividing GDP by employment growth. Productivity levels in 1950 for the United States and twelve European countries came from Maddison (1991); thefiguresfor Spain and Ireland were very tentatively obtained by regressing Bairoch's (1976) estimates of per-capita GDP on to Maddison's data for per-capita productivity for twelve European countries, and applying the resulting coefficients to Bairoch's Spanish and Irish data. The 1950-69 GDP shares of investment in machinery and equipment (at constant 1963 prices) came from the OECD's National Accounts of OECD Countries, 1950-1968 and 1953-1969; for Italy and Norway thefiguresbegin in 1951, for Belgium in 1953, and for Spain in 1954. Definition of'growth products': the twelve 'growth products' are SITC 266 (synthetic fibres), SITC 512 (organic chemicals), SITC 521 (crude coal and petroleum chemicals), SITC 581-99 (plastic and chemical materials), SITC 711 (non-electric power generating machines), SITC 714 (office machines), SITC 715 (metal working machines), SITC 717-19 (other industrial machines), SITC 722-9 (electric machines), SITC 734 (aircraft), SITC 861 (scientific, optical and photographic instruments) and SITC 891 (musical instruments and sound recorders).

Convergence, competitiveness and the exchange rate

127

NOTES 1 This assumes little change in the terms of trade - an assumption that seems broadly acceptable in the Western European context until the oil shocks of the 1970s. 2 Thus, linking the growth rate of productivity over the two decades (ChPr) to initial productivity levels relative of those of the United States (Pr/Prus) and to the share of machinery and equipment investment in output (lme/Y) gives the following result for a sample of thirteen European countries (f-ratios in brackets): ChPr = 5.0 - 6.9Pr/Prus + 0.21J Y (5.5) (8.0) (2.8)

R2 = 0.90 S£ = 0.35

(1)

The data sources for the fourteen countries initially selected are provided in the Statistical Appendix. Norway was, however, excluded from the regression. The country is an outlier with respect to its investment share in output, which (at 14.5 per cent of GDP) is some 50 per cent above that of the sample's mean - largely a reflection of the highly capital-intensive nature of some of its industry (e.g. aluminium and shipping). 3 The 1950 to 1970 data for the nominal exchange rate and for wholesale prices come from the IMF's International Financial Statistics Yearbook (various issues). 4 The output share of investment in machinery and equipment was made dependent on a simple accelerator variable (the change in GDP over the two decades, or ChY) and on various indicators of the real exchange rate (e.g. its average cumulative deviation over the period from its 1950 level, or DvRE). An example of the type of result obtained is given by the following: IJY

= 5.8 + 0.1 ChY + O.ODvRE (3.6) (2.2) (0.4)

R2 = 0.33 SE = 1.20

(2)

5 Thus, according to Nurkse, 'At the end of 1936 . . . exchange relationships between the principal free currencies were not widely different from what they had been in 1930' (League of Nations, 1944: 129), while Kindleberger suggests that the 1937 exchange rates were 'broadly back to the 1929 pattern' (1986:269). This pattern, in turn, bar the overvaluation of the pound, seemed a reasonably stable one (Lewis, 1949). 6 This is most obvious for the wholesale price indicator and least obvious for the export price one or for the absolute measure. Arguably, however, these last two indicators are less significant, since in 1950 most of Europe's economies were price-takers on the world markets. Hence, they would have set their tradables' prices at, or close to, United States levels. Unit labour cost data would have been more appropriate, but unfortunately they are not available for most countries. Even the indices shown in Table 5.1 (for three countries only) must be considered as very tentative. 7 Investment shares were now calculated for cyclically comparable subperiods (four for France and Germany, three for Italy and Spain), and linked again to output growth rates, lagged one year, to cumulative real exchange rate deviations from their level at the outset of each subperiod, and to a (debatable) time variable (t) that could proxy, inter alia, for a trend towards increasing capital-output ratios or even for the perceived lower riskiness of investment as growth expectations firmed between the 1950s and 1960s: IJY

= 2.6 + 0.6ChYt_] - O.lDvRE 4- 1.3* (1.7) (2.8) (2.1) (5.6)

R2 = 0.79 S£ = 0.91

(3)

The subperiods were chosen to cover full cycles, with the cyclical peaks taken

128 Andrea Boltho

8 9

10 11 12

13 14

from OECD (1973). Initial and terminal years are as follows: France, 1951-7, 1957-61,1961-6, 1966-70; Germany, 1950-5, 1955-60,1960-5, 1965-70; Italy, 1951-5, 1955-62, 1962-9; Spain, 1954-8, 1988-66, 1966-70. While most of Europe devalued by 30 per cent vis-d-vis the dollar, Germany devalued by just over 20 per cent and Italy by less than 10 per cent. Indices of 'revealed comparative advantage' measure the ratio between a country's share of world exports in a particular product and its share of total world exports. The 'world' is here defined as the OEEC area (Canada, the United States and Western Europe, excluding Finland, Spain and Switzerland, for which early 1950s data are not available). For the definition of the twelve 'growth products', see the Statistical Appendix. The products represented 18.4 per cent of total OEEC exports in 1951-2 and 30.3 per cent in 1967-8. The initial year for Spain's RCA calculations is 1961, rather than 1957-8, for lack of comparable figures before that date. This is true even if, with the benefit of hindsight, it appears that the short-term costs that one would normally associate with trade liberalization were much smaller in Europe than feared, thanks to the unexpected growth in intra-industry trade. I am grateful to Stephen Nickell for this point. United States experience following the dollar's steep appreciation to 1985 would seem to confirm this conclusion. Despite much discussion of hysteresis effects, these receive little empirical support from the evidence (Krugman, 1991).

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University Press. (1982b) 'Growth', in Boltho (1982a). Borchardt, K. (1967) T h e Federal Republic of Germany', in G. Stolper (ed.), The German Economy, 1870 to the Present, London: Weidenfeld and Nicolson. Brech, M.J. and D.K. Stout (1981) The rate of exchange and non-price competitiveness: a provisional study with UK manufactured exports', Oxford Economic Papers, 33 (supplement), pp. 268-81. Brown, A.J. (1979) 'Inflation and the British sickness', Economic Journal, 89 (353), pp. 1-12. Budd, A. and G. Dicks (1982) Inflation - a monetarist interpretation, in Boltho (1982a). Carre, J.-J., P. Dubois and E. Malinvaud (1982) La croissance francaise: Un essai d'analyse economique causale de I'apres guerre, Paris: Le Seuil. Cipolla, C M . (ed.) (1976) The Fontana Economic History of Europe, vol. 6, Glasgow: Collins/Fontana. Cornwall, J. (1977) Modern Capitalism: Its Growth and Transformation, London: Martin Robertson. D'Antonio, M. (1973) Sviluppo e crisi del capitalismo italiano, 1951-1972, Bari: De Donato editore. De Long, J.B. and L.H. Summers (1991) 'Equipment investment and economic growth', Quarterly Journal of Economics, 106 (2), pp. 445-502. Eichengreen, B. (1989) 'International monetary instability between the wars: structural flaws or misguided policies?', CEPR Discussion Paper No. 348, November. Erhard, L. (1954) Germany's Comeback in World Markets, London: George Allen and Unwin. Fagerberg, J. (1988) 'International competitiveness', Economic Journal, 98 (391), pp. 355-74. Fohlen, C. (1976) 'France, 1920-1970', in Cipolla (1976). Fontana, J. and J. Nadal (1976) 'Spain, 1914^1970', in Cipolla (1976). Fua, G. (1981) 'II "miracolo economico", in una interpretazione dell'epoca', in G. Fua (ed.), Lo sviluppo economico in Italia, vol. I, Milan: Franco Angeli editore. Gatz, W. (1963) 'Grunde und volkswirtschaftliche Wirkungen der D-MarkAufwertung', Weltwirtschaftliches Archiv, 90 (2), pp. 379-432. Giersch, H., K.-H. Paque and H. Schmieding (1992) The Fading Miracle: Four Decades ofMarket Economy in Germany, Cambridge: Cambridge University Press. Gilbert, M. and associates (1958) Comparative National Products and Price Levels, Paris: OEEC. Graziani, A. (1979) 'Introduzione', in A. Graziani (ed.), L'economia italiana dal 1945 a oggi, new edn, Bologna: II Mulino. Hardach, K. (1976) 'Germany, 1914-1970', in Cipolla (1976). Hennings, K.H. (1982) 'West Germany', in Boltho (1982a). Hill, T.P. (1964) 'Growth and investment according to international comparisons, Economic Journal, 74 (294), pp. 287-304. INSEE (1974) Fresque historique du systeme productif, Collections de 1'INSEE, Serie E, no. 27. Kaldor, N. (1981) T h e role of increasing returns, technical progress and cumulative causation in the theory of international trade and economic growth', Economie appliquee, 34 (4), pp. 593-617. Kindleberger, C.P. (1986) The World in Depression, 1929-1939, Harmondsworth: Penguin. Krugman, P. (1989) 'Differences in income elasticities and trends in real exchange

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rates', European Economic Review, 33 (5), pp. 1031-46. (1991) Has the Adjustment Process Worked?, Washington, DC: Institute for International Economics. Krugman, P.R. and M. Obstfeld (1988) International Economics: Theory and Policy,

Glenview, IL: Scott, Foresman and Co. Lamfalussy, A. (1963) The United Kingdom and the Six: An Essay on Economic Growth in Western Europe, London: Macmillan. League of Nations (1944) International Currency Experience: Lessons of the

Inter-war Period, Princeton, NJ: Princeton University Press. Levine, R. and D. Renelt (1992) 'A sensitivity analysis of cross-country growth regressions', American Economic Review, 82 (4), pp. 942-62. Lewis, W. A. (1949) Economic Survey, 1919-1939, London: George Allen and Unwin. Lieberman, S. (1982) The Contemporary Spanish Economy: A Historical Perspective,

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European Community, Oxford: Carendon Press. Rey, G.M. (1982) 'Italy', in Boltho (1982a). Sautter, C. (1982) Trance', in Boltho (1982a). Stern, R.M. (1967) Foreign Trade and Economic Growth in Italy, New York: Praeger. Svennilson, I. (1954) Growth and Stagnation in the European Economy, Geneva:

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6

British economic growth since 1945: relative economic decline . . . and renaissance? CHARLES BEAN AND NICHOLAS CRAFTS

1

Introduction

It is a commonplace that the growth and productivity performance of the British economy has been disappointing in the postwar period, at least until the 1980s, which can be regarded as still controversial. Explanations for this 'failure' abound in the literature, as Alford's (1988) introductory essay well reflects. It will be useful at the outset to distinguish between three categories of analysis to which we can return in the concluding section, after the details of the historical record have been reviewed. First, we can look at proximate sources of growth in the manner of growth accounting, which shows both low investment and low productivity growth in the UK compared with its peer group. Second, we can explore the correlates of these aspects of growth performance in terms of their association with particular forms of institutions or policies, such as vocational training systems and ill-conceived industrial policy. Third, and most difficult, we can consider the fundamental factors which sustain the relatively low growth path as an equilibrium. Here we need to consider the incentive structures facing decision-makers both in business and in government, which produced market failure and/or precluded effective supply-side policy responses. In exploring the UK's growth performance we can take advantage of insights from recent work in growth economics. In particular, it will be useful to bear in mind the following points. First, new models of growth have tended to reassert the importance of capital accumulation and have, in effect, proposed various ways of endogenizing technical progress and productivity change. Second, broad capital is now seen as being at the heart of the growth process, with a strong emphasis on the roles of human capital formation and research and development. Third, investment decisions must be thought of in terms of optimizing decisions; taxes and institutional arrangements influencing the ability to appropriate quasi-rents will affect investment and, thus, growth outcomes. Fourth, comparative growth performance across countries may be influenced by the catching up of leading countries by followers, as obstacles to technology transfer are removed in a world where catching-up is not automatic. 131

132 Charles Bean and Nicholas Crafts

The problem of relative economic decline dominates the literature on postwar British economic growth and, from at least the late 1950s, has been a constant preoccupation for policy-makers. Both the right- and left-wing policy recommendations drawn from new growth theory have their echo in all this discussion. British industrial policy from the mid-1950s to the early 1970s has been described as dominated by attempts to promote investment-led growth (Morris and Stout, 1985), while the Thatcher reforms of the 1980s sought to lower direct taxes and to support an enterprise culture. Academic analyses have for a long time found fault with policy in ways which anticipate some of the key themes of recent theorizing on growth. The famous broad-brush approaches of Bacon and Eltis (1976) and Kaldor (1966) exemplify this point. The former proposed an explanation for slow growth in the UK based on an excessive expansion of the non-marketed sector, leading to high taxes and to the detriment of investment, while the latter stressed the need for policies to switch activity from services to manufacturing, to reap the benefits of learning-by-doing effects. At a more detailed level, Tanzi (1969) is representative of a large group condemning high marginal income tax rates as a significant impediment to growth, while Prais (1981) marks the beginning of a concerted critique on the deficiencies of human capital formation in the UK. It is obviously important to bear in mind that the UK had less scope for rapid catch-up or reconstruction-based growth than most European countries in the early postwar period. Even so, it seems clear that the UK was less successful in exploiting what opportunities there were for catch-up, and attention therefore needs to be directed at Abramovitz's (1986) emphasis on the role of 'social capability' in this context. Here, particular importance attaches to industrial relations, competition policy and capital markets. In each of these, the UK exhibited significant idiosyncrasies which had important effects on the environment in which British company management - perhaps the most common scapegoat^of all - operated. In this chapter, for example, we consider both short- and long-run implications of bargaining between firms and their workers, which took place for most of the postwar period in a traditional, unreformed context. It is well recognized that productivity levels are one of the outcomes of such bargaining, and that circumstances such as weak competition in product markets, low unemployment and nonencompassing unions can lead to low productivity equilibria, and this implies a relatively low steady-state income level at the end of a catching-up process. In a context of new growth theory, however, it should be recognized that firm-worker bargaining arrangements can have long-run growth rate effects through their influence on the accumulation of broad capital (which will usually be measured in practice as an impact reflected in total factor productivity growth). To a substantial extent, the framework within whichfirmsand workers bargain is determined by government either directly or indirectly. Here it should be noted that, in the postwar UK, governments have traditionally looked to short-run macroeconomic performance as the economic underpinning to their re-election chances, rather than to productivity or long-run growth outcomes. Price and Sanders (1994: 302-3) suggest that this heavy concern with unemployment and inflation in the short term was perfectly rational; their econometric estimates show substantial effects of these variables on electoral popularity. This tended to push governments

British economic growth since 1945 133 Table 6.1. Growth of real output per head and productivity, 1950-89 (% per year)

1950-73 GDP/head Labour productivity TFP in business sector 1973-9 GDP/head Labour productivity TFP in business sector 1979-89 GDP/head Labour productivity TFP in business sector

UK

12-country median

2.4 2.5 2.3

3.4 3.6 3.0

1.5 1.3 0.6

2.0 2.2 1.4

2.1 1.7 1.5

1.9 1.6 1.2

Sources: Maddison (1991) and OECD (1991b). Labour productivity is measured using persons employed, and TFP estimates are for 1960-73 not 1950-73. towards formal or informal incomes policies and 'social contracts' which both precluded reform of industrial relations and lowered the competitive pressures on firms. The important implication of recent work in growth economics is that this policy preference may have had a long-run growth rate effect, not simply reduced the level of productivity. Table 6.1 examines the raw data of British growth in a comparative context. Relatively slow growth of both output and productivity through to the end of the 1970s shows up prominently, while relative but not absolute performance looks rather better in the 1980s, as other countries' growth slowed down. Although growth was disappointing by international standards in the Golden Age of 1950-73, it was most respectable relative to the UK's own historical performance. In 1873-1913 and 1924-37, real GDP grew at 1.8 and 2.3 per cent, with TFP growth at 0.5 and 0.7 per cent respectively (see Table 6.8 below). Table 6.2 reports purchasing power parity adjusted estimates of relative productivity levels. This makes more explicit economic decline relative to France and Germany, both of which were more successful in catching up the USA. Indeed, British productivity was overtaken by each of these countries during the Golden Age, and an increasing gap developed during the 1970s, especially in manufacturing. The 1980s, by contrast, saw a notable reduction in the UK's manufacturing productivity gap. Growth accounting exercises involving comparisons of the UK with France and Germany are reported in Table 6.3. Both Denison and Maddison made their estimates within a framework derived from traditional growth theory. Taken at face value, there are strong messages in Table 6.3. According to Maddison, during 1973-87 the sources of growth in each economy were brqadly similar, whereas during 1950-73 both capital input and, much more importantly, TFP growth were less strong in the UK.

134

Charles Bean and Nicholas Crafts

Table 6.2. Estimates of comparative levels of productivity, 1950-89 (UK =100) (a) Comparisons of real GDP/person employed France Germany 1950 1960 1973 1987

69.7 88.6 110.2 116.4

63.3 90.2 104.7 105.6

USA 167.4 167.5 151.6 128.9

(b) Comparisons of real value added/hour worked in manufacturing France Germany USA 1950 1960 1973 1979 1989

76.7 90.3 113.3 134.1 120.4

88.8 115.7 126.8 151.0 117.4

250.0 226.2 190.8 186.2 165.3

Sources: Maddison (1991); van Ark (1993).

In turn, this was only partly based on greater initial backwardness, and a major weakness in the UK is recorded as lower improvement in residual efficiency. Very similar results were obtained earlier by Denison in his classic study; indeed a major theme of Denison's paper was the substantial shortfall in UK productivity levels in 1960, coming from differences in work effort, restrictive labour practices and management quality. He estimated that this amounted to a shortfall of 14.3 per cent relative to France and 13.2 per cent relative to Germany (1968: 274). Evidently the details of these results may not be robust when confronted with new growth theory and, in any event, rely on assumed rather than estimated relationships. For example, the elasticity of output with respect to capital is assumed to be equal to the share of profits in G D P - which ignores the possibility of externalities to physical investment, as argued by Romer (1986) - while education's contribution is assumed to be through the impact of formal schooling on earnings - which ignores not only the externalities suggested by Lucas (1988), but also the impact of vocational training. An alternative accounting framework based on regression analysis provides an interesting check on these results. In Table 6.4, we have used an equation estimated to 'explain' growth in the international cross-section of countries after 1960, to consider the UK in a European context during the last part of the Golden Age. The equation taken from Levine and Renelt (1992) predicts that growth is increased by higher investment and higher school enrolment, and uses estimated rather than imposed coefficients. The equation includes a negative impact of government consumption spending on growth (presumably through both direct and indirect effects on productivity change), and normalizing for these variables also predicts a, catch-up or conditional convergence effect. This approach produces results which are not so very different from Maddison's, bearing in mind the difference in period covered. The main differences are in a somewhat bigger impact from lower investment and from scope for catch-up. Again

British economic growth since 1945

135

Table 6.3. Differences in the sources of growth, 1950-87 (% per year) (a) Maddisoris estimates France 1950-73 Labour input Education Capital input Total factor productivity Backwardness Other specific Residual efficiency 1973-87 Labour input Education Capital input Total factor productivity Backwardness Other specific Residual efficiency

Germany

UK

0.18 0.39 1.84 3.02 0.71 0.43 1.88

0.15 0.19 2.27 3.50 0.70 0.54 2.26

0.01 0.20 1.75 1.27 0.17 0.35 0.75

-0.24 0.56 1.48 0.92 0.11 0.19 0.62

-0.49 0.05 1.28 1.01 0.28 0.22 0.51

-0.19 0.41 1.12 0.82 -0.25 0.33 0.74

(b) Denison's estimates for 1950-62 Excess over the UK Labour input Capital input Total factor productivity Backwardness Other specific Residual efficiency Total

France

Germany

-0.15 0.28 2.50 1.47 0.31 0.72 2.63

0.77 0.90 3.30 2.14 0.35 0.81 4.97

Sources: (a) Derived from Maddison (1991); capital and labour include both quantity and quality; and 'backwardness' comprises technology diffusion and structural change. (b) Derived from Denison (1968: table 6.4); 'backwardness' is the sum of rows 20 and 24 in Denison's table, 'other specific' is row 14 and residual efficiency is row 29. some part of the shortfall in growth is 'unexplained' and represents a possible productivity failure. Indeed, the hypothesis of relatively poor UK growth performance after allowing for differences in factor accumulation has not been refuted by other investigations based on new growth theory. Crafts (1992: table 8) shows that much lower residual TFP growth for the UK in 1950-73 still shows up strongly after reasonable allowances are made for the Romer and Lucas externalities and a regression-based estimate of the differential impact of backwardness. The residuals from different specifications of regression-based estimates of new growth models allowing for catch-up and factor accumulation conclude that the UK's growth was unusually

136 Charles Bean and Nicholas Crafts Table 6.4. Levine and Renelt accounting for UK growth shortfall, 1960-73 (% per year)

Scope for catch-up Investment Education Public sector Unexplained Total

-0.49 -0.55 -0.08 -0.19 -0.32 -1.63

Source: Crafts (1996); comparisons of the UK with the average offifteenWestern European countries. low in the Golden Age (Crafts, 1992; Do wrick and Nguyen, 1989; van de Klundert and van Schaik, 1996). These studies give an average residual of —0.63 per cent for the UK between 1950 and 1973. Table 6.5 takes a closer look at some aspects of investment. Britain has a relatively low rate of physical investment, particularly in the period 1950-73. This may have been less serious for growth than might be imagined. De Long and Summers (1991) have argued that the key category of investment spending, where social returns are exceptionally high, is machinery and equipment; here the gap relative to other countries is quite small. The main shortfall lies in (residential and non-residential) construction expenditure; in 1960-73 the UK investment share of GDP was 5.4 percentage points below the twelve country median (OECD,1991a). Moreover, recent work at NIESR has found no evidence that social returns were significantly larger than private returns to fixed capital formation in British manufacturing (Oulton and O'Mahony, 1994). Crafts (1991a) also points out that relative to German manufacturing the UK investment rate throughout the postwar period has been fairly similar, and the main UK problem has appeared to be in the incremental capital to output ratio. The UK experienced quite normal European tax rates in the early postwar period, while since then taxation, notably direct taxation, has risen somewhat less than the average. Crafts (1991a: table 6) also shows that in the long run the Bacon and Eltis (1976) hypothesis that the rise of the non-marketed sector replaces investment is incorrect - actually marketed sector consumption has given way over the long run. If it were to be argued that relatively high taxation was the reason for relative economic decline, some more nuanced data would be required, reflecting the disadvantageous structure of the system, as Tanzi (1969) argued. Similarly, as Table 6.5 suggests, the crude data on school enrolment do not show a serious British shortfall and match Maddison's growth accounting findings on education, but a more subtle examination focusing more on training may give more insights. This issue is taken up in sections 4 and 7. In the recent literature, links between macroeconomic policy and productivity have been examined explicitly in terms of a bargaining model (Machin and

British economic growth since 1945 137 Table 6.5. Some comparisons relating to investment UK Fixed capital formation (% GDP) 1950-73 1974-9 1980-9 Equipment investment (% GDP) 1950-73 1974-9 1980-9 Total taxes (% GDP) 1950-73 1974^9 1980-9 Non-consumption taxes (% GDP) 1950-73 1974-9 1980-9 Gross primary school enrolment rate (%) 1950-73 1974-9 1980-9 Gross secondary school enrolment rate (%) 1950-73 1974^9 1980-9

12-country median

16.9 19.4 17.4

24.6 22.4 20.4

8.1 8.8 8.2

8.8 8.8 8.4

31.6 39.0 41.4

31.6 44.0 46.8

22.3 30.7 30.7

19.0 32.0 34.9

95 104 103

105 104 100

67 73 83

58 76 91

Sources: Investment data from OECD (1991a); taxation data from OECD, Revenue Statistics of Member Countries (various issues) - for 1950-73 an average of 1955, 1960, 1965 and 1970; school enrolment rates from Unesco, Statistical Yearbook (various issues).

Wadhwani, 1989). In this chapter it will be argued that the UK's postwar macroeconomic policy stance was to some extent harmful to productivity improvement through the 1970s, and that the experience of the 1980s reveals that willingness to invest in a spell of high unemployment in the short term can pay dividends in the longer term. Given the existence of these short-term trade-offs and the wide range of macropolicy regimes experimented with through time, it is particularly interesting to review short-term macroeconomic performance using Table 6.6. This shows that during 1950-73 the UK Misery index was no better than the European average, that inflation was extremely high in the 1974-9 period without the recompense of lower unemployment than elsewhere, and that during the 1980s the UK's inflation fell to a level similar to that in other European countries, but unemployment was rather higher and by now much above the level of the 1950s and 1960s. It is also noteworthy that the UK appears during the 1970s and 1980s to have moved to a high equilibrium level of unemployment both compared with other

138 Charles Bean and Nicholas Crafts Table 6.6. Inflation and unemployment: UK, 1950-89 (%) UK 1950-73 Inflation Unemployment 1974-9 Inflation Unemployment NAIRU 1980-9 Inflation Unemployment NAIRU

12-country median

4.6 2.8

4.6 2.3

15.6

9.2 4.4 3.2

5.0 5.2 7.3

10.0 7.9

7.0 7.2 5.0

Note: Layard and Nickell (1985) estimated the UK NAIRU as 1.96% for 1956-66. Sources: Maddison (1991) except for NAIRU estimates which are from Layard et al. (1991); the twelve countries are the European entries in the Maddison database. The NAIRU estimates are actually averages for 1969-79 and 1980-8. countries, especially those with more corporatist labour markets (Calmfors and Driffill, 1989), and compared with the early postwar period. 2

The legacy of the 1930s and World War II

As is well known, World War II left the UK with formidable problems of macroeconomic management, which are dealt with in some detail in Cairncross (1985). Key features of this legacy are reported in Table 6.7, which reflects a serious monetary overhang resulting from the forced savings of wartime, a major balance of payments problem, particularly in terms of dollars, and a high ratio of national debt to national income. In addition, of course, the government was well aware of the large productivity gap between the UK and USA (see Table 6.2), and realized that during 1940-4 net non-war capital formation had averaged minus 14 per cent of NNP (Pollard, 1992: table 5.8). Equally widely recognized are the implications of the 'Road to 1945' (Addison, 1975). The 'inescapable experience' of the economic problems of the 1930s and life on the home front during the war generated a large electoral majority for a Labour government committed to major increases in welfare spending and nationalization of a significant fraction of economic activity. Other important aspects of the postwar legacy prominent in the economic history literature are generally less well understood by non-specialists. As Table 6.8 reports, the interwar economy enjoyed some economic growth and, indeed, experienced a small increase in growth relative to the late Victorian/Edwardian period. Encouragement has been derived from the strong recovery from the depression after 1932, together with accelerated TFP growth and restructuring in manufacturing, and a reading of some texts gives quite an optimistic picture (Pollard, 1992).

British economic growth since 1945 139 Table 6.7. National debt, money supply and balance of payments: UK, selected dates (£m, current prices)

1938 1945 1950

Stock of national debt

Ml

8149 23774 25986

1862 4967 5710

Balance of payments Visible

Invisible

Current account

GDP at FC

-285 -250 -51

+ 230 -620 + 524

-55 -870 + 473

4932 8787 11391

Source: Mitchell (1988).

Table 6.8. Growth rates of output, capital stock and TFP: UK, selected dates (% per year)

1870-1913 Whole economy Manufacturing 1924-37 Whole economy Manufacturing

Output

Capital

TFP

1.8 2.0

2.0 2.6

0.5 0.6

2.3 3.2

1.8 1.3

0.7 1.9

Source: Matthews et al. (1982: table 8.3).

Nevertheless, in common with most of Europe, in a number of important facets interwar Britain was still very far from the type of economy to exhibit high growth potential for the years after 1945. Gross investment averaged only 8.9 per cent of GDP between 1923 and 1938 (Feinstein, 1972), and Table 6.8 shows a slow rate of growth of the manufacturing capital stock. Investments in other types of capital stressed by new growth theory were also weak. Research and development spending was only about 0.3 per cent of GDP (Sanderson, 1972), and only 10 per cent of the top 200 British manufacturing firms had their own research laboratory compared with 73 per cent of the American top 200 (Mowery, 1986). Of the cohort born in 1910-29, only 17.6 per cent went into secondary education (Floud, 1954). The UK had a revealed comparative advantage very different from that of the United States. Table 6.9 indicates this and shows clearly the US strength and British weakness in the high-technology, R & D-intensive industries of the period. This partly reflects American advantages in natural resources and a large home market, which raised the payoff to R & D (Nelson and Wright, 1992). It is also associated with the weak educational background of British managers (Gourvish, 1987) and the continued survival of small-scale family capitalism in an era when the hostile takeover was unknown (Chandler, 1990; Hannah, 1974). Last, but by no means least, the postwar legacy included a dangerous combination of traditional, craft-based trade unionism and product markets in which competition

140 Charles Bean and Nicholas Crafts Table 6.9. Revealed comparative advantage rankings: UK and USA, selected dates UK Agricultural equipment Car and aircraft Industrial equipment Electricals Iron and steel Non-ferrous metal Book and film Chemicals Metal manufactures Brick and glass Wood and leather Rail and ship Fancy goods Apparel Alcohol/tobacco Textiles

USA

1913

1929

1937

1913

1929

1937

10 12 5 8 3 16 13 11 7 14 15 1 9 6 4 2

16 14 8 7 4 13 6 10 11 12 15 1 5 9 2 3

16 11 7 5 9 15 8 12 13 10 14 3 4 6 1 2

2 4 3 5 9 1 10 12 6 11 7 8 13 14 15 16

1 2 4 5 8 3 6 9 7 12 10 11 14 13 15 16

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Note: At this time hi-tech sectors might be thought of as cars and aircraft, chemicals, electricals and industrial equipment based on research and development spending. Source: Derived from Crafts (1989: table 1). was very weak. British economic policy reacted to the world recessionary shock by moves to stabilize profitability and raise prices relative to vyages, including the encouragement of collusive agreements among firms and the imposition of tariffs. This was a sensible policy for the short term but had unfortunate implications for productivity improvements (Broadberry and Crafts, 1990,1992). Protectionism and trade associations were further strengthened in the war economy.

3

Reconstruction

On the whole, the Attlee government has been well regarded by recent academic commentators (e.g. Hennessy, 1992). Economic historians have been impressed in particular by its macroeconomic management in the difficult early postwar circumstances (Cairncross, 1985; Tomlinson, 1990). Three questions deserve to be raised in this section, and consideration of them leads to a somewhat less favourable assessment. They are the following: • Was the policy stance as good for long-term growth as it seems to have been for short-run macroeconomic performance? • Would a less gradualist approach to liberalizing the wartime economy have been better? • Was the 'New Jerusalemism' of the postwar welfare state policies a major reason for relative economic decline, as famously alleged by Barnett (1986)?

British economic growth since 1945

141

Table 6.10. The short-term UK macroeconomic position, 1948 and 1951 (1938 = 100)

1948 1951

GDP

IND Y

C

I

G

X

M

111.9 123.4

120 145

100.3 103.6

100.8 116.6

129.1 147.2

113.3 142.2

85.3 99.3

Sources: Feinstein (1972), except for industrial production taken from Eichengreen and Uzan (1992). Table 6.10 reflects the short-run position and the policy priorities of the government. Given the difficulties shown in Table 6.7, policy emphasized rapid increases in exports, tight control of imports and home consumption, and an early return to a balanced budget. The reconstruction years of the late 1940s were a time of moderate inflation (about 5 per cent per year) and very low unemployment rates (around 1.5 per cent as measured at the time). Afixedexchange rate was maintained, apart from a devaluation in 1949 of 9 per cent in the effective exchange rate (30 per cent against the dollar). By 1950 the balance of payments position had been rectified. The increase in industrial output reported in Table 6.10 is average for Western Europe excluding Germany (Eichengreen and Uzan, 1992: table 7). In many respects this was a successful stabilization, bearing in mind the precariousness of the original situation. Nevertheless, there were costs attached to the approach adopted. The most obvious was the preservation of market power of British producers. The tough anti-trust policy which the Board of Trade had originally proposed to introduce was abandoned (Johnman, 1991; Mercer, 1991), and the fear of harming the postwar export drive together with the threat perceived to the balance of payments from superior American industrial productivity also encouraged the retention of import controls. These still applied to 54 per cent of imports in 1951 (Dow, 1964: 175), and the threat of import competition remained remote for most manufacturers - the share of imports in home demand was still only 4.7 per cent in 1955 (Scott, 1963: 41). Eichengreen (1993) estimates econometrically that excess money balances were still around 50 per cent and a monetary overhang persisted until the mid-1950s. The policy choice was to forgo both currency reform and elimination of the overhang by price liberalization and an associated devaluation. Accordingly, the desire to hold down consumption implied retention of rationing and import controls, while the currency remained inconvertible apart from an ill-fated brief experiment in 1947. This gradualist approach to liberalization of the economy fitted with the overall approach of the government to its dealings with organized labour, in a climate where not only was a high priority given to redistribution of income but fears of wage inflation loomed large in the changed employment situation (Jones, 1987). The government sought a cooperative 'social contract* with the trade unions, in which wage restraint was accepted in return for welfarism, a commitment to full employment and non-interference in industrial relations (Tomlinson, 1991). Broadberry (1994) suggests this was conducive to a low NAIRU and shows econometrically that wage-setting behaviour changed substantially from its prewar mode. Nevertheless, the gradualism of the social contract implied that opportunities

142 Charles Bean and Nicholas Crafts

to increase competitive pressures on British managers were passed up - there would be no Thatcher-shock. It would seem likely that the overall approach to macroeconomic stabilization, the approach to improving the balance of payments, the failure to reform industrial relations and the obstacles to increasing product market competition all combined to lower productivity improvement relative to a more thorough and rapid liberalization of the wartime economy. Postwar welfare policy was largely based on the approach of the wartime Beveridge Report, which had argued the need to double benefit expenditures. Comparison of 1938 with 1951 shows that in the latter year government outlays were about 7.6 per cent higher as a share of GDP, about 4.8 per cent of which was accounted for by social services (Peacock and Wiseman, 1961). The share of direct taxes in private income from production doubled, rising from 11 per cent in 1938 to 22 per cent in 1950 (Weaver, 1950: 202). Clearly, the Beveridge approach to social security, relying on a contingency benefit/social insurance structure, was unduly expensive (Dilnot et al., 1984). A sizeable fraction of benefits went to the non-poor - Weaver's estimates suggest that about 25 per cent of expenditures in 1949 were received by the middle or wealthy classes and that, if these flows had been eliminated, direct taxation could have remained at its 1938 level without unbalancing the budget (1950: 202, 208). Nevertheless, the main reason for initiating a very progressive system of income taxation was to hold down the consumption of the rich in the postwar austerity period, not to fund the National Insurance system. It would seem mistaken to put undue blame on the expansion of the welfare state alone for any adverse effects high direct taxation may have had on postwar capital accumulation and growth. Nor would it be right to suggest that the situation was one of complacency on efficiency while concentrating too much on equity, as does Barnett (1986). The government was keenly aware of the advantages of higher productivity for achieving its macroeconomic objectives (Tomlinson, 1993), but had to accept that the social contract and the short-term imperatives reduced its leverage. Finally, how much impact did the Marshall Plan have on postwar British growth? Aid to the UK amounted to about 1.8 per cent of GDP in 1948-51. Eichengreen and Uzan (1992) estimate that the direct effects of this on growth were very small, while recent British research also argues that any impact of conditionality of the aid was also quite limited, apart from pushing the UK into the European Payments Union (Burnham, 1990). The UK did accept the idea of the Anglo-American Productivity Council as a way of seeking to reduce the productivity gap, or at least of placating American sentiment, but this appears to have had little or no success in raising British productivity levels in the prevailing circumstances of firms with market power and traditional industrial relations structures (Carew, 1987; Middlemas, 1986:158-62). In sum, the European Recovery Program probably had no more than a marginal impact on reconstruction in postwar Britain. 4

The Golden Age

The years 1950-73 are a period when British economic growth appears to have been exceptionally disappointing when placed in a comparative international context, as section 1 made clear. At the start of the period, the new Conservative administration

British economic growth since 1945

143

sought to change relatively little and, in particular, continued to aim for a social contract with the Trades Union Congress. By the end of the 1950s, slow growth had started to be perceived as a problem by politicians, and from then on there were a series of policy innovations designed to promote growth by stimulating investment, striving to achieve economies of scale and to improve technology. Two central questions permeate the literature on this growth experience: • How far was slower growth due to low UK investment? • What part did government policy play in inhibiting growth? Answers to these questions are far from agreed, but recent research at least provides some new, if preliminary clues. The simplest approach to the first of these questions is mechanically to apply recent cross-section regression results from studies of OECD growth to the difference in investment rates between the UK and the twelve-country median reported in Table 6.6. Using the Levine and Renelt (1992: table V, equation (v)) regression and accepting their standard approach to measurement, schooling differences are inconsequential and all the action comes from lower physical investment in the UK, which would have had 0.8 per cent higher growth if investment had been at the median level. An alternative approach would be to consider only equipment investment, as proposed by De Long and Summers (1991); here the gap is smaller between the UK and the median country, and an impact of only 0.2 per cent per year would be predicted. Englander and Mittelstadt (1988) also find for OECD countries that growth of the stock of R & D has an impact on growth. Prima facie, this should have been an aspect of British investment favourable to faster growth in the UK. By 1995 UK R & D spending had risen to 1.7 per cent of GDP and by 1960 to 2.5 per cent, second only to the USA (United Nations, 1964). Table 6.11 shows that this relatively high spending has not continued during the past twenty years, but during the Golden Age the UK was a big spender and this marks a substantial change from the 1930s. Unfortunately, much of this effort may have been misdirected from the point of view of economic growth (Pavitt, 1976), and after 1960 the stock of R & D was growing faster elsewhere. Englander and Mittelstadt's estimates imply that from 1960 to 1973 R & D may have accounted for 0.3 per cent per annum of the growth gap between the UK and Germany, while the patent statistics shown in Table 6.11 are clearly disappointing from the late 1950s on. Government accounted for much of the spending, and this concentrated on high-technology defence-related activities, which offered little in the way of externalities to the rest of the economy (ACOST, 1989). A detailed examination also suggests some weaknesses in human capital formation not well captured by either growth accounting or cross-section regression studies. These relate to training rather than education, an aspect of the British economy which has been the subject offiercecriticism lately. Table 6.12 shows the relative shortfall of vocational qualifications which had built up in the British workforce relative to Germany by 1979, the earliest available date. O'Mahony (1992) seeks to estimate the impact of the different proportions of qualified workers on the German-UK productivity gap in a cross-section of industry in 1987, allowing for both direct and Lucas-externality effects. She concludes that these together were responsible for a 13.4 percentage point gap.

144 Charles Bean and Nicholas Crafts Table 6.11. Research and development and patenting, 1938-89 (a) R&D

expenditure/GDP (%) 1964 1970

France Germany Japan UK USA 12-country median

1.8 1.6 1.5 2.3 2.9

1.9 2.1 1.8 2.2 2.6 1.3

1980

1989

1.8 2.4 2.2 2.2 2.4 1.4

2.3 2.9 3.0 2.2 2.8 2.0

(b) Share of non-American patents granted in USA (%) 1938 1950 1958 1979 France Germany Japan UK

9.2 38.2 1.5 22.7

15.5 0.6 0.03 36.0

10.4 25.6 1.9 23.4

7.9 22.7 27.8 10.8

1988 6.8 17.4 41.3 8.1

Sources: OECD (1991c, 1991d); Englander and Mittelstadt (1988); Nelson and Wright (1992); Pavitt and Soete (1982). Table 6.12. Labour force with intermediate vocational qualifications, 1979 and 1988 (%)

France Germany UK

1979

1988

32 61 23

40 64 26

Source: Steedman (1990).

Assuming that this applied across the economy as a whole and had accrued entirely in the period 1950-79, this might have accounted for a difference in growth between the UK and Germany of about 0.4 per cent per year. Given that German training is probably substantially better than the European average, and that there was a similar qualifications gap in the oldest workers in 1978/9 who would have been trained in the 1930s and 1940s (O'Mahony and Wagner, 1994: 16), this no doubt exaggerates the part training played in the UK's growth gap with the twelve-country median. In sum, it is likely that traditional growth accounting somewhat underestimates the role of lower investment in lowering UK growth relative to other European countries in the Golden Age. If so, it may turn out that this is not because of large externalities to physical investment, but because of failure to appreciate fully the role of differences in training of the workforce. It should also be noted that O'Mahony's estimates, while consistent with the Lucas externality, do not confirm the hypothesis of completely endogenous growth; her point estimates for manufac-

British economic growth since 1945 145 Table 6.13. Labour productivity comparisons in international companies: reasons for differentials, 1972 German advantage over UK (%) 'Economic' causes Length of production runs Plant and machinery Other 'Behavioural' causes Strikes and restrictive practices Manning and efficiency Total

5.5 5 2 3.5 8.5 27

American advantage over UK (%) 20.5 6 6 5 6 50

Source: Pratten (1976). turing would imply an elasticity of output with respect to broad capital of less than 1, with a best guess of about 0.6. It seems unlikely on this evidence, however, that the whole of the shortfall of UK growth, discussed in section 1, can be accounted for by elements of broad capital formation. This impression is confirmed by a consideration of the literature on UK productivity performance at this time - and by the events of the 1980s (see section 6). Pratten's study of productivity differences in international companies operating in several locations, summarized in Table 6.13, suggests that 'behaviourial differences' were responsible for about half the observed productivity gap between the UK and Germany. This is consistent with twenty-five studies relating to 1950-73, summarized in Pratten and Atkinson (1976: 574), twenty-three of which suggest that inefficient use of labour lowered productivity. There seems also to have been an impact from industrial relations reducing the rate of growth of productivity from new technology, according to the case studies in Prais (1981). How could such poor performance persist? The answer seems to lie partly in the 'public bad' of unreformed industrial relations, which even incoming American firms had to endure, partly in the weakness of entry threats, and partly in the ineffectiveness of takeover threats as a discipline on management that was still weak on qualifications (Acton Society Trust, 1956). Big changes appeared on the company scene during the 1950s and 1960s. At this point, the move towards corporate capitalism advocated by Chandler (1990) took place, and at a pace faster than on the continent. By 1970,72 per cent of the top 100 companies were M-form compared with 40 per cent in Germany (Channon, 1973; Dyas and Thanheiser, 1976). The 1948 Companies Act increased disclosure requirements; the improved information facilitated mergers and, for the first time, hostile takeovers. Whereas in the 1940s only 788 firms disappeared via merger, in 1960-9 the number was 5635 (Hannah, 1983). By 1970 the share of the largest 100 firms in manufacturing output was about 40 per cent, almost double the level of 1949, while the averagefive-firmconcentration ratio had risen to about 65 per cent (Walshe, 1991: 340-1).

146 Charles Bean and Nicholas Crafts

While these changes appear to have increased market power (Cowling and Waterson, 1976), there is little evidence that the merger and takeover boom resulted in better productivity performance or selectively eliminated bad managers, rather than promoting a race for survival throughfirmsbecoming too big to be vulnerable to takeover (Cowling et al.y 1980; Meeks, 1977; Singh, 1975). The role of government policy in the UK's growth failure during 1950-73 is not easy to quantify, but it was probably important in terms of both acts of commission and acts of omission. Both demand- and supply-side policy deserve to be considered. From the early 1950s, macroeconomic policy embraced Keynesian demand management, particularly aiming at fine tuning through tax changes, based on a strong commitment to full employment, but retaining the rules-based approach of a fixed exchange rate until 1972, with only one devaluation from $2.8 to $2.4 in 1967. Modest budget deficits of around 3-4 per cent of GDP permitted a reduction in the ratio of national debt to GDP to about 87 per cent in the late 1960s (Ward and Neild, 1978). The Conservative governments of the 1950s assiduously pursued the social contract and even appeasement of the trade unions (Smith, 1990). As the locus of bargaining moved to a more decentralized shop steward-based level, governments from 1962 onwards turned to more formal incomes policies, which in various forms were a major plank of counter-inflationary policy until 1979. Dow (1964) delivered a damning indictment offinetuning, arguing that stop-go policy had actually destabilized the economy. This verdict has subsequently been challenged, but the econometric evidence does not suggest any great contribution to stabilizing demand growth (Hatton and Chrystal, 1991). At the same time there is evidence that the UK experienced milder fluctuations than most other OECD economies (NEDO, 1976), and any damage done may have mostly resulted from distracting the Treasury from potentially more fruitful policy initiatives. Supply-side policy evolved very considerably over time, although continuously embracing substantial subsidies to physical investment (Musgrave and Musgrave, 1968). Policy towards investment was generally poorly designed, however, and most commentators are sceptical of any substantial impact on investment volumes (Morris and Stout, 1985: 868). The system of investment allowances was subject to frequent alteration, targeted physical while neglecting human capital, where the externalities were probably much larger, and was highly distortionary in its effects. The 1960s saw a series of innovations to policy, including the establishment of the National Economic Development Council in 1962, the Industrial Training Act (1964) and the setting up of the Industrial Reorganization Corporation (1966), which marked a shift towards a more selective approach to sponsorship of industry. The tradition of voluntarism and absence of reform prevailed in industrial relations until the unsuccessful Industrial Relations Act (1971). There is no evidence, however, to indicate that these initiatives had any substantial positive effects. Probably more helpful was the strengthening of pressures on managers from competition and trade policy, including notably the Restrictive Practices Act of 1956 and during the 1960s participation in tariff reductions under GATT. On the other hand, the nationalizations of the 1940s were not reversed, and a combination of principal-agent problems and lack of competition delivered poor performance in this sector, which accounted for nearly afifthof all investment (Vickers and Yarrow, 1988).

British economic growth since 1945

147

The biggest failings probably lay in the neglected areas of policy - the unwillingness to tackle industrial relations problems, the failure to recognize fully or to give priority to the need to strengthen workforce training, and the inability of successive governments to face up to inefficient use of labour and to create an environment which put pressure on managers to eliminate X-inefficiency. All of these problems were known to informed commentators of the day, although they have certainly been put in sharper focus by the experience of the 1980s. 5

Shocks and stagflation

In common with the rest of Europe, the UK faced a turbulent macroeconomic environment after 1973, entailing severe adverse shocks to both aggregate supply and aggregate demand. Extremely pessimistic prognoses of future growth prospects were common, and great stress was placed both on the balance of payments position and a declining share of profits as long-term obstacles to a revival of growth. In fact, the long-term threat to growth from the stagflationary shocks was generally overestimated. Some of the inhibitions to faster growth in the Golden Age do, however, emerge more clearly when the disappointing years after 1973 are considered. In particular, government supply-side policy once again was developed in the context of an attempt to sustain a social contract with the trade unions. Two questions worth addressing are as follows: • Was growth performance as bad as Table 6.1 suggests? • How successful were industrial policies in remedying market failures which constrained growth? Table 6.1 reported TFP growth of only 0.6 per cent between 1973 and 1979, with the growth rate of real GDP/head falling to 1.5 per cent. This would have been smaller still had it not been for North Sea Oil, which accounted for growth of about 0.5 per cent per year. Recent work suggests that two mitigating factors need to be considered: namely, errors in the estimates of capital inputs and the implications of incorrect expectations in the new situation after the first oil price shock. Muellbauer (1991) discusses the first of these factors, noting that standard series do not adequately adjust for changes in capacity utilization and that the oil shock probably led to 'premature scrapping': that is, asset lifetimes lower than assumed by the CSO statisticians. Allowing for utilization, in manufacturing at least, leaves the productivity slowdown little altered. The 'premature scrapping' bias may play a significant role, but it cannot at present be estimated reliably. Darby and Wren-Lewis (1991) review the second hypothesis. They conclude that there is good survey evidence thatfirmsfailed to anticipate that sales growth would not recover quickly towards its pre-1973 level and hoarded labour during the late 1970s, only to shake this out in the early 1980s when their mistakes became both obvious and very costly. This gives a flavour of disequilibrium to the observed productivity performance of the 1973-9 period. Both arguments point to the possibility of exaggerating the impact of the changes in policy after 1979 on productivity performance. Indeed, Darby and Wren-Lewis claim that underlying labour productivity growth in manufacturing tended to a constant trend rate of about 2.7 per cent over 1967-87.

148 Charles Bean and Nicholas Crafts

The growth outcome took place in the context not only of the oil price shock, but also of a strong domestic tendency to inflation in the context of a new macroeconomic policy regime. After 1972 the pound was afloatingcurrency, allowing greater policy discretion, while at the same time a combination of fears of unemployment, technical changes in methods of monetary control and a hope that a dash for growth might promote productivity advances combined to produce a very loose policy stance (Blackaby, 1978; Dimsdale, 1991). M3 grew at over 27 per cent per year in both 1972 and 1973, while the budget, which had been in balance in 1970, showed a deficit of 9 per cent of GDP by 1975. The incoming minority Labour government of 1974 inherited massive inflationary pressures, but was politically much too weak initially to act to contain them (Dell, 1991). When disinflation was eventually introduced in 1975, incomes policy was at the centre of the stage in the attempt to regain price stability without jeopardizing employment levels, and again the cooperation of the trade unions was seen by the government to be the key to its success. This placed major constraints on policy, and indeed one recent commentator concluded that The recurring theme of this review of the 1974-9 government has been that of the damage done by its anxiety not to offend the trade union movement' (Brown, 1991: 226). Supply-side policy for growth by the mid-1970s had become strongly linked to a more active and selective set of industrial policies, while reforms of taxation, training and industrial relations were neglected (Artis and Cobham, 1991). Further nationalizations included British Aerospace, British Leyland and British Shipbuilders, while the Industrial Reorganization Corporation was succeeded in 1975 by the National Enterprise Board. These interventionist moves were generally supported by trade unions. Subsequent comment by economists has been much less enthusiastic. For example, Hindley and Richardson (1983) show how relatively low the returns were on government-backed mergers where soft loans were involved, while Morris and Stout (1985: 873) concluded that 'through these institutions, it was losers like Rolls-Royce, British Leyland and Alfred Herbert who picked Ministers'. Table 6.14 demonstrates a very mixed productivity performance in the nationalized industries, although airways, gas and telecommunications all show fast growth of output per worker during 1970-80. Reports by the Monopolies and Mergers Commission on coal (1983) and electricity (1981) were severely critical of long records of misuse of both manpower and capital. It is certainly difficult to conclude that nationalization was a plausible way to accelerate catch-up growth, taking into account the data on comparative productivity levels. Vickers and Yarrow, who highlight the very low returns made on nationalized industry investment, stress deficiencies in government control and, associated with this, excessive investment and internal inefficiency as characteristic of nationalized industries in the 1970s (1988: 143-7). In sum, although the raw data probably exaggerate somewhat the weakness of productivity performance in the later 1970s, this was a period in which growth was weak and supply-side policy was badly orientated. As in the 1930s and the early postwar period, the exigencies of coping with a difficult short-term macroeconomic situation produced a policy package which precluded reforms that might have improved medium-term growth performance. The disruptions of the 1970s probably had a worse impact in reducing growth in

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Table 6.14. Productivity outcomes in UK nationalized/privatized sector, selected dates

Coal Railways Steel Electricity Postal Gas

Telecom Airways

Labour productivity growth (% per year) 1970-80 -2.4 -2.0 -1.7 3.7

-0.1 4.9 4.3 8.1

1980-90 8.1 3.2

13.7 2.5 3.4 4.9 7.2 6.0

Relative US/UK labour productivity level Late 1930s Mid-1970s 3.80 2.97 1.97 1.93 1.63

7.60 3.95 2.57 3.47 2.28 2.79 2.69 1.52

Sources: Bishop and Thompson (1992); Rostas (1948); Smith et al. (1982). the short term than in further weakening the UK supply side or bringing new binding constraints on long-term growth. At any rate, as theory would predict (Layard et al., 1991:100-90), the profits squeeze turned out to be temporary, and the dismal record of the 1970s promoted an eventual reaction against the supply-side policies of the 1960s and 1970s. 6

Recovery in the 1980s and its legacy

The Conservative government elected in 1979, with Margaret Thatcher as its leader, offered an escape from the disappointments of the 1970s through institutional reform on the microeconomic front, and the espousal of monetarism in macroeconomic policy. Among the key elements of this new policy stance were the following: • Supply-side policy moved towards increasing pressure for cost reductions to eliminate X-inefficiencies, and away from the pursuit of allocative efficiency. Government regulatory rather than market failures were targeted for policy action, subsidies were reduced and eventually privatization was given a high priority. This amounted to a rejection of the central thrust of postwar industrial policies. • The government finally abandoned counter-cyclical policy in the form of demand management, as practised by the Keynesian policy-makers of the 1950s, 1960s and early 1970s. The Thatcherites, if not the Wets, accepted rapidly rising unemployment as the consequence both of seeking to establish a credible counter-inflationary policy and of reducing the UK's productivity gap, although they did not foresee the full implications of the switdi in policy stance. • There was a heightened emphasis on efficiency relative to equity in the resolution of policy conflicts. Thus, priority was given to cutting personal taxes rather than

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expanding welfare spending, and to faster growth and restructuring rather than income redistribution or support for lame ducks. In all these respects the government was proceeding contrary to the wishes of trade union leaders and saw itself as seeking to escape from the trade unions' veto on economic reform (Holmes, 1985). The poor performance of the 1970s and fortuitous political circumstances - notably the Falklands War, which may have raised the Conservative vote by 25 per cent in 1983 (Price and Sanders, 1994) - gave a radical British Prime Minister an extended window of opportunity to undertake economic reform. Many of the policy developments of the 1980s would indeed have been regarded as inconceivable by informed opinion in the 1960s and 1970s - for example, the reduction of the top marginal income tax rate to 40 per cent, the privatization of the major public utilities and many council houses, the indexing of welfare benefits to prices rather than wages, the outlawing of the closed shop and the decimation of the National Union of Mineworkers. Similarly, the government's re-election in 1983 and 1987, despite the very high levels of unemployment in those years, flew in the face of the conventional wisdom previously accepted by all postwar governments. Tables 6.1 and 6.2 give prima-facie support to the suggestion that the new policy regime brought an improvement in productivity performance. This view is strengthened by regression studies allowing for catch-up and factor accumulation. Crafts (1992)findsthat growth is now better than predicted, whereas in the Golden Age it was worse, while looking at the growth component unexplained by Levine and Renelt's (1992) regression along the lines of Table 6.4 suggests that the previous growth shortfall turns into a superior UK performance. The estimated turnarounds are about 1.5 per cent and 0.8 per cent per year respectively. Two important and closely related questions arise from this: • Was the Thatcher Experiment worth it? • What might be the long-term as opposed to the short-term effects of the policy switch? Everyone would agree that there were losses as well as gains from the new policies, and a decisive argument in their favour probably requires a positive impact via a long-run rather than a transitory growth rate improvement. This may seem more plausible than it might once have, since new growth theory suggests ways in which this result could occur. The new policy stance affected the framework in which investment decisions and bargains between management and their workers were made, as well as having direct effects on the use of capital and labour. The thrust of policy was to attack restrictive practices and overmanning, rather than to aim for government sponsorship of investment-led growth. Changes in taxation were relied upon to promote capital accumulation. Table 6.2 showed a large reduction of the manufacturing productivity gap with Germany between 1979 and 1989, much of which occurred in the first half of the 1980s. Yet it is widely agreed that, at least until 1985, this recovery owed little or nothing to investments in plant, people or technology, but came from more efficient use of existing factors of production. Econometric studies found that this initial

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change was linked to the conduct rather than the structure of industrial relations, with changed working practices and manning levels contingent on reduced trade union bargaining power, which resulted from unemployment shocks, anti-union legislation and greater competition in product markets (Bean and Symons, 1989; Haskel, 1991; Machin and Wadhwani, 1989). Notably, it has been argued that it is undeniable that the most dramatic changes in working practices have been achieved in industries with product market crises' (Brown and Wadhwani, 1990: 68). Similarly, as is reflected in Table 6.14, the government had some success in improving productivity in the public enterprise sector, notably after defeating major strikes in steel (1980) and coal (1984-5). It appears, then, that in the 1980s the UK performed a somewhat belated catching-up exercise; this seems to confirm the diagnosis that slow growth in the Golden Age owed a good deal to institutional factors which reduced productivity growth, and which were politically difficult to reform once entrenched. Obviously job shedding in manufacturing tended to raise broad capital per worker for the remaining labour force, but O'Mahony and Wagner (1994:8,24-5) conclude on the basis of a growth accounting exercise that about half the improvement in labour productivity in British relative to German manufacturing came through greater efficiency in factor usage (TFP), and they also note that regressions at the sectoral level suggest a doubling of the speed of catch-up of its German counterpart by the average British industry in 1979-89 compared with 1960-73. By contrast, British weaknesses in technology and capital accumulation, both human and physical, continued throughout the 1980s. The immediate route to faster growth was not apparently the one prescribed by new growth economics, as the data on investment, R & D, patenting and vocational training in Tables 6.5,6.11 and 6.12 indicate. An assessment of technological capabilities in the late 1980s concluded that the UK remained a weak performer (Patel and Pavitt, 1988), and spending on R & D by industry lagged behind that in competitor countries - 1.6 per cent of industrial GDP in 1988 compared with 2.2 per cent in Germany and 2.1 per cent in Japan (Stoneman, 1991: 12). O'Mahony (1992) provides estimates of the sources of the German productivity lead over the UK in the late 1980s based on a cross-section production function analysis of productivity gaps by sector. The essence of her results is reproduced as Table 6.15. The key implications are that the pressures of the 1980s did not eliminate the German advantage in accumulation of factors of production, but they did succeed in forcing British management to make better use of the factors of production that were available than their German counterparts. This is an interesting reflection on the relative strengths and weaknesses of German and British institutions, as pointed out by Carlin (1996). So, were these policy reforms worthwhile? The answer obviously depends on what social welfare function is assumed, and on assumptions about the counterfactual path of both policy and the economy. The main costs of the policy reforms can be expected to have arisen in terms of additional unemployment and increased inequality of incomes. Thus, on a standard definition adopted by Eurostat that 'poverty' is an income less than 50 per cent of average equivalent income, the UK experienced a sharp change dissimilar to the rest of the EU. From 1975 to 1985 the percentage of persons in poverty rose from 6.7 to 12.0 per cent in the UK compared

152 Charles Bean and Nicholas Crafts Table 6.15. Productivity of labour in manufacturing, 1987: sources of German lead over UK

Human capital Physical capital R&D Efficiency Total

13.4 10.1 5.8 -7.5 22.2

Source: O'Mahony (1992). with an (unweighted) average increase from 13.4 to 14.1 per cent in the other eleven EU countries (O'Higgins and Jenkins, 1990). Johnson and Webb (1993) estimate that about 80 per cent of the rise in UK inequality was policy induced. The policy stance also risked a large rise in structural (long-term) unemployment as manufacturing shed jobs, particularly among unskilled males. Layard et al. (1991:446) estimate that 'mismatch' raised the NAIRU by 1.54 percentage points in the 1980s relative to the 1970s, and Table 6.6 confirms that the UK NAIRU rose by more than the European average. An illustrative calculation might go as follows. The additional mismatch component of the UK NAIRU of 1.5 percentage points per year might be taken to indicate the cost of abandoning conventional 1970s policies. Evaluating this at average labour productivity (presumably a slight overestimate) implies an annual loss of the same fraction of GDP per head. Losses from rising inequality will depend on the investigator's degree of inequality aversion (e). Crafts (1993) suggests that welfare may have been reduced by about 5.6 per cent of GDP by rising inequality not experienced elsewhere in Europe, if the well-known Atkinson (1970) approach is adopted with e = 1.0, or about 2.9 per cent with e = 0.5. Annual welfare losses from the Thatcher Experiment on this approach can be put at somewhere between 4.4 and 7.1 per cent of GDP. Against this needs to be set the value of the productivity gains it produced. If a 20 per cent improvement in productivity in manufacturing relative to the average of France and Germany between 1979 and 1989, as shown in Table 6.2, is regarded as a plausible lower-bound guess, then these gains were worth at least 6 per cent of GDP by 1989, with at least half coming by 1984. A more refined calculation might seek to express these flows in present-value terms, but would require still more assumptions. On balance, then, it appears that, if the productivity gains are a once-and-for-all catch-up (levels effect), the assessment is finely balanced and will be very sensitive to assumptions and value judgements. If, on the other hand, the changes of the early 1980s were to lead to permanently faster growth, then virtually everyone would be likely to conclude that the present value of this welfare improvement is worth the short-run unemployment and inequality costs. It is exactly such possibilities that are contemplated by endogenous growth theory. An early return to the policy approach and weak performance of the 1970s seems unlikely, despite doubts about the continued political appeal of Thatcherism (Crafts, 1991b). The framework in which firms and unions operate will be

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characterized by the competitive environment of the single European market, and by the end of the 1980s, changes in the structure of industrial relations consolidating the loss of trade union power were evident (Gregg et aL, 1991; Purcell, 1991). Also the gains from future technological improvements are less likely to be diluted than in the past by workers' resistance to new working arrangements, so there should be some permanent improvement to the rate of productivity growth (Muellbauer, 1991: 106). Any large long-run effect probably depends on greater broad capital accumulation. Here the evidence is hard to read, although the data of Tables 6.5,6.11 and 6.12 are not particularly encouraging. A more optimistic view might be entertained, if late 1980s education and training reforms bear fruit, if the changes in industrial relations enhance investment and innovation activities offirms,and if lower marginal direct tax rates do eventually have the effect predicted by new growth theory, perhaps reflected in the higher private sector investment of the late 1980s. By 1989 this amounted to 17.1 per cent of GDP compared with 13.1 per cent in 1979 and 13.3 per cent in 1985. On the downside, there are some negative long-term effects to contemplate, mostly reflecting the deindustrialization which accompanied the Thatcher period, and which is considered more fully in section 9. The reduced size of the tradables sector implies future terms of trade losses from a need over time to devalue the real exchange rate in order to combine internal and external balance. The estimates in Church (1992) indicate a possible real income loss from this effect of the order of 0.4 per cent per year. More speculatively, deindustrialization may reduce the opportunity to benefit from externalities to investment and learning effects. Fixed investment in manufacturing fell from 3.6 per cent of GDP in 1979 to 2.8 per cent in 1989. In sum, the long-run implications of the recovery and reforms in the UK during the 1980s are uncertain, and accordingly a full assessment of the Thatcher Experiment is still premature. The next three sections take up these issues in more detail. 7

Bargaining models and productivity change

The surge in manufacturing productivity of the 1980s gave rise to a substantial modelling and empirical effort by economists. The most fruitful approach so far has explored the implications of bilateral bargaining between unions and management over wages and effort (manning levels). In essence, the predictions of this model are that bargained productivity levels will tend to rise when workers' bargaining power is reduced and when the rents available tofirmsin the product market decrease. This leads to the expectation that higher unemployment (which will tend to weaken labour's bargaining position) and greater product market competition will tend to raise output per head, while unionization, particularly of a fragmented and non-encompassing kind, will tend to lower it. Government industrial relations, competition and macroeconomic policies will all, of course, potentially affect the outcome of the bargain. The approach is set out clearly in Haskel (1991), which also contains references to the earlier literature. The emphasis of this literature on bargaining and productivity has thus been on the comparative statics of shifts in the balance of bargaining power between labour and capital that induce changes fn effort levels and productivity. According to this

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view, the effect of the reduction in the relative bargaining strength of labour brought about by the Thatcher government's industrial relations reforms would be to produce a temporary surge in productivity growth during the transition to a higher level of output per worker, but no permanent effect on the growth rate. This contrasts with the rhetoric of Conservative politicians, who argued that the reforms would not only raise productivity immediately through ending overmanning and permitting a more efficient use of the workforce, but also foster a more entrepreneurial spirit in the economy and thus generate a permanently higher growth rate. The 'new' growth theory identifies a number of potential 'engines' of growth in total factor productivity. These include: externalities from investment in physical capital (Romer, 1986); externalities from investment in human capital (Lucas, 1988); and purposeful investment by firms in R&D and new product development (Aghion and Howitt, 1992; Grossman and Helpman, 1991; Romer 1987,1990). All of these approaches suggest ways in which industrial relations and other policies can affect the long-term growth rate of total factor productivity and thus also of per-capita output. In particular, in all of these models total factor productivity is the result, either unintentional or intentional, of an investment decision. Anything that reduces the return to that investment will end up reducing the growth rate. In an important contribution, Grout (1984) showed how bargaining between management and unions can lead to underinvestment in the absence of binding contracts, because ex post the workforce is able to expropriate some of the quasi-rents that are properly the return to capital. In Grout's model, this reduces the amount of capital invested and thus the level of productivity. Furthermore, the more powerful is the union, the bigger is the adverse effect on output. However, with an engine of growth of the kind considered by the new growth theory, this translates into an effect on the long-term growth rate. In an appendix, we integrate Grout's insight into an endogenous growth model in which the engine of growth is purposeful investment by firms in R & D in order to develop new products-specifically Romer's (1987) expansion-in-varietiesmodel. In this model,firmsinvest resources in order to develop new products. The reward for innovation is a period of monopoly profits. (New products are protected by patent. If this were not so, and new goods could be costlessly imitated, then nobody would ever find it profitable to invest in R&D.) When there is bargaining between management and the workforce, the latter is able ex post to extract some of these monopoly profits for itself. This in turn reduces the incentive to undertake new product development in thefirstplace. The result is an inefficiently low growth rate. Since a particular feature of the British industrial relations scene during the postwar period has been the presence of craft-based rather than industrial unions, the analysis also explores the implications of bargaining with multiple unions. Because each union can 'hold the firm to ransom' in turn the inefficiency is worse, and the growth rate lower, than with a single union representing all the workforce. This inefficiency due to bargaining would disappear either if the union, or unions, could write a binding contract ex ante that ties its hands and ensures that investors reap the full return from R & D, or if a reputational equilibrium could be established in which the workforce eschews exploiting its bargaining power today, knowing that in return the firm will undertake more R&D. While the former may be infeasible, the latter is not impossible (see the paper by Eichengreen (1996) for

British economic growth since 1945 155 Table 6.16. Panel regressions of total factor productivity growth in British industry (dependent variable: total factor productivity growth) With Order dummies 0.153 (1.49) Union recognition -0.086 (0.25) Multiple unions -0.754 (2.06) Multiple union dummy 0.689 (1.33) Employment shock -0.130 (3.36) Concentration ratio 0.703 (1.22) -0.301 Import share (0.47) 2.391 Standard error R2 0.210 2.042 Durbin-Watson No. of observations 794 Capital growth

No Order dummies 0.141 (2.11) 0.055 (0.17) -1.112 (3.38) 0.668 (1.28) -0.134 (3.62) 0.388 (0.96) 0.561 (1.07) 2.689 0.196 1.959 794

Notes: f-statistics in parentheses; coefficients on time and Order dummies omitted for brevity.

further discussion of such co-operative equilibria). However, it is far less likely when multiple unions are involved, because of the difficulty of preventing individual groups of workers from free riding on the restraint of others. Thus the model points to the presence of multiple unions as a particular depressing factor on the growth rate. Table 6.16 reports empirical evidence on this, and other, explanations for the UK's relatively poor postwar growth performance from a panel study of British industrial performance. Ideally, one would like to test the hypothesis using firm-level data, but unfortunately at present the best we can do, if we wish to examine both time-series and cross-section variation, is the three-digit industrial level. The dependent variable in these regressions is thus the average annual growth rate of total factor productivity in 137 industries (Orders III-XIX of the 1968 Standard Industrial Classification) over eight periods (1954—8, 1958-63, 1963-8, 1968-73, 1973-6, 1976-9, 1979-82 and 1982-6; data are not available for all industries over all periods, so the panel is unbalanced). These data are taken from table H.ll of Oulton and O'Mahony (1994), which contains more details about its construction, including the linking of data from the 1968 and 1980 SICs. The independent variables include the following: the average annual rate of growth of the capital stock in the industry (from table H.3 of Oulton and O'Mahony); the fraction of workplaces within the industry in which there is at least one recognized union for manual labour (from the 1980 Workplace Industrial Relations Survey); the fraction of workplaces within the industry in which there is

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more than one manual union (also from the 1980 WIRS); a multiple union dummy that takes the value zero before 1979 and is the same as the previous variable for 1979-82 and 1982-6; an employment 'shock' dummy which takes the value zero before 1979 and the proportionate fall in employment during 1979-82 for 1979-82 and 1982-6 (from table H.4 of Oulton and O'Mahony); thefive-firmconcentration ratio in the industry (from the Census of Production); the ratio of imports to home demand (from Wells and Imber (1977) and Business Monitor); and a set of common time dummies. The rationale behind the inclusion of these variables is as follows. The growth rate of the capital stock is included to pick up externalities from physical capital formation on to knowledge creation of the sort discussed by Romer (1986). Since the variable in question relates to capital formation within the industry, this variable should be thought of as relating to 'local', rather than economy-wide, externalities. The latter will be related to the total rate of capital accumulation in the economy, and so will be captured by the time dummies. However, it is surely reasonable to believe that the spillovers of the sort identified by Romer should be stronger on to firms producing similar products than on to those in relatively unrelated industries. Because the rate of capital accumulation may be correlated with the rate of total factor productivity growth, we treat it as endogenous and instrument it with lagged capital growth. The next four variables capture the impact of the industrial relations environment - in particular, the impact of multiple unions. The multiple union dummy permits the adverse effects of multiple unions to be ameliorated during the 1980s as a result of the reduction in union power brought about by the twin effects of the 1980-2 recession and the Thatcher government's industrial relations reforms. The employment shock dummy is intended to capture the idea that the transformation of industrial relations was greatest in those industries subject to the greatest shakeout of employment in the 1980-2 recession; this variable has been widely employed in other work on the 1980s productivity resurgence (Bean and Symons, 1989; Layard and Nickell, 1989; Metcalf, 1989). The concentration ratio and the level of import penetration are intended to capture the intensity of domestic and foreign competition. Theory suggests that the impact of these variables could go either way. On the one hand, a protected market position allows managers to opt for a quiet life and rest on their laurels. On the other hand, it allows larger and more durable quasi-rents from innovation, so promoting growth. All of the regressions include a full set of common time dummies; these are highly significant, with a marginal significance level close to zero. Unfortunately, there is no time-series dimension available for the industrial relations variables, the 1980 WIRS being thefirstof its kind. Consequently, it is not possible to include a full set of three-digit industry dummies and still identify the industrial relations effects. However, we have tried including a set of fifteen Order-level dummies. The first column of Table 6.16 includes these, while the second column omits them (they are just significant at the 1 per cent level). Fortunately, the results do not seem to be too sensitive to their exclusion. In addition, the Durbin-Watson statistics in both regressions are very close to 2, while if a lagged dependent variable is included in the regression, it invariably attracts a small, statistically insignificant coefficient.

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Consequently, we are led to conclude that industry fixed effects are relatively unimportant, and their omission should not bias the results unduly. Both sets of empirical results suggest that the presence of multiple unions significantly depresses total factor productivity growth, with multiple union workplaces having exhibited an annual rate of total factor productivity growth some 0.75-1 percentage points lower than that achieved by single union workplaces over the 1954-79 period. Once the presence of multiple unions is controlled for, there appears to be no residual effect from union recognition. This suggests that cooperative outcomes that avoid the Grout-style inefficiencies may have been relatively easy to establish in single union workplaces. The WIRS data set also allows us to distinguish between multiple unions which bargain separately with management, and those which bargain jointly. Machin et al. (1993), using the 1984 WIRS, find that pay tends to be higher, and company financial performance worse, in workplaces where multiple unions bargain separately compared with single union workplaces; however, where they bargain jointly there is no noticeable difference. Thisfindingis in line with the theoretical model of the appendix, which suggests that the adverse effect of joint bargaining by multiple unions should be less than where there is separate bargaining. When we decompose the multiple union variable into the fraction who bargain jointly and the fraction who bargain separately, the point estimates of the coefficients are quite similar, and a formal test of equality of the two coefficients fails to reject the hypothesis that they are in fact the same (the marginal significance levels are 98 per cent with the Order-level industry dummies and 74 per cent without them). However, we cannot reject with much confidence the hypothesis that it is only where multiple unions bargain separately that there is an adverse effect on total factor productivity growth (the marginal significance levels are 30 and 7 per cent respectively). We conclude that there is insufficient information in this data set to indicate conclusively how the precise structure of bargaining has affected the growth rate. Turning next to the impact of the 1980-2 recession and the industrial relations reforms of the Thatcher government, we find that the coefficient on the multiple union dummy is positively signed and of the same order of magnitude as the coefficient on the multiple union variable itself. This suggests that the adverse effect of multi-unionism has been significantly ameliorated during the 1980s; indeed the implication of the estimates containing the Order-level industry dummies is that the effect had been almost completely eradicated. The results are therefore in line with those of Machin and Stewart (1994), who, using the 1990 WIRS and a subjective measure of productivity growth,findno effect from multi-unionism during the late 1980s. The employment shock variable is also highly significant, in line with most earlier work. The rate of capital accumulation is only rather marginally significant. In addition, the size of the coefficient is rather small, being about a quarter of the size required to generate endogenous growth under the Romer (1986) model. Thus the evidence for externalities from capital formation is rather thin, although it should be remembered that the economy-wide externalities are picked up by the time dummies. In addition, a curious feature of the results is that the bias under Ordinary Least Squares turns out to be negative rather than positive as expected. This could reflect the impact of measurement error, perhaps because the effect of capital externalities takes some

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time to spill over to other firms. Neither of the variables intended to capture the impact of thefirm'scompetitive environment seems to play any major role. If anything, the results seem to suggest that a high degree of competition, at least from domesticfirms,may tend to depress total factor productivity growth, but clearly there is insufficient information in the data to draw any firm conclusions. These estimates are, of course, only preliminary and may be subject to reappraisal in the light of further work. They do, however, confirm the view that the UK's poor postwar growth performance has been due in at least some measure to the industrial relations environment, and in particular to its fragmentary, craft-based union structure. 8

Human capital formation

During the 1980s a wide consensus developed that education and, particularly, vocational training were seriously in need of reform, and that successful implementation of new arrangements could contribute to better growth and productivity performance. Research at NIESR was fundamental to this heightened awareness of weakness in human capital formation in the UK. Policy initiatives were seen as necessary to success in this area by virtually all economists, given the prevalence of market failure in training activities and the likelihood of suboptimal skills formation in an environment characterized by multiple equilibria (Finegold and Soskice, 1988). While early government policies seemed to be dominated by massaging the youth unemploymentfigures,the later 1980s were characterized by several new initiatives, notably the development of a new system of National Vocational Qualifications from 1986 and the introduction of the National Curriculum in the Education Reform Act of 1988. The government has announced itself pleased with its new policies, which it sees as delivering record levels of both participation and achievement in education and training (Cm 2563, 1994: 49). Some of the numbers certainly look encouraging (Robinson, 1994). For example, in 1978-9 only 23.6 per cent of school-leavers hadfiveor more A-C grade passes at O level, compared with 41.2 per cent in 1992-3 at GCSE. In 1993, 32 per cent of eighteen-year-olds went into higher education, compared with only 15 per cent in 1988 and 12 per cent in 1981. The Labour Force Survey showed a rise in the proportion of employees receiving job-related training in the last four weeks from 8.2 per cent in 1984 to 15.4 per cent in 1990, with only a small dip in the ensuing recession. The fraction of employees in manufacturing with no qualifications fell from 71 per cent in 1979 to 56.8 per cent in 1989 (O'Mahony and Wagner, 1994:15). Nevertheless, criticisms of both the quantity and quality of the training of the British labour force continue to be made in an extremely vociferous way. For example, Layard et al. (1994: 11) conclude that 'our training system remains a formula for national decline', while Ekinsmyth and Binner (1994: 15) find that 'literary and numeracy problems are just as prevalent among young adults in 1992 as they were in 1981'. Wagner (1991) emphasizes the continued higher content and volume of foreman (Mdster)-level training in Germany, while Prais (1993) deplores a dilution of standards in curricula and tests for those acquiring vocational qualifications. At present, it is quite unclear what has been achieved in terms of human capital

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formation. Undeniably, there have been failings in policy design, and incentives to politicians and educational providers to exaggerate the quality of the outputs of the training system have undoubtedly been important. On the other hand, real expenditures by employers on training appear to have roughly trebled between 1970 and 1989 (Crafts, 1991b: 94), and it is difficult to believe that this, together with additional participation in education after sixteen, does not indicate a higher real accumulation of human capital. Given that replication of a German-style system in the UK is not feasible, the focus on higher education in the UK may be a better alternative than many critics imply (Soskice, 1993). It is possible, therefore, that the UK has improved its medium-term growth prospects somewhat as a result of improved human capital accumulation, but this remains to be demonstrated. The quantification of the impact on growth of reforms in this area is highly desirable, but it is not likely to be an easy research project. 9

Deindustrialization

It is widely believed that manufacturing is of crucial and special importance to the achievement of rapid and sustained economic growth in the UK. In 1973,42.6 per cent of employment and 38.4 per cent of value added was in industry, while by 1989 the percentages were 29.4 and 29.5 respectively. Closely linked to this are suggestions that the UK has in the past and once more now faces a balance of payments constraint on growth, and that the experience of deindustrialization and shrinkage of the manufacturing base in the 1980s has adversely affected future growth prospects. Neoclassical economics certainly recognizes that weak export performance and/or a voracious demand for imports may mean that growth implies adjustment to this through adverse moves in the terms of trade: that is, a depreciation of the real exchange rate. The implication would be that growth of real income would fall below that of real GDP, but this would not mean that the latter would be reduced. Thirlwall (1979) argued that, for economies like the UK, real wage rigidity prevented this adjustment mechanism from functioning, and this would lead to persistent deflation and failure to realize fully the growth of productive potential. This fear seems not to be justified, however; OECD (1989: 35) presents data which show that neither the UK nor other OECD economies were characterized by long-run real wage rigidity in the 1970s and 1980s. More recently, the notion that manufacturing matters for growth arises from new growth models of the type proposed by Lucas (1988), building on earlier work by Krugman (1987). Here human capital is accumulated through work experience, but at rates which differ across sectors. Thus an economy's initial comparative advantage, or shocks which temporarily shift equilibrium specialization, can determine future growth rates. If specialization is in activities which have high learning effects, living standards improve relatively quickly and learning effects will also tend to lock in the initial pattern of specialization. High-technology industries have been highlighted in the literature as characterized by strong dynamic learning effects (Mowery and Rosenberg, 1989) and spillovers of R & D (Jaffe, 1986). Krugman (1987) saw the Thatcher-shock as running a risk of lowering long-term growth through switching specialization away from manufacturing. The implications

160 Charles Bean and Nicholas Crafts Table 6.17. Value added in high-technology industry, 1979 and 1988

Germany Japan UK USA

% of manufacturing

% of GDP

1979

1988

1979

1988

16.5 16.6 15.0 20.8

20.3 22.9 19.7 24.4

5.6 4.9 3.7 4.8

6.3 6.6 3.9 4.7

Source: OECD (1992b, 1984); high technology as defined in OECD (1992a). of large invisible earnings from rentier foreign investments might have had similar implications before World War I (reflected in Table 6.9), and the model obviously could be deployed as a theory of why Britain's early start was a disadvantage to later generations. Despite its intuitive appeal, this model is probably not a very good approximation to the way the world works, or a good reason for inferring disastrous long-run growth consequences arising from the decline of the British manufacturing base. There would be greater reason to worry if international trade led to complete specialization, there were no spillover effects of learning and R & D internationally, and productivity growth potential varied enormously between sectors. Even in the interwar period when these conditions were more nearly fulfilled (Nelson and Wright, 1992), the model would be highly overstated - the direct investment of foreign multinationals like Ford, General Motors, GEC and Hoover sustained many of the fast-growing, hi-tech industries (Jones, 1988). The increasing importance subsequently of multinationals and intra-industry trade weaken its validity further. In any event, it must be doubted whether differences or changes in the structure of activity have had or are likely to have a large effect on overall growth. The UK has had a higher than average deindustrialization since 1973, but an arithmetic calculation based on differences in sectoral productivity growth rates shows that, if it had deindustrialized at the average-rate for Maddison's (1991) sample of countries, the impact would haVe been enough only to raise UK growth over 1973-89 by 0.15 per cent per year. Moreover, as Table 6.17 shows, although high-technology industry is a smaller proportion of British manufacturing than in Germany or Japan, it is not negligible and its share rose in the 1980s. It must be doubtful whether the differences in structural changes shown in Table 6.17 are really big enough to carry serious implications for future growth rates.

10

Conclusions

Our aim in this chapter has been to explore the reasons for the UK's relative economic decline during the postwar period, and to assess the evidence that recent changes in the economy have promoted a permanent improvement in growth potential. At the outset we distinguished between three levels of explanation, to which we now return in reviewing our findings - proximate sources of growth, institutional and policy influences on investment in broad capital/productivity

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161

improvement, and fundamental factors sustaining the equilibrium growth path. Various forms of growth accounting provide information on the proximate sources of growth, but as we have stressed, they are subject to quite serious possibilities of measurement error. If human capital formation is proxied by a schooling measure, then this work suggests that the UK's relatively low growth during the Golden Age was due both to low investment and, particularly, to relatively weak total factor productivity growth. The latter probably reflects, in part, a substantial component attributable to less initial scope for catch-up and reconstruction. Better measurement of broad capital formation would probably highlight shortfalls in workforce training and in production of commercially valuable new products and processes (reflected, for example, in patenting) as weaknesses on the British supply side. This would reduce but not eliminate a residual gap in TFP growth stemming from inefficiency in factor usage. During the 1980s, there was a substantial shakeout of inefficiencies in the British economy and, by now, the UK was no longer an economy with relatively low scope for catch-up. The implication was that, compared with the Golden Age, TFP growth in the UK slowed by much less than the European average. The UK remained an economy with relatively low physical investment, but the gap with other countries narrowed somewhat. Despite some successes, notably in pharmaceuticals, British technological performance continued to look relatively weak, while the net effect of changes in education and training is at present impossible to assess. There surely was a significant transitory (catch-up) component in the productivity improvement during the Thatcher years. At the second level of explanation, that of identifying the impact of institutional arrangements and policy frameworks on growth, research is less comprehensive. This is unfortunate because modern growth theory suggests that these effects are central to understanding relative growth outcomes. Our own results, described in the chapter, suggest (1) that the structure of industrial relations in the UK, with its unfortunate emphasis on fragmented bargaining and multiple unionism, operated to reduce TFP growth prior to the 1980s, and (2) that the changed industrial relations scene of the recent past has not only allowed a once-and-for-all productivity gain, but also improved future growth potential. We do not wish to exaggerate the importance of these findings, or to give disproportionate emphasis to this aspect of the British institutional and policy scene. Our discussion has also identified a number of other features which require detailed analysis. These include, in particular, the incentive structures facing agents contemplating investment decisions, and the extent to which the UK differed from its European peer group. Certainly one aspect which is not well understood is the precise impact of the tax system, but more generally it would be interesting to know how ex ante hurdle rates on investment projects compared, and both how and why they may have differed. At the third level of explanation, that of trying to understand why failures might persist and why government policy interventions seemed to perpetuate rather than eradicate relative decline, at least through the 1970s, we have highlighted the short-termism promoted by the pressures of macroeconomic management and the high weighting given to inflation and unemployment rather than growth. In particular, we have suggested that the pursuit of social contracts in the British case

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worked to inhibit rather than improve necessary supply-side reforms, including, of course, effective reform of industrial relations. Again, we do not wish this argument to be overplayed. We see a need for a great deal of further research into 'government failure', and recognize that poor choice and design of policy played a part alongside vote seeking. We also anticipate that much more will eventually be written on the implications for growth of the interplay of government and producer interests. Finally, how optimistic should we be on future growth prospects and the present administration's claim that the period of Conservative government has ended the long period of relative economic decline? As we noted at the end of section 6, any answer to this question can only be provisional, and that remains our view after the more detailed assessment of the following three sections. To some extent, the answer depends on the relative weight given to the success of supply-side reform compared with negative implications that might stem from the deindustrialization of the economy. We take the changes in industrial relations to be good news and unlikely now to be reversed; we regard the new world of education and training as unproven; and we also wait to see whether evidence is forthcoming to support the argument that the slimming down of British manufacturing will have deleterious effects on future TFP growth. To some extent, however, the answer also turns on future governments' ability to commit themselves to a framework more conducive to effective supply management and, in particular, to taking a long-term rather than a short-term view of supply-side reform. Here too we remain to be convinced; if, for example, the debates over privatization policy are anything to go by, short-termism among politicians of all persuasions still holds sway. Appendix We start by setting out the behaviour of the economy under competitive conditions. Output of final goods, Y, is produced using a fixed number, m, of different types of labour, Lt(i = 1... m), and a composite capital good, K. We assume a Cobb-Douglas structure with

The total supply of each variety of labour is inelastic and normalized to unity, while the composite capital good is a CES aggregate of a variable number, nt, of different varieties of capital good:

Xt = (ir = i xr a ) 1 / ( 1 " a )

(2)

The engine of growth will be an expansion in the number of varieties of capital input. This final goods industry is competitive. It would be nice to be able to introduce imperfect competition, since there is abundant evidence to suggest that unions in imperfectly competitive industries tend to be more successful at rent extraction. It would also be nice to allow the number of required varieties of labour to increase as production becomes more complex; this might permit us to capture demarcation disputes between unions, which the evidence suggests have been important. However, both these extensions of the basic model complicate matters significantly and are left for development elsewhere. Turning now to the capital goods industry, a capital goods producer can develop a new variety of capital good by expending p units offinaloutput. Thereafter it can

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163

produce as many units as it likes of the new capital good at a constant marginal cost of r\ units of final output. It can also acquire a patent giving it an infinitely lived monopoly in the supply of the new good. (If there were no patents, and new designs could be costlessly imitated, then nobody would ever develop new varieties of good.) However, entry into the research activity is free. Finally, the demand side of the economy assumes a representative consumer with an additively separable isoelastic utility function (C 1 " 1 ^ — 1)/(1 — I/a) and time preference rate 0. Assuming also perfect capital markets, this generates the usual intertemporal optimality condition for consumption, Ct: g=Ct/Ct = (j(rt-d)

(3)

where rt is the market interest rate. We start by deriving the growth rate under competitive conditions, in the labour market. In that case, all varieties of labour are fully employed and the market demand for the ith variety of capital good is just the usual marginal productivity condition: (1 - oi)AK7t* = Rit

(4)

where Rir is the user cost of capital (rental rate) for the ith capital good. Now it turns out that, under the assumed structure for the economy, Kin Rit and rt are all independent of time (see Romer (1987) for proof). In that case, it will be optimal for the capital goods supplier to produce all the capital it intends to lease out as soon as it has developed a new design. Dropping redundant time subscripts, we may then write the present discounted value of profits, 7tf, from the innovation of a new variety of capital as: 7i* = R.KJr ~(P + rjK;)

(5)

where the demand for the ith variety of capital is given by (4). Thefirstterm on the right-hand side is the present value of the infinitely livedflowof revenues, while the second term is the combined cost of innovation and production. Maximizing (5) subject to (4) gives the profit-maximizing rental rate as Rt = ri7/(l - a)

(6)

If there is free entry into research, we also know that 7r* = 0 and hence from (5) that Kt = 0(1 - a)/oiy

(7)

Combining (4), (6) and (7) then gives the interest rate as r= (l-o# 1

(8) l

where ij/ = A{\ — a) ~\<xl$frf~ . Equation (8) incidentally confirms the conjecture that the interest rate is time invariant. Substituting (8) into (3) then gives the competitive growth rate as 3comp = «x[(l - o # - 9] (9) We also note in passing that the socially efficient growth rate that would be chosen by a benevolent social planner is (see Romer (1987) for proof) 0SocPlan = < # " 0)

(10)

Thus growth in the competitive equilibrium is too low, essentially because of the monopolistic pricing of capital goods.

164 Charles Bean and Nicholas Crafts Now let us turn to the main topic of interest: namely, the impact on this outcome of the bargaining institutions in the final goods industry. The sequencing of decisions is as follows. First, firms decide how much of each variety of capital to install; this decision is irreversible within the period. Second, bargaining over wages and employment occurs. We assume so-called 'efficient bargains' over wages and employment (McDonald and Solow, 1981) in order to isolate the Grout-style inefficiencies that arise due to the inability of workers to precommit themselves not to extract some of the quasi-rents associated with capital. However, similar results can be obtained if one assumes a 'right-to-manage' set-up in which management retains the right to determine employment unilaterally. Let us start by assuming m( > 2) separate 'craft' unions in each firm that bargain independently with management over pay and employment on behalf of each of the m varieties of worker. For simplicity, each union is an expected income maximizer with V{ = w^i + vv/L, — Lt), where wt is the outside wage (e.g. unemployment benefit) and £, is the number of members of the union (unity in aggregate). In the event that there is disagreement, no production occurs (because Lt is an essential input) and no wages are paid, although the firm still has to finance the leasing payments on the installed capital; the workers are free to claim w-. The Nash bargain then solves

Max(w,,,L,i}fi,, = (n, - nunvu - P,,)1"' = (ATIf. , V " * , 1 - - ^ " L . w ^ i K - wJZ,,]1-*

(11)

where an overbar denotes the 'status quo' points and y is an index of relative bargaining strength. The first-order conditions for this problem are M

- OLYJm) = (Yt-^=1wjtLjt)(l

~ y)

yLit(wit - wit) = (Yt- Z 7 = ^ ^ X l - y)

(12) (13)

These imply bilateral efficiency in employment determination: *Yt/mLit = wit

(14)

and also by summing (12) across labour varieties that the wage share is given by [y + (1 - y)m]i; = ,wjtLjt = [ay + (1 - y) m] Yt

(15)

To close the model we need an explanation for the outside wage, w. Here we make the simplest possible assumption: namely, that w represents unemployment benefit paid by the government and financed by lump-sum taxes. Furthermore, the government is assumed to vary w so as to achieve full employment, although unions and firms in the final goods sector will treat it as parametric when making their own wage and employment decisions. While the assumption of continuous full employment is obviously not realistic, it does help to focus attention on the key issues involved. By virtue of the symmetry of the problem, wages (and unemployment benefits) for all labour types are identical. Using (15), we may then write ex ante profits in the final goods industry as 71, = Yt - i ; = ^jtLjt

i Kjt

- L? = 1 RjtKjt a

- £J'= 1 RjtKjt

(16)

where 4>(m) = 5(\ — a)/(d + m) and d = y/(l — y) is an index of the firm's relative

British economic growth since 1945

165

bargaining strength. Note that <j> < 1 and
= Rit

(4)

It follows that the rental price of capital is still given by (6) and the volume of each variety of capital by (7). Combining (4'), (6) and (7) gives the equilibrium interest rate as r, = ftmXl - o #

(8')

and the associated growth rate is 0Craf. = 'WtmXl - «)* - « ] <0Con,p

W

Growth is lower than in the competitive equilibrium because of the Grout-style inefficiency whereby unions capture some of the quasi-rents attributable to capital. This reduces the demand for capital and drives down both the interest rate and the growth rate. The inefficiency is worse the greater the number of labour varieties, because each union manages to capture a share of these rents. What happens if a single union bargains on behalf of all types of labour, i.e. there are 'industrial' rather than 'craft' unions? Assuming that all worker types have the same weight in the super-union, so that the model is_fully symmetric, we may write the super-union utility function as F = wL + w(L — L) where L = EJL tLt and L = ZJL JLi (with L = m in aggregate). The new Nash maximand is then

The solution to this problem is formally the same as in equations (12) to (15), with m set to unity and A implicitly replaced by Am~a. Remembering that Lt = m at full employment, ex ante profits are then exactly as given in the last line of equation (16) with (j) = (j)(l). Consequently, the growth rate is 0Ind = *[#1X1 - 0 # "

ft

CO

Thus 0C«f I < 01nd < 9 Comp < 0SocPlan

The primary reason that growth is lower under a craft-based system than an industrial one is that more of the return to capital is expropriated by the workforce under the former regime, because each union can 'hold the firm to ransom' in turn. Note that this result depends heavily on the fact that the different varieties of labour are essentially complements because each is essential for production to take place at all (compare this result with Horn and Wolinsky (1988)). Furthermore, at the existing capital stock levels, it is not difficult to show that union utility levels are higher with multiple craft-based unions than with a single union. Specifically, since there is full employment, from (15) Vit = wit =

(OLS

+ m)AK} ""/(m + S)m

(18)

whence d VJdm < 0 (assuming that relative bargaining strength d is left unaffected). Consequently, the multiple union structure, although generating an inferior outcome in terms of both growth and lifetime utility, is inherently stable if workers are myopic. Furthermore, note that more efficient outcome's would be possible if there were bargaining over investment as well. If that were the case then the equilibrium would replicate that achieved in a competitive economy, i.e. still

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suboptimal, but better than previously achieved. Bargaining over investment seems rather unlikely, but it is even less likely in the presence of multiple unions, since in the absence of legally enforceable contracts it would be hard to prevent individual unions from free riding by subsequently reneging on any agreement and attempting to extract the maximum surplus for their members. Such bargains would be time inconsistent and reputational equilibria would probably be harder to enforce in the presence of multiple unions. NOTES We are grateful to Steve Machin for help with data and to participants in the CEPR conference, 'Europe's Postwar Growth', Oxford, December 1993, and Mark Stewart for their comments on an earlier version. The usual disclaimer applies. REFERENCES Abramovitz, M. (1986) 'Catching up, forging ahead and falling behind', Journal of Economic History, 46, pp. 385-406. ACOST (1989) Defence R and D: A National Resource, London: HMSO.

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170 Charles Bean and Nicholas Crafts Lazonick (eds.), The Decline of the British Economy, Oxford: Clarendon Press. Mowery, D.C. and N. Rosenberg (1989) Technology and the Pursuit of Economic Growth, Cambridge: Cambridge University Press. Muellbauer, J. (1991) 'Productivity and competitiveness', Oxford Review of Economic Policy,! (3), pp. 99-117. Musgrave, R.A. and P.B. Musgrave (1968) 'Fiscal policy', in R.E. Caves (ed.), Britain's Economic Prospects, London: Allen and Unwin. National Economic Development Office (1976) Cyclical Fluctuations in the UK Economy, London. Nelson, R.R. and G. Wright (1992) 'The rise and fall of American technological leadership: the postwar era in historical perspective', Journal of Economic Literature, 30, 1931-64. OECD (1984) Industrial Structure Statistics 1982, Paris. (1989) Economies in Transition, Paris. (1991a) Historical Statistics, 1960-1990, Paris. (1991b) Economic Outlook, Paris. (1991c) Main Science and Technology Indicators, Paris. (199Id) Basic Science and Technology Statistics, Paris. (1992a) Structural Change and Industrial Performance, Paris. (1992b) Industrial Structure Statistics 1989/90, Paris. O'Higgins, M. and S.P. Jenkins (1990) 'Poverty in the EC: 1975, 1980, 1985', in Eurostat, Analyzing Poverty in the EC, Luxembourg. O'Mahony, M. (1992) 'Productivity and human capital formation in UK and German manufacturing', National Institute of Economic and Social Research Discussion Paper No. 28. O'Mahony, M. and K. Wagner (1994) Changing Fortunes: An Industry Study of British and German Productivity Growth over Three Decades, London: NIESR. Oulton, N. and M. O'Mahony (1994) Productivity and Growth: A Study of British Industry, 1954-86, Cambridge: Cambridge University Press. Patel, P. and K. Pavitt (1988) 'The international distribution and determinants of technological activities', Oxford Review of Economic Policy, 4 (4), pp. 35-55. Pavitt, K. (1976) 'The choice of targets and instruments for government support of scientific research', in A. Whiting (ed.), The Economics of Industrial Subsidies, London: HMSO. Pavitt, K. and L. Soete (1982) 'International differences in economic growth and the international location of innovation', in H. Giersch (ed.), Emerging Technologies, Tubingen: Mohr. Peacock, A. and J. Wiseman (1961) The Growth of Public Expenditure in the UK, Princeton, NJ: Princeton University Press. Pollard, S. (1992) The Development ofthe British Economy, 1914-1990, London: Arnold. Prais, S.J. (1981) Productivity and Industrial Structure, Cambridge: Cambridge University Press. (1993) 'Economic performance and education: the nature of Britain's deficiencies', National Institute of Economic and Social Research Discussion Paper No. 52. Pratten, C.F. (1976) Labour Productivity Differentials Within International Companies, Cambridge: Cambridge University Press. Pratten, C.F. and A.G. Atkinson (1976) 'The use of manpower in British industry', Department of Employment Gazette, 84, pp. 571-6. Price, S. and D. Sanders (1994) 'Economic competence, rational expectations and government popularity in postwar Britain', Manchester School, 62, pp. 296-312.

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Purcell, J. (1991) T h e rediscovery of the management prerogative: the management of labour relations in the 1980s', Oxford Review ofEconomic Policy, 7(1), pp. 33-43. Robinson, P. (1994) T h e comparative performance of the British education and training system', Centre for Economic Performance, LSE Discussion Paper No. 644. Romer, P.M. (1986) 'Increasing returns and long run growth', Journal of Political Economy, 94, pp. 1002-37. (1987) 'Growth based on increasing returns due to specialisation', American Economic Review, 11, pp. 56-62. (1990) 'Endogenous technology change', Journal ofPolitical Economy, 98, pp. 71-102. Rostas, L. (1948) Productivity, Prices and Distribution in Selected British Industries, Cambridge: Cambridge University Press. Sanderson, M. (1972) 'Research and the firm in British industry, 1919-1939', Science Studies, 3, pp. 107-51. Scott, M. (1963) A Study of UK Imports, Cambridge: Cambridge University Press. Singh, A. (1975) Takeovers, natural selection and the theory of the firm: evidence from the postwar UK experience', Economic Journal, 85, pp. 497-515. Smith, A.D., D.M. Hitchens and S.W. Davies (1982) International Industrial Productivity, Cambridge: Cambridge University Press. Smith, J.D. (1990) The Attlee and Churchill Administrations and Industrial Unrest, 1945-55: A Study in Consensus, London: Pinter. Soskice, D. (1993) 'Social skills from mass higher education: rethinking the company-based initial training paradigm', Oxford Review of Economic Policy, 9 (3), pp. 101-13. Steedman, H. (1990) 'Improvement in workforce qualifications: Britain and France, 1979-88', National Institute Economic Review, 133, pp. 50-61. Stoneman, P. (1991) T h e promotion of technical progress in UK industry: a consideration of alternative policy instruments', Warwick Business School Research Paper No. 11. Tanzi, V. (1969) The Individual Income Tax and Economic Growth, Baltimore, MD: Johns Hopkins University Press. Thirlwall, A.P. (1979) T h e balance of payments constraint as an explanation of international growth rate differences', Banca del Lavoro Quarterly Review, 128, pp. 44-53. Tomlinson, J. (1990) Public Policy and the Economy Since 1900, Oxford: Clarendon Press. (1991) T h e Labour government and the trade unions, 1945-51', in N. Tiratsoo (ed.), The Attlee Years, London: Pinter. (1993) 'Mr Attlee's supply-side socialism', Economic History Review, 46, pp. 1-22. United Nations (1964) Some Factors in the Economic Growth of Europe during the 1950s, Geneva, van Ark, B. (1993) International Comparisons of Output and Productivity, Groningen: University of Groningen. van de Klundert, T. and A. van Schaik (1996) 'On the historical continuity of the process of economic growth', in B. van Ark and N.F.R. Crafts (eds.), Quantitative Aspects ofPostwar European Economic Growth, Cambridge: Cambridge University Press. Vickers, J. and G. Yarrow (1988) Privatization: An Economic Analysis, Cambridge, MA: MIT Press. Wagner, K. (1991) Training efforts and industrial efficiency in West Germany', in J.

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Stevens and R. Mackay (eds.), Training and Competitiveness, London: Kogan Page. Walshe, G. (1991) 'Industrial organization and competition policy', in N.F.R. Crafts and N.W.C. Woodward (eds.), The British Economy Since 1945, Oxford: Clarendon Press. Ward, T.S. and R.R. Neild (1978) The Measurement and Reform of Budgetary Policy, London: Heinemann. Weaver, F. (1950) Taxation and redistribution of income in the United Kingdom', Review of Economics and Statistics, 32, pp. 201-13. Wells, J. and J. Imber (1977) T h e home and export performance of United Kingdom industries', Economic Trends, 286, pp. 78-89.

7

Economic growth in postwar Belgium ISABELLE CASSIERS, PHILIPPE DE VILLE AND PETER M. SOLAR

1

Introduction

Over the postwar period as a whole, the Belgian economy has grown more or less in line with the economies of its neighbours. Long an industrialized country, Belgium was relatively well-off after the Second World War and remains so today. But Belgian postwar growth followed a distinctive path, the main feature of which was a sharp improvement in its relative performance around 1960. Belgium started the postwar period with an economic structure that resembled that of the UK, another early industriahzer, and, like the UK, it lagged behind other countries in improving productivity during the 1950s. Since 1960 Belgian growth has accelerated, and productivity growth, especially in manufacturing industry, has been unusually rapid and sustained. One major task of this chapter is to explain why growth was relatively weak before the 1960s and why it improved so strikingly thereafter. Another is to consider the nature and sustainability of Belgium's relatively strong growth performance in the 1970s and 1980s, particularly when seen against its very high unemployment rate and the parlous state of its public finances. This survey builds on a diverse, yet relatively underdeveloped, secondary literature. There have only been a few attempts to survey the Belgian experience of economic growth since the war (De Brabander, 1981; Van Rijckeghem, 1982; Vandewalle, 1982; Vandeputte, 1985, 1993; Van der Wee, 1985, 1987; Mommen, 1994). The rest of the existing literature tends to break at around 1960, although not because relative performance improved then. While influential interpretations of the 1950s had already been published in the 1960s (Lamfalussy, 1961; Denison, 1967), detailed historical investigation of thefirstdecade or so after war has largely been the product of the last decade, as archives have become available and as there has been broader international interest in reconstruction and European integration (Blomme and Scholliers, 1993). Work by economists, as against historians, has been shaped by the major macroeconomic databases, in which 1960 is often the first observation. This reflects an important statistical constraint: Belgium's official national accounts start only in 1953, although there are some partial accounts dating from 1948. * The lack of earlier national accounts hinders longer-term growth accounting and also makes the early years of the series for the postwar capital stock, 173

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constructed by the perpetual inventory method, somewhat shaky (de Biolley and Gilot, 1987). With due caution, then, the next section of this chapter gives a short statistical overview of Belgian economic growth. There follows a discussion of the distinctive features of the country's economic structure and sociopolitical institutions, and a look at the legacy of the interwar years and the Second World War. Postwar growth is then treated in greater detail for four periods: reconstruction in the late 1940s; the 1950s; the 1960s and early 1970s; and the late 1970s and 1980s. Finally, the question of whether the country's structure of production impeded growth is examined, with particular attention on the role of corporate control in structural inertia and productivity growth.

2

Postwar economic growth: main features, structures and institutions, initial conditions

2.1

Belgian growth in historical and comparative perspective

The basic features of Belgian economic growth during the twentieth century are shown in Table 7.1.2 Up to 1950 the growth rate of GDP was among the slowest in Europe, in part because of the country's early demographic transition and very slow population growth (Lesthaeghe, 1977). But the growth of output per capita was also slower than in any neighbouring country, and only Germany and the Netherlands had slower rates of growth in output per hour worked. Relative to France and Germany, which in 1913 had distinctly lower levels of per-capita income, this need not be surprising. But Belgium's slow growth meant that it fell further behind both the UK, the European leader in 1913, and the Netherlands, more or less Belgium's equal on the eve of World War I. After the Second World War, Belgian growth accelerated, but until 1960 it remained relatively weak. Although output per hour worked grew more rapidly than in the UK during the 1950s, output per capita grew at about the same rate. At the end of the 1950s, by which time European reconstruction had been completed, the Belgian economy stood in much the same relation to the British economy as it had on the eve of World War I. It had been passed during the preceding half century by all of the countries in north-west Europe except Austria and Finland. There had been no catching up and a lot of falling behind (Camu, 1960: 404). Since 1960, Belgian performance has distinctly improved. The 1960s were truly golden for the Belgian economy. Its rate of labour productivity growth increased by more than 2 per cent per annum and its growth in output per capita was among the highest in north-west Europe. Since the early 1970s, growth has, like elsewhere, slowed down, but the growth in both output per capita and per hour has remained relatively respectable. The fundamental break in Belgian performance around 1960 corresponded to an increase in the rate of non-residential investment. The investment share increased sharply from the 1950s to the 1960s, remained high until the early 1970s, then fell off during the late 1970s and 1980s (van Meerten, 1993, and Figure 7.2 in section 3.3). But, at least in simple calculations using conventional factor shares, the increase in capital formation does not account for much of the acceleration in the growth of

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Table 7.1. Major growth indicators: Belgium and north-west Europe, 1913-90 (annual compound growth rates) Belgium GDP 1913-29 1929-38 1938-50 1950-60 1960-73 1973-90 1913-50 1950-90 1913-60 1960-90

Netherlands

France

Germany United NW Kingdom Europe

1.43 -0.04 1.29 3.00 4.93 2.19 1.03 3.27 1.44 3.37

3.65 0.33 2.41 4.61 4.83 2.11 2.43 3.61 2.89 3.28

1.86 -0.39 1.36 4.57 5.38 2.39 1.15 3.90 1.87 3.67

1.20 3.78 -0.41 8.17 4.34 2.13 1.30 4.33 2.72 3.08

0.71 1.90 1.63 2.67 3.18 1.90 1.29 2.51 1.58 2.46

1.41 1.61 1.33 4.70 4.33 2.13 1.43 3.48 2.12 3.08

GDP per capita 1913-29 1.13 1929-38 -0.50 1938-50 1.03 2.40 1950-60 1960-73 4.43 2.07 1973-90 0.70 1913-50 1950-90 2.91 1913-60 1.06 1960-90 3.08

2.15 -0.89 1.11 3.29 3.57 1.51 1.07 2.62 1.54 2.40

1.94 -0.59 1.39 3.65 4.31 1.94 1.14 3.13 1.67 2.96

0.76 3.12 -1.03 7.05 3.45 2.13 0.74 3.77 2.05 2.70

0.27 1.45 1.13 2.23 2.65 1.79 0.84 2.18 1.13 2.16

1.06 1.14 0.85 3.88 3.50 1.92 1.01 2.92 1.61 2.60

GDP per hour 1913-29 1.83 1.02 1929-38 1.17 1938-50 1950-60 3.15 5.30 1960-73 3.02 1973-90 1.42 1913-50 3.79 1950-90 1913-60 1.78 1960-90 4.00

2.88 -0.12 0.33 4.16 5.25 2.42 1.31 3.77 1.91 3.64

2.79 3.04 0.62 4.58 5.25 2.98 2.14 4.11 2.66 3.96

1.38 2.38 -0.39 7.08 5.16 2.67 1.04 4:57 2.30 3.74

1.45 0.92 2.25 2.11 3.90 2.03 1.58 2.66 1.69 2.84

1.89 1.78 1.25 4.19 4.81 2.44 1.66 3.64 2.19 3.46

Note: The growth rates for NW Europe refer to total output for the region comprising Austria, Belgium, Denmark, Finland, France, Germany, Netherlands, Norway, Sweden, Switzerland and the UK. Sources: Maddison (1989, 1991, 1994).

176 Isabelle Cassiers, Philippe De Ville and Peter M. Solar

output per worker. This conclusion is fully consistent with results from international cross-section studies. Both Dowrick and Nguyen (1989) and Crafts (1992)findthat, after allowing for investment effort and the opportunities available for catching up to the United States, Belgium did distinctly less well than it should have done during the 1950s, and better than it should have done during the decades thereafter. Over the long term, the pattern of economic growth in Belgium most resembles that of its French and Dutch neighbours. All three countries grew relatively fast from 1913 to 1929, then, as members of the Gold Bloc, they saw output per capita fall in the 1930s. All were occupied during World War II, but managed to make modest gains in output and productivity over the 1940s. All three countries did better in the 1960s than in the 1950s. 2.2

Continuities in economic structure and sociopolitical institutions

Throughout the postwar period, the Belgian economy has been characterized by several structural features that form the context for growth and the economic policies that might influence it. First, the Belgian economy has long been very open to international trade, and during the postwar period it has become increasingly so. The share of exports infinaldemand shows a fairly steady rise from the already high level of 19 per cent in 1953 to more than 44 per cent in the mid-1980s. This openness to trade has meant that international competitiveness and external balance have been central concerns for businesses, unions and government. The interactions between the large and important open sector and the rest of the Belgian economy, more sheltered from international competition, will figure prominently in the analysis of the country's economic growth. Trade is all the more important because Belgian production and exports have a high import content. Belgium essentially imports raw materials (and since the late 1950s energy) and exports the value added in transforming them. One example is non-ferrous metals, an industry based initially on local mines but in the twentieth century dependent on supplies from the Congo and other parts of the world. Another is the automobile industry: Belgium has no native manufacturers, produces relatively few components, but is one of Europe's major assemblers (Bloomfield, 1978: 187). Belgian commercial policy has reinforced this sort of specialization by maintaining low or no duties on raw materials (Duquesne de la Vinelle, 1963: 84). High import content is the other side of having few natural resources. Coal, the country's major resource since its early industrialization, continued to be mined into the 1980s, thanks to subsidies, but its importance declined significantly as domestic production was allowed to fall off sharply from the early 1960s. Belgian producers have tended to specialize in standardized, semi-finished manufactures: yarn instead offinishedcloth, bulk chemicals instead of Pharmaceuticals, steel products instead of engineering goods (Camu, 1960: 413). Belgium's revealed comparative advantage has persistently been in bricks and glass, non-ferrous metals, chemicals (mainly fertilizers), iron and steel, and textiles and apparel (Crafts, 1989; Balassa, 1977; Culem, 1984). Dreze (1961) saw this choice of products as a consequence of the small size and the openness of the economy. Yet there has been a persistent concern that such products have low income elasticities of demand, have high degrees of cyclical volatility and are highly susceptible to competition from

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countries with lower labour costs (Waelbroeck and Rosselle, 1961; Krul, 1964: 59). The human capital content of Belgian exports has also been low (Tharakan and Waelbroeck, 1988). The Belgian economy, and especially the manufacturing sector, has come increasingly under the control of foreign firms (Van Den Bulcke, 1978; Sleuwaegen,1987; Vanden Houte and Veugelers, 1989; Daems and Van de Weyer, 1993). Siemens, General Motors, Philips and IBM were all present in Belgium before the Second World War. Since the war, and particularly since the 1960s, the role of foreign firms has increased. In 1968 they accounted for 22 per cent of value added in manufacturing; by 1990 this had reached 59 per cent. This is far higher than in other small countries such as the Netherlands or Denmark. The other side of foreign multinationals' large role in the Belgian economy is that there have been few Belgian multinationals (Van Den Bulcke, 1986; Devos, 1993). Belgian financial capital has been relatively mobile. At the beginning of the century, Belgian holding companies mobilized resources to finance tramways and other engineering projects throughout the world. Later, during the interbellum and in the 1950s, they made major investments in the Congo, now Zaire (Van der Wee, 1981). Smaller savers, including the famous Belgian dentist, have long been welcome at banks in Luxembourg and elsewhere. The international mobility of Belgian capital has been a major constraint on tax and exchange rate policy. The nature of Belgian society and politics has also influenced growth and constrained policy. Belgium has been described as the most thorough example of 'consociational democracy*: that is, a political system replete with mechanisms for resolving conflicts and protecting minorities in a deeply divided society (Lijphart, 1981). Longstanding and strong ideological differences among anti-clerical conservatives, socialists and Catholics on both the right and the left have been overlaid with linguistic and territorial quarrels between French and Dutch speakers.3 The result has been a fragmented but very stable party system, a thorough politicization of public services, and the prevalence of coalition governments able to act only on the basis of complex compromises (Frognier, 1988). One important consequence of this political structure has been persistent problems with the public finances. Pressures to satisfy all interest groups have inflated spending while making it difficult to raise more revenue, particularly in the frequent periods of political crisis (Vuchelen, 1991). Borrowing has been a relatively easy alternative, since the National Bank has lacked independence from the Ministry of Finance and has formally or informally been able to mobilize funds via its control of the commercial banks. This soft budget constraint has contributed to Belgium's persistently high debt-GDP ratio and to its sharp increase since the late 1960s. Another consequence of the Belgian political structure has been excessive short-termism. During most of the postwar period, as will be seen, it is difficult to discern any coherent strategy for economic growth. The weakness of Belgium's parliamentary government has been compensated to some extent by parallel institutions of decision making. Representatives of trade unions, business and government come together frequently, not only in collective bargaining, but in a dense network of institutions and advisory bodies developed in large measure since the Second World War (Balthazar, 1981). Yet Belgian corporatism has been less centralized and authoritative than that in other small

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countries. The labour interest has been riven by competition between socialist and Catholic trade unions. The central employers' organization has faced competition from regional organizations and has had difficulty reconciling sectoral and regional interests. Over the entire postwar period, the level of strike activity has been distinctly higher than in Germany, the Netherlands or Sweden; similar to that in France; and lower than that in the United Kingdom (Cornwall, 1990: 121). There has been a shifting, and often ambiguous, balance between centralization and decentralization in industrial relations. Some factors, notably widespread indexation and links between wages and social security benefits, have made for centralized negotiations. Yet large differences across industries and regions in costs and markets have pushed towards decentralization. One result has been that the relative importance of national, sectoral, regional and enterprise negotiations has varied considerably across industries and across periods. This accounts for the difficulty that Belgium has posed for constructors of indices of corporatism (Bruno and Sachs, 1985:226). Another result has been that the government has increasingly found it necessary to intervene in order to deal with the contradictions arising from the mix of centralized and decentralized institutions. A third result has been extremely strong attachment to agreements once arrived at, notably to the systems of wage indexation and social security (Scholliers, 1991). These economic and political features have distinguished Belgium from other European countries, even other small countries, and they provide the context for postwar growth and policy. Since the war, the increasing internationalization of product and capital markets, along with deterioration of the public finances from the late 1970s, has steadily reduced the scope for classic macroeconomic policy. The great importance of foreign trade (along with wage indexation) has inclined governments towards preserving stable exchange rates with principal trading partners. Monetary policy has generally been dedicated to this goal, although in periods of general exchange rate instability Belgium has faced the problem of which currency or currencies to follow (Duquesne de la Vinelle, 1963: 80-1). The use of fiscal policy has been limited both by the state of the public finances and by the difficulties of securing agreement on tax and spending programmes. What has been left in the government arsenal are policies, either explicit or disguised, that have sought to influence the distribution of income between capital and labour. The close conjunction of economic and social policy, particularly where it affects distribution, recurs in the history of the Belgian economy. High relative cost elasticities of exports and imports have meant that exchange rate changes can have large effects on the distribution of income, and that the success of monetary policy depends crucially on the behaviour of wage earners. At several critical junctures - in the mid-1930s, just after the Second World War and in the early 1980s - major changes in direction have explicitly linked exchange rate policy with packages of measures dealing with taxation, indexation, social security and bargaining institutions. 2.3

The legacy of the 1930s and World War II

At the end of the Second World War, Belgium found itself with an overall productive capacity that had hardly changed since the late 1920s. During the Depression of the 1930s, output grew hardly at all, as Belgium's adherence to gold

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delayed recovery (Cassiers, 1989). Once it finally left gold and devalued by 28 per cent in 1935, the economy enjoyed a few years of limited prosperity before the threat of war put a damper on activity. In the 1930s, the investment rate fell offmarkedly. It was well below levels in other European countries and probably at best only sufficient to maintain the overall capital stock (van Meerten, 1993). During five years of German occupation, output was severely reduced by materials shortages and there was little new investment (Baudhuin, 1945: 269, 357-9). Belgium thus finished the war with an outmoded productive apparatus, albeit one that had suffered relatively little damage (Durviaux, 1947: 243). Labour productivity and real wages rose only modestly during the 1930s (Table 7.1 and Scholliers, 1991). There were few gains from structural change. The sectoral distributions of both industrial production and exports had altered little from before World War I (Hogg, 1986: ch. 2). The major Belgian industries remained coal, steel, non-ferrous metals, textiles and glass. The industries of the second industrial revolution - automobiles, electrical equipment, organic chemicals - saw only limited development during the interwar years. If anything, overall productivity was adversely affected by shifts in employment during the 1930s, as labour shed by the export industries often found low-productivity employment on farms and in small shops (Goossens et ai, 1988). Despite low levels of investment, labour productivity in some parts of the open sector of the economy appears to have grown rapidly during the 1930s (Cassiers, 1989). This was particularly evident from 1932, as firms started shedding labour previously kept on short time. Some inefficient firms closed or were merged into other concerns, but coherent programmes to rationalize capacity were rare and often failed due to the desire of family enterprises to remain independent (Hogg, 1986: 76-7). The large holding companies proved unwilling or unable to use their financial power to coordinate production. As there is little evidence of major new technological developments in the 1930s, most of the gains in productivity must have been incremental, the result of persistent pressures to reduce production costs in order to remain competitive on shrinking international markets. During the war, the German authorities singularly failed to rationalize Belgian production (Gillingham, 1977: 153-4, 170). Productivity gains in the open sector of the economy must have been counterbalanced by relatively little change in the sheltered sector, although systematic evidence on this point is wanting. As in the UK, liberal economic policies gave way to many anti-competitive practices (Broadberry and Crafts, 1992; Mommen, 1994: chs. 2, 3). Protection was not a serious option for most Belgian manufacturing, dependent as it was on exports. New legislation made it easier to cartelize the domestic market, although its effects were limited (Vanthemsche, 1983). Belgian farmers and coal producers, oriented primarily to the home market, but previously open to international competition, acquired special privileges (Hogg, 1986: ch. 3). Backed by powerful interest groups, they managed to obtain quotas, import duties and subsidies during the 1930s. Small shopkeepers, another powerful group, also secured protection against larger retailers (Boddewyn, 1971: 53-4). Many of these anti-competitive practices survived the Second World War. Not all developments in the 1930s and during the war were so unpromising for postwar growth. One important longer-term change was the continued improvement

180 Isabelle Cassiers, Philippe De Ville and Peter M. Solar

in the education of the labour force. School attendance only became compulsory in 1914, and actual attendance before the First World War had been low by north-west European standards. Belgium thus started the twentieth century with a population that was poorly educated, so the rate of growth of the labour force's average educational attainment grew relatively rapidly during the interwar years and into the postwar period. But despite these changes, there were still persistent complaints during the 1930s about the lack of technical skills in the Belgian workforce (Hogg, 1986: 65-7). Another potentially positive legacy of the Depression and the war for subsequent economic growth was the move, albeit more limited than in other small countries, towards corporatism (Katzenstein, 1985; Luyten, 1993). In Belgium the years 1935 and 1936 were crucial. In March 1935 the socialists entered the government and became involved in shaping a package of measures to deal with the economic crisis. In June 1936 a major strike, largely initiated from the shop floor and involving about a fifth of the workforce, posed a serious threat to the government, but also faced trade union leaders with the need to regain control of their members (Strikwerda, 1988). At union instigation, the government called a National Labour Conference which produced important agreements on the length of the working week and on union recognition in collective bargaining. By the late 1940s, such conferences would become a permanent feature of Belgian industrial relations. The late 1930s also saw an acceleration in the development of an expanding network of parastatal institutions run by representatives of employers and unions, and dealing with industrial relations, social security, and economic and social development. Contacts during the war furthered the entente between management and labour. Employers reluctantly came to accept that organized labour would become a limited but institutionalized player in a bargaining process with business and government. The unions, especially the socialists, obtained a share of power, but came to acknowledge the legitimacy of management (Balthazar, 1981). A final legacy of the war for postwar growth was a healthy foreign exchange position. The Belgian gold stock survived the war largely unchanged, and sales of minerals from the Congo added to reserves. In the immediate aftermath of the war, Belgium's foreign exchange position was further strengthened by dollars earned from billeting American forces and from traffic through Antwerp, the only major European port still largely intact. The Belgians thus had far more room for manoeuvre in economic policy than did other European countries, most of which faced serious foreign exchange shortages.

3

The phases of postwar economic growth

3.1

Reconstruction in the late 1940s

The rapid recovery of output and consumption after the Second World War has popularly been known as the 'Belgian miracle' (Cassiers, 1995). By 1948 Belgium's relative position seemed so enviable that it hardly appeared to need Marshall Plan aid, and indeed received very little. Yet this miracle was short-lived. By 1950 only Germany and Austria among countries in north-western Europe had registered less growth in per-capita output since 1938.4 Only France and Germany had had

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smaller increases in hourly productivity. Belgium's share of world exports only remained much the same in 1952 as it has been in 1938 thanks to big increases in textile and metal exports within the newly formed Benelux (Adam and Waelbroeck, 1962). The 'miracle' owed much to strong demand for Belgian goods in the first years after the war. The concentration of American troops on Belgian territory in 1945 gave rise to large expenditures. Then, as reconstruction got under way elsewhere in Europe, Belgian specialities such as coal, metals, glass and cement were in great demand. Domestic demand was also strong. The Belgian government relatively quickly left the allocation of goods to the market, following what has been called alternatively the 'economics of abundance' or an 'exercise in supply-side economics' (Baudhuin, 1958; Kindleberger, 1987). Some of this demand spilled abroad, but domestic producers also benefited. Belgian producers were in a good position to respond to postwar demand. There had been relatively little war damage, so once shortages of materials, especially coal, had been eased, production could be restored quickly. Balance of payments problems were not a serious impediment to imports of materials and machinery. A monetary reform just after the liberation reduced the monetary overhang and made it possible to maintain relatively stable prices in the years after the war. But some aspects of the 'Belgian miracle' may have impaired subsequent growth. Liberal economic policies favoured consumption. In the absence of trade controls, Belgians imported substantial quantities of nylon stockings, Coca-Cola, passenger automobiles (including Cadillacs) and spirits from the United States in 1946 and 1947 (Kindleberger, 1987). Although the investment rate increased after the war, to 15-16 per cent of national income, it remained well below that in other European countries (Bismans, 1992:413; van Meerten, 1993). In the interests of price stability, the central bank kept interest rates high, which may have stifled industrial borrowing (MEA, 1948: 88; MEA, 1949: 100). Most private investment, in practice, wasfinancedout of retained earnings, which tended, however, to reinforce existing specializations. In the late 1940s there was surprisingly little public concern for modernizing industry (Camu, 1961: 495-9). The government's worries about its own finances kept public investment at low levels, and much of this was channelled into transport and coal mining. In the initial negotiations for Marshall Plan assistance, Belgium requested no direct aid, only help in financing its exports to other European countries (Kurgan-van Hentenryk, 1993a, 1993b). When, in 1950, the Belgians did ask for direct aid, they intended to use it for public investment (40 per cent), for agriculture andfishing(30 per cent), and for coal mining (30 per cent). The aid they did receive went almost entirely down the mines. More generally, the government's major concern after the war was maintaining social peace, which meant that it favoured production and consumption over investment (Kurgan-van Hentenryk, 1993b). Labour costs rose after the war, turning Belgium from a low-wage economy in the 1930s into a high-wage economy by 1950 (Dupriez, 1951; Cassiers and Solar, 1990). This has often been attributed to an across-the-board nominal wage increase of 60 per cent granted by a national labour conference in 1994, but careful examination reveals that real wages immediately after the war were only 50-60 per cent of those

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before the war, and that prewar real wage levels were not reached until 1947 or 1948 (Scholliers, 1993). These wages were high by European standards, but can be seen as the other side of the strong demand for Belgian goods and of Belgium's rapid recovery of output. Up to 1948 unemployment was quite low and employers were particularly concerned to keep factories running, so trade unions were well placed to push up wages, despite government attempts to control increases (Dupriez, 1951; Dancet, 1988). The rationalization and extension of the social security system from 1945 also contributed to the rise in labour costs. Energy costs also increased, thanks to government policy towards coal mining. Belgian heavy industries - steel making, non-ferrous metal refining, glass making were very energy intensive. Until the 1930s, Belgian manufacturers benefited from relatively cheap coal and electricity. This started to change during the Depression, as protection was granted to domestic coal producers. After the war, Belgian prices for coal and electricity were higher than in neighbouring countries, which created particular problems for heavy industry (Dupriez, 1951). These increases in labour and energy costs were not particularly damaging while demand for Belgian goods was strong. But by 1949 other European economies were getting back on their feet. The devaluation of sterling, along with the Scandinavian and Dutch currencies, in 1949 gave an additional boost to these countries. Belgium chose to devalue by only 12.3 per cent, instead of Britain's 30.5 per cent, which magnified the cost disadvantages of its export-oriented industries. Strikingly, even this small devaluation - in fact, a relative revaluation - was opposed by the Socialist Party, whose leader deemed it a 'measure against the common man' (Bismans, 1992: 475). This general concern for maintaining a strong and stable franc would cast a shadow over much of the following decade. 3.2

The silver fifties

Growth in Belgium during the 1950s was, like elsewhere in Europe, faster than had ever been experienced before. The rapid growth of world trade and the reduction of trade restrictions created great opportunities for a small country. Maddison (1982) reckons that gains from trade added 0.4 per cent to the Belgian growth rate from 1950 to 1962. Yet output and productivity growth lagged behind neighbouring countries, even when allowances are made for Belgium's lack of war damage and its already high level of income (Dowrick and Nguyen, 1989; Dumke, 1990; Crafts, 1992). In the growing export markets, Belgian manufacturers were losing market share (Waelbroeck and Rosselle, 1961; Kindleberger, 1967:121-3). Unemployment remained relatively high throughout the decade. Much of the 1950s can be seen as a prolonged, and not entirely successful, adaptation to the large shocks caused by recovery elsewhere and by the relative revaluation of the franc in 1949. During the 1950s, Belgian wages grew less rapidly than those in neighbouring countries. Yet the appreciation of the Belgian franc had wiped out these potential gains in competitiveness. Labour costs per unit output expressed in dollars increased by 3 per cent in Belgium (and 1 per cent in France) between 1948 and 1957, while they fell in the United Kingdom by 5 per cent, in the Netherlands by 28 per cent and in Germany by 29 per cent (Eichengreen, 1993). Energy prices, too, remained relatively high during the 1950s (Krul, 1964: 61; De

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Staercke, 1963; Van der Rest, 1962). Demand for Belgian goods was quite volatile (Romanis, 1964; Krul, 1964: 59). As a marginal supplier of standardized semi-finished goods, Belgium often did very well in booms and very badly in troughs. Domestic demand did not take up much slack in downturns. Government policy was generally deflationary, as the predominant intellectual current put priority on monetary stability.5 There was no counter-cyclical public investment policy for several reasons: concern for the state of the public finances, the political difficulties of taking decisions, and the absence of a strong Keynesian influence in policy making (Krul, 1964: 348-9). In this environment, the investment share, though higher than before the war, was low by European standards. But the investment share may understate Belgian efforts because the relative price of capital goods seems to have been a good deal lower in Belgium than in its neighbouring countries (de Voghel, 1961). On the other hand, the relatively capital-intensive nature of Belgian industry meant that depreciation as a share of national income was high, and that Belgium's investment share had to be higher than elsewhere to achieve the same net increase in the capital stock (Denison, 1967: 137-9). Investment was not low for lack of savings (Beuthe, 1964:106-8; De Brabander, 1981). The household savings rate was high and rising. Although the predominance of retained earnings infinancingbusiness investment has sometimes been taken as an indicator of weaknesses infinancialintermediation, capital does not seem to have been in short supply in the 1950s. A persistent trade surplus suggests that funds were flowing abroad. Large investments were made in the Congo, and firms such as Bekaert and ACEC expanded internationally. Much investment during the 1950s has been described by Lamfalussy (1961) as 'defensive'. Enterprises were faced by a squeeze on profits, as the result of high wage and energy costs and low export prices, and reacted by investments designed to rationalize production. They modified existing productive facilities only on the margin without renewing or diversifying them. These defensive investments brought some rapid productivity gains. In manufacturing industry, labour productivity growth was lower than in France, Germany and the Netherlands, but much higher than in the UK (Beuthe, 1964:36). The opportunities for such gains may be traced to the relatively ripe age of the capital stock just after the war. Replacing old machines with up-to-date equipment could bring large increases in efficiency, but by the early 1960s the potential for such vintage effects was being exhausted (Paelinck, 1962). Outside manufacturing industry, productivity growth was relatively slow. Competitive pressures were less in the parts of the economy sheltered from trade. Most of the measures adopted during the Depression to protect farmers and small retailers were retained throughout the 1950s, and the formation of Benelux was hampered by the demands for protection by Belgian farmers and textile producers (Beokestijn, 1990; Mommens, 1990). The weaknesses in coal mining, particularly in the Walloon region, were a constant preoccupation and a drain on resources (Milward, 1992: ch. 3). During the 1950s, the energies of Belgian governments were largely focused on non-economic issues, notably the royal question in the late 1940s, and the control andfinancingof schools during much of the 1950s. The dominant economic policy stance in the 1950s put priority on the balance of payments, then price stability, then

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employment (Bismans, 1992: ch.13). There were some measures to encourage investment and productivity growth, but these were quite limited in scope, and public investment was relatively low (De Brabander, 1981). The lack of government initiatives owed much to its chronic deficit. The Belgian public sector was the only net dissaver in western Europe during the 1950s (Camu, 1960: 415-17). Governments did try to encourage good relations between employers and unions in the hope of promoting private sector growth. Yet, despite the so-called social pact of 1944, industrial relations after the war were far from peaceful (Pasture, 1993). It took some time before new institutions of bargaining became fully operative, and there were variations in their development across regions (Dancet, 1988). Strike activity was as high (or higher) during the late 1940s and 1950s as it had been in the 1930s. But the trend was towards better relations. The joint protocol on productivity signed in 1954 has often been hailed as a sign of new attitudes. Productivity bonuses were widely introduced in the 1950s and early 1960s, but they were usually tied to the firms' profits rather than individual effort or labour productivity (Dancet, 1988). 3.3

The golden sixties (and early seventies)

The sharp acceleration in output growth from around 1960 is a central feature of postwar Belgian economic history (Table 7.1). As in other countries, the investment rate increased in the early 1960s. But more significant was the improvement in the efficiency with which capital and labour were used: here Belgium did much better in the 1960s than its state of development and factor inputs would have warranted (Dowrick and Nguyen, 1989). Belgian performance on international markets also improved. Where in the 1950s it had lost market shares, during the 1960s these were maintained (Van Rijckeghem, 1982; NBB, 1988). The improvement in Belgium's performance in the 1960s, as well as its subsequent difficulties in the 1970s and 1980s, had a differing incidence across the economy. The openness of the Belgian economy calls for a disaggregation into an open (or tradables) sector and a sheltered (or non-tradables) sector. The open sector includes most of manufacturing and, in a small country like Belgium, has little influence on the prices of either its imported inputs or its final products. The sheltered sector includes construction, transport and communications, and marketed services, and is primarily influenced by internal demand and domestic costs. Government is held apart from this disaggregation of the private sector. The growth in output and productivity by sector is shown in Figure 7.1 and Table 7.3. Growth in the early 1960s accelerated first in the open sector, but remained more or less balanced until around 1967. The same is true of the growth in labour productivity. By contrast, in the late 1960s and early 1970s, the growth of both output and labour productivity in the open sector was exceptionally high. The sectoral rates of capital formation are shown in Figure 7.2. The golden sixties and early seventies stand out as a prolonged investment boom in the open sector. Capital formation in the sheltered sector also increased, but much more gradually, and only reached its peak rate in the mid-1970s. Both the labour force and employment grew little in the early 1960s, with the open sector taking on more labour than the sheltered sector. Later in the decade, when the-labour force began to grow faster, most of the increase in employment occurred in the sheltered sector (Figure 7.3).

Economic growth in postwar Belgium

185

1952 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 Source: Bureau du Plan. Figure 7.1 Sectoral growth rates of output: Belgium, 1953-86 (three-year centred moving averages, 1980 prices) 7Open 65432-

1952 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 Source: Bureau du Plan. Figure 7.2 Sectoral growth rates of capital formation: Belgium, 1953-86 (three-year centred moving averages)

The initial impulses for the acceleration in growth around 1960 came both from abroad and from the domestic economy. Table 7.2 shows the growth rates of the various components offinaldemand. During the first years of the 1960s, almost all of the growth in exports went to Belgium's partners in the newly formed European Economic Community. This had profound effects on the nature of Belgian trade, about which more later, but it did not increase the already high rate of export

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Isabelle Cassiers, Philippe De Ville and Peter M. Solar

60 1? 1952 54

56

58

60

62

64

66

68

70

72

74

76

78

80

82

84

86

Source: Bureau du Plan.

Figure 7.3 Sectoral employment: Belgium, 1953-85 (1970 = 100) Table 7.2. Final demand growth: Belgium, 1953-86 (1980 prices, % per annum)

Private consumption Investment Public consumption Internal demand Exports (World demand) GDP

1953-60

1960-7

1967-74

1974-81

1981-6

2.77 5.37 3.26 3.20 7.65 n.a. 3.06

3.39 6.44 5.89 4.25 7.42 8.29 4.67

4.87 3.94 4.71 4.60 10.78 10.26 4.78

2.35 -1.59 3.11 1.52 4.39 3.88 1.76

1.04 0.64 0.31 0.89 3.56 3.96 1.03

Source: Bureau de Plan.

growth. The initial demand stimulus came from an increase in government spending. This was not really a belated conversion to Keynesianism (Bismans, 1992: 520-39). Although the Eyskens governments of 1958-60 did intend to increase public investment on infrastructure and to provide subsidies for private investment, they planned to do so without resort to additional borrowing. But expenditure increased by more than expected, largely as a result of commitments made in the School Pact of 1958. Additional tax revenue was not forthcoming because the government's package of fiscal and social measures was weakened as a result of the general strike of 1960-1. The net effect was to raise the full employment deficit from about 2 per cent of GNP in the 1950s to about 4 per cent in the early 1960s (Boelaert, 1983). This increase in public sector demand could simply have led to a balance of

Economic growth in postwar Belgium

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payments crisis, but changes in the productive structure of the economy made it possible for expansion to continue. Belgian membership of the European Economic Community was a crucial factor. Studies of the gains from integration show that the direct effects of tariff reductions were not large (Van Meershaeghe, 1992:78). But the prospects of the large market and the suppression of barriers gave a new dynamism to the Belgian economy. One indication is the noticeable improvement in Belgian performance relative to other EEC members in the important German market, although all of them benefited from similar tariff reductions (Kervyn de Lettenhove, 1968). Changes in industrial structure during the 1960s were subtle, but profound. The distribution of output across major industries did not change markedly, leading Van der Wee (1985) to argue that the rapid growth of demand during the 1960s boom retarded necessary shifts in specialization. But important changes did take place within sectors (Kervyn de Lettenhove, 1968). Many traditional Belgian products lost market share, even within the EEC. Producers of both linen and cotton yarn, longstanding Belgian specialities, suffered (though wool spinners benefited from the rise in carpet manufacture). At the same time, new specialities, such as plastics, soap, plywood and automobiles, developed within traditional sectors (NBB, 1969). The rise of new products was often associated with direct investment by foreign firms. Between 1960 and 1972 investment by foreign firms may have accounted for one-third of gross investment and half of net investment in manufacturing, although the net inflow of capital was much less, since foreign firms raised funds in Belgium (Van Rijckeghem, 1982: 592-3). For a country with few indigenous multinationals, American and European firms were important conduits for new technologies and new forms of organization (Vanden Houte and Veugelers, 1989). Both by direct competition and by example, they probably improved the performance of domestic firms (Kervyn de Lettenhove, 1968; Weber, 1983). The effect of the multinationals was likely to have been strongest towards the latter part of the period, when the stock of foreign direct investment had become large enough to make a difference to aggregate output growth. Foreign investment was disproportionately concentrated in Flanders, and helped output and incomes in the hitherto impoverished north of the country to surpass those in the older industrial areas of Wallonia (Van Rompuy, 1978; Vandersmissen, 1975). The so-called Expansion Laws of 1959 were intended to stimulate both inward and domestic investment, and are commonly cited as a reason for improved performance (Van der Wee, 1985). These laws - one national in scope, the other directed at regions in difficulty - provided loan guarantees, interest subsidies, tax relief and other benefits to investors. Originally intended as temporary measures to help get the economy out of recession, they were repeatedly prolonged until the late 1970s. More than a third of gross capital formation in the 1960s benefited from some assistance under the Expansion Laws. Much of the aid went to foreign firms, particularly those setting up in Flanders, so that far from backing 'national champions' Belgium, if anything, bent over backwards to attractfirmsfrom abroad. But the importance of the Expansion Laws has been questioned. The aid given was probably not large enough to have significantly increased the rate of investment (De Brabander, 1981; Gilot, 1987). It was given unselectively and tended to favour

188 Isabelle Cassiers, Philippe De Ville and Peter M. Solar

capital-intensive projects, often by existing firms (Camu, 1961: 496-7; Van den Broeke, 1984). Subsidies played only a minor role, relative to other considerations, in attracting multinational investment (Weber, 1983; Vanden Houte and Veugelers, 1989). The turnabout in Belgian economic performance around 1960 also owed something to the renunciation of a variety of anti-competitive policies that impeded the reallocation of resources. Fiscal pressures and the impatience of Belgium's partners in the European Coal and Steel Community led to the decision, in November 1959, to let the coal-mining industry in Wallonia run down (Milward, 1992: ch. 3). Subsidies and restrictive agreements employed in the 1950s to limit the effects of Dutch competition within Benelux were wound up (Boekestijn, 1990, 1992). Other restrictions were lifted in the service sector. After 1961 small shopkeepers lost much of their protection from the competition of supermarkets and large-scale retailers (van Waterschoot and Deleeck, 1992). From 1962 commercial banks were no longer required to keep 65 per cent of their assets in government securities. These policy changes were made individually and for a variety of reasons, but together they represented a move towards liberalization of the economy. Industrial relations improved noticeably in the 1960s, with a marked falling off in strike activity. Increasing cooperation between employers and unions was consecrated in 'social programming', another innovation made around 1960 (Dancet, 1988; Pasture, 1993). This involved biannual consultations between employers' organizations and trade unions. A national agreement first established norms, often minima, for changes in wages and other benefits. These norms then guided sectoral and enterprise negotiations. The government was not a formal partner in these negotiations, but it was expected to legislate in accordance with their outcomes (Janne and Spitaels, 1975). Whether social programming helped foster the acceleration of economic growth, or faster growth made it easier to reach agreements, remains an open question. The programmed social progress of the late 1960s involved significant extensions of the social security system, which would be a major factor in the rising public sector deficits of the late 1970s and early 1980s. When economic conditions did become more difficult in the 1970s, the system singularly failed to deliver agreements that were consistent with macroeconomic stability. From the late 1960s and into the early 1970s, the driving force behind growth was the rapid increase in exports, with domestic consumption playing a supporting role (see Table 7.2).6 Output and labour productivity growth were particularly high in the open sector. Unemployment remained very low, exerting some upward pressure on wages. But, thanks to rapidly rising productivity, unit labour costs in both the open and sheltered sectors hardly changed (Table 7.3). The share of wages and salaries in value added, as well as profit rates, remained relatively stable through most of the 1960s and early 1970s (Figure 7.4 and Weber, 1983). Some commentators have seen in the late 1960s and early 1970s the seeds of subsequent difficulties. Lowenthal (1987) stresses the pressure on public finances, pointing to increases in spending and in national debt per head. Government spending certainly grew faster than national product in the 1960s, but Belgium was by no means exceptional in this regard. For long-term growth the more important question is whether the government used the increased resources efficiently. Doubts have been cast on the value of infrastructure projects such as the port of Zeebrugge

Economic growth in postwar Belgium 189 Table 7.3. Sectoral cost, price and productivity growth: Belgium, 1953-86 (% per annum) 1960-7

1967-74

1974-81

4.37 4.41

8.22 7.42

12.26 10.48

13.59 10.06

7.63 5.93

0.37 1.57

3.47 3.20

4.83 6.88

3.70 7.82

4.13 6.76

3.99 2.80

4.59 4.08

7.09 3.37

9.54 2.07

3.36 -0.78

3.57 3.11

4.15 3.95

7.09 3.33

4.80 0.16

5.23 0.91

0.40 -0.30

0.42 0.13

0.00 0.04

4.52 1.91

-1.78 -1.67

1954-60 Nominal wages Open Sheltered Value-added prices Open Sheltered Real product wages Open Sheltered Labour productivities Open Sheltered Real product unit labour costs Open Sheltered

1981-6

Source: Bureau de Plan.

A

9085 -

Open/

\ _ _ / -

80/ / Sheltered

75 70651952 54

56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86

Source: Bureau du Plan.

Figure 7.4 Sectoral shares of wages in value added: Belgium, 1953-85

and some of the later extensions to the motorway system (De Brabander, 1981). The true capital costs of many projects were inflated by the long time it took to complete them (Vandersmissen, 1975). Expenditures on education, which increased rapidly during the 1960s, served to create overlapping and competing programmes, particularly in secondary education (Solar, 1993). The burden of the public debt - measured as the share of interest payments in

190 Isabelle Cassiers, Philippe De Ville and Peter M. Solar

national product - remained roughly constant from the early 1960s until around 1977. The Belgian debt ratio did not fall by as much in the 1960s as it did in other countries, and in 1970 it remained relatively high: 48 per cent, as against 13 per cent in France, 7 per cent in Germany and 29 per cent in the Netherlands (Van Rompuy and Vleminckx, 1983). But this large debt did not necessarily make the country more vulnerable to a downturn, since it was mostly held by Belgians. Moreover, it has not been alleged that government borrowing crowded out private investment during the late 1960s and early 1970s. Vandeputte (1993: 137-45), by contrast, sees the emerging problem as state interference in the economy. A proliferation of tax laws in the late 1960s created confusion and more work for businesses. Price controls of varying strength were used to fight inflation. Subsidies were increasingly used to keep firms in business. Whatever the deficiencies of these boom years, and they are easier to see with hindsight, the first years of the 1970s were marked by considerable optimism (Savage, 1991:334). Trade was growing rapidly. Investment remained at historically high levels. Foreign firms were continuing to set up in Belgium. Even traditional sectors like steel and textiles were adding to capacity. 3.4

The leaden seventies and eighties

In Belgium, as almost everywhere else in Europe, economic growth slowed down markedly from the mid-1970s. For a small country dependent on exports, the effects of the unexpected deceleration in the growth of world incomes and trade were particularly harsh. Belgian export volume fell by 11 per cent in 1975, and subsequently grew at rates much slower than those which had prevailed in the 1960s and early 1970s. Even when the growth of world demand recovered in the late 1980s, it was nowhere near the level of the golden sixties. This fall in the growth of export demand was the major factor making for the slower growth of output and employment in Belgium in the 1970s and 1980s (Mehta and Sneessens, 1990). But to make matters worse, during much of the period, adverse domestic price and cost changes made it particularly difficult for Belgian producers to compete on international markets. In this unfavourable environment, the growth of labour productivity remained relatively high, with the consequence that measured (and disguised) unemployment rose markedly. These sombre decades can be broken into two fairly distinct subperiods, with the break coming around 1982. This break does not correspond to any sharp or definitive change in the pace of growth. Output growth, if anything, slowed down somewhat in the early and mid-1980s. Only in 1988-90, after the countershock in energy prices and an improvement in world trade, did output grow faster than it had in the late 1970s, although still at a rate well below that common in the golden sixties. Moreover, this more rapid growth was not sustained after 1991. The reason for breaking these decades into two subperiods concerns not the results, but the underlying dynamics of growth. The 1970s were marked by mounting disequilibria - between sectors, in the labour market, the public finances and the balance of payments. These disequilibria were, in general, more pronounced than elsewhere in Western Europe, and can be traced to major institutional failures in Belgium. Decisive action in the early 1980s, which included the devaluation of the

Economic growth in postwar Belgium

191

120-. 110100b 90807060 1952 54

56

58

60

62

64

66

68

70

72

74

76

78

80

82

84

86

Source: Bureau du Plan.

Figure 7.5 Relative value-added prices, sheltered sector/open sector: Belgium, 1953-86

franc and a highly restrictive incomes policy, stopped things from getting worse. Whether these and subsequent policies have done more than stabilize the situation remains an open question. 3.4.1 Increasing disequilibria and policy inertia, 1973-82

The fall in output growth after 1973 took place in both the open and sheltered sectors of the Belgian economy, but after the giddy successes of the late 1960s and early 1970s it was much larger in the open sector. The growth rate of labour productivity also fell in both sectors, although it has remained at both historically and internationally high levels in the open sector. The very large gap which opened up between productivity growth rates in the two sectors was distinctively Belgian. Englander and Mittlestadt's (1988) estimates show that in other European countries the gap between the manufacturing sector and the entire enterprise sector in both labour and total factor productivity growth was usually no more than 0.5-1.0 per cent. In Belgium the difference was 2.0-2.5 per cent. One implication of this large gap in productivity growth was that, with only modest output growth in both sectors, the contraction in employment would be concentrated in the open sector (Figure 7.3). During the 1970s, the open sector faced a particularly severe squeeze on profits (Weber, 1983; Savage, 1991:132-9). Its proximate causes were, in more or less equal part, the sharp fall in the rate of growth of labour productivity and faster growth in the real product wage (Table 7.3). The latter was the result of an acceleration in nominal wage growth combined with a slowdown in the growth of the sector's value-added price. In the wake of the 1973 oil shock, the open sector was hit by a large rise in the costs of its intermediate inputs, which since it was unable to pass them on in increased output prices, reduced its value-added price. One element was, of course, the rise in

192 Isabelle Cassiers, Philippe De Ville and Peter M. Solar

901968

70

72

74

76

78

80

82

84

86

Note: Competitiveness in national currency calculated by dividing an index of unit labour costs for Belgium's principal competitors by an index of Belgian unit labour costs. In common currency the foreign index has been adjusted by an index of the trade-weighted exchange rate. Source: IRES.

Figure 7.6 Indices of competitiveness: Belgium, 1969-91

energy prices. This affected producers in all countries, but since important sectors of Belgian industry are energy intensive, Belgium was affected relatively more (Savage, 1991). The open sector also saw increases in the prices of the inputs it purchased from the sheltered sector. Sheltered sector producers were more able to pass along cost increases, which led to a marked and continuing deterioration in the intersectoral terms of trade (Figure 7.5). Nominal wages did not adjust to these changed conditions, but continued to rise rapidly on the basis of agreements signed before the shock. These agreements provided for substantial real wage increases and, as always, the indexation of nominal wages. From 1974 the consumer price index rose faster than the GDP deflator and much faster than value-added prices in the open sector, so indexation further increased real product wages. These increases in wage and intermediate input costs put pressure on profits and led to a sharp increase in the share of wages in value added, from about 74 per cent until 1973 to around 84 per cent from 1975. The overhang of high wages and the continuing deterioration of the intersectoral terms of trade meant that this increase persisted throughout the 1970s (Figure 7.4).7 These cost pressures combined to produce a marked deterioration in Belgium's international competitiveness during the early 1970s. This was severely exacerbated by exchange rate policy. Maintaining a strong franc kept Belgium's relative unit labour costs high until the late 1970s, even though relative wage and productivity movements began to favour Belgium from around the mid-1970s (Figure 7.6 and Buyst, 1993). The country suffered persistent losses in its share of foreign markets, even after allowance has been made for its relatively unfavourable export structure (Konings, 1988; Savage, 1991: 313-14; Pagano, 1993).

Economic growth in postwar Belgium

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In the sheltered sector of the economy, labour productivity growth also slowed down in the 1970s. Real product unit labour costs rose more rapidly than in the 1960s, but not nearly so fast as in the open sector, thanks to the ability of sheltered sector producers to pass through rising wage and energy costs into higher prices. Profit rates in finance, energy and distribution remained relatively high in the late 1970s (De Grauwe, 1983). Yet there was still pressure on the profit share: as in the open sector, the share of wages in value added increased by about 10 percentage points in the mid-1970s (Figure 7.4). Many workers in the sheltered sector were able to secure handsome gains during the 1970s. In 1980, average earnings in several service sector occupations were far higher than in neighbouring countries, whereas in manufacturing the differences were much smaller (Petit, 1986: 174). National and sectoral wage negotiations in the late 1960s and early 1970s tended to produce fairly uniform increase in wages and benefits across the economy. Any individual industry's fortunes thus depended on its rate of productivity growth and the extent to which it could pass on cost increases (Houard, 1977). The same was true across regions: slower productivity growth in Wallonia than in Flanders, with similar wage trends, led to a fall in Wallonia's relative competitiveness from the late 1960s to the mid-1970s (Ghymers, 1977; De Grauwe, 1980). Rising labour costs put pressure on the system of industrial relations and led the state to assume a more central role in wage determination. From the mid-1970s, employers, particularly those in the open sector, began to press hard for wage moderation and an end to indexation. The system of national collective agreements between employers and trade unions broke down in 1975, leading the government to intervene (De Ville, 1986; Bogaert et aL, 1991). Indexation was suspended, as a temporary measure, for nine months in 1976, then promises of wage moderation were exacted from the unions during the next few years. The initial surge in wages in 1973-5 led Belgium to diverge from other European countries. High wages kept internal demand at internationally high levels from 1974 to 1980 (Savage, 1991: 246). Those with jobs gained at the expense of those who became unemployed or lost their businesses. High import demand, along with reduced competitiveness in the open sector, led to a persistent balance of trade deficit from 1974. The rise in real wages was a major factor behind both the rise in unemployment and the presence of inflationary pressures in Belgium during the 1970s (Bruno and Sachs, 1985: 206-7, 214-15). To keep inflation under control, the Belgian government relied primarily on monetary policy in the absence of any consensus on restrictive fiscal or incomes policies. This monetary policy centred on maintaining the nominal exchange rate, which reinforced the loss of international competitiveness up to 1977 or 1978 (De Grauwe, 1983; Spaey, 1982). The mid-1970s have an eerie resemblance to the 1950s, with exchange rate policy undermining wage moderation and firms concentrating their investments on rationalization. The government'sfinancesdeteriorated very rapidly in the late 1970s (Figure 7.7). This happened in other European countries, but was more severe in Belgium (De Grauwe, 1983). Much of the deterioration was endogenous, the result of an essentially passive reaction to changing circumstances after 1973. Tax revenues fell, unemployment payments rose and, after several years of large deficits, interest charges increased (Beckers, 1982; Lowenthal, 1987). But some of the rise in the

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2-1

0-2-4% -6-

-10-12-14

T ' I ' I

' I ' I ' I ' I ' I ' I ' I

' I

' I ' I ' ' I

' I ' I

' I I ' I

' I ' I

195254 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 Sources: Bureau du Plan and Banque nationale de Belgique.

Figure 7.7 Net financial need of the government as a share of GDP: Belgium, 1953-93

government deficit resulted from decisions taken at the time. Some of the increase in social security costs, which rose from 15.9 per cent of GDP in 1974 to 22.5 per cent in 1981, arose from extensions of coverage and benefits. Government spending on industrial subsidies and job creation in the public sector also increased rapidly (Figure 7.3 and Buyst, 1993). The rise in the deficit was also the result of decisions not taken. Vuchelen (1991) estimates that about a third of the total increase in the public debt over the 1970s and 1980s can be attributed to political instability, much of which stemmed from conflicts over non-economic issues. The second oil shock in 1979 and recessions in other European countries in the first years of the 1980s exacerbated all of Belgium's problems. The import price shock was once again translated into increased wages, which by maintaining consumption and by increasing firms' costs worsened the trade deficit. The government's finances began to deteriorate more rapidly as the burden of interest charges rose and industrial subsidies and unemployment benefits increased. The rising government deficit could only be reconciled with a strong franc by real interest rates that were from 1979 among the highest in Europe. The domestic consensus behind restrictive monetary policy began to break down, but agreement could not be reached on an alternative, particularly since politicians were preoccupied with conflicts between Walloons and Flemings that were only in part economic. 3.4.2 Stabilization and limited recovery, 1982-90 Severe pressures onfirmprofitability and on the exchange rate led to major changes in policy in 1981-2. The government's immediate objective was to restore competitiveness by a substantial redistribution of primary income from households to firms (De Ville, 1986). A first, somewhat timid step was taken in 1981: the Christian Democrat-Socialist coalition negotiated moderate wage restraints and decreased employer social security contributions for blue-collar workers. These measures quickly gave way in 1982, with the replacement of the Socialists by the

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Liberals in the government, to stronger wage and price controls and an 8.5 per cent devaluation of the franc. The system of social programming, which had broken down from the mid-1970s, was suspended altogether from 1981 to 1985, and the government used special executive powers to pursue its economic goals. These measures produced an effective real wage cut of about 12 per cent and a restoration of business profits (Bogaert et al., 1991). The government's medium-term objective was to restore the public finances by new substantial transfers from households and firms to the state. This was to be done by increasing social security contributions, reducing transfers and reducing public sector employment. There was, of course, a contradiction between the short-term and medium-term policies: the rise in social security contributions continued to increase the wedge between after-tax wages and labour costs until the mid-1980s, which limited the gains in competitiveness and complicated collective bargaining. The change in policy had mixed results. It was effective in righting the balance of trade, although initially more through the restriction of domestic demand than through increased exports. After 1980 internal demand fell off to a level below that in other countries (Savage, 1991: 246). The rise in unit labour costs was halted, then partially reversed, from 1982 (Table 7.3). But cost pressures on the open sector from the rise in sheltered sector relative prices continued unabated into the mid-1980s (Figure 7.5). Wage moderation and exchange rate changes during the early 1980s did restore competitiveness, pushing relative unit labour costs below their level around 1970 (Figure 7.6). Although Belgium consistently ran a trade surplus from 1983, an improvement in its performance on export markets is perceptible only, if at all, from 1986 (Pagano, 1993). Reliance on a strong franc policy, implicitly in 1983-4 and explicitly from 1987-8 in the context of the European Monetary System, did not help prospects in the open sector. One reason why a strong, or at least a stable, exchange rate has been a major policy goal is that the system of indexation has been maintained.8 Although indexation has at times been suspended and manipulated, particularly in the early 1980s, it has remained sacred to Belgian trade unions. The persistence of indexation and the importance of social security contributions in labour costs have been centralizing tendencies in Belgian industrial relations, although throughout the 1980s and in the early 1990s it has been extremely difficult to conclude national agreements between employers and unions without government intervention. At the same time, the locus of wage bargaining has tended to become increasingly decentralized: regional and enterprise negotiations have become more important than those at national and sectoral level (Beaupain, 1983; Dancet, 1988). The restoration of profitability in the 1980s was not sufficient to produce significant increases in private sector investment until the very end of the decade. In the mid-1980s,firmsused increased profits to retire debt and improve their balance sheets. New tax advantages for shareholders, another element in the government's programme, also helpedfirmsto substitute equity for debt. In any case,firms'profits never recovered to the level of the early 1970s, nor did they improve over the longer term relative to profits in other countries.9 Low investment and the substitution of capital for labour since the mid-1970s have reduced the Belgian economy's employment capacity (Figure 7.8). With the

196 Isabelle Cassiers, Philippe De Ville and Peter M. Solar 4300n Labour force

42004100-

Employment at full capacity

40003900380037003600-

*

•* Actual employment

350034003300 1952 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 Note: Employment at full capacity has been calculated using the estimated parameters from a disequilibrium macroeconomic model of the Belgian economy. Source: Mehta and Sneessens (1990).

Figure 7.8 Labour force, employment capacity and actual employment: Belgium, 1953-88

continuing rise in the labour force, unemployment worsened during the late 1970s and 1980s, and would not easily be reduced simply by an increase in demand. Government policy since 1981 has been only partly effective in restoring the public finances. The 'snowball effect' of rising interest charges on the government deficit was slowly halted. Interest charges as a share of GNP continued to grow until 1986, reaching a peak of 11.7 per cent. Since then they have levelled off, remaining at 10-11 per cent of GNP, despite a major fall in other government spending. Expenditures, exclusive of interest payments, fell from just over half of GNP in the early 1980s to around 42 per cent in the early 1990s, with most of the fall taking place between 1984 and 1989. Public sector investment has been severely cut back, from a relatively high 3.6 per cent of GDP in 1980 to only 1.6 per cent in 1989, the lowest level in Western Europe. Employment in the public sector stopped growing, but did not decline in the 1980s (Figure 7.3). While government policies during the 1980s managed to halt the potentially disastrous trends of the late 1970s, they have not been able to increase the rate of economic growth. When more rapid growth did take place in 1988-90, it was the outcome of drastic improvements in the external environment. The fall in oil prices helped energy-intensive industries in Belgium and contributed to the resurgence of world demand for Belgian products. 3.4.3 Continuities in performance during the 1970s and 1980s

In the 1970s and 1980s, both labour and total factor productivity in the open sector of the Belgian economy rose rapidly by international standards. Although much of the investment that took place was oriented towards saving labour (Mehta and

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Sneessens, 1990), the rapid growth of total factor productivity indicates that the substitution of capital for labour was not the whole story. In any case, until the late 1980s, capital formation in the open sector was quite low, in part because of the squeeze on profits and in part because of slower growth of world demand (Figure 7.2 and Van Rompuy et al, 1986). One way in which productivity grew was through the closure of less efficient enterprises, although perhaps not too much should be made of this effect. In some sectors,firmswhich ought to have been closed were kept open. Out of concern to maintain employment, governments in the 1970s and early 1980s were all too willing to subsidize loss-making firms (Leonard and Van Audenrode, 1993). Between 1975 and 1984, aid to enterprises grew by 9-13 per cent per annum (Gilot, 1987). The so-called national sectors - steel, textiles, coal, shipbuilding and glass soaked up large subsidies, which were carefully calibrated to satisfy regional interests. During the 1980s, the pressures on central government finances and the devolution of industrial policy to the regions led to a reduction in subsidies and a rundown of these industries. The 1970s and 1980s saw a profound shift in the control of industry. During the troubled years of the 1970s, employment in multinational enterprises held up better than it did in Belgian firms (Van Den Bulcke, 1983). In the 1980s, many of the Belgianfirmswhich survived the 1970s were taken over by foreignfirms(Daems and Van de Weyer, 1993: 56-7). Foreign ownership may have brought technological or marketing advantages, or it may have imposed greater discipline on costs. In either case, the large increase in foreign control of Belgian industry must have contributed to the relatively rapid rate of labour productivity growth in the open sector. Productivity growth in the sheltered sector was much slower than in the open sector during the 1970s and 1980s. This is not, perhaps, surprising since the sheltered sector contains many service industries. But productivity in many Belgian services grew less rapidly than in neighbouring economies, although the differences were not so great as in the open sector (Englander and Mittelstadt, 1988). Some of the relatively poor productivity performance of the sheltered sector must be laid to industries run or controlled by the state. Until the 1980s, these industries often operated with a soft budget constraint. Studies of several state-run industries (and of some public services included in the government sector) suggest that in the 1980s they were, by international standards, very inefficient providers of services (Vuchelen and Van Impe, 1987: 103; Moesen, 1990). Whether they had become relatively more inefficient during the 1970s and 1980s is not known. Englander and Mittelstadt's (1988) total factor productivity calculations for transport and communications, which in Belgium includes the state-owned railway, airline, telephone and postal companies, show Belgian performance to have been relatively poor. During the late 1970s, state-owned industries were certainly under pressure to take on additional labour (De Borger, 1993). This changed in the 1980s as the deterioration of governmentfinancestightened the budget constraint. But another consequence of tighter control of the public purse was a sharp drop in public sector investment, including investment in state-run industries. Yet, unlike in other European countries, there were no significant privatizations during the 1980s (Vuchelen and Van Impe, 1987).

198 Isabelle Cassiers, Philippe De Ville and Peter M. Solar 4

Structural change and the control of industry

A persistent criticism of Belgian economic performance during the pastfiftyor sixty years has been that it has depended too much and for too long on steel, non-ferrous metals, textiles and other products of its early industrial development, and that there has been a failure to move towards more modern industries (Hogg, 1986; Van der Wee, 1981, 1984, 1987; Lowenthal, 1987). The blame for this structural inertia has often been placed on the holding companies, the predominance of which has been a distinctive feature of Belgian capitalism. These concentrations of financial power, which once had control over a large share of heavy industry, are alleged to have acted mainly to preserve and exploit their existing assets in Belgium (and the Congo), and to have lacked the dynamism to channel resources into new activities (Van der Wee, 1981,1984). This argument, while it contains an important element of truth, needs refinement. As an explanation of alleged weaknesses in Belgian economic growth, particularly before 1960, too much emphasis has been put on shifts in the composition of industry and trade. Simple analyses of the hypothetical effects of shifting resources among sectors or among industries show that plausible changes in structure would have had little impact on the growth rate (Daems, 1978: 130-5; Sprumont, 1986). Similarly, the studies of Belgian export performance, while showing a consistently unfavourable product specialization, find that loss of market share within product groups has generally been a much more important factor (Waelbroeck and Rosselle, 1961; NBB, 1988; Konings, 1988; Pagano, 1993). These results should not be surprising. Structural change has contributed very little to explaining growth elsewhere (Denison, 1967: 223-4; Maddison, 1982; Matthews et ai, 1982: ch. 9). The largest structural effects in postwar Europe came from shifting resources out of low-productivity agriculture, a path along which Belgium had already travelled a long way by 1945. Nor should it be surprising that Belgium has not managed to alter markedly its trade structure. Studies of revealed comparative advantage show a high degree of persistence in most European countries (Crafts, 1989). Moreover, the great exception to this persistence has been the UK, where changes in specialization have been seen as a sign of economic weakness rather than of strength. If changes in industrial structure have been less important than performance within industries, and this was certainly true of the major improvement in Belgian growth around 1960, then criticism of the holding companies for failing to shift resources into more modern industries is not really telling. More to the point would be the observation that they failed to assure that their subsidiaries performed better. While holding companies have at various times sought to reap gains from cooperation among their subsidiaries, their internal organization has left much to be desired, as this appraisal from the 1970s bears witness: The holding company conducts an ill-defined corporate policy through a loose organization, which might be too flattering a term to describe the real system... There is nothing in the holding company comparable to the staff functions of the conglomerate's head office. Uniform control systems such as standardised accounting practices are not utilized, which should make it much more difficult to coordinate the operations of the subsidiaries

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and to evaluate performance . . . The holding company structure is probably the poorest way in a modern economy to organise control, which apparently is the central business of the large Belgian holding company. (Daems, 1978: 34-5) Why did this form of organization persist for so long? Daems, the leading student of the holding companies, argues that it was not because they were particularly efficient financial intermediaries. Instead, their structure permitted large investors to implement their policy preferences and diversify their wealth at the same time' (1978: 122). Uncertainty about the future and the likelihood of conflict among shareholders over corporate policy made this control worth paying for. This explanation for the persistence of holding companies raises more questions than it answers. What sorts of policy have been pursued by those with control? Why has the central organization of the holding companies remained so weak? It particularly raises difficulties in the case of the dominant holding company, the Societe Generale, in which large individual investors have never held more than a few per cent of the shares. An alternative interpretation, which also emphasizes the importance of corporate control, is that the holding companies can be seen as federations which served to permit owners or managers to retain effective control of the constituent firms (De Geest, 1972; Kurgan-van Hentenryk and Puissant, 1990: 217-18). They were vehicles through which firms in capital-intensive industries could, with less risk of losing control, raise funds and cooperate with other firms in the same and related industries. Firms in highly cyclical industries, like steel, could benefit from the holding's financial support in downturns, thus protecting themselves against the loss of control. This interpretation is consistent with the lack of staff functions, which remained in the subsidiary firms; with the specialization of directors, who supervised sectors from which they were recruited (and by which they were sometimes even paid); and with the very limited mobility of managers and investment capital among holding company subsidiaries (CRISP, 1962: 403, 424; Granick, 1962: 136-40; Cvetkov, 1972). The holding companies, a legacy of Belgium's industrial past, had once played a dynamic role in growth. Before the First World War they mobilized capital for industrial development and channelled Belgian savings into transport and utility companies abroad, thus providing export markets for their industrial subsidiaries (Van der Wee, 1981). But during the interwar years, the holding companies increasingly concentrated on the domestic market and exploited their privileged position in the Congo colony (Kurgan-van Hentenryk, 1992). In these contexts, federations of firms were likely to be anti-competitive. The Societe Generale was instrumental, for example, in putting together domestic coal and cement cartels and both domestic and international steel cartels (Kurgan-van Hentenryk and Puissant, 1990: 240-3; Hogg, 1986). By the postwar period, holding companies had become a vehicle for largely conservative interests. They played a major role in delaying mine closures and in securing national and European Community subsidies for coal mining (Milward, 1992: ch. 3). The electricity generators and distributors, largely controlled by the holdings, resisted efforts at nationalization and have kept electricity prices among

200 Isabelle Cassiers, Philippe De Ville and Peter M. Solar

the highest in Western Europe (Mommen, 1994: 96,167). In the steel industry, capacity increases in the 1950s took the form of enlargements and modernizations of existing mills rather than construction of new integrated mills.10 When Belgian economic growth accelerated in the 1960s, the holding companies played only a minor role. They have, in fact, offloaded many of their industrial subsidiaries, sometimes with state help, and have shifted their resources increasingly towards the sheltered sector of the Belgian economy and abroad (Revue Nouvelle, 1972: 445; Storms, 1972; Sortia, 1986). Viewing the holding companies as federations serving the interests of constituent firms brings them into line with a more general, and equally common, criticism of Belgian capitalism: that it is too familial (Daems and Van de Weyer, 1993: 116). Familyfirms,it is argued, have been oriented more towards short-term profits and maintaining their autonomy rather than towards growth (Camu, 1960: 411). The share of investmentfinancedby retained earnings has been persistently high (Camu, 1960: 41L; Maldague et al., 1993: 140). Family firms have been more risk averse, particularly with respect to intangible investments in research or overseas marketing. In general, Belgianfirmstend to spend less on both of these activities than do firms in other small countries, such as the Netherlands, Sweden or Switzerland (Jacquemin and De Jong, 1977: 124; Fagerberg, 1988). Industrial policy has done little to overcome these deficiencies. Its main thrust from the 1950s to the 1970s has been to subsidize physical capital formation (Boelaert, 1983; Gilot, 1987). This bias, along with the country's traditional product specialization, may explain why the structure of Belgian trade suggests that the country is abundant in capital- and natural resources and scarce in human capital (Culem, 1984; Tharakan and Waelbroeck, 1988). Moreover, industrial subsidies have been given unselectively. The politique de guichet, which has also characterized grants for research and product development, has meant that resources have tended to go to existing firms and industries (CEB, 1962: 436; Boelaert, 1983; Gilot, 1987; Jaumotte, 1987). The major way in which the deficiencies of Belgian familial capitalism have been overcome is through the participation of multinational firms in the Belgian economy. Whatever its other defects, industrial policy has been relatively non-discriminatory, making Belgium one of the European countries most open to foreign investment (Sleuwaegen, 1987: 167). Multinational investment, especially since the 1960s, has introduced new products and methods. In the 1970s, multinationals were more ruthless in closing inefficient plants, thus avoiding the long and costly agonies offirmsin the 'national sectors' and/or under the wing of the Societe Generate. Foreign firms have played a major role in the high and sustained rate of productivity growth in the open sector of the Belgian economy. The importance of foreign control in the Belgian economy, and its increasing role in other European economies, should impose a certain caution on the interpretation of variables for national research and development in the cross-section regressions used in testing the new growth theories. Royalties and fee payments by Belgian subsidiaries to their foreign parent companies suggest the crucial importance of technology transfers from abroad (Van Den Bulcke, 1983:313; Sleuwaegen, 1987:164). This view of indigenous Belgian enterprise is not too far from Chandler's characterization of British capitalism as personal (Chandler, 1990). Both countries

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had dynamic entrepreneurial classes in the nineteenth century. Both had a relatively slow development of large firms with managerial hierarchies. The role of the holding companies, seen as federations, is analogous to the British mergers that resulted in little rationalization and left the constituent companies with considerable autonomy. But, fortunately for Belgium, its industry did not suffer from other defects of British capitalism. Its owners and managers were, as in France, often trained as engineers, making for technical, if not always commercial, competence (Granick, 1962:259). Its trade unions, while well developed and firmly implanted, left shop floor control in the hands of management. 5

Conclusion

The history of Belgian economic growth since the Second World War is a tale of decline and resurgence. From the First World War until around 1960, Belgium fell behind its neighbours. During the interwar years, and particularly in the 1930s, it suffered from being a small open economy in an unfriendly world. Its plight was made worse by long adherence to the Gold Standard, which weakened its export industries, and by the rise of anti-competitive practices in the domestic economy. Belgium emerged from the Second World War with relatively little damage, but few gains in productivity, and with an unusually good foreign exchange position. Perhaps because it was relatively well off, Belgium failed to take full advantage of this situation. The late 1940s and 1950s were marked by a search for social peace and the protection of established economic interests. Private and public complacency prevailed. From 1960 to the present, Belgian economic growth has been stronger than that of its neighbours. The decisive elements in this resurgence were a liberalization of the economy, which was not unrelated to Belgium's adherence to the European Community, and the accompanying influx of foreign investment. Growth has been led by a dynamic open sector which has had unusually rapid productivity growth. This has been true even after 1973, despite (or as a response to) the slowdown in world trade, rising unit labour costs and restrictive monetary policy. In this period, productivity increases have come at the expense of open sector jobs - one element making for Belgium's unusually high rate of unemployment in the 1970s and 1980s (De Ville and Van der Linden, 1993). The dark side of Belgian growth since 1960 has been the public sector and those parts of the open and sheltered sectors controlled by the state. Productivity growth has been slow relative to that in other countries, and these sectors have absorbed considerable resources in subsidies and public investment. The government's own finances have deteriorated since the early 1970s. This has been a consequence of the slowdown in growth, but also of political instability and the difficulty of reconciling diverse and well-established interests. The prospects for Belgian economic growth in the 1990s rest ultimately on a resurgence of growth elsewhere in Europe. Whether Belgium benefits fully from any increase in external demand will depend on the strength of its open sector, over which hangs the dreadful dilemma posed by the public debt. Failure to reduce the debt burden will undermine the credibility of government policy, with the likelihood of a risk premium on interest rates, and it will endanger Belgian participation in the

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European Monetary Union, which may lead to exchange rate volatility. Neither of these effects would encourage the international investors who have been so important to the Belgian economy. On the other hand, a serious reduction of the public debt would be likely further to increase taxes and social security charges, which have already had the effect of discouraging the creation of jobs. Austerity could also poison relations between management and labour, which would discourage foreign investors.

NOTES The authors would like to thank E. Buyst, J. Hannes, G. Kurgan-van Hentenryk, P. Lowenthal, H. Van der Wee, G. Vanthemsche, J. Vuchelen, D. Weiserbs and participants at seminars at the Vrije Universiteit Brussel and the Universite catholique de Louvain and at the CEPR-Institutet for Framtidsstudier workshop in Lund for their comments on earlier drafts of this chapter. They are also grateful to F. Mehta and T. de Biolley for advice and help in preparing the figures. Financial support from the Ministry of Education and Research, French Speaking Community of Belgium (ARC 93/98-162) is gratefully acknowledged. 1 Thefirstten years of the national accounts were put together retrospectively and published only in the mid-1960s. These and subsequent official figures may themselves be a weak reed (Denison, 1967; Kestens, 1990). Some coefficients used in estimating consumption and value added have not been changed since 1953. 2 These comparisons draw on the data in Maddison (1989,1991,1994). Maddison's estimates for Belgium before 1953 are based on extrapolations using production indices and should be regarded as provisional and perhaps not highly reliable. The detailed reconstruction of historical Belgian national accounts is currently under way at the K.U. Leuven, so that betterfiguresshould be available in the years to come. 3 There have been regional differences in economic growth that have important implications for Belgian politics. Here the differences between Flanders and Wallonia will only be touched on incidentally, since, by comparison with other European countries, these regional variations are not large. 4 Comparisons with 1938 tend to favour Belgium. Belgian output was lower in 1938 than in 1937. In all other European countries for which Maddison (1989) presents data, output was higher in 1938. On the other hand, the year 1950 may be relatively unfavourable to Belgium. 5 Another factor is the slow growth of consumption demand, which grew by only 2.3 per cent per annum, while in the OEEC it advanced by 4.2 per cent on average. Households started to save more of their income, with the average savings rate rising from 9.4 per cent in 1950 to 15.0 per cent in 1960. Lamfalussy (1959) saw this behaviour as even more deflationary than the National Bank's monetary orthodoxy. 6 Some of the growth in exports is exaggerated by thefinerinternational division of labour. Export statistics record total value rather than value added. Automobiles accounted for 9 per cent of Belgian exports in 1965, but the Belgian contribution was only about one-third (Kervyn de Lettenhove, 1968). It has been alleged that the rapid growth of both exports and imports during one year in the 1960s can largely be explained by the increase in shipments of materials between Ford plants in Belgium and Germany (Kindleberger, 1967). 7 An increase in the wage share took place in other European countries, but the

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Belgian increase was much larger (De Grauwe, 1983). 8 Another reason for a strong currency stand was to help reduce the costs of financing the national debt. By credibly linking the franc to the mark, interest rates could be brought down. 9 The OECD profitability index for the private sector went from 94.8 in 1971 to 62.7 in 1981, a 34 per cent decline (Economie Europeenne, no.50, Dec. 1990). For Germany, the comparablefiguresare 96.4 and 84.3 ( —13 per cent); for France, 114.4 and 79.7 (— 33 per cent); for the Netherlands the decline was 9 per cent, and for the twelve EEC countries, 12 per cent. But profitability recovered strongly between 1981 and 1988: it increased by 32 per cent in Belgium compared to 20 per cent for Germany, 25 per cent for France and 26 per cent for the Netherlands. However, it is immediately clear that the recovery did not (as for France and the UK) restore profitability to its 1971 level. 10 Lamfalussy (1961) and De Brabander (1981) use the fact that the holdings controlled a large share of the steel industry as an argument against indivisibilities in investment. It would take a more detailed study of decision-making by the holding companies in the 1950s to discriminate between these explanations. REFERENCES Adam, A. and J. Waelbroeck (1962) 'Nouvelles donnees sur 1'evolution des exportations de la Belgique (1925-38 et 1952-60)', Cahiers economiques de Bruxelles, no. 15, pp. 413-25. Balassa, B. (1977) '"Revealed" comparative advantage revisited: an analysis of relative export shares of the industrial countries, 1953-197 1', Manchester School, 45, pp. 327-44. Balthazar, H. (1981) 'Bien-etre social et politique de concertation, un souhait non accompli', in L'industrie en Belgique: Deux siecles d'evolution 1780-1980,

Brussels: Credit Communal. Baudhuin, F. (1945) L'economie beige sous I 'occupation 1940-1944, Brussels: Bruyland. (1958) Histoire economique de la Belgique 1945-1956, Brussels: Bruyland. (1970) Histoire economique de la Belgique 1957-1968, Brussels: Bruyland.

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Boelaert, R. (1983) 'Het budgettaire beleid 1953-1980', Bulletin de documentation du Ministere des Finances, July, pp. 5-38. Bogaert, H., T. de Biolley and J. Verlinden (1991) 'L'ajustement des salaires face aux chocs petroliers et les reponses de la politique economique', Department des Sciences Economiques, Universite Catholique de Louvain, Discussion Paper No. 9108. Broadberry, S. and N.F.R. Crafts (1992) 'Britain's productivity gap in the 1930s: some neglected factors', Journal of Economic History, 52, pp. 531-58. Bruno, M. and J.D. Sachs (1985) Economics of Worldwide Stagflation, Cambridge, MA: Harvard University Press. Buyst, E. (1993) T h e decline and rise of a small open economy: the case of Belgium (1974-1990)', in E. Aerts et al. (eds.), Studia Historica Economical Liber Alumnorum Herman Van der Wee, Leuven: Leuven University Press. Camu, A. (1960) 'Essai sur revolution economique de la Belgique', Revue Nouvelle, 32(11), pp. 397-418. (1961) 'Essai sur revolution economique de la Belgique - IF, Revue Nouvelle, 33(5), pp. 481-500. Cassiers, I. (1989) Croissance, crise et regulation en economie ouverte: la Belgique entre les deux guerres, Brussels: De Boeck-Wesmael. (1995) '"Belgian miracle" to slow growth: the impact of the Marshall Plan and the European Payments Union', in B. Eichengreen (ed.), Europe's Postwar Growth Revisited, Cambridge: Cambridge University Press. Cassiers, I. and P. M. Solar (1990) 'Wages and productivity in Belgium, 1910-1960', Oxford Bulletin of Economics and Statistics, 52, pp. 437-49. CEB (1962) 'Les nouveaux produits et services et les problemes d'implantations qui'ils soulevent', Cahiers economiques de Bruxelles, no. 15, pp. 429-52. Chandler, A. (1990) Scale and Scope: The Dynamics of Industrial Capitalism, Cambridge, MA: Harvard University Press. Cornwall, J. (1990) The Theory of Economic Breakdown, Oxford: Basil Black well. Crafts, N.F.R. (1989) 'Revealed comparative advantage in manufacturing, 1899-1950', Journal of European Economic History, 18, pp. 127-37. (1992) 'Productivity growth reconsidered', Economic Policy, 15, pp. 387-426. CRISP (1962) Morphologie des groupesfinanciers, Brussels: Centre de Recherches et d'lnformation Socio-Politique. Culem, C. (1984) 'Comparative advantage and industrial restructuring: the Belgian case 1970-1980', Cahiers economiques de Bruxelles, no. 103, pp. 457-84. Cvetkov, P. (1972) 'Le controle de la SG sur les principales entreprises beiges et ses mecanismes', Revue Nouvelle, 56(11), pp. 343-7. Daems, H. (1978) The Holding Company and Corporate Control, Leyden and Boston, MA: Martinus Nijhoff. Daems, H. and P. Van de Weyer (1993) L'economie beige sous Vinfluence, Brussels: Fondation Roi Baoudhuin. Dancet, G. (1988) 'From a workable social compromise to conflict: the case of Belgium', in R. Boyer (ed.), The Search for Labour Market Flexibility, Oxford: Clarendon, de Biolley, T. and A. Gilot (1987) The Capital Stock of the Belgian Economy: Evaluation and Analysis, Brussels: Planning Bureau, DG 3965. De Borger, B. (1993) 'The economic environment and public enterprise behaviour: Belgian railroads, 1950-86', Economica, 60, pp. 443-63. 4 De Brabander, G. (1981) 'La creation d'un etat d'abondance', in L'industrie en Belgique: Deux siecles d'evolution 1780-1980, Brussels: Credit Communal.

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8

France, 1945-92 PIERRE SICSIC AND CHARLES WYPLOSZ

1

Introduction

France has managed to deliver one of the fastest and smoothest European growth performances since 1950. Why that is so remains largely a matter of debate. Alternative explanations centre on catching-up (Carre et ai, 1972; Dubois, 1985), on new personnel at the helm of the state (Sautter, 1982), and on the benefit from opening up to international trade (Adams, 1989). In revisiting French growth we exploit the advantage of hindsight, extending the period of observation to the 1980s and early 1990s, and explore some of the implications of the 'new' growth theory emphasizing aggregate increasing returns. This leads us to look at human capital accumulation and the role of institutions. By 1958, France had not quite exploited all of its potential for catch-up. Its growth performance was impressive in the 1960s, but since 1973 it has undergone the same slowdown as most other European countries. In searching for explanations, like Carre et al. (1972) - the landmark work on French growth - we devote particular attention to industry-level data and emphasize the key role played by the state as part of its traditionally active industrial policies. Like Villa (1993), we note the important role of equipment age and vintage. As we focus on institutions, we pay particular attention to income distribution and find that the large swings in the rate of investment are well correlated with the share of GDP allocated to profits. More than previous authors, perhaps, we find many footprints of distortionary policies, mainly in the distribution of saving for physical capital accumulation and in the education system for human capital accumulation. In the immediate postwar period, there is some evidence of inefficient capital, favouring industries already capital intensive. We can link this process to government control on subsidies and credit distribution, as part of its industrial policy. Following the Treaty of Rome (1957), however, France had to integrate itself into the Common Market. As a result of more competition and with the need to redirect trade towards its European partners, the process of reallocation of factors of production became markedly more efficient. Another efficiency boost occurred in 210

France, 1945-92 211 the mid-1980s as financial markets were liberalized and macroeconomic policy became driven by the objective of a 'strong franc' tied to the Deutschmark. The picture that emerges from our study is that of a country which has actively sought to integrate itself completely into the wider European economy, and in the process has given up much of its idiosyncratic approach to economic policy making. The next section presents the broad facts at the aggregate level: the main phases of postwar growth, the evolution of unemployment, inflation and the external sector. Section 3 looks at the immediate postwar period, involving reconstruction after the effects of both World War II and the economic decline observed during much of the interwar period. Section 4 covers the best years, between 1954 and 1976, during which GDP per capita nearly tripled, and asks why it took so long for growth to reach its peak rate after the war. The two following sections cover the oil shock and its aftermath, up to the new wave offinancialliberalization during the second half of the 1980s. Section 7 focuses on human capital accumulation, while section 8 explores the role played by institutions. The last section concludes.

2

Aggregate performance

2.1

Output growth and variability

The broad facts to be kept in mind are presented in Table 8.1. Wefindit helpful to distinguish four subperiods. First is the reconstruction and consolidation period (1945-58), during which France restarts its economy in a context of shortages, rationing, and import and export licensing under the aegis of the Planning Office. During much of that period the political environment is unstable, marked by short-lived governments and rapidly changing alliances. The economy grows steadily while France forges an alliance with Germany within the Coal and Steel Community. The second period (1958-73) is France's golden age. It starts with the creation of the Common Market and the return to external convertibility of the franc, and ends with thefirstoil shock. Growth is faster than in the immediate postwar period, and is accompanied by a marked increase in the labour force, both in manufacturing and in the service sector. During the third period (1974-81) France adapts with difficulty to the wage and oil shocks. Overall growth slows down very markedly, and employment grows only in the government sector, declining fast in the manufacturing sector. Finally, since 1981 France has embraced more forcefully market principles for its goods markets. Yet labour markets remain highly protected and, as productivity growth has not recovered from its post-1973 decline, limited growth in public employment is insufficient to prevent a massive rise in unemployment. One little-known particularity of France's growth, as measured by the real GDP, is that it has been remarkably smooth, significantly more so than elsewhere. Figure 8.1 illustrates this point by comparing the French and German GDPs. The visual impression is easily confirmed by formal tests as in Table 8.2, which looks for a number of countries at the deviation of annual growth rates from a (split) trend, what is sometimes called the output gap. The table presents the ratio of the variance of France's output gap to the variance of other countries' output gaps. A value

Table 8.1. Aggregate performance: France, 1950-92 1950-8 GDP, with financial services and non-market sectors GDP, without financial services and non-market sectors

Manufacturing

Growth rate Growth rate per employed person Growth rate Growth rate per employed person Growth rate per hour worked TFP growth Growth rate Growth rate per employed person Growth rate per hour worked TFP growth

1981-92

4.3

1958-73 5.2

1973-81 2.5

2.2

4.3 4.8

4.6 5.4

2.2 2.1

2.0 2.2

4.9 4.9 3.6 6.2

5.3 5.6 3.6 7.3

2.4 3.4 2.0 1.7

2.5 3.0 2.1 0.9

5.7 5.7 4.4

6.4 6.7 4.8

3.1 4.0 2.8

2.7 3.2 2.1

Note: GDP is measured as the sum of the value added, omitting indirect taxes and import duties, which are normally included in GDP by the French national accounts.

France, 1945-92 213 300—B- Germany France 250-

200-

150-

100-

50 1950

1955

1960

1965

1970

1975

1980

1985

1990

Source: IMF.

Figure 8.1 GDP: France and Germany, 1950-92 (1960 = 100)

below 1 indicates a lower variance in France and asterisks indicate that the ratio is significantly smaller than 1. At the 90 per cent confidence level, we cannot reject the hypothesis that the variance of growth is smaller in France than in any of the OECD countries in the sample.1 At the 98 per cent level, the only country for which we cannot reject the hypothesis is Belgium. The table also reports the same test performed with the industrial production index. Strikingly, it is not the case that the French index is smoother than in the other countries. Only in Germany and the USA does the industrial production index exhibit significantly more volatility than in France. Industrial production actually exhibits a lower variance in some countries, although not significantly so. How can these two results be reconciled? France has been subject to similar output disturbances as the other OECD countries, hence the behaviour of industrial production. The relative stability of GDP means that these disturbances did not translate to the same extent into income fluctuations. 4One rather implausible explanation is that France is better able to absorb shocks: for example, because of more flexible product or labour markets. A more likely possibility is that counter-cyclical policy has been systematically more active. This is confirmed by the

214 Pierre Sicsic and Charles Wyplosz Table 8.2. Ratio of variances: France relative to other countries Germany United Italy Kingdom GDP growth 0.42** 0.34** 0.32** IPI 0.54** 1.11 0.71

Netherlands

Belgium

USA

0.38** 0.99

052* 0.79

0.35** 0.44**

Note: Variance of GDP and industrial production index (IPI) growth rates are computed vis-a-vis split trends. One (two) asterisk(s) indicate that variance in France is significantly lower at the 90% (98%) confidence interval. Sample periods: 1960-91 for GDP, 1949-91 for IPI. Table 8.3. Ratio of variances: France relative other to countries

Budget deficit Unemployment Inflation

Germany United Kingdom 1.26 0.26** 0.41* 0.16** 3.44** 1.03

Italy

Netherlands

Belgium

USA

0.30** 0.85 0.97

0.33** 0.19** 1.98**

0.19* 0.30** 2.32**

0.80 0.15** 2.66**

Note: Variances of budget deficit (as a ratio of GDP) and inflation are computed vis-a-vis split trends. Variance for unemployment is computed vis-d-vis a five-year centred moving average. One (two) asterisk(s) indicate that variance in France is significantly lower at the 90% (98%) confidence interval. Sample periods: 1961-91 for GDP, 1964-91 for unemployment, 1950-92 for inflation.

result, shown in Table 8.3, that inflation has been more and unemployment less volatile than in the comparison group. The question, then, is what instruments have been used to that effect. The natural ones to investigate arefiscaland monetary policies. Table 8.3 shows that it cannot befiscalpolicy: there is no evidence that budget deficits (as a percentage of GDP) have been more volatile in France than elsewhere. This leaves open the possibility that monetary policy has been used more extensively. In principle, a comparatively more activist monetary policy cannot fail to affect the exchange rate. The fact that France adhered to afixedexchange rate regime for the whole period, except for a few quarters at the time of the collapse of the Bretton Woods system, seems to contradict this conclusion. It is important to keep in mind, however, that France operated nearly continuously under capital controls until 1990, and that until the mid-1980s bank credit was rationed and often directed to objectives identified by the government.2 It is impossible to measure directly such a procedure for policy actions, since it operates through quantities, not prices. We provide evidence of the role of directed credit below. At this stage, we conclude that activist monetary policy is the more likely cause of the remarkable stability of GDP along its growth trend path.

France, 1945-92

215

11 n 10 -

France 12 EC countries 9 EC countries

9 -

/

/

i

i

8 7 6 5 4 3 -

i

i

I

1975

i

i

i

i

i

i

1980

i

i

i

1985

I

i

i

i

1

i

I

1990

Source: European Economy, 1994.

Figure 8.2 Unemployment rates, 1973-93 2.2

Unemployment and inflation

The rate of unemployment, mainly unchanged at about 2 per cent throughout the 1950s and 1960s, has exhibited a strong trend since 1973. Figure 8.2 shows that its relentless rise reflects the experience observed throughout the EU countries. Except for a slight delay, the pattern is nearly identical with that of the twelve EU countries. Relative to the nine EU countries, which exclude most of southern Europe, the French performance was significantly worse after 1984. Similarly, the rise and fall of inflation follows the average European pattern remarkably closely, except for a slightly better performance since the late 1980s. For believers in the Phillips curve, this would suggest that the French inflation-unemployment trade-off is representative of Europe's, corresponding to a typical European labour market structure. Alternatively, this could be interpreted as reflecting a great degree of similarity in disturbances and policy responses. 2.3

The exchange rate and the current account

The external sector displays a mostly unexciting story.3 Existing data for the current account after 1967 indicate that France never underwent serious external imbalances. This confirms earlier suggestions that France has never been subject to serious idiosyncratic disturbances.

216

Pierre Sicsic and Charles Wyplosz

1.20 -I

Dollar DM

1.12-

1.04-

0.96-

0.88-

0.800.72-

0.64-

0.56 1950

1955

1960

1965

1970

1975

1980

1985

1990

Source: IMF.

Figure 8.3 Real franc exchange rate, 1949-92

The current account has nearly always remained within ± 2 per cent of GDP. The largest deficit in 1982,2.5 per cent of GDP, forced a change in economic policy as described below. Overall the current account has on average been balanced throughout the postwar period. According to Sinn (1990), France had a small positive net asset position, amounting to 5.7 per cent of its GDP in 1970, and 6.2 per cent in 1987. As for the exchange rate, by and large it has closely followed purchasing power parity. Whatever limited real exchange rate movements can be observed, they are essentially due to a frequent tendency to delay nominal corrections after a period of relatively high inflation. Figure 8.3 reveals the existence of two distinct periods. Until the end of the 1960s, the real exchange rate remained quite stable vis-a-vis the US dollar. Once the Bretton Woods system came to an end, it appears that the dollar ceased to be used by French monetary authorities as an anchor. Rather, the fact that the real exchange rate was next stabilized against the Deutschmark suggests a shift in the conduct of exchange rate policy. Thefigure,in fact, tells an interesting story about the shift from a dollar anchor to a Deutschmark anchor. Over the period 1971-3, we observe a marked, one-off, real depreciation vis-d-vis the Deutschmark which seems to offset perfectly a real appreciation vis-d-vis the US dollar, suggesting a near-constancy of the effective real exchange rate.4 This episode may offer a telling insight into the French approach to exchange rate policy. France made sure that it entered the DM zone with a competitive rate. That it appreciated when it left the dollar zone may also indicate that it had maintained a highly competitive rate in relation to the dollar.

France, 1945-92

217

Table 8.4. Capital growth: France, 1930-58. (average annual growth rates)

1930-9 Gross equipment capital Gross building capital Net equipment capital Net building capital

0.2 0.3

-1.2 -0.5

1939-46

1946-50

1950-8

-3.9 -2.9 -4.2 -4.0

5.8 1.0 9.2 2.2

5.8 1.0 6.4 1.8

Source: Villa (1993: statistical mimeo. appendix). 2.4

A brief assessment and a list of questions

The rapid overview of France's aggregate performance allows a few robust conclusions. First, French growth gradually picked up speed in the mid-1950s and proceeded at a fast pace until the oil shock. Second, GDP moved away little from its trend growth path. Third, there is an abundance of indications that successive French governments adopted a hands-on approach to economic policy making, at least until the 1980s. Fourth, after the oil shock, the French performance, as measured by the traditional macroeconomic indicators, closely resembled that of the average of European countries, including a slowdown in productivity advance and an apparently permanent sharp rise in the rate of unemployment. Beyond these points, a number of interesting questions emerge and will be pursued in the rest of the chapter. First, why is it that the expected postwar catch-up seems to have been delayed by a decade? Second, if government interventions were rather heavy handed, what precise form did they take? For example, there is no evidence of a particularly activist use of the budget. Third, has France's famed attempt to charter a 'third way' between central planning and full reliance on the markets achieved its aims? Fourth, has the adoption by a socialist government of more market-oriented policies produced lasting changes? Finally, how far has France given up its cherished specificity as it has integrated itself into Europe?

3

The legacy of the 1930s and reconstruction

At the outset of its phase of reconstruction, France was facing two adverse legacies: war destruction, as in all other continental European countries, but also a ten-year period of stagnation prior to the war itself. The depression of the 1930s was quite protracted in France. As a result, net capital (i.e. capital adjusted for both depreciation and obsolescence according to vintage) decreased. In addition, the Second World War had worse effects on French capital accumulation than the First. While the war effort prevented investment from falling too much between 1914 and 1918, there was no net investment in occupied France during the Second World War (Figure 8.4). According to recent estimates by Villa (1993), fifteen years of negative net investment from 1930 to 1945 led to a fall of 40 per cent in net equipment capital, while net building capital fell by 29 per cent (see Table 8.4 for yearly growth rates). Yet war destruction explains only 16 and 14 per cent of the fall in net equipment and building capital respectively. The major legacy of the 1930s was therefore worn-out capital.

218

Pierre Sicsic and Charles Wyplosz

20 n

18-

16-

14-

12-

10-

8-

1890

1900

1910

1920

1930

1940

1950

1960

1970

1980

Source: Villa (1993).

Figure 8.4 Investment rate: France, 1890-1984

This very bleak investment performance had serious consequences in terms of output. For example, Dubois (1985) considers what would have been the real GDP had France maintained the average rate of growth achieved between 1896 and 1929. He finds that it took thirty years for actual output to reach projected output, somewhere between 1955 and I960.5 This result, among many others pointing in the same direction, warns us that France's performance in the years immediately following World War II was not at all impressive. In fact, a number of postwar economists were keenly aware that all was not well. In the mid-1950s they started to voice concern that recent growth was merely a modest catch-up on the effects of the war, and that France might fall back into sluggishness, never quite recovering from the economic decline that had set in before the war.6 Given the relatively low level of capital in postwar France, one would expect a high return on capital. This conjecture is borne out by the calculations by Saint-Paul (1993:101), who rightly asks why investment remained relatively low at the beginning of the 1950s (see Figure 8.7 below). In fact, this period is best characterized by very limited international private capital mobility. Most of the capitalflowswere related to the Marshall Plan and hence resulted mostly in public spending. When one realizes that liquidity constraints were the rule for most private agents, it becomes clear why investment has followed, and not preceded, growth. For example, Figure 8.7 shows that productive investment suffered more than total investment during the slump of the early 1950s.

France, 1945-92 219 The disappointing performance of investment, and its effect on growth, can be related to three main features of postwar France. First is a continuing fall in the share of profits in GDP at a time of widespread liquidity constraints. Second comes the absence of an international market for private capital. Third, we find the clear priority given by the government to dwellings and public infrastructure. Whether this choice indeed impedes growth rests on assumptions about the social return on equipment and infrastructure, putting aside the welfare-enhancing effect of badly needed new dwellings: it is argued below that, given the volume of productive investment, it might have been possible to allocate capital better, mainly away from energy and railways and towards manufacturing and services. 4

The 'vingt glorieuses' (1954-76)

After the reconstruction period and the mild recession following the Korean War boom, Divisia, Pupin and Roy entitled the second volume of their book A la recherche du franc perdu, 'Stagnation de la production', because they had noted that output in 1952 was not uniformly higher than in 1929.7 These concerns extended beyond the circle of neoclassical economists opposed to French planning, who were already arguing in the mid-1950s that international competition and market forces should be given a bigger role. Concerns about stagnation were also shared by members of the left-wing circle assembled around Mendes France. It is only after investment had started to soar in 1955 that the prospect of a long-lasting stagnation evaporated. Rioux (1983: 184, 248) even observes that it took much longer for mainstream public opinion to realize that the country had embarked on a remarkable path of steady growth, since the turning point was detected by polls only in 1957. The data on aggregate TFP growth presented in Table 8.1 conceals two important differences between the two subperiods 1950-8 and 1958-73. First, TFP in manufacturing and transport and telecommunications speeded up after 1958, while TFP in services slowed down. Second, it is the reallocation of capital and labour between industries which lies behind the acceleration observed during the second subperiod, as we will now show. 4.1

TFP growth rates

Table 8.5 presents TFP growth rates at the industry level. TFP growth is measured using the standard 'residual' methodology. Financial services and the non-market sector are excluded from output, which is measured by value added. Factors of production are measured as net capital and the number of hours annually worked. In principle, net capital productivity is less sensitive to age structure than gross capital productivity, since a given investment has a declining weight in net capital, while it is counted as a fixed amount until it is scrapped in gross capital. Results from previous works may help assess our calculations. We have not made any adjustment for capital quality, but we use net capital data. Carre et al. (1972: 657, 275) assume 4 per cent improvement of capital quality at constant prices for equipment, and 1 per cent yearly improvement for buildings. Theyfinda 0.4 per cent annual impact of the reduction in the mean age of capital on production growth

220

Pierre Sicsic and Charles Wyplosz

Table 8.5. 777* growth by industries, and relative prices of value added: France, 1950-92

TFP growth

Agriculture Food industries Energy Intermediate goods Investment goods Consumption goods Manufacturing Building, public works Trade Transport and telecommunications Services Total

1950-8

1958-73

3.0 1.7 2.0 4.7 3.6 4.2

4.3 3.5 3.2 4.2 5.0 5.0

4.8 1.3 2.3 1.9 2.6 2.6

U06 U07 U08

4.4 2.0 2.5

4.8 2.1 0.9

2.4 2.2 0.9

-0.3

U09 U10

2.9 3.4

4.2 0.2

3.2

-0.1

0.3 2.6

3.6

3.6

2.1

U01 U02 U03 U04 U05 U06

1973-92

Relative prices 1950-8 -0.4 -4.0 1.3

U04to 3.4

-0.1

U01 to U10

Source: French National Accounts and authors' adjustments for data prior to 1970. INSEE (1981: 203) for relative prices. from 1951 to 1969. They report a mean age of equipment in 1951 of 18.4 years, declining to 12.2 years in 1966. New estimates by Villa (1993) from 1896 to 1985 show an increase in the mean age of equipment from 7.8 years in 1930 to 11.5 in 1945, and then a sharp decline to 9.1 in 1950 and 7.6 in 1958; the bottom was reached at 6.3 in 1973, followed by a rise up to 7.3 years in 1985. The absolute mean age reduction found by Villa (1993) for the period 1950-8 is about half that found by Carre et a\. (1972), respectively 0.2 and 0.4 years per annum, and even smaller from 1958 to 1973. A gross correction on TFP growth for capital age could therefore be -0.2 to -0.4 per cent for thefirstperiod, half that much for the second period, and + 0.2 per cent for the most recent one.8 No attempt has been made to take into account the quality of labour. Carre et al. (1972: 275) estimate that its impact on growth was 0.4 per cent per year. Dubois (1985: 26), in his update piece, noticed that the quality of work, defined by average years of schooling and age of the employed population, increased after 1973 more quickly than between 1951 and 1973, and concluded that the influence on the output growth was 0.7 per cent per year after 1973. The change in the quality of work therefore goes against a drop in the measured TFP growth, and offsets the capital age effect. Not surprisingly perhaps, the overall stability of TFP growth between the first two subperiods conceals a significant amount of variability across industries. Similarly, the fall in TFP growth after 1973 is mainly due tQ manufacturing (labelled U04 to U06 in the French accounting system).9 This stands in contrast to the USA, where manufacturing did not suffer from a productivity slowdown (Griliches, 1988).

France, 1945-92 221 This has led some observers to consider that 1973 signals the end of a long period of postwar catching up. Indeed, the adoption of best practices is expected to have had a declining positive influence, presumably highest in the early postwar years. However, the catch-up hypothesis is at odds with the observation that TFP growth in manufacturing increased quite sharply after 1958. It is only for trade and services that the break occurs in 1958, but these are not industries where one would expect to see catch-up play any important role. A third pattern of acceleration after 1958 and still strong TFP growth after 1973 can be found in transport and telecommunications. Thus we are left with a puzzle. One possible explanation could be mismeasurement. For example, Dubois (1985) does not find any break in the evolution of manufacturing TFP growth until 1979. This is because after 1973 the positive influence from a reduction in the age of gross capital (0.4 per cent per annum) disappears while a negative influence of capacity utilization (0.9 per cent per annum) appears at that time. However, according to Dubois himself, these explanations are not sufficient to account for what happened to total factor productivity in manufacturing after 1979. Our own computations show that TFP in manufacturing grew at an annual rate of 3.5 per cent from 1973 to 1979, declining to 2.1 per cent from 1979 to 1984, and 1.8 per cent from 1984 to 1992. 4.2

Factor reallocation

Another explanation has been popular for a long time. It has always been suspected that labour mobility could be a major explanation of French growth after 1945. According to this view, French backwardness was the result of the inability of peasants to move to other activities. Carre et al. (1972: 274) addressed this point by estimating the difference in marginal productivity between industries. They attributed to labour mobility an annual contribution of 0.5-0.7 per cent to total productivity (with outmigration from agriculture explaining 0.4-0.6 per cent) an4 they concluded that this influence seemed to have increased during the 1950s, before lessening. This is at odds with the interpretation given by Adams (1989:204), who argues that after 1958 'exposure in the competitive world markets through international trade and investment does stimulate economic growth and structural change'. To assess the influence of factor allocation on measured productivity growth for the economy as a whole, we have used the accounting decomposition proposed by Matthews et al. (1982: ch. 9). TFP growth can be written as:

Note that the two last terms equal:

where i refers to particular industries and a,- are the industry-level labour shares (corrected for self-employment) in nominal value added for 1974 (when the overall

222

Pierre Sicsic and Charles Wyplosz

share of labour in value added was 0.66, close to its 1970-89 mean, 0.67). Thus TFP growth is shown to consist of two parts. The first part is simply the weighted average of individual industry factor productivity growth rates. The second part, in turn, consists of two terms: for each factor of production it is the cross-product between its increase and a measure of its productivity in the sector relative to its aggregate productivity. Thus the second part can be seen as measuring the contribution of the reallocation of each factor to overall growth. Indeed, if the factor flows into industries where its productivity is higher than in the aggregate, this will raise overall TFP. It is, of course, possible that a factor moves into an industry where it is less productive, thus contributing negatively to TFP growth. This is why we call the two terms of this second part deallocation' of capital and labour.10 Note that if L-Wi = o^g, and K,rf = (1 — OLt)Qh equation then the cross-product terms would become:

The results of this decomposition are presented in Table 8.6 and Figure 8.5. The table shows that the 'reallocation' terms explain 0.5 of the 3.6 per cent growth between 1950 and 1958, but as much as 1.5 of the same 3.6 per cent growth between 1958 and 1973. This result goes a long way towards solving the puzzle apparent so far. There was a catch-up process in the early postwar period which delivered a 3.1 per cent average annual gain in productivity net of reallocation from 1950 to 1958, gradually falling to 2.1 per cent over the nextfifteenyears and 1.6 per cent after the oil shock. If TFP growth did not decline after 1958, it is because the allocation of inputs had become more efficient. Thus we now need to understand what lies behind this reallocation effect. It is clear that factor reallocation was particularly poor in the early postwar years. It is natural to ask which industries were responsible for this. Service and trades are the two sectors where TFP growth sharply decreased after 1958 (Table 8.5), and they necessarily account for the decline in the average industry factor productivity growth. As relative productivity (measured in 1970 relative prices) was larger in these sectors, factor allocation towards them was highly favourable. To find out about the role of other industries, we turn to Figure 8.5. Along the vertical axis we represent the relative increase in each factor of production for each industry, using the French classification numbers shown in Table 8.5: this is thefirstproduct term in the reallocation term - the second part - of the TFP growth decomposition. Along the horizontal axis we represent the difference between the industry shares in value added and the industry shares in use of factors of production: this is the second product term. The cross-products of these variables are the reallocation terms.11 In principle, we would expect a positive correlation on the assumption that a factor's accumulation is faster where it is initially used less intensively. It would correspond to a positive factor reallocation term and appear on the figure as a positively sloped regression line. This is what is found for both factors of production and all subperiods with one important exception: capital over the period 1950-8. The implication of this result is

France, 1945-92 223 Table 8.6. Accounting decomposition of TFP growth: France, 1950-92 1950-8 TFP growth Weighted average of sectoral TFP growth rates 'Reallocation' of capital deallocation' of labour TFP growth without services Weighted average of sectoral TFP growth rates 'Reallocation' of capital 'Reallocation' of labour

1958-73

1973-92

3.6

3.6

2.1

3.1 0.7 3.9

2.1 1.1 0.4 4.8

1.6 0.3 0.2 2.2

3.1 0.1 0.7

4.1 0.4 0.4

-0.1

-0.2

2.2 0.1

Note: The labour share corresponds to 1974. All other variables are in constant 1980 francs from 1970 to 1992, and retropolated before using data in 1970 francs. The labour variable is the hours of work. Accounting terms are used to weight overall TFP growth from Table 8.5 to get rid of decompounding problems. Source: See Table 8.5. particularly interesting. The disappointing performance of France's TFP growth in the early postwar period can be ascribed to misallocation of productive investment. Capital was put in place in industries which were already capital intensive and where, therefore, it is natural to expect lower returns. More precisely, the industries which clearly appear to have undergone excessive productive investment are those classified as U03 (energy, including coal, gas and electricity). Also suspect are industries U04 (intermediary goods) and U05 (investment goods). It is also important to note that the positive impact of reallocation almost disappears when the service and trade sectors are removed, as shown in the second panel of Table 8.6.12 What stands out there is the increase in the weighted average of industry TFP growth rates. We return to these points in section 8, where we consider the role of the opening of France to foreign competition. 5

Shocks and stagflation in the 1970s

By and large, throughout the two oil shocks France maintained its position as the average European country. Figure 8.6, for example, tracks inflation and unemployment in both France and the whole of the European Union. The two shocks are seen to produce nearly identical short-run effects in both dimensions, and the long-run rise in unemployment is likewise very similar. This average behaviour, though, did not come by chance: the shocks forced macroeconomic discipline on France, which abandoned initial attempts at chartering its own path irrespective of the external constraint. The interpretation of oil shocks is now standard (see Bruno and Sachs, 1985) and we know that a country's reaction is fashioned by two main aspects. The first issue concerns the authorities' willingness to accommodate the initially inflationary impact. This choice affects both the size and duration of the unavoidable burst of inflation. Characteristically, the initial French reaction in the mid-1970s was an attempt at stabilizing incomes, in effect fully accommodating the inflationary

224

Pierre Sicsic and Charles Wyplosz U03

0.7 -

U05 0.6 -

U04

0.5 -

U07

0.4 Ui

0.3 -

U( 2

U09

0.2 -

6 ^ U08 U10

0.1 -0.08 -0.06 -0.04 -0.02 0.00 0.02 Relative factor intensity

0.04

0.06

0.5 -0.06

-0.04

(a) Capital, 1950-8

-0.02 0.00 0.02 Relative factor intensity

(b) Capital, 1958-73

-0.04 -0.03 -0.02 -0.01 0.00 0.01 0.02 0.03 Relative factor intensity

0.04

-0.10

(c) Capital, 1973-92

-0.05 0.00 Relative factor intensity

(d) Labour, 1950-8

0.4

>5

0.302

1

I

U10

y^u

U07

0.4 -

"

01 " 0

0.2 U09

^

I -0.2 -

~02 "

^^^^U06

-0.4 -

-0.3 -0.4-0.5

-0.6 -0.8 -0.08

-0.04 0.00 Relative factor intensity

0.04

(e) Labour, 1958-73

0.08

i

i

i

i

i

-0.04 -0.02 0.00 Relative factor intensity

(f) Labour, 1973-92

Source: See text.

Figure 8.5 Factor reallocations

shock, while Germany most concentrated on containing inflation. The resulting emergence of a large inflation gap between France and Germany in the aftermath of the first oil shock would not be eliminated for nearly two decades and strongly impressed the French, particularly as the Deutschmark emerged as the strongman of Europe. The lesson eventually drawn was that the proper response to a supply shock is a non-accommodating policy; not only did Germany manage almost completely to avoid the initial burst of inflation, but the ensuing Deutschmark appreciation significantly reduced the increase of the Deutschmark price of oil, thus cushioning the blow at the root. As the average European country, France could not benefit from this exchange rate effect, of course. When the second oil shock came about, France was determined to follow a 'German strategy'. But as most other European countries had drawn the same lesson and also adopted this strategy,

France, 1945-92 225

4 6 8 10 Unemployment (%) (a)EU

2

4 6 8 10 Unemployment (%) (b) France

Source: OECD, Main Economic Indicators.

Figure 8.6 Inflation and unemployment: EU and France, 1971-92 France again found itself in the average position. Consequently, it did not benefit from an effective exchange rate appreciation the second time around either. The second aspect of an oil shock is that it represents a transfer of income away from oil-consuming countries toward oil-producing countries. It matters a lot how the income shortfall is distributed between the factors of production within each oil-consuming country. If most of the burden is borne byfirms,investment declines, which ultimately affects growth and the demand for labour. If instead labour bears the cost - in the form of lower real compensation - growth is reduced only temporarily and unemployment need not rise, at least not permanently. Figure 8.7 shows that the first shock was entirely borne byfirms,while the second shock was followed by a slow process during which income gradually shifted back from labour to profits. Oudiz and Sterdyniak (1982) have shown how wages were perfectly and swiftly de facto indexed on prices and little responsive to demand pressure. Their conclusion, which anticipated what was to follow, was that it would take a high and prolonged level of unemployment to reverse the shift of income away from profits. They also correctly predicted that high unemployment would be tolerated by the authorities because of the increasing importance for macroeconomic policy of the external constraint imposed upon France by its integration within the European Community. In the event, the constraint operatedfirstand foremost through the exchange rate. After the demise of the Bretton Woods system, France had joined the European 'Snake' arrangement in April 1972.13 Soon after the first oil shock, however, by the end of 1973 the franc had to leave the arrangement because of the emerging mismatch between France and Germany, which came to dominate the Snake. France re-entered the Snake in July 1975, only to leave it again in March 1976. It then took three years of austerity under the 'plan Barre' to bring the franc up to the level required for the launching of the European Monetary System (EMS) in March

226

Pierre Sicsic and Charles Wyplosz

28 -i

Profit/national income Total investment/GDP Productive investment/ . / * , ' value added of business sector

26-

/

r44

\ *

%

'

- 42

24-

-40

2 a 22 H

- 38

20-

- 36

18-

- 34

16 -J-r

1950

32 1955

1960

1965

1970

1975

1980

1985

1990

Source: French National Accounts and authors' caculations. Figure 8.7 Investment rates and non-wage share in national income: France, 1949-92

1979. The 'plan Barre' matches closely the principles noted above. It explicitly referred to the external constraint to justify restrictive measures, even if the policy stance was far less restrictive than advertised. Its most lasting impact may well have been pedagogical; it explicitly warned wage- and price-setters that the policy of depreciating the exchange rate to ratify inflationary behaviour was not appropriate if France wanted to stop its inflationary spiral. The sense of defeat at being twice forced out of the Snake, and the pedagogical efforts of the 'plan Barre', greatly contributed to the subsequent decision to stick to the EMS. Freshly elected (in May 1981) President Mitterrand, after some soul searching during the first few months of his presidency, decided to return to policy orthodoxy and to blend France into the European fold. Indeed, by the end of 1981, the franc was under heavy pressure. In the aftermath of the second oil shock, the new socialist government seemed to have reversed the Barre strategy of nonaccommodation, as it led a largely unsuccessful attempt at macroeconomic expansion while the rest of the EC was pressing the brakes. Facing a stark choice, to leave the EMS or to change its policies, Mitterrand opted for the latter; this choice would determine the next decade.14 6

A partial recovery

The new policies developed after the exchange crises of 1981-3 relied on three pillars. First, an explicit move against wage indexation was deemed necessary to

France, 1945-92 227

1

1 1974-80 V///A 1981

France

Germany

Italy

UK

Spain

USA

Source: IMF.

Figure 8.8 GDP growth rates: selected countries, 1974-83 (% per annum)

bring inflation down. Second, exchange rates would not be used to correct past policy mistakes. Instead macroeconomic policies would be steered towards the attainment of stability in prices, exchange rates and budget balance. Third, industrial policy would be reconsidered, with much less sympathetic eyes. All three approaches represented a major innovation because they were proposed by a leftist majority whose history had been dominated by radical talking. The first year of Mitterrand's presidency was marked by a series of expansionary measures coupled with policies inimical to the supply side. The budget, in balance in 1980, reached a 2.8 per cent deficit by 1982, and money growth increased quickly as well. The working week was reduced from 40 to 39 hours without a reduction in monthly wages, and tight limits were imposed on overtime work. Regulations on working conditions (hiring and firing, safety) were tightened and union power was increased withinfirms.Several large industrial groups and banks were nationalized. The outcome can be read in two different ways. On the dark side, inflation and unemployment both rose, and the current account quickly worsened, even in the non-oil sector, a clear sign of a supply-side shock. Thus Mitterrand's promise of an expansion and more jobs did not materialize. The bright side is visible in Figure 8.6, which shows that, following the second oil shock, France did no worse than the rest of the EC. In fact, among the large countries, France arguably achieved the best growth performance, as it managed to avoid negative growth in the post-second oil shock period (see Figure 8.8). This performance, however, was borrowed against future growth. The feeling that the economy was badly wounded forced a profound rethink and ushered in a period of serious change. Paradoxically, it took a socialist government to move towards more market-oriented policies, gradually and quietly giving up a number - but far from all - of the dogmas which lay at the root of the Trench way'.

228

Pierre Sicsic and Charles Wyplosz

5.04.5 4.03.5 3.0-

1950

1955

1960

1965

1970

1975

1980

1985

1990

Source: Laroque et al (1990).

Figure 8.9 Real consumer wages: France, 1946-91 (1946 = 1)

A key step in tackling inflation was to disindex wages. The procedure, however, was politically clever. Rather than attempting to sever formally the - mostly informal - link between wages and prices, the new policy aimed at keeping real wages constant: that is, promising 100 per cent indexation but nothing more. As a result, productivity gains would entirely benefit profits and rebuild firms' shattered positions. The policy came in stages. It started with a complete freeze on wages, followed by a carefully staged removal of controls. Figure 8.9 provides evidence of a break in the behaviour of real consumer wages in 1982, and shows that the lost ground was never recovered afterwards. The rebalancing of income distribution, which achieved more than the restoration of the pre-1973 situation (see Figure 8.7), was the result of both the wage policy and the dampening effect of rising unemployment. Investment responded, with a lag, but as shown in Figure 8.7 never quite recovered the very high rates of the 1960s. In the labour market, additional measures were subsequently introduced to bring back someflexibility:for example, a relaxation of restrictions on part-time work and on lay-offs. It must be admitted, however, that the results have been quite disappointing. The best that can be vouched is a suspension of the continuous increase in the rate of unemployment, which soared again during the recession of the early 1990s. Market liberalization was not confined to labour markets. Financial markets and the banking sector have undergone a deep transformation (see Melitz, 1982), including the end of administrative rationing of credit, the near-elimination of

France, 1945-92 229 subsidized credit, and the development of the Paris Bourse, freed from the numerous regulations which were initially designed to give priority to the financing of state borrowing needs. Privatization, while temporarily stopped and partially reversed in 1988-9, has proceeded fairly fast since 1986. The outcome of these supply-side efforts, while visible in Figure 8.6, has been mostly disappointing so far. Growth of output certainly recovered from the generalized slowdown of the early 1980s, but with considerable delay and only a modest retrenchment from high unemployment. The return to high profit shares has not been followed to the same extent by investment and job creation. While the recession of the early 1990s may have concealed deeper favourable effects under way, supply-side policy has yet to demonstrate its usefulness in France. There are three possible ways of explaining this modest outcome. One interpretation is the presence of hysteresis effects in the labour market. According to this view, temporary increases in unemployment become permanent. This may occur when employed workers seek and obtain higher wages, trading off a reduced workforce against wage moderation at the expense of the unemployed. An alternative route for hysteresis asserts that unemployed workers suffer an erosion of their human capital, which reduces their chances offindinga new job, the situation worsening continuously the longer they remain unemployed. Thus protracted periods of high unemployment leave a permanent imprint. Hysteresis effects have indeed been documented for labour markets in France and elsewhere in Europe.15 An alternative interpretation lays the blame on the new macroeconomic policy adopted after the great exchange rate debacle of 1981-3. The pledge to tie the franc to the Deutschmark forced France to adopt a monetary stance considerably tighter than it had grown accustomed to. Blanchard and Muet (1993)findthat, while low inflation eventually improves competitiveness and favours growth, the process is extremely slow, while the contractionary effects of the deflationary policy are front-loaded. According to this view, the return to faster growth and lower unemployment predicated by virtuous supply-side policies will eventually emerge once the dampening effects of the anti-inflation policy have petered out. A third interpretation is that France suffers from capital shortage. A long period of insufficient capital accumulation has reduced the number of available jobs. With little ex post substitutability between capital and labour, a period of low investment may indeed leave a legacy of lower marginal productivity of labour. A last interpretation is that the policies have not gone far enough. This view asserts that labour markets still remain rigid and distortions from faulty government intervention have been reduced, but not far enough. 7

Human capital

So far, the analysis has only tangentially considered the possibility of non-decreasing returns and the associated endogenous growth effects. This section and the next take up this aspect, starting here with human capital and following the initial idea in Lucas (1988). The approach adopted here is comparative: is there any indication that human capital accumulation has been very different in France from elsewhere? As a basis for comparison, we look at France's chief partner and competitor, Germany. A full comparison of human capital accumulation and its effect on growth would

230

Pierre Sicsic and Charles Wyplosz

Table 8.7. Estimates by Maddison (1987) of the effect of education on growth: France and Germany, 1973-84

Average years of formal education Estimated growth effect

France

Germany

Primary Secondary Higher

Primary Secondary Higher

5.00

4.0

4.9

0.48

0.9

5.2

0.3

0.07

Source: Maddison (1987: 679, 688). require detailed econometric work beyond the scope of this paper - in particular, for lack of readily available data. Most work in this area has used data measuring spending on education. This may be misleading for two reasons: first, the data do not allow a precise discrimination within the group of advanced countries which spend similar amounts on education; second, they rely on a measure of the input into education, not of the output, which is the important variable. Our approach is therefore to draw on recent studies comparing France and Germany to seek meaningful ways of assessing an element gradually being recognized again as the key success factor in growth. Data based on input into capital accumulation usually conclude that France has done better in this respect than Germany. For example, Table 8.7 reports the results obtained by Maddison (1987) based on the average number of years of formal education. Total average time spent in education in 1984 was 10.8 years in France and 9.5 in Germany. An index based on these data shows econometrically that education accounts for an additional average 0.5 per cent annual growth in France over the period 1974-84, and only 0.07 per cent in Germany. We provide evidence which, in our view, casts some doubt on these input measures. At the high school and university levels, France and Germany differ little when one considers the proportion of the population having completed a given number of years of schooling. Instead the main difference between the French and German education systems appears at lower levels and mainly concerns how training is organized. Germany differs in having an extensive system alternating schooling and training withinfirms.In Table 8.8 this is referred to as vocational training, while the corresponding French structure only includes shorter-term 'internships', which makes the difference with 4no degree' rather formal. The table shows that in 1989 more than 50 per cent of the active German population emerged from this particular track, while nearly half of the French employees had no degree at all, or a degree which simply corresponded to completion of school. The difference made by serious vocational training in Germany is particularly striking when we look at the unemployment rates. Among young people (less than twenty-five years old), the unemployment rate stood at 22.6 per cent in France and 7.1 per cent in Germany in 1989, a year when the overall unemployment rates were 9.6 and 7.2 per cent respectively. The table shows that the main reason for this sharp difference is the low

France, 1945-92 231 Table 8.8. Highest degree obtained (D) (% of employed) and unemployment rate (U) (Vo of each category): Germany and France, 1989

0

No degree

Vocational* High school Higher education shortc Higher education long

D U D U D U D U D U

Germany

France

19.5 13.0 55.4 7.0 13.4 5.6 4.0 4.3 7.7 4.2

43.1 13.7 28.9 10.4 11.6 7.4 8.2 4.2 8.2 4.1

Notes: Labour force excludes apprentices and internships. Lowest possible qualifications, including some certificates (e.g. BEPC in France, Realschule in Germany). b In Germany necessarily includes on-the-spot training; not so in France. c Typically 2-3 years after high school, e.g. Fachhochschule in Germany; DEUG, BTS, DUT in France. Source: Mobus and Sevestre (1991).

a

rate of unemployment among young Germans who underwent vocational training. This is evidence that on-the-job training in Germany represents an efficient investment in human capital, while it has little discernible effect in France. These data are suggestive of insufficient investment in human capital or, more precisely, a misallocation of resources, as the French school system appears to operate less efficiently than its German counterpart. According to some endogenous growth theories, inadequate investment in human capital might have significant permanent effects on growth. For part of the slowdown in TFP growth reported in section 4 to be ascribed, a necessary - but not sufficient - condition would be a worsening in the performance of the French education system. Casual observation does not indicate any major loss of performance at the upper end of the education system. More likely is an aggravation of the misperformance at the lower end, evidenced in Table 8.8. Could it be that the mass of the French labour force, those with no degree, have actually become less well adapted to demand? One way to answer this question is to look at their marginal productivity. Under standard assumptions,16 marginal productivity is measured by the real wage. Table 8.9 presents the cumulated proportion of workers without a degree among those whose earnings are the 10, 25 and 50 per cent lowest, respectively. The message is unambiguous. For example, while in 1970 15.3 per cent of males without a degree were among the lowest decile, by 1985 this proportion had doubled to 30.4 per cent. The evidence is indirect, but the fingerprints are there. The French education system, at least in comparison with its German counterpart, has not managed to provide about half of its labour force with an adequate stock of human capital. The effects on unemployment are beyond dispute. It is highly plausible that this massive

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Table 8.9. Proportion of employees without degree according to relative earnings: France, 1970 and 1985 (%) Female

Male Lowest decile Lowest quartile Lowest half

1970

1985

1970

1985

15.3 50.4 78.9

30.4 56.0 82.4

24.5 49.6 78.8

15.3 53.0 92.0

Source: Baudelot and Glaude (1989). underinvestment has adversely affected growth. There is also some evidence that the situation has deteriorated, even though real wages do not reflect the gap in marginal productivity. This could be one element, among others, in explaining the puzzling lack of noticeable effect from the supply-side policies of the 1980s.

8

Institutions

Institutions are being recognized as another understudied but potentially powerful influence on growth. This section focuses on two aspects of postwar France. First, we look at French planning, long considered as an original experiment with strong implications for the allocation of financial resources before 1958. Second, we review the impact of the European Common Market, which promoted the opening of France to foreign competition.

8.1

French planning

In our review of the role of planning, we focus on the influence exerted by the government in directing credit to industries. Table 8.10 presents available information on the different channels used to provide firms with financing. To permit meaningful comparisons, total credit outstanding in 1956 is presented along with the share of productive capital held in each industry in 1950. It is safe to consider that bank credit was government controlled - most banks were state owned in any case. Loans provided by the Fonds de Modernisation et d'Equipement and by the Fonds de Developpement Economique et Social (FDES) were provided by the government to be distributed in a way that would meet the objectives of industrial policy. It is clear which industries have been given preferential treatment. While energy and transport were the most helped, equipment and consumption goods were the least. This is consistent with the choices stated in the first plan (Bloch-Laine and Bouvier, 1986: 126), which considered that strong externalities from these industries justified such a choice in the immediate postwar period. In addition, industrial policy initially sought to buttress activities where minimum efficient scale was large, and where the technology was well known and stabilized. Our results in section 5 have already shown that the preferential treatment of these industries may well have been maintained for too long.

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233

Table 8.10. Credit outstanding in France, 1956 (billions of current francs) Banks FDES Govt subsidies cumulated, 1947-56 Agriculture Food industries Energy Intermediate goods Investment goods Consumption goods Building, public works Transport and telecom. Trade and services Total

U01 U02 U03 U04 U05 U06 U07 U09 U08 and U10

176.7 156.8 319.2 442.3 420.8 336.9 167.7 142.5

Shares of Shares of sums of capital in previous 1950 columns

340.6

517.4 128.08 1056.2 260.73 202 361.28 343.72 0.3 275.19 136.98 209.2 1780.8

11.63 3.20 18.38 11.30 8.59 6.88 3.42 23.96

9.49 7.01 14.90 9.77 8.56 7.74 3.34 20.11

607.5 21.3 496.22 2770.4 1829.6 4300.4

12.64 100.00

19.08 100.00

Note: Subsidies are known only for non-agriculture non-transport; they have been distributed like bank credits. Value added in 1956 was 1754.5 billion (old) francs. Sources: Annual reports of the CNC; annual report of the FDES (1958); Delorme and Andre (1983); Mairesse (1972). In addition to these concerns based on efficiency considerations, it may be relevant to note that most of the favoured industries (electricity, gas, coal, railways) were made up of large nationalized firms. Their managers may have been drawn from various quarters (former trade unionists, high-ranking civil servants, heads of private firms), but it is likely that industrial policy aimed to placate trade unions, which were particularly strong in these industries. Thus, it could well be that the allocation of resources by the government was the result of rent seeking from employees of these industries, seen by Crafts (1992) as an impediment to growth. This hypothesis is corroborated by the observation in section 5 that these industries did not benefit to the same extent from a preferential allocation of capital after 1958, when France opened its economy to international competition. By then heightened pressure for strict efficiency may have made rent seeking more difficult and forced a political change. It can be objected that this kind of government intervention actually benefited the whole economy. This would certainly be the case if the prices of subsidized industries had been kept low thanks to these subsidies, which is why we show in Table 8.5 the evolution of each industry's relative (value-added) price between 1950 and 1958. The available evidence does not bear out this justification. Relative price movements of energy and transport and telecommunications appear to be well in line with the relative evolution of industry-level TFP growth. There is no indication that subsidies to these industries have been passed on to consumers through lower prices. Further evidence questioning the efficiency argument is provided by Figure 8.7, which displays the shares of non-business investment (housing and government investment) and of business investment. It appears that the business investment rate

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had been declining from 1950 to 1954. While total investment increased by 34 per cent from 1949 to 1956, non-housing business investment increased by 13 per cent, its share in total investment declining from 77 to 64 per cent from 1949 to 1956 (INSEE, 1958: 293). Later on, the share of 'productive investment' - that is, non-housing business investment - levelled off between 55 and 50 per cent from 1964 onwards (INSEE, 1981: 156).17 When investment in transport equipment is removed from total business investment, the increase in the volume of machine investment from 1949 to 1956 is very small (4 per cent). That investment in machines increased slowly during the 1950s may be due to the constraint of national saving at a time when the possibility of foreign borrowing was remote. The national saving rate took off in the late 1950s when growth expectations themselves had become firmly established. Investment rates, as displayed in Figure 8.7, increased from 20 per cent at the beginning of the 1950s to 28 per cent in 1974 (the plateau from 1957 to 1960 is obviously related to the costs of the Algerian war). In the end, wefindthat the preferential treatment of some industries did not translate into a powerful push in equipment investment, strengthening our view that priorities either had little to do with efficiency or failed to achieve their aims. We have questioned the effectiveness of planning a lafrangaise. In France, it has long been considered as a successful specificity. Dissenting voices have been rather limited to economists dubbed 'neoclassical', such as Divisia and Roy. To this day the institution, the Commissariat General du Plan, still exists. Even if its role has been sharply reduced since the mid-1960s to a forum where the 'social partners' exchange views, it still produces five-year indicative plans which are formally adopted by Parliament. It is perceived too much as a French way of life to be scrapped. Abroad, French planning has enjoyed for a while at least some interest, but by the early 1960s professional assessments seem to have turned mostly critical. Representative of the non-French view is the following opinion by Lutz (1969:184): 'I have concluded, on both empirical and logical grounds, that French planning never had worked in France - nor could have worked there or anywhere else - as a largely "noninterventionst" form of integral central planning . . . Doubtless its effects on economic growth were not all positive.' These distortions could be part of an explanation of the relatively low growth observed in the period up to 1958. 8.2

Opening to foreign competition

The effect of opening to trade on growth in France has been emphasized by Adams (1989). As noted by Marseille (1984), rather than an increase in the ratio of exports or imports to GDP, the most important effect was to redirect trade away from the former colonies and towards Europe. This development resulted in increased competition, and therefore, according to Adams, made innovation more advantageous, prompting French firms to become more innovative. The distribution of French exports by destination changed remarkably between 1958 and 1973, as can be seen in Table 8.11. In 1952,43 per cent of French exports went to OECD countries: by 1958 this share was 47 per cent, and it rose to 76 per cent in 1973, then slightly declined to 68 per cent in 1984 when after the oil shock someflowswere redirected toward oil-producing countries. The bulk of this overall change was towards the original EEC countries, explaining 26 of the 29 percentage

France, 1945-92

235

Table 8.11. Share of French exports by destination, 1952-84

1952 1958 1962 1968 1973 1984

Former French colonies

Non-EEC OECD

Original EEC

42.2 37.5 20.8 13.5 9.2 9.3

27.3 24.4 27.9 27.0 27.5 30.7

15.9 22.2 36.8 43.0 48.6 37.3

Source: Adams (1989: table 22, pp. 178). points increase in the OECD share. The major shift in the distribution of French exports occurred during the first four years of existence of the Common Market, as the share of exports to the EEC countries increased on average by 3.5 points a year, while the overall share towards the OECD rose by 4.5 points per year. During the following eleven years, both shares increased by 1 point per year. Non-EEC OECD share went up between 1958 and 1962 and stopped increasing afterwards. Thus we observe first a redistribution away from former French colonies following the decolonization, and then a movement specifically towards EEC members after 1962. The impact of the Treaty of Rome on French exports was gradual. The treaty had prescribed a long transition which ended in 1968. France had failed to fulfil the OEEC requirements to loosen quotas in the 1950s. These quotas were very stringent in France and in Italy: less than 3 per cent of home production for a large number of products. They were finally removed under the Treaty of Rome provisions only at the end of 1961 (Adams, 1989:132). Tariffs internal to the EEC were reduced in steps, and the only tariffs left were those on agricultural products (Adams, 1989: 132). In 1958, the average French tariff rate, computed as the average of the tariffs by SITC groups, stood at 17 per cent, second only to Italy (18.7 per cent) among the EEC countries. The average rate was 6.4 per cent in Germany and 9.7 per cent in the Benelux (Resnick and Truman, 1975: 63). With respect to non-EEC trade, the main tariff reductions occurred within the framework of the Dillon and Kennedy Rounds, negotiated within GATT by the European Commission. For the EEC as a whole, the average external tariff rate stood at 10.4 per cent in 1968 and declined to 6.6 per cent following the Kennedy Round. (Adams, 1989:157) notes that among manufacturing industries, tariff levels in 1959 are correlated with the change in import exposures as measured by the ratio of imports to the home market; in textiles the tariff duties were about 25 per cent of the import values in 1959. The degree of French openness, measured as the ratio of exports to production, increased only after 1966: in 1966, as in 1959, the ratio of exports to production in manufacturing was 14 per cent; it went up to 21 per cent in 1973 and 27 per cent in 1979. However, exports to the OECD as a share of production regularly increased after 1958. Import exposure of the domestic market developed more swiftly, its share being 8 per cent in 1959,12 per cent in 1965, then 17 per cent and 25 per cent in 1971 and 1979 (Adams, 1989: 156, 159).

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This evolution is consistent with the observed increase in TFP growth in manufacturing after 1958, at a time when the catch-up effect should have become less important. While Adams meant his evidence to concern the micro level of the firms, our evidence instead emphasizes the role of resource allocation between industries. After 1958, we believe that the 'new spirit of innovation' inside the firms prompted by foreign competition showed up in the measured TFP growth in manufacturing, and that a more market-oriented resources allocation, impossible to describe at our level of aggregation by industries, helped the most efficient firms to expand. 9

Conclusion

France's postwar growth has gone through four phases. The strong growth performance of the 1950s was helped by a catch-up phenomenon on best foreign practices, and by a positive effect of capital rejuvenation. Yet, the best performance comes next and covers a period of nearly twenty years starting around 1958 and coming to an abrupt end in 1973. The macro treatment of the oil shock was less than happy, and the supply-side measures came to a standstill. The 1980s did not prove to be better, even though further liberalization measures were taken, this time concerningfinancialmarkets as well as the privatization of a significant part of still state-owned industry. At the time of writing, the privatization is undergoing a new phase of acceleration, possibly bringing down state ownership to minority shares everywhere. We have argued that France's golden years in the 1960s are the result of the introduction of market forces in the wake of goods market integration, which made widespread government intervention more difficult. Strong intervention under the planning procedure, we believe, slowed down the early postwar catch-up period by promoting inefficiency in the allocation of resources both at the national level and at thefirmlevel. Despite several waves of liberalization, most active after the creation of the EEC and the return of the franc to convertibility, both in 1958, and then in the 1980s, France still appears to be struggling with lingering powerful rigidities. This is most evident when one considers the rate of unemployment, which has remained stuck at a very high level for a decade. In our view, labour market institutions and the process of human capital accumulation play an important role in these rigidities and may be a source of slower growth, much as protection and inefficient productive capital accumulation were in the 1950s.

NOTES This chapter is based on a paper presented at the Conference on Comparative Experience of Economic Growth in Postwar Europe in Oxford, 17-19 December 1993. We have benefited from many useful comments and suggestions from the conference participants, in particular Nick Crafts. We thagk Isabelle Lacoste for excellent research assistance. Financial support has been provided by INSEAD. The views expressed in this chapter do not necessarily represent the opinions or policies of the Bank of France.

France, 1945-92 237 1 We have looked at other OECD countries with the same result. The choice of countries reported is based on data availability for the series used in Table 8.2 and 8.3. 2 We return to this issue in section 4. 3 Saint-Paul (1993) provides a detailed account of the postwar period, including exchange crises and restrictions on capital movement. 4 Standard measures of the effective real exchange rate (e.g. from the IMF) are not available before 1975. 5 Dubois also noticed that the rate of growth from 1896 to 1913 was equal to the rate from 1913 to 1923: 1.7 per cent. 6 See below the concerns by Divisia, Pupin and Roy. 7 Quoted by Bloch-Laine and Bouvier (1986: 40). 8 Mabille (1990) found a —0.5 per cent influence of capital age on TFP in manufacturing from 1970 to 1990, using gross capital (TFP should be 0.5 above what she reported using gross capital), and practically nothing for the non-manufacturing industries. Using gross capital instead of net capital, we have found a TFP growth about 0.2 below figures reported in Table 8.5. 9 This point is statistically confirmed when one looks at the difference between the means of annual TFP growth after and before 1973. 10 Note that for capital this is not exactly a correlation between relative productivity and factor use because the capital stock is always growing. For labour which has an average growth rate less than approximately zero it is not incorrect to think of this term as a correlation. 11 That capital accumulation was slow between 1950 and 1958 appears on the vertical axis: during these eight years industry average capital increase was about 40 per cent, while in the fifteen years from 1958 to 1973 it was about 150 per cent. 12 Mabille (1990:77) found a positive reallocation effect from 1970 to 1989 because of the shift in favour of financial services, which are included in her work, but not in ours. 13 For a detailed account, see Oudiz and Sterdyniak (1982). 14 For a detailed analysis of this period, see Sachs and Wyplosz (1986) and Muet and Fonteneau (1990). 15 See Burda (1990), Coe (1990) and Grunner (1993). For a dissenting view, see Cotis and Mihoubi (1990). 16 These assumptions are unlikely to be verified because of the existence in France of a minimum wage which is binding across all industries and concerns directly about 8 per cent of the employed, while another 10 per cent of the labour force is slightly above this wage level. This distortion actually strengthens our conclusions. Indeed, the existence of a binding minimum wage (called SMIC, an acronym for salaire minimum interprofessionel de croissance), which has been de facto indexed

on the cost of living with occasional additional increases, would tend to bias wages upwards as if the marginal productivity of the less skilled workers had increased faster than it actually has. The data corresponding to the lowest quartile in Table 8.8 show that the relatively fast increase in the SMIC has had the effect of narrowing the wage dispersion, bringing the lowest deciles closer to the median (Baudelot and Glaude, 1989: 12). 17 The share of business investment is 3.8 per cent larger in the 1971 National Account Base, from which figures after 1959 are taken, than in the 1956 National Account Base, from which figures from 1949 to 1956 are taken.

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REFERENCES

Adams, William J. (1989) Restructuring the French Economy, Washington, DC: Brookings Institution. Baudelot, Christian and Michel Glaude (1989) 'Les diplomes se devaluent-ils en se multipliant?', Economie et Statistique, 225, pp. 3—15. Blanchard, Olivier and Pierre-Alain Muet (1993) 'Competitiveness through disinflation: an assessment of the French macroeconomic strategy', Economic Policy, 16, pp. 11-56. Bloche-Laine, Francois and Jean Bouvier (1986) La France restauree, 1944-1954, Paris: Fayard. Bruno, Michael and Jeffrey D. Sachs (1985) The Economics of Worldwide Stagflation, Oxford: Blackwell. Burda, Michael (1990) 'Some evidence on the membership hysteresis hypothesis in Europe', Empirical Economics, 15, pp. 143-61. Carre, Jean-Jacques, Paul Dubois and Edmond Malinvaud (1972) La croissance francaise: un essai d1analyse economique causale de I'apres-guerre, Paris: Le Seuil.

Coe, David T. (1990) Insider-outsider influences on industry wages', Empirical Economics, 15, pp. 163-83. Cotis, Jean-Philippe and Ferhat Mihoubi (1990) 'L'hysteresis du chomage en Europe', Economie et Prevision, 92-3, pp. 127-44. Crafts, Nicholas (1992) 'Productivity growth reconsidered', Economic Policy, 15, pp. 388-426. Delorme, Robert and Christine Andre (1983) L'Etat et Veconomie, Paris: Le Seuil. Divisia, Francois, Rene Pupin and Rene Roy (1995) A la recherche du franc perdu, Paris: Societe d'Editions Hommes et Mondes. Dubois, Paul (1985) 'Ruptures de croissance et progres technique', Economie et Statistique, 181, pp 3-31. Griliches, Zvi (1988) 'Productivity puzzles and R & D: another nonexplanation', Journal of Economic Perspectives, 2 (4), pp. 9-21.

Gruner, Hans-Peter (1993) 'Evidence of EMS credibility and evidence on insider effects: a critical survey', chapter 3 of doctoral dissertation, EHESS, Paris. INSEE (1958) Mouvement economique en France de 1944 a 1957, Paris: Imprimerie

Nationale et Presses Universitaires de France. (1981) Le mouvement economique en France, 1949-1979, Paris: Imprimerie Nationale.

Laroque, Guy, Pierre Ralle, Bernard Salanie and Joel Toujas-Bernate (1990) mimeo., INSEE, Department de la Recherche, no. 113/G305. Lucas, Robert E. (1988) 'On the mechanics of economic development', Journal of Monetary Economics, 22, pp. 3-42. Lutz, Vera (1969) Central Planning for the Market Economy, London: Longman.

Mabille, Sylvie (1990) 'La productivity en France de 1970 a 1989: une approche sectorielle', Economie et Statistique, 237-8, pp. 69-86. Maddison, Angus (1987) 'Growth and slowdown in advanced capitalist economies: techniques of quantitative assessment', Journal of Economic Literature, 25 (2), pp. 649-98. Mairesse, Jacques (1972) 'L'evaluation du capital fixe productif, Collections de VIN SEE, no. C 18-19. Marseille, Jacques (1984) Empire colonial et capitalisme fran^ais: Histoire d'un

divorce, Paris: Albin Michel. Matthews, R.C.O., C.H. Feinstein and J.C. Odling-Smee (1982) British Economic Growth, 1856-1973, Stanford, CA: Stanford University Press.

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Melitz, Jacques (1982) T h e French financial system: mechanisms and questions of reform', Annales de 1'INSEE, 47-8, pp. 359-87. Mobus, Martine and Patrick Sevestre (1991) 'Formation professionnelle et emploi: un lien plus marque en Allemagne', Economie et Statistique, 246-7, pp. 77-89. Muet, Pierre-Alain and Alain Fonteneau (1990) Reflation and Austerity: Economic Policy Under Mitterrand, New York: Berg. Oudiz, Grilles and Henri Sterdyniak (1982) 'Inflation, employment and external constraints: an overview of the French economy during the seventies', Annales de 1'INSEE, 47-8, pp. 9-50. Resnick, Stephen A. and Edwin M. Truman (1975) 'An empirical examination of bilateral trade flows in Western Europe', in Bela Balassa (ed.), European Economic Integration, Amsterdam: North-Holland. Rioux, Jean-Pierre (1983) La France de la Quatrieme Republique, Vol. 2: L'expansion et I'impuissance, 1952-1958, Paris: Le Seuil. Sachs, Jeffrey D. and Charles Wyplosz (1986) T h e economic consequences of President Mitterrand', Economic Policy, 2, pp. 261-312. Saint-Paul, Gilles (1993) 'Economic reconstruction in France: 1945-1958', in R. Dornbusch, R. Layard and W. Nolling (eds.), Post-war Economic Reconstruction: Possible Lessons for Eastern Europe, Cambridge, MA: MIT Press. Sautter, Christian (1982) 'France', in A. Boltho (ed.), The European Economy: Growth and Crisis, Oxford: Oxford University Press. Sinn, Stefan (1990) Net External Asset Positions of 145 Countries, Kieler Studien 234, J.C.B. Mohr, Tubingen. Villa, Pierre (1993) 'Productivity et accumulation du capital en France depuis 1896', Observations et diagnostics economiques, 47, pp. 161-234.

9

Economic growth and the Swedish model MAGNUS HENREKSON, LARS JONUNG AND JOAKIM STYMNE

1

Introduction

In the middle of the nineteenth century, Sweden was among the poorest countries in Europe. Approximately 80 per cent of the population was engaged in the agricultural sector. Signs of a take-off in economic growth emerged in the 1850s. In the early 1870s, industrialization based on raw materials, notably iron ore and lumber, provided a base for sustained economic growth, which continued largely uninterrupted for one hundred years. The Swedish economic growth rate was the highest of all industrialized countries during the period 1870-1970 (Maddison, 1990). This exceptional and remarkably smooth growth made Sweden one of the most affluent countries in the world by the late 1960s. Since then economic performance has been weak compared to other industrialized countries, and in terms of GDP per capita Sweden is now no more than average among the OECD countries. This long-run development makes Sweden an interesting case. How can we explain this pattern of rapid economic growth, sustained for an extraordinarily long period of time, which was interrupted fairly abruptly and followed by the current period of slow growth and relative decline? Much of the industrialized world has experienced a slowdown since the early 1970s, but in Sweden this development has been particularly pronounced. The purpose of this study is to identify the 'ultimate' causes of Swedish growth performance relative to other OECD countries in the postwar period. We aim to explain the slow economic growth since the early 1970s. The analysis is largely exploratory. We can only roughly, if at all, quantify the relative importance of the various explanations we shall put forward. Our study is organized as follows. In section 2 we examine Sweden's growth performance from the mid-nineteenth century up to the present, comparing it to that of other OECD countries, with a strong emphasis on the postwar period. The OECD average serves as the main benchmark for comparisons. The purpose is to identify the central issues prompting further exploration. Key features of 'the Swedish model' are identified and discussed in relation to the macroeconomic 240

Economic growth and the Swedish model

241

record and structural changes of the postwar period. In section 3 we review macroeconomic policies according to the chronological outline determined jointly for the CEPR project, of which this study is a part. Here we trace the development of fiscal and monetary policies since the 1930s. In section 4 we consider a number of developments that we propose as the 'ultimate' determinants of Swedish growth performance. We assess the validity of several potential explanations of the comparatively slow growth of the Swedish economy in recent decades: the catching-up effect, the role of saving and physical capital formation, the lack of competition, the effects of stabilization and labour market policies, and the role of public sector expansion, of taxation, of human capital formation, of investment in R & D and briefly of sclerosis. In section 5 we summarize our conclusions. In this study, we attempt to take seriously the distinction made between proximate and ultimate sources of growth in the overview chapter in this collection of essays. The most straightforward fashion in which to study aggregate economic growth - and at present the only reasonably quantifiable one - is to start from a production function: that is, the notion that output is a function of measurable inputs (usually labour and accumulated capital) and the productivity of these factor inputs. At this level of explanation, the analysis of economic growth largely boils down to quantifying how much of the increase in output is due to the increase in each of the inputs, and how much is due to the increase in their productivity. Following the seminal contributions of Kendrick (1961) and Denison (1962), the 'growth accounting' technique has been gradually improved. In growth accounting, with the help of statistical and economic models, one arrives at measures of the 'proximate' sources of growth. The upshot of such exercises has generally been that most of economic growth can be attributed not to increased amounts of measurable inputs, but rather to increased productivity of the inputs: that is, to growth in total factor productivity (TFP). Growth accountants do not accept this as the whole story; with the help of ancillary assumptions, growth in TFP has been attributed to factors such as the advance of knowledge, growth of human capital, economies of scale and improved resource allocation. Even if growth accounting could successfully identify and accurately measure the proximate causes of economic growth, we would still be interested in understanding the underlying - 'ultimate' - sources of growth. Abramovitz (1989:23) has cogently pointed out how far growth accounts can take us, and what their limitations are: The aim of the accounts is modest but definite. It is to measure the proximate sources of theriseof output and so tell us where we must look if we are to find its more basic causes. Whatever the underlying causes may be, growth accounting asserts that they act through the sources identified in the accounts with a force that the accounts measure . . . Growth accounting, therefore, holds that the sources it measures act independently of one another so that each makes its own contribution. There are good reasons, however, to question that claim. The growth sources feed from one another. In this study we will draw on studies of proximate causality made by others, whereas our own contribution will be almost wholly in the realm of ultimate causality. Our

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Magnus Henrekson, Lars Jonung and Joakim Stymne

Table 9.1. Growth in GDP per man-hour in 16 OECD countries, 1870-1970 1870-1970 1870-1950 1870-1913 Australia Austria Belgium Canada Denmark Finland France Germany Italy Japan Netherlands Norway Sweden Switzerland UK USA Unweighted average

1.36 2.25 1.87 2.31 2.23 2.70 2.49 2.40 2.26 2.84 1.97 2.51 2.89 2.08 1.69 2.32 2.26

1.07 1.34 1.32 2.14 1.79 2.06 1.87 1.49 1.43 1.57 1.41 2.05 2.56 1.75 1.38 2.28 1.72

0.63 1.73 1.25 2.03 1.93 2.10 1.79 1.86 1.15 1.83 1.19 1.68 232 1.42 1.22 2.04 1.64

L913-50 L59 ().89 L40 :>.27 1.63 :>.01 1.97 1.05 L.75 L.27 1L.67 :>.48 :184 :>.14 1L57 :>.56 1L.82

Note: For the very long-run growth comparison between Sweden and other OECD countries, we use data from Maddison (1982) instead of Maddison (1991). The reason for this is that the figures for Sweden for 1870-1950 are based on a provisional series not intended for publication. The only full series for Swedish G D P for this period is the one published in Krantz and Nilsson (1975), which is used in Maddison (1982). To date, this is also the series used by all scholars doing analyses on long-run Swedish economic growth. Since the figures for Sweden presented in Maddison (1991) greatly differ from those in Maddison (1982), we find it is inappropriate to use this series until definite data exist. Source: Maddison (1982: 212).

study of ultimate causality is facilitated by our focus on Sweden's growth performance relative to other countries. This makes it suitable to search for circumstances where Sweden differs from other industrialized countries in important respects.

2

Aggregate performance

2.1

The growth

record

In the middle of the nineteenth century, Sweden was among the poorest countries in Europe. 1 Approximately 80 per cent of the population was engaged in the agricultural sector. A take-off began in the 1850s, and in the early 1870s industrialization based on raw materials, notably iron ore and lumber, provided a base for sustained economic growth which continued largely uninterrupted for one hundred years. As Table 9.1 demonstrates, Swedish productivity growth was exceptional in the period 1870-1950 compared to other rich countries. An analysis of the comparative success

Economic growth and the Swedish model 243 Table 9.2. Growth in GDP per man-hour in 16 OECD countries, 1950-70 1950-70

1950-60

1960-70

Sweden

TTo

lib

497

Unweighted average Unweighted average excluding Japan and Germany

4.46

3.89

5.04

4.08

3.55

4.62

Source: Maddison (1982: 212). Table 9.3. Average annual growth rate of GDP, GDP per person employed and GDP per capita, 1950-70 (%) GDP per person employed GDP per 1950-60 1960-70 1950-60 1960-70 1950-60 2.8 Sweden 3.4 4.6 3.8 2.7 OECD 3.6 5.0 3.9 OECD Europe 3.4 4.9 4.5 GDP

capita 1960-70 3.9 3.9 3.8

Sources: National Accounts from Statistics Sweden for Sweden; Maddison (1991); OECD, National Accounts 1950-1968; OECD, Historical Statistics. of this period is beyond the scope of the present paper, but reasons that have been emphasized include a sizeable initial stock of human capital followed by rapid human capital formation, a resource-based industry that developed into a technologically advanced investment goods industry, partly as a result of sharp exposure to international competition, a liberal policy environment, and the good luck to have avoided participating in wars during the period. Fully comparable data for the 1950s for all OECD countries are not available. Thus, in order to assess Sweden's relative growth performance in this period, we have to rely on several sources. In Table 9.2, Sweden's growth rates in GDP per man-hour are compared to the averages for Maddison's sixteen countries. The growth in GDP per hour worked was very close to the average for the sixteen countries in 1950-70. But if we exclude the extremely war-torn countries Germany and Japan, which disproportionately benefited from a positive catching-up effect, the Swedish growth rate is above the average for the period 1950-70. OECD data for the 1950s and 1960s confirm the view that emerges from Maddison's data (Table 9.3). Overall growth rate for Swedish GDP, GDP per employed and GDP per capita is practically on a par with developments in the rest of the OECD during both the 1950s and 1960s. The economy performed well during the 1960s, despite the fact that it was clearly disfavoured from a catching-up perspective by having a very high income level compared to the OECD average. Sweden's lagging growth did not manifest itself in the data until around 1970, although signs of an underlying weakness in the economy had shown up a few years earlier. One of the first manifestations of a deterioration in economic performance was that when the Swedish economy grew at a rate comparable to other OECD

244 Magnus Henrekson, Lars Jonung and Joakim Stymne Table 9.4. Average annual growth rate of GDP, GDP per person employed and GDP per capita, 1970-92 (%) GDP

GDP per person employed

GDP per capita

Sweden

~L7

T~2

T~2

OECD OECD Europe

2.9 2.4

1.9 2.0

2.0 1.8

Note: No data exist for the development of GDP per employed before 1977 for the two aggregates. Instead we have used unweighted averages for these years. Sources: OECD, Economic Outlook, June 1993 for GDP and GDP per employed; OECD, National Accounts, Main Aggregates, vol. 1, 1982 and 1994 for GDP per capita. countries, a current account deficit tended to emerge. In 1970-1 a sizeable current account deficit arose, prompting the government to respond with drastic austerity measures. Moreover, in 1969, the real product wage began to exceed the level consistent with long-run equilibrium (Wissen, 1982). For these and other reasons, it is proper to regard 1970 as a watershed year, rather than 1973, which is customarily used in economic growth studies. From Table 9.4 it is clear that the growth rate of GDP in Sweden has been only slightly more than half that of the OECD. The same pattern is apparent for GDP per person employed and GDP per capita. Sweden's relative economic performance appears more favourable in terms of GDP per capita than in terms of GDP per employed. This reflects the fact that the growth of employment has been much faster than the OECD average, particularly in the latter half of the 1980s. Thus, in terms of both overall growth and the simplest productivity measures, the performance of the Swedish economy has lagged behind^ since 1970. More sophisticated productivity comparisons across countries are not readily available. In Table 9.5 the results from one study of TFP in fourteen countries during 1970-85 is presented. Swedish TFP growth is the lowest of all fourteen countries. In Table 9.6 a simple growth accounting decomposition of growth of value added in the non-government sector during the period 1950-90 is presented. The decomposition is done using the conventional formula Y A L - = - +(l_a)- +

a

K -

where K is the capital stock, L is hours worked, a denotes the actual income share of capital averaged over the relevant period, and A is the level of TFP. A dot above a variable indicates rate of change. This simple exercise shows that, until the mid-1980s, growth in value added in the non-government sector can be predominantly ascribed to growth in TFP, although increases in the capital stock in some subperiods have been of great importance. During the 1960s and 1970s, the contribution from labour was invariably negative. In the last period, 1987-90, the pattern is dramatically different: the growth rate of

Economic growth and the Swedish model

245

Table 9.5. Growth rate of total factor productivity (TFP) in the private sector in 14 OECD countries, 1970-85 (% p.a.)

TFP growth Japan Australia Belgium Italy Canada France USA Finland Denmark West Germany Netherlands Norway UK

3.29 2.54 2.53 1.95 1.77 1.72 1.66 1.65 1.53 1.21 0.89 0.74 0.67

Sweden

0.61

Note: TFP growth in a country is estimated as the average output growth in the private sector in each country minus the growth rate accounted for by growth of labour, capital and catching-up potential where the latter is measured by the log of the ratio of labour productivity between the productivity leader and the respective country (productivity leadership is measured at the industry level, i.e. different countries are taken to be the technological leader in different industries). Source: Hansson and Lundberg (1991b).

TFP fell to a fraction of earlier levels, whereas the strong growth of employment and capital stock contributed substantially to output growth. The slow economic growth rate in Sweden since 1970 has had a highly significant impact on the Swedish income level vis-a-vis that of other countries. It is well known that comparing income levels is more difficult than comparing growth rates across countries. The most suitable method is probably to use the OECD's purchasing power parity adjusted measures of GDP per capita. Sweden together with Luxembourg had the third highest GDP per capita in the OECD area in 1970. By 1990, Sweden had fallen below the OECD average for the first time. In 1991, Sweden fell to rank 14, and the GDP level was 8 per cent below the OECD average. In 1993, Sweden was ranked seventeenth with a GDP per capita 13 per cent below the OECD average. Sweden is not the only country that has fared relatively badly; the Netherlands, Australia and New Zealand also lag behind, but no other country has regressed to the same extent. On the other hand, there are a number of countries that have performed extremely well, notably Japan, Iceland, Norway and Austria. In summation, the analysis in this section shows that the rate of economic growth in Sweden was comparable to the average of other industrialized countries until the late 1960s. But the data on growth and productivity indicate clearly that since 1970 Sweden's economic performance has been well below the average of other OECD

246

Magnus Henrekson, Lars Jonung and Joakim Stymne

Table 9.6. Proximate sources of economic growth in the non-government sector, 1950-90: contributions from growth of TFP, labour (hours worked) and capital

Decomposition of growth

Period

1950-60 1961-5 1966-70 1971-7 1978-86 1987-90 1961-90

Y ~Y

A ~A

3.3 5.4 3.9 1.9 2.3 2.5 2.8

2.3 4.7 4.4 2.2 2.0 0.6 2.6

Relative contribution from

L

<1-«)Z 0.1

-0.3 -1.3 -1.1 -0.2 0.9

-0.5

L

K *K

A ~A

(1 - a) -

0.9 1.0 0.8 0.8 0.5 1.0 0.8

0.70 0.87 1.13 1.16 0.89 0.23 0.93

0.03 -0.06 -0.33 -0.58 -0.11 0.38 -0.21

k

Li

0.27 0.19 0.21 0.42 0.22 0.39 0.29

Note: The results in Tables 9.5 and 9.6 are not directly comparable due to different levels of aggregation, and differences in estimation methods and in methods used to calculate capital stocks. Furthermore, in Table 9.5 a potential catching-up effect is taken into account. Sources: Bentzel (1991) for 1950-60; data from Bergman and Hansson (1992) for 1961-90. countries. Apart from the period 1978-86, when the economy was boosted by a series of devaluations, the growth record is poor. This tendency was accentuated during the latter part of the 1980s and the early 1990s. The accumulated effect of the slow economic growth has been substantial. In terms of the GDP level per capita, Sweden now ranks in the lower half among the OECD countries. 2.2

The policy environment and macroeconomic performance

2.2.1 The Swedish model

The performance of the Swedish economy in the postwar period is commonly discussed under the heading 'the Swedish model'. There is no clear or commonly accepted definition of the Swedish model, although the literature on the model constitutes something of a growth industry in itself.2 Economists, sociologists and political scientists tend to give different interpretations. Recent surveys of the development of the Swedish economy during the post-1945 period emphasize as a rule the following three features deemed specific to Sweden (see, for example, Andersen and Akerholm, 1982; Jorberg, 1991; Lundberg, 1985; Samuelsson, 1988). 1. The labour movement, as represented by the Social Democratic Party and the blue-collar trade union (the LO), has held a uniquely strong position of political power since the election of 1932. The Social Democrats ruled the country either alone or in coalitions from 1932 to 1976 and from 1982 to 1991. In no other European OECD country has one party held power for so long. This dominant political role has allowed the Social Democrats to shape Swedish society in a Social Democratic mould, creating an institutional set-up encompassing unions and organizations, and conducive to the growth of corporativism, non-market-oriented regulations and a large public sector.

Economic growth and the Swedish model 247 Table 9.7. Composition of GDP: Sweden, 1950-90 (%) 1950 66.4 Private consumption Government consumption 14.0 6.9 of which: central 7.1 of which: local 19.2 Investment of which: private 13.6 5.3 of which: government -0.2 Stocks 22.4 Exports -21.7 Imports

1960

1970

1980

1990

57.9

53.9

52.8

52.6

17.7 8.4 9.3 22.2 15.0 7.2 2.8 24.4 -25.1

21.8 8.3 13.5 22.7 14.2 8.5 3.1 24.3 -24.9

29.6 9.6 20.0 20.0 16.6 3.4 1.1 30.1 -32.0

27.7 7.9 19.8 20.7 18.2 2.5 0.0 30.8 -27.8

Source: National Accounts. 2. Sweden has carried out a very ambitious package of economic policies in the postwar era. This package includes stabilization policies, growth policies, industrial policies, labour market policies, and far-reaching welfare policies.3 The prime goal of stabilization policy from the end of the war until the end of the 1980s was the maintenance of full employment. A number of instruments have been used. Government regulation of investment and interest rates, of the flow of credit and capital within different sectors of the economy, and of foreign exchange are other features of the Swedish policy mix. Labour market policies have been extensive. The policies of taxation and transfers have aimed at reducing differences in income and wealth. 3. The public sector is very large. Measured in relation to GDP, public expenditure expanded rapidly in the 1970s and 1980s, from a level fairly close to the average of the OECD in the early 1960s. In 1993 the ratio reached a record level above 70 per cent. According to this measure, Sweden holds a unique position among the OECD countries. In 1992, when total government outlays constituted 67.3 per cent of GDP in Sweden, the OECD average was 41.2 per cent. High public expenditure has been accompanied by high average and marginal taxes. Accounts of the Swedish model commonly emphasize that Sweden is a small open economy with a large export sector. Exports as a share of GDP increased from a low of 5 per cent at the end of World War II to above 30 per cent in the 1980s (see Table 9.7). The unweighted average for the OECD in 1990 was 19 per cent. As a consequence of the high degree of openness, the secular and cyclical growth of the Swedish economy has been closely tied to international developments. Commentators focusing on a broad definition of the model generally stress a well-functioning relationship between government, labour and industry: that is, a political climate based on consensus, cooperation and corporativism. The role of the government in this framework is to stabilize the economy and to form it 'progressively', while avoiding direct interference in the wage-setting process between unions and private industry, and in the management of the leading multinational firms that constitute the core of the export sector. Other commentators

248

Magnus Henrekson, Lars Jonung and Joakim Stymne

suggest a narrow definition, arguing that the Swedish model basically refers to the workings of the labour market and of labour market policies. The Swedish model developed gradually, starting in the 1930s. The 1950s and 1960s mark its heyday. A broad political consensus reigned concerning the general framework of the Swedish model roughly until the end of the 1960s and early 1970s, when a more radical wing of the Social Democrats pressed for far-reaching reforms, for more equality and less stress on growth. Many of the prerequisites for the model have now been abolished or have disappeared: the system of foreign exchange and credit controls which allowed political control over capital formation, the strong position of the blue-collar union (LO) and the political hegemony of the Social Democratic Party. The following account of Swedish economic performance, structural changes, policies and institutions attempts to describe various aspects of the evolution of the Swedish model. 2.2.2 Macroeconomic performance The goals or objectives of Swedish stabilization policy are generally summarized as maintaining high economic growth, full employment, low inflation and external balance. Often the aim of stabilization policies is expressed as minimizing cyclical fluctuations and maintaining a 'proper' demand pressure (see Table 9.8). 1. Growth. The growth rate of real GDP from 1940 until 1993 is displayed in Table 9.8. According to the table, the growth rate of the 1960s was considerably higher than that of any other decade. The rate of growth of the 1970s and 1980s was positive but declining. During the early 1990s it was negative for three consecutive years. The growth rate during the 1950s was fairly high, although lower than during the 1960s. The tables demonstrate a major difference between the fairly high growth performance of the 1950s and 1960s and a phase of lower growth from around 1970 until today. This pattern is a common one for the OECD countries as a whole.4 However, the relative decline in Sweden is more pronounced. This decline is strikingly apparent in the growth of industrial production. Figure 9.1 compares Swedish industrial production to that of the OECD. The growth rate of the 1960s appears to be a unique episode, a period of uninterrupted industrial expansion without precedent, followed by dismal performance in the 1970s - more precisely, by an absolute decline between 1975 and 1978. A similar fall in the index of industrial expansion took place in 1981-2 as well as in the first years of the 1990s. The fall in 1991-3 is the most dramatic one in the whole period, demonstrating the severity of the most recent downturn. 2. Cycles. The cyclical pattern is shown in Figure 9.2, displaying a three-year moving average of the annual percentage change in real national income as well as the behaviour of a composite index measuring the Swedish business cycle. The average length of the cycle is roughly four years from peak to peak. The international business cycle has been a prime determinant of the Swedish cycle (see, for example, Lundberg, 1968). However, after the fall of the Bretton Woods system, domestic stabilization policies have been a considerable source of cyclical disturbances as well. This was particularly the case during the policy of 'bridging over' in 1974-5, when the authorities tried to bridge over the expected

Economic growth and the Swedish model 249 Table 9.8. Macroeconomic outcomes: Sweden, 1940-93 (period averages, %)

Growth Unemployment Inflation Current account

1940-9

1950-9

1960-9

1970-9

1980-9

10 5.7 4.8 0.3

28 2.2 4.4 0.3

41 1.5 3.7 -0.2

23 2.1 8.6 -0.4

L6 2.5 7.9 -1.7

1990-3 ~i 4.5 6.6 -1.7

Notes: Growth: G D P per capita, annual percentage change. Unemployment: annual averages. Inflation: consumer price index, annual percentage change. Current account: as a percentage of GDP in current prices. iou * OECD / total /

160-

^OECD — ^. , Europe

/

140*

/

\

' " ^ ""

120-

'

//

100-

/ ^ / Sweden

y

vy ^

80-

60-

-

'S

M\ 1960

1965

1970

1975

1980

1985

1990

Source: OECD.

Figure 9.1 Industrial production in Sweden and OECD, 1960-92 (1970 = 100) international downturn by applying a set of expansionary measures. In retrospect this policy of meeting a supply shock with demand expansion did not turn out successfully. Swedish prices and wages rose more rapidly than international prices and wages. Competitiveness was sharply reduced, which eventually induced a series of devaluations of the krona in the period 1976-82. The amplitude of the cycle (a rough measure of the cyclical performance of the Swedish economy) has been constant throughout the period 1948-88 (see, for

250

Magnus Henrekson, Lars Jonung and Joakim Stymne

• Business • cycle index

GDP growth (threeyear moving average)

1980

1985

1990

Source: Frennberg and Jonung (1992).

Figure 9.2 Annual percentage changes in Swedish GDP and the Swedish business cycle, 1945-90

example, Bergman and Jonung, 1993). The disturbances hitting the economy after the fall of the Bretton Woods system appear, however, stronger than during the Bretton Woods period. As is evident from Figure 9.2, the growth performance began to worsen around 1970. In the 1950s and 1960s, cycles were growth cycles: growth in real income was positive during the downturns of the cycle, at least 1-2 per cent a year. After 1970 the downturns became associated with gradually lower growth rates. 3. Unemployment. Full employment has been the overriding goal of Swedish economic policy in the postwar period, at least until 1990. There has been considerable popular support across party lines for this goal. Between 1950 and 1990 the unemployment ratefluctuatedbetween 1 and 3 per cent. Most remarkably, the Swedish rate remained low in the 1980s, when the rate of the OECD varied between 5 and 10 per cent. Unemployment has also displayed a cyclical pattern, peaking as a rule a few quarters after the bottom of the business cycle. Behind these aggregate numbers lie large cyclical and secular sectoral differences. Employment in the private sector displays more pronounced cyclical fluctuations than employment in the public sector. Employment in the public sector, as shown below, displays a strong positive trend during the postwar period. Furthermore, high labour force participation rates for women and the elderly characterize the Swedish labour market. 4. Inflation. As a consequence of the firm commitment to full employment, inflation has been given secondary priority in the policy process, in particular after the breakdown of the Bretton Woods system. Swedish inflation in the 1950s and 1960s roughly followed the international trend. This pattern was consistent with the EFO-model of wage and price inflation, which is based on a separation of the Swedish economy into two sectors: an open and a sheltered sector. In this model,

Economic growth and the Swedish model

251

export firms, which comprise the major part of the open sector, are viewed as price-takers in international markets. The wage inflation in the tradables sector is determined by productivity growth and international inflation. Domestic inflation is determined by the international rate of inflation and domestic productivity gains, assuming that the rate of wage inflation is identical for the two sectors.5 The model was based on a system offixedexchange rates and thus applied to the conditions of the Bretton Woods period. Since OPEC I, Swedish inflation has been considerably higher than that of the OECD. 4. The external balance. Since Swedish growth and cycles have primarily been regarded as driven by export demand, the external balance plays a major role in the forming of economic policies. In the 1950s and 1960s there were no balance of payments problems, except at the end of the 1960s. Since OPEC I, Sweden has experienced more or less permanent problems with its balance of payments (see Table 9.8). The current account balance has displayed considerable short-run fluctuations, movements that are not shown in the table. 2.2.3 Structural changes

The structure of the economy has changed considerably in the pastfiftyyears. The most striking feature is the growth of the public sector, and the decline in agriculture and in industry. Looking at the demand side of the economy displayed in Table 9.7 above, private consumption fell from 66 per cent as a share of GDP in 1950 to 53 per cent in 1990, while public consumption rose in the same period from 13 to 28 per cent. Practically all of the expansion is due to a rise in the expenditure of local authorities. The share of investment remained roughly unchanged, while the share of exports rose from around 20 to 30 per cent between 1950 and 1990. Changes in the employment shares in the Swedish economy displayed in Figure 9.3 cogently illustrate structural shifts. Employment within agriculture as a share of total employment fell from 25 per cent in 1945 to 3 per cent in 1990. For manufacturing, the same numbers are 33 per cent and 20 per cent. The number of industrial workers peaked in 1965, when more than 743000 were employed in industry. The employment share of the public sector rose from 8 per cent in 1945 to more than 30 per cent by 1990, most of the expansion taking place in the 1960s and 1970s. Employment in the remaining sectors, primarily in the service sector and notably - in construction, expanded from 33 to over 40 per cent at the end of the 1980s. The expansion of the public sector reflects major structural shifts within the labour market, primarily a large increase in the employment of women. Labour force participation rates of women increased rapidly, particularly in the 1970s, reaching the highest ratio within the OECD. A large part of the expansion of jobs took the form of part-time employment. Significant immigration of labour started in the 1960s. Structural changes in the economy may also be analysed using the EFO approach, which was originally presented as a structural model of inflation in an open economy. Figure 9.6 is based on two sectors: a competitive sector and a sheltered sector, which can in turn be subdivided into a public and a private sheltered sector.6 The figure shows that the competitive sector has declined secularly since 1952, most rapidly in the 1950s and 1960s. In the early 1990s it comprised less than 20 per cent of the Swedish economy.

252

Magnus Henrekson, Lars Jonung and Joakim Stymne 50 n Private services and other private sector 40-

S a,

20-

10

0 1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

Source: National Accounts.

Figure 9.3 Structure of Swedish employment, 1945-91 3

A review of macroeconomic policies

3.1

Legacy of the 1930s and World War II

The economic and political events of the 1930s and World War II had far-reaching effects on economic policies in the postwar period. Sweden was influenced fairly late by the depression of the 1930s. As a consequence of the British decision to let the pound float in September 1931, the krona was forced to leave the gold standard. It depreciated significantly, which had expansionary effects on the domestic economy. The Swedish economy was isolated from the full impact of the international depression in 1932-3, although unemployment reached high levels in those years. The rapid rise in unemployment in the early part of the 1930s made unemployment the major economic, social and political issue: a challenge for the economics profession. A new generation of economists, the Stockholm School of Economics, made its breakthrough in the 1930s.7 The Stockholm Scho61 included Bertil Ohlin, Gunnar Myrdal, Erik Lundberg and Erik Lindahl. They attempted to find policies

Economic growth and the Swedish model

253

to reduce unemployment and cyclical disturbances. They favoured active countercyclical policies with deficitfinancing.Their message, which had a strong Keynesian flavour, prior to the publication of Keynes's General Theory, attracted wide attention. The influence of the Stockholm School in the 1930s paved the way for the rapid absorption of Keynesian views after World War II. Thus, at a very early stage Sweden became a Keynesian showcase, and it remained so until the end of the 1980s.8 In fact, the fall of the Bretton Woods system in 1973 allowed the government to experiment with demand policies to a greater extent than during thefixedrate of the Bretton Woods arrangement. The Social Democrats laid the foundation in the 1930s for their unique dominance of Swedish politics in the postwar period. To the voters they appeared to have brought the country out of the depression.9 The party remained in power for the rest of the 1930s. The experience of World War II exerted a profound influence on economic policies for a long time to come. Most importantly, a system of exchange controls was instituted in 1940, and it remained in effect until 1989. The Swedish economy was characterized by far-reaching controls in the setting of wages, prices and rents. A comprehensive housing policy was initiated during the war. The country was isolated from foreign trade, which also facilitated the system of rationing and controls. Business, labour and government cooperated closely in the framing of economic policies. The regulatory system established during the war was commonly regarded as successful. It was viewed as proof that economic planning and far-reaching government intervention could work in Sweden, and even that this could also be the case under peacetime conditions. It increased public belief in regulation and disbelief in markets, which facilitated the establishment of regulations and controls in the postwar period. In order to function, government actions such as economic policies have to be acceptable and regarded as legitimate by the public. Sweden's ability to stay out of the war while the rest of Europe was devastated lent legitimacy to government actions, per se. This legitimacy also carried over to domestic affairs, contributing to a greater acceptance of government intervention in the economy after the war.10 3.2

The return to peace, 1945-51

The second half of the 1940s marks the transition from wartime to peacetime conditions. Domestic policy debate was lively. The postwar programmes of the Social Democrats aimed at far-reaching controls of economic activity, inter alia, to maintain the full employment that had been established during the war. Many expected the war to be followed by a depression. For this reason, requests for expansionary economic policies were made. In 1944 parliament adopted a monetary programme for the postwar period. The programme codified a policy of low and stable interest rates and a stable price level. Actual monetary andfiscalpolicies turned out to be expansionary in the second half of the 1940s. Inflation, not unemployment as expected, became the major economic policy problem. The Riksbank tried to curb the inflationary impulse by an appreciation in July 1946. This step was eventually counteracted by a devaluation in

254 Magnus Henrekson, Lars Jonung and Joakim Stymne

1949, as part of a general European depreciation vis-d-vis the US dollar. Growth was rapid in 1945-51 as Sweden benefited from the rebuilding of Europe. 3.3

'The Golden Age9, 1951-73

Sweden officially entered the Bretton Woods system in 1951. Swedish economic thinking of the day strongly recommended government intervention to stabilize the economy as well as to foster economic growth, primarily by enhancing investment. Fiscal policy was characterized by ambitious attempts to stabilize private investment activity by taxes, subsidies and investment funds. Fiscal policy was regarded as superior to monetary policies, and direct controls and regulations were accepted as part of this outlook. One aspect of the policy mix was the stress on planning. A national medium-term budget was set up at the end of the 1940s, and medium-term plans have been published regularly ever since. The Riksbank, which was not an independent central bank, aimed at maintaining a low' and stable rate of interest.11 This policy forced the Riksbank to introduce non-market-oriented techniques of monetary control in 1952, since it could not raise its discount rate and thus any other interest rates to an equilibrating level. From then on the Riksbank directly controlled the rate of interest and theflowof credit in the economy behind the insulation furnished by foreign exchange controls. The system of credit controls was extended to the bond market through the Riksbank's control over new issues of bonds. The timing, size and interest rates of every new bond issue had to be approved by the bank - a system that remained in force until the 1980s. Sweden's growth performance in the 1950s and 1960s was impressive. According to Table 9.8, the growth rate in the 1950s averaged 2.8 per cent per annum, which increased to 4.1 per cent in the 1960s. Unemployment and inflation remained at low levels. 3.4

Shocks and stagflation, 1973-82

The period 1973-82 represents a severe deterioration in Swedish economic performance relative to the OECD average. Economic growth and industrial production declined sharply (see Figures 9.1 and 9.2 above). Wage costs and domestic inflation increased more rapidly then internationally. Domestic saving and investment fell. The soaring budget deficit and a current account deficit were financed by borrowing from abroad. Unemployment, however, remained at a low and stable rate as a result of the economic policies pursued, in particular due to a rapid rise in public employment. When facing the rise in energy prices and an expected international recession in 1974-5, the government adopted a policy of'bridging over'. This strategy involved an expansionaryfiscalpolicy that was supposed temporarily to counterbalance the fall in foreign demand. However, the expected international recovery was slow in materializing. Moreover, policy-makers did not recognize that OPEC I was a supply shock and that bridging over meant delaying necessary real adjustments. Instead, Sweden experienced high price and wage inflation, a loss of international

Economic growth and the Swedish model

255

competitiveness, a fall in exports and a rapidly growing deficit on the current account. The expansionary fiscal policy, involving large subsidies to declining industries, contributed to an expanding budget deficit. Government debt as a ratio of gross domestic product rose from 20 per cent in the mid-1970s, peaking at over 60 per cent ten years later. As a consequence, the Swedish currency, which after 1973 was pegged at a fixed rate to the German mark, was devalued twice in 1977 and tied to a currency basket. After the devaluations, domestic fiscal policy was not made sufficiently contractionary. Public expenditures continued to rise. The liberal minority government, formed a year before the election of 1979, gave its policies an expansionary profile in 1978-9. OPEC II represented a large contractionary disturbance in 1979-80. At this point no attempt to initiate a new policy of bridging over was made. A new devaluation of the krona took place in August 1981. Eventually, as a response to the large twin deficits, a programme of fiscal restraint was initiated. 5.5

The 'recovery' of the 1980s and its legacy

Having been in opposition since 1976, the Social Democrats returned to power in 1982 with an election programme aimed to counter the cutdowns in government expenditure made by the former centre-liberal government. The new government attempted to 'jump-start' the economy with a devaluation of 16 per cent, which resulted in a sizeable undervaluation of the krona. The aim of the devaluation, which was supposed to be a once-and-for-all measure, was to increase demand for Swedish exports and to cause an expenditure switch, moving resources out of the sheltered sector and into the tradables sector. The devaluation was supposed to be followed by a tight monetary and fiscal policy to hold down inflation. This policy was called 'the third way'. The strategy appeared to work for a short time in 1983-5. Demand for Swedish exports increased. Industrial production expanded. The rise in unemployment was arrested at a level of around 3 per cent. The budget deficit declined. However, from the middle of the 1980s, the third way showed increasing signs of malfunction. The expenditure switch did not take place. The growth in public expenditures continued. Price and wage inflation was not arrested. Swedish industry expanded abroad instead of domestically. The large increase in profits was not accompanied by a rise in domestic investments. Fiscal measures dominated the mix of economic policy that followed OPEC I. The major task of monetary policy after OPEC I was tofinancethe twin deficits: the budget deficit and the balance of payments deficit. The Riksbank began by expanding its system of credit controls. However, this process was soon arrested and replaced by financial deregulation, which took off around 1983. A number of selective credit controls were abolished. After abolishing domestic credit controls in 1985, the policy of the Riksbank began to focus solely on stabilizing the exchange rate of the Swedish currency to a basket of currencies,while largely refraining from attempts to regulate the flow of credit and capital domestically. In the second half of the 1980s, the economy entered a phase of'overheating', with rapid inflation and a rate of unemployment around 1 per cent. The domestic

256

Magnus Henrekson, Lars Jonung and Joakim Stymne

deregulation contributed to a boom in the real estate business, causing rapid asset inflation. The stock market displayed impressive growth. Newfinancialtechniques and instruments emerged as part of the deregulation. In the middle of the 1980s, Swedish Keynesianism came under heavy attack, in particular by the SNS Economic Policy Group.12 Low economic growth and high inflation in the 1970s and early 1980s were regarded as a dismal record and were blamed on the Keynesian strategy. With the international trend towards a greater emphasis on the role of expectations and the credibility of policy commitments, the prevailing Keynesian ideology came increasingly under fire. Furthermore, the public choice school introduced ideas that contributed to a sceptical attitude towards discretionary economic policy. Influenced by the emergence of a new policy view, the Social Democratic government made its prime goal a low rate of inflation at the expense of full employment, and this was made official in the budget of 1991. A number of supply-side measures were taken, most importantly a major tax reform aimed at increasing the incentive to work and save. In the spring of 1991, the Swedish currency was tied unilaterally to the ECU. And in the summer of 1991, Sweden applied for EC membership. The 1986-90 period of overheating created a major loss in competitiveness. When the Social Democrats lost the election of 1991, the Riksbank and the new government tried to avoid a new devaluation by a number of austerity measures. Open unemployment rose from 2 per cent to 7-8 per cent in a short time. The Swedishfinancialsystem suffered from a severe deflation in asset values, and was hit by a deep crisis. In the aftermath of the European currency crises in the autumn of 1992, the Riksbank was forced eventually to let the krona float, marking the end of the era of a fixed exchange rate. 4

Ultimate causes of Swedish economic performance

At the end of the Second World War, Swedish income and productivity levels were very high compared to the OECD average. Sweden managed to retain its lead vis-a-vis an average of other industrialized countries in the 1950s and 1960s. However, since then relative economic decline has set in, and in the last two decades Sweden has been overtaken by several other countries. This development motivates a focus on aspects where Sweden differs from other countries to a large extent. In this section we deal with a number of factors that may help explain the Swedish growth performance. 4.1

Catching-up effect

Long-run economic growth among OECD countries has been influenced by a catching-up effect, particularly during the 1950s and 1960s (Dowrick and Nguyen, 1989; Abramovitz, 1989). The catching-up hypothesis maintains that, when the productivity level is higher in one or more countries than in a number of other countries, the latter have the opportunity to embark on a catching-up process by applying superior production techniques transferred from the more advanced economies. Hence, we should expect technologically less advanced countries to

Economic growth and the Swedish model

257

grow faster than the technologically leading country or countries. In 1950, Sweden had the second highest productivity level of all European countries (Maddison, 1982), which no doubt gave the country less scope for catching up. Crafts (1992) estimates that Sweden's potential growth bonus from catching up in GDP per hour worked was 0.8 percentage points per annum below the average for European countries during the 1950s, and 0.2 percentage points below the European average in the period 1960-73. Dowrick and Nguyen (1989) have estimated that Sweden's smaller scope for catching up, ceteris paribus, led to a lower rate of growth in GDP per capita of about 0.8 percentage points during the period 1950-73 compared to the OECD average. Hence, there is little doubt that catching up was an important factor in Sweden's relative growth performance in the 1950s and 1960s, but is it a valid partial explanation for the bleak performance of the economy after 1970? Although it was straightforward at the end of World War II to assume that the USA was the technological leader in virtually all industries, over the years this assumption became increasingly questionable. Now technological leadership in different industries is likely to be spread among different countries. In order to account for this possibility, it is necessary to use disaggregated data. This is done by Hansson and Henrekson (1994a), who test for the existence of catching up in fourteen OECD countries during the period 1970-85, using a data set disaggregated into fourteen different industries (the OECD Intersectoral Data Bank, ISDB). There are nine industries in the tradables sector andfiveindustries in the non-tradables sector. In no instance do they find catching up in the tradables sector, and if a uniform catching-up effect in both sectors is assumed, no significant catching up is found. This is the case regardless of whether the catching-up potential is measured by the ratio of a country's labour productivity or total factor productivity (TFP) to that of the leading country. The results indicate that technological catching up in the tradables sector, although it was probably important in the 1950s and 1960s, seems to have lost importance after 1970. This indicates that, in the part of the economy facing direct competition from foreign rivals, the potential for fast TFP growth based on catching up was exhausted by 1970. Based on the results of the Hansson and Henrekson study, we conclude that the catching-up effect can be reasonably dismissed as an explanation for Sweden's slow growth since 1970 compared to the OECD average. 4.2

Sa ving and physical capital formation

4.2.1 Saving The development of saving is shown in Table 9.9. Saving rose between the 1950s and the 1960s, and has thereafter declined sharply. Average gross saving as a share of GDP declined by almost 8 percentage points between the period 1960-9 and the period 1980-92. Average net saving fell by over 10 percentage points, reflecting a more rapid rate of capital consumption during the latter period. The magnitude of the drop can be explained by the deterioration of public saving. Although the magnitude of the decline in household saving is smaller, the secular decline in this category throughout the period under study is noteworthy.

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Table 9.9. Saving as a percentage of GDP: Sweden, 1950-92 (annual averages)

Gross saving Household Corporate Consolidated government of which: social insurance Net saving Household Corporate Consolidated government of which: social insurance

1950-9

1960-9

1970-9

21.9 7.2 10.3 4.4 0.1 11.9 4.5 4.0 3.4 0.0

24.8 6.4 9.2 9.2 2.6 14.7 3.6 2.6 8.4 2.6

21.8 4.6 9.6 7.5 4.1 11.5 2.1 3.0 6.4 4.1

1980-92 17.0 3.6 11.9 1.5 2.7 4.3 0.9 3.7 -0.4 2.8

Source: National Accounts. Public saving began to increase rapidly after 1960 due to the establishment of the national pension system (the AP fund) in 1959, according to Figure 9.4. The build-up of reserves within the AP system had a dramatic impact on the capital market. Saving in the social insurance system increased from zero in 1959 to 4.7 per cent of GDP in 1972. While gross public saving rose from around 3 per cent of GDP to over 10 per cent, private saving fell at the same time from around 17 per cent to a little over 12 per cent. Part of the reduction in private saving reflects the reduced saving for retirement purposes. In addition, a number of policy measures - in effect, institutions that are often seen as the core of Swedish social policies - all served to reduce the precautionary motive as well as the life-cycle consumption-smoothing motive for private saving. The laws which most probably had this impact on private saving are: general child allowance (which went into effect in 1947); work disability insurance (1954); social assistance (1956); the national pension scheme (1959); student support (1964); supplemental old-age pension (1969); housing allowances (1969); general unemployment insurance (1973); general dental insurance (1974); paid parental leave (1974); adult education support (1976); support for partial retirement (1976); and extensions of and increases in child allowances, parental leave allowances, partial retirement allowances, child care allowances, etc. (198 5-). No attempt is made to quantify these schemes here. The point is that since they are in practice available to all, and since they mostly provide significant replacement of forgone income, they reduce incentives for private individuals to save. The term insurance' for these programmes is something of a misnomer. First, the link between fees and benefits is often weak. Second, the schemes are mostly compulsory, with fees being payable by the employer, leaving the individual no choice about whether to participate or not. Adding to this list free schooling, up to and including tertiary education, as well as almost free hospital care, further diminishes incentives for private saving. The inflationary environment of the 1970s and 1980s provided additional saving disincentives. Nominal earnings on the return on capital were taxed at the same rate

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259

30 n

25 \ Total saving 20-

15 -

1950

1955

1960

1965

1970

1975

1980

1985

1990

Private saving: household, corporate. Public saving: government, social insurance. Source: National Accounts.

Figure 9.4 Private and public sector gross saving as a percentage of GDP: Sweden, 1950-92

as earned income until the late 1980s. As a result of rapid inflation and high marginal taxes, the after-tax real return on saving was negative for many categories of saving and for most income groups throughout the period. Similarly, interest payments for all kinds of borrowing (mortgages as well as borrowing for consumption) were fully deductible against earned income until the end of the 1980s, implying that the real cost of borrowing was negative. Understandably, demand for borrowing was high. The deregulation of capital markets during the 1980s removed the last constraints on household borrowing. Household saving fell to an all-time low of — 2.4 per cent of GDP in 1988 and 1989 (net household saving; gross saving was approximately zero). Against this background, the dramatic increase in private saving between 1989 and 1992 is understandable. Today the perceived ability of the national pension system to fulfil its future obligations is increasingly questioned. Compensation

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levels have been reduced in sick leave allowances and unemployment allowances. Rapid disinflation since early 1991 has increased pre-tax real interest to significant positive levels. Post-tax returns to saving (and costs of borrowing) have risen additionally as a result of the reduction in taxation of capital income (and deductibility of capital expenditures) to 30 per cent. Thus, public commitments reduced private incentives to save throughout the postwar period. Public finances, on the other hand, began deteriorating after the early 1970s. Increasing payments of benefits have reduced saving in the social insurance system by about 2 percentage points as a share of GDP since the peak in 1972. Public saving excluding social insurance has deteriorated even more rapidly. As can be seen from Figure 9.4, the recent increase in private saving has not been sufficient to substitute for this drop, and total saving is currently at its lowest level for the postwar period. 4.2.2 Physical capital formation Throughout the postwar period, the process of capital formation has been the outcome of compromises between market-oriented philosophies and a strong political move to direct investment activity. A heated debate about central planning took place immediately following the war, but the push for planning was eventually abandoned. However, Social Democratic policy-makers proposed methods to influence investment decisions that had fundamental effects on capital formation in the ensuing decades.13 The strategy of the Social Democrats, in the words of Pontusson (1992: 11), was 'to influence investment decisions in ways that respected the autonomy of corporate managers and owners of capital'. At least four policy developments during the 1950s are of central importance for the understanding of this statement. Thefirstis the implementation of the policy of low interest rates'. Interest rates were kept at levels below market equilibrium. This made it necessary to maintain binding credit rationing, which involved active central bank monitoring of commercial bank activities (Jonung, 1993). The second policy development is the system of 'investment funds'. This instrument was introduced before World War II, but increased in importance from the mid-1950s. It allowed firms to reduce taxable profits by setting aside current earnings for future investment. The government announced the periods when firms were allowed to draw from the investment funds. The counterpart of the policy was high levels of taxation of corporate profits and dividend payments. Taken together, the investment funds and corporate taxation served to lock in profits infirms,as was the intention (Bergstrom and Sodersten, 1990). Combined with credit controls, this amounted to a system with a bias towards the expansion of existing firms rather than the establishment of new ones. A third important development was the 'solidaristic wage policy' of the Rehn-Meidner model, described elsewhere in this paper. Since it contributed to a flat-tening of wage levels across firms and sectors, it discouraged investment in low-productivity activities. Through this mechanism the policy influenced capital formation. However, it is unclear to what extent the Rehn-Meidner model reached its goal of releasing resources for higher-productivity investments. Since there was already a bias towards existingfirms,this model contributed to making resources

Economic growth and the Swedish model 261 Table 9.10. Gross investment as a share of GDP: Sweden, 1950-89 (annual averages per decade)

1950-9 1960-9 1970-9 1980-9

Public

Private Machinery and equipment

3.0 4.1 3.7 2.7

17.8 19.9 17.5 16.3

7.6 8.2 8.3 8.2

Residential

Other Total construction

5.6 6.3 4.7 4.6

7.6 9.4 8.3 6.3

20.8 24.0 21.2 19.0

Source: National Accounts.

50Machinery and^ equipment Other construction 40-

30-

Residential construction

20-

10

0 1950

1955

1960

1965

1970

1975

1980

1985

1990

Gross investment, current prices. Source: National Accounts.

Figure 9.5 Swedish capital formation by category, 1950-92 available for surviving firms and for public investments. However, the sources of finance for potential high-productive investment outside existing enterprises were limited. Gross investment as a share of GDP averaged 20.8 per cent during the 1950s (see Table 9.10). Investment in machinery and equipment fell gradually as a share of

262 Magnus Henrekson, Lars Jonung and Joakim Stymne

total investment from about 40 per cent in the early part of the decade to around 35 per cent towards the end of the decade (see Figure 9.5). Public investment rose from about 2 per cent of GDP to 4 per cent during the same period. A fourth important policy development was the introduction of the national pension fund system (AP funds) discussed in the previous section. During the 1960s, public intervention in capital formation became increasingly direct. The high saving rate of the social insurance system manifested itself in rapidly growing stocks of assets in the AP funds. The AP funds were subject to politically determined rules concerning the composition of the portfolio, and priority was given to the housing sector, the government sector and the export industry. In the early 1970s, the AP fund system accounted for 35 per cent of the total supply of credit. The AP funds lent to industry through intermediate credit institutions. At the end of 1976, these funds accounted for 69 per cent of the long-term liabilities of these institutions (Pontusson, 1992). Englund (1993) argues that capital was directed into the housing sector from as early as the 1950s, while the policy of iow interest' was still maintained. Beginning in 1965, the process was accelerated through the 'million programme' - a political programme to construct one million new housing units by 1974. In the years 1967-72, 100000 units were constructed each year, and residential investment accounted for between 5 and 6 per cent of GDP. During that period, about 50 per cent of net lending by the AP funds went to housing construction (Pontusson, 1992). Total gross investment as a share of GDP fell by some 5 percentage points between the 1960s and the 1980s (see Table 9.10). Part of the explanation for this was that investment was unusually high during the 1960s, in particular because of the abundance of funds made available through public saving. In addition to the housing investment already mentioned, ambitious public investment programmes were undertaken during that decade. To sum up, the credit market was regulated from the beginning of the postwar period (Jonung, 1993). The importance of public policy both in the mobilization of savings and in their transformation into capital became pronounced during the period. The gradual socialization of saving (and later, dissaving) was a strong tendency. A potential justification for this policy was that it was a way of channelling saving into investment, which gave higher economic returns than if investment decisions were left to private agents. However, the reduction of total factor productivity in the post-1970 period indicates that this was not successful. De Long and Summers (1991) have provided evidence that there is a strong correlation between investment in machinery and equipment and economic growth. A change in the composition of investment away from equipment would show up in basic two-factor growth accounting as a reduction in total factor productivity. Could this be part of the explanation for the Swedish productivity slowdown? Judging from Table 9.10, this is not the case. Although there have been significant year-to-year variations in investment in machinery and equipment, annual averages as a share of GDP have remained almost unchanged for three decades. Thus, in Sweden's case, the explanation has to be sought elsewhere. Another possible explanation for the growth slowdown is that the capital stock is sufficiently large for marginal returns on capital to be smaller than elsewhere. However, this is a variant of the catch-up hypothesis, and does not explain why Sweden has been overtaken by a number of countries.

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263

0.8-1 Total sheltered sector 0.7-

0.6-

0.5-

0.4Competitive sector 0.3

0.2

0.1

0 1955

1960

1965

1970

1975

1980

1985

1990

Source: Edgren et al. (1970) and the EFO-grouped National Accounts.

Figure 9.6 The competitive and sheltered sectors of the Swedish economy, 1952-90

A tentative conclusion from the experience of saving and capital formation is that the cause of the Swedish slowdown is not so much a question of a reduction in levels of potentially productive investment. Rather the cause may be that the political system has increasingly determined the mobilization of saving and the allocation of investable resources. 4.3

Competitive pressures

In analyses of the Swedish economy, following Edgren et al. (1970), a distinction is often made between the competitive and sheltered sectors of the economy. The competitive sector consists of the export and import-competing industries, whereas the sheltered sector comprises all non-tradables industries. The sheltered sector is at times further divided into the private and the public sheltered sectors. The share of the competitive sector has been halved since the early 1950s, while the public sheltered sector increased dramatically up to the early 1980s (Figure 9.6). During the 1980s, the private sheltered sector increased relative to the two other sectors. But does this change in the composition of the economy have any bearing on economic growth? It is clear from Table 9.11 that productivity growth was roughly twice as large in the competitive sector as in the sheltered sector in the 1950s and 1960s. In this period, the competitive sector constituted on average approximately

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Table 9.11. Growth in productivity per hour worked in the competitive and sheltered sectors of the Swedish economy, 1951-90

Period

Competitive

Private sheltered Total sheltered

1951-5 1956-60 1961-5 1966-8 1951-68 1971-7 1978-86 1987-91

3.0 4.9 7.9 4.8 5.7 3.0 3.2 2.3

2.4 2.3 3.6 2.8 3.1 4.0 2.3 1.3

1971-91

2.6

3.0

1.9 1.9 3.2 2.5 2.6 —

Sources: Edgren et al. (1970) for 1951-68; the EFO-grouped National Accounts compiled by Statistics Sweden for 1970-91. one-third of the economy, and therefore its strong productivity growth contributed sizeably to a high overall growth. Since the 1970s, the competitive sector has declined in relative importance, but more importantly, after 1970 its rate of productivity growth was no longer higher than in the private sheltered sector. This is all the more remarkable since average productivity growth in the (secularly shrinking) competitive sector has been bolstered by a positive Salter effect: that is, average productivity has partly increased as a result of closures of the least efficient plants and firms. Thus, productivity growth in the competitive sector has not exceeded that of the private sheltered sector since 1970, even though employment there has declined. This may indicate that exposure to international competition did not continue to function as a forceful productivity-enhancing mechanism in the way it was conceived by the main architects of the Swedish model. According to Flam et al. (1993), there is considerable evidence of lack of competition in tradables as well. Many industries are highly concentrated, and sometimes domestic markets are segmented from international markets even in traded goods. The lack of competition could have been corrected by policy measures. But the government has had a permissive attitude towards low competition within the country, generally resorting to the argument that the country's openness is sufficient to impose discipline on Swedish industry, at least in the competitive sector, but also indirectly in the sheltered sector. However, this mechanism has probably been largely ineffective since the late 1960s. One important reason may be the effect found by Wissen (1982), that after 1967 the real product wage exceeded the level consistent with long-run equilibrium. Somewhat simplified, this implies that the EFO relationship was fulfilled ex post but not ex ante, which led to an excessive shrinkage of the industrial sector. In particular, Wissen notes that the (erroneous) EFO assumption that productivity growth is independent of the growth of the real product wage has had detrimental effects. As a response to the excessive contraction of the competitive sector, policy-makers

Economic growth and the Swedish model

265

hastened the expansion of public sector employment in order to avoid unemployment (Soderstrom and Viotti, 1979). This was particularly prevalent during the 1970s (see Figure 9.7). In the 1980s an expansionary economic policy allowed the private service sector to grow at a rate that proved unsustainable (Henrekson, 1991). In all, we deem that these features of economic policy have lowered the transformation pressure and hence the rate of economic growth. 4.4

Effects of stabilization and labour market policies

The priorities and the strategies of macroeconomic policies have differed from those of the average OECD country in a number of respects. Most remarkably, Sweden maintained a low rate of unemployment in the 1970s and 1980s, while unemployment in the OECD area increased significantly. At the same time, the rate of inflation remained above the OECD average after OPEC I. During these decades, Swedish relative growth performance deteriorated as well. To what extent - if any - is there a connection between the design of short-run stabilization policies, including labour market policies, and long-run economic growth in the Swedish economy?14 The effects of monetary and fiscal policies on growth should be considered in the context of the unique labour market policies and labour market institutions that emerged in Sweden in the postwar period. Wage setting has been strongly centralized. Incomes policies have not played any major role. The degree of unionization is the highest in the OECD for all segments of the labour market. Government expenditures for labour market programmes (public relief work, labour market training, disability programmes, youth programmes) are substantial. The unemployed are expected actively to move to a new job or to be retrained. Cash support is avoided. In the 1989/90fiscalyear, when unemployment was as low as 1.5 per cent, expenditures on active labour market measures were equal to approximately 1.5 per cent of GDP. In 1992/3, with unemployment at almost 7 per cent, these expenditures were equal to more than 3 per cent of GDP. The labour market policy was originally based on the Rehn-Meidner programme developed at the end of the 1940s and in the early 1950s. This programme, which aimed to reconcile full employment with a low rate of inflation, consisted of the following basic elements:15 • A restrictive fiscal and monetary policy to curtail inflation and high profits. • A solidaristic wage policy, defined as equal pay for equal work across firms and branches, regardless of productivity and profit developments. • An 'active' and 'ambitious' labour market policy that could quickly move those who became unemployed, as a consequence of the solidaristic wage policy and the restrictive demand policy, towards new employment. The Rehn-Meidner programme should be regarded as a model for structural change and economic growth.16 The goal was to eliminate low-productivity firms and branches, and move labour into firms and industries with high productivity, thus improving economic growth as well as paying a higher wage rate. The heyday of the Rehn-Meidner policy was the end of the 1950s and the early 1960s, but later it started to run_into trouble for a number of reasons. Popular resentment against structural changes increased. Regional policies counteracted the

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mobility necessary for the model to work. Rapid growth in transfer payments reduced the incentives for people to move and accept new jobs. Fiscal and monetary policies became more expansionary than the model allowed. In the 1970s, a number of laws went into force that aimed at inducingfirmsto not lay off workers with low productivity. The scope and aims of labour market policies were thus gradually increased. Following OPEC I,firmswere supported by subsidies to maintain their workforce. As a consequence of low economic growth, the labour market programmes tended to expand throughout the 1980s, reaching a record level in the early 1990s. The prime goal of economic policies in Sweden, in particularfiscal,monetary and labour market policies, has been to establish and maintain full employment in the short run, basically regardless of the type of disturbances and shocks the economy is subjected to. Sweden has been a 'high-pressure economy', maintaining overfull employment - that is, unemployment below the NAIRU level - for long periods of time.17 Overfull employment lowers productivity growth in various ways. It reduces the allocative efficiency of the labour market. It strengthens the bargaining power of unions, while making employers less prone to resist wage demands. Wage drift becomes stronger in periods of high demand pressure. Thus, it contributes to high inflation and recurrent cost crises, which per se may lower economic growth. Due to the high priority given to full employment, Swedish economic policies have accommodated the wage agreements reached between the unions and employers, even if the contract wages have been above the level consistent with the fixed exchange rate: that is, above the rate warranted by the EFO model.18 This response by the policy authorities has run counter to the original Rehn-Meidner programme, which was based on a restrictive aggregate demand policy - not an accommodating one. The accommodation policy seriously undermined wage discipline. Labour unions tended to ask for and successfully obtain large nominal wage increases, expecting the government to guarantee full employment by adjusting its policies accordingly. Accommodation policies developed in several stages during the postwar period. Initially, the process started as an element of the Rehn-Meidner programme. The basic idea was to squeeze firms and industries with low productivity, forcing them out of business. With the help of an active labour market policy, those who became unemployed would be transferred to jobs infirmswith high productivity. However, as the growth in the number of jobs in the manufacturing sector ceased in the mid-1960s, the public sector in effect became the employer of last resort. According to this interpretation, the solidaristic wage policy contributed to the decline of the Swedish manufacturing industry, in particular of the consumption industry. It also contributed to the growth of the public sector, since there was no private industry that could re-employ those pushed out of the labour force due to high wage demands. This development is reflected in Figure 9.7, which displays cumulative changes in public and private sector employment in the period 1960-92. During these years, private employment fell by close to 300 000, while public sector employment rose by over 900000, and most of this expansion took place during the 1960s and 1970s. To the extent that the productivity of new jobs within the public sector was lower than that of the old jobs disappearing from the private sector - and much suggests

Economic growth and the Swedish model 1200

267

n

1000-

800Public sector employment 600-

400-

200-

-200-

Private sector employment

-400-

-600 1960

1965

1970

1975

1980

1985

1990

Source: National Accounts.

Figure 9.7 Cumulative changes of public and private employment in Sweden, 1960-93

that this was the case - this form of accommodating employment policy reduced overall growth in the economy. The rise in employment within the public sector was influenced by other factors as well, most importantly by women entering the labour force in large numbers.19 Due to the ideological outlook of the Social Democrats, a number of services began to be supplied by the public sector, instead of the private sector. This expansion in the job opportunities of women made the labour force participation rates of Swedish women the highest among the OECD countries.20 The second phase of the accommodation strategy started in the second half of the 1970s. At this time, the large budget deficit prevented a continuation of the expansion of public employment as a means of counteracting the negative disturbances after OPEC I. Internal accommodation was then combined and eventually replaced by external accommodation: that is, by exchange rate policies. The devaluations of 1976,1977,1981 and 1982 were all part of a policy of regaining the international competitiveness that had been lost due to domestic wage

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Magnus Henrekson, Lars Jonung and Joakim Stymne

accommodation. The devaluations had detrimental effects on productivity and growth because they reduced the pressure on firms to innovate and upgrade their products and productive capacity.21 The pressure on companies to improve productivity growth was reduced when it became common knowledge that wage and cost increases would eventually be accommodated by devaluations.22 Furthermore, the devaluations were beneficial for established labour-intensive industries. Thus, they preserved the existing industrial structure.23 The devaluations were intended to accomplish a reswitching of expenditures, increasing the size of the tradables sector at the expense of the sheltered sector. Such a structural shift did not materialize in the 1970s or 1980s, however, since the political process resisted a fall in the relative size of the sheltered sector. To sum up, in the short run, the devaluations were successful in raising profitability in the tradables sector. In the long run, they did not bring about the structural adjustment needed in order to increase the size of the tradables sector, nor did they improve productivity growth. A third and final stage in the evolution of the full employment accommodation policy may be envisaged. At the end of the 1980s there was a political consensus that Sweden should not use devaluations or increases in public employment to meet future negative shocks. Thus, the Riksbank and the government made a serious attempt in 1990-2 to maintain thefixedrate for the krona in spite of a large loss of competitiveness due to the overheating of the late 1980s. This policy was abandoned in November 1992 after a loss in industrial production larger than after OPEC I and II. 24 The full employment policy was associated with a high inflation. To the extent that high inflation per se contributes to low economic growth, as suggested, inter alia, by De Long and Summers (1992), Swedish growth was reduced in this way by the policy mix.25 Hence, the design of stabilization policies after the fall of the Bretton Woods system probably reduced economic growth. The long-run effects on the supply side of short-run demand policies appear to have been detrimental to economic performance.26 The low unemployment rate in Sweden (see Table 9.8) has often been attributed to successful labour market policies. This view has increasingly come under question. Calmfors (1993) is unable to find evidence that centralized wage bargaining and active labour market policy provide any favourable effects on unemployment. On the contrary, the policies may only have contributed to wage pressure. According to Calmfors (1993), the main cause of the lower unemployment in Sweden than in the OECD during the 1980s was Sweden's more accommodative fiscal and monetary policy. 4.5

Effects of public sector expansion

One salient feature of the Swedish economy is the exceptionally large public sector. Since the late 1960s, Sweden has had the largest public sector, measured as a share of GDP, in the OECD. In particular, government consumption as a share of GDP has become extremely high (close to 30 per cent of GDP), which has resulted in a very large share of public employment (Figure 9.8). Three measures of government size

Economic growth and the Swedish model

269

Table 9.12. The public sector share as a percentage of GDP in Sweden and in the OECD, selected dates

Sweden

Total OECD

1960 1971 1983 1992 1960 1971 1983 1992

Total outlays

Consumption

Current receipts

31.1 45.3 66.0 67.3 28.0 32.9 41.5 41.2

15.8 22.5 28.7 27.8 14.4 16.0 17.5 17.7

32.1 49.4 59.6 60.2 27.6 31.1 35.8 37.5

Sources: OECD, Economic Outlook and Historical Statistics. 35 -i

30-

25 -

20-

15 -

10-

5-

0 1950

1955

1960

1965

1970

1975

1980

1985

1990

Source: Statistics Sweden.

Figure 9.8 Public employment as a share of total employment in Sweden, 1950-93 relative to G D P in Sweden compared to the OECD average are presented in Table 9.12 for selected years. In 1960, Sweden was not an exceptional case. The relative size of the public sector was only marginally above the OECD average. 27 But over the following quarter of a century this situation changed dramatically. Total government expenditures as a share of G D P were almost 25 percentage points above the OECD average by 1983,

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and the share of government consumption expenditures in GDP was two-thirds larger than the OECD average. During the latter half of the 1980s, this difference diminished somewhat on the expenditure side, but measured from the income side, the public sector remained at a level that was more than 20 percentage points larger as a share of GDP than the OECD average. In the early 1990s, the expenditure ratio exploded, largely reflecting the abysmal downturn of the economy. In 1993, the government expenditure ratio exceeded 73 per cent of GDP. Does government expenditure have a positive or negative effect on economic growth? A priori, we do not know.28 Barro (1989) and Engen and Skinner (1992) have used the Summers-Heston database to test for the effect of government expenditure on growth. Barro finds that the level of government consumption excluding education and defence as a share of GDP has a negative effect on the growth of GDP per capita. On the other hand, he finds no effect of government investment, whereas educational expenditure has a positive effect. Engen and Skinner use an explicit production function approach, where they attempt to identify separate effects of expenditure and taxation. The main finding is that a balanced budget increase in the government spending share by 10 percentage points reduces GDP growth by 1.4 percentage points. A number of studies find that the level of government as a share of national income has a significantly negative effect on GDP growth for OECD countries (see, for example, Smith, 1975; Saunders, 1985; Landau, 1983; Cameron, 1982). In sum, the level of government consumption appears to have a fairly robust negative effect on economic growth, in particular in the richer countries. For other types of expenditure the results are less consistent, although it is fair to say that expenditure for investment and educational purposes has at least no negative effect on growth. The measured effects also seem to differ between developed and developing countries. Negative effects of government expenditure on economic growth are more prevalent among the rich than among the poor countries. In a recent study, Hansson and Henrekson (1994c) argue that it is more appropriate to focus on the effect of government expenditure on the non-government sector, specifically on the rate of growth of TFP. In their study, they use a production function approach based on disaggregated data. Account is taken of a potential catching-up effect. The study covers fourteen industries in fourteen OECD countries during the period 1970-87. The results indicate that the levels of government consumption, transfers and total spending as a share of GDP have a strongly negative effect on the growth of TFP in the non-government sector. Educational spending has a positive effect, and the level of government investment has no effect. Increases in the level of government consumption, transfers and total outlays are estimated to lead to a decrease in the annual rate of growth of TFP in the non-government sector of 1.4,0.7 and 0.8 per cent per annum, respectively. Since the level of transfers and consumption expenditure exceed the OECD average by approximately 10 percentage points and total outlays exceed the OECD average by roughly 20 percentage points, the results from the Hansson and Henrekson study would indicate that Sweden's large government sector could account for a decrease in TFP growth of approximately 1.5 per cent per annum compared to the OECD average.

Economic growth and the Swedish model

271

1000 -

0 1950

1955

1960

1965

1970

1975

1980

1985

1990

GDP in 1985 prices. Source: National Accounts.

Figure 9.9 GDP and taxation in Sweden, 1950-93

4.6

Taxation

Rising levels of taxation have been an integral part of Swedish economic policy. The rate of increase of taxes as a share of GDP has since the mid-1960s been considerably higher in Sweden than in the OECD as a whole. In the early postwar period, the levels of taxation were similar. In 1950, Swedish tax receipts corresponded to about 20 per cent of GDP. By 1960 they had grown to 27 per cent, as compared with the OECD average of just under 25 per cent. By the late 1970s, the OECD average had just exceeded 30 per cent, and in the early 1990s it is still slightly less than 40 per cent. In Sweden, tax receipts increased monotonically to reach 51 per cent in 1977, and have since fluctuated between 50 and 56 per cent of GDP. Real tax receipts rose from 60.6 billion kronor in 1950 (in 1985 prices) to 484 billion in 1982, an annual average growth rate of 5.1 per cent. This can be compared

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Table 9.13. Total tax wedge on labour income: Sweden, 1952-92 Year

Average earner

White collar

1952 1955 1960 1962 1965 1967 1970 1975 1980 1982 1985 1988 1989 1990 1991 1992

n.a. 40.2 47.9 n.a. 55.3 n.a. 62.3 69.6 72.4 73.7 71.4 73.0 73.3 71.5 63.4 60.9

37^8 42.2 52.2 52.4 59.1 64.3 68.2 74.7 81.7 79.8 72.9 79.2 79.3 n.a. 69.0 n.a.

Source: Calculations made by Ingemar Hansson (average earner) and Gunnar Du Rietz (white collar).

to the average growth rate of G D P of 2.7 per cent over the same period. In Figure 9.9, G D P is divided into real taxes and 'after-tax' GDP. The latter is not a standard concept. It should be noted that it is not the same as disposable income, since a large share of tax receipts is returned to taxpayers in the form of transfers. However, the relevance of'after-tax' G D P is that it indicates the share of national income which is neither consumed nor redistributed by the public sector. This measure of 'after-tax' GDP grew by about 50 per cent from 1950 to the mid-1970s. In the following two decades it has grown very little, reflecting increasing government ambitions combined with a slowdown in growth. During this period, most of the increase in national income has, through taxation, been either redistributed or used for public consumption. The egalitarian goals of postwar economic policies have in part been expressed through the redistribution of income through high marginal taxes in higher income brackets. 29 However, the marginal tax on labour income has been high and increasing for average salaries as well. In Table 9.13, two different calculations of total marginal taxes are presented. The methodology varies somewhat between the two calculations, but the general pattern is clear. Both sources calculate taxes on marginal income increases and take into account direct wage taxes as well as wage fees payable by employers. Such fees have added up to approximately 50 per cent of the wage bill. In his calculations, Hansson corrects for the fact that wage fees are to be seen partly as insurance premia, partly as outright taxes, which should account for his consistently lower calculation of the tax wedge. Also, his calculations are based on a median earner for the various years, while Du Rietz's calculations are based on a typical earner.

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273

Although the effects of taxation on behaviour have been much studied, both theoretically and empirically, the results are not conclusive. In the traditional theoretical models, the dynamic effects of taxation are limited to steady-state levels of wages, the capital-labour ratio, etc., while growth rates remain unchanged, as shown in Atkinson and Stiglitz (1980). The advent of endogenous growth models has made it possible to consider theoretically growth effects of taxation. There is considerable debate also on the static welfare effects of taxation. Hansson (1984), using Swedish data, estimates the excess burden of raising additional public funds for redistributive purposes, and finds that increases in marginal taxes need to generate benefits of between 1.5 and 7 times the amount raised. Gustafsson and Klevmarken (1993), in a survey of the incentive effects of taxes and transfers in Sweden, present results from studies of income taxation and various transfer systems such as unemployment insurance, sickness benefits and family allowances. Theirfinalconclusion is that the evidence on labour supply effects of the welfare system is incomplete. From a growth perspective, however, the question is different. The issue is not limited to one of labour supply or static welfare costs, but rather concerns whether the system of taxes and transfers has contributed to an inefficient allocation of resources, and whether tax wedge-induced differences between private and social returns on labour and saving have reduced the growth performance of the economy. If it is the case that high levels of marginal and average taxation stifle growth, this should be evident in Sweden, given that Sweden's tax burden is particularly high in an international perspective. This is not inconsistent with Sweden's growth experience over the past quarter century. The deterioration of the relative growth performance coincides with the divergence in the growth in tax burdens between Sweden and the OECD. It can be noted that Gustafsson and Klevmarken (1993) conclude that the most important consequence of recent reductions in marginal taxes may not be an increase in labour supply, but 'although there is even less empirical evidence about the incentives to invest in human capital, increased investments in human capital might well become the most important result of the Swedish tax reform'. This leads us to questions concerning the relationship between human capital formation and growth. 4.7

Human capital formation

In the literature on economic growth, human capital has been assigned several roles. First, it is often seen as a separate factor of production (see, for example, Mankiw et a/., 1992). Second, it is a source of innovative activity, and therefore an important input in the production of basic knowledge (Nelson and Phelps, 1966; Verspagen, 1991). Third, a larger stock of human capital makes it easier for a country to absorb the new products or ideas that have been discovered elsewhere, and hence the catching-up potential may be better exploited (Hansson and Henrekson, 1994b). Fourth, there may be an external effect of human capital: that is, human capital embodied in a worker may raise the productivity of colleagues (Lucas, 1988). In cross-country studies of economic growth, human capital has also proven to have significant explanatory power (see, for example, Barro, 1991; Mankiw et ai,

274 Magnus Henrekson, Lars Jonung and Joakim Stymne Table 9.14. Share of labour force having completed secondary education, 1987 (%)

Total Manufacturing

Sweden

Germany

UK

USA

Japan

55.9 49.9

77.5 73.1

43.8 42.5

83.6 79.4

70.8 67.9

Source: Landell and Victorsson (1991). Table 9.15. Share of labour force having completed tertiaryeducation, 1987 (%)

Total Manufacturing

Sweden

Germany

UK

USA

Japan

11.1 4.9

6.3 2.7

17.0 10.4

23.4 18.1

14.5 11.7

Source: Landell and Victorsson (1991). 1992). Although the accumulation of human capital is of vital importance for economic growth, it is as yet unclear how important each of the hypothesized mechanisms are. In our analysis we take as given that human capital is important for growth, rather than specifying exactly through which routes. Directly comparable data on the level and rate of human capital accumulation are scant. However, the data presented in Tables 9.14 and 9.15 do not indicate that the educational level in Sweden is high relative to the technologically most advanced countries. In particular, in manufacturing the educational level is comparatively low. A more sophisticated attempt to rank the Swedish education level compared to eleven other countries has recently been made by Sohlman (1992), in which she ranks Sweden in seventh place. But it is well known that international comparisons of educational levels are imperfect measures of human capital, and therefore a more direct test of the rate of human capital accumulation in Sweden relative to other OECD countries may be obtained by studying changes in the pattern of specialization. Hansson and Lundberg (1991a) show that during the 1980s the structure of industrial production was shifted towards industries with a low level of human and physical capital per employed. Lundberg (1992) examines how the use of human capital per unit of output has changed in Swedish imports and exports during the period 1969-89. The exports/imports ratio remained virtually unchanged during the 1970s, but at the end of the 1970s imports started becoming relatively more human capital intensive. These studies show that Sweden appears to have successively lost its comparative advantage in human capital-intensive production. According to human capital theory (Becker, 1964; Schultz, 1960), the decision to acquire human capital should be analysed as an individual investment decision. In other words, the individual decision to acquire and use human capital is governed by the rate of return on human capital. Thus, one hypothesis is that the incentives to accumulate human capital have fallen since the 1960s. If the direct costs of education are small and the individual has an infinite time horizon, the rate of return is approximately equal to the educational premium: that is, the relative increase in the wage that can be attributed to an additional year of schooling (Willis, 1986). The educational premium is conventionally estimated

Economic growth and the Swedish model 275 Table 9.16. Before-tax educational premiums (Mincerion rates of return) in Sweden, 1968-91 (%) Study

1968

Bjdrklund (1986) Fornwall (1991)

7.8

Palme and Wright (1992)

7.6

a h

1974 4.3

1981

1984

3.5

3.9 4.2° 2.0*

3.6

1991

3.5

Concerns individuals born before 1950. Concerns individuals born in 1950 or later.

using Mincer's (1974) method. A number of such studies have been performed on Swedish data for selected years during the period 1968-91. The results, reported in Table 9.16, are noteworthy. First, it is obvious that the educational premium fell dramatically from the end of the 1960s to the early part of the 1980s. Since then the rate of return has stabilized at a low level according to Palme and Wright (1992). Edin and Holmlund (1992), on the hand, find an increase in educational premiums during the latter half of the 1980s and early 1990s, when they compare the evolution of high school/compulsory education and college/high school premiums. Unfortunately, their study is not directly comparable to the studies cited in Table 9.16, since they allow for differential effects of each additional year of schooling. Second, the sharp increase in the college/high school premium experienced in the USA between 1979 and 1986 (Murphy and Welch, 1989) cannot be detected in Sweden. We conclude that the rate of return on education fell to very low levels in the early 1980s, and as Fornwall (1991) shows, the fall was larger for young people. But there is evidence indicating an increase in the late 1980s. Why did the rate of return on schooling decrease so much, and what effect did this have on the willingness to invest in human capital? Since the Swedish labour force cannot be said to have considerably more schooling than in other countries, it can probably not be explained by a lower scarcity value. Another possibility is that the successful implementation of the solidaristic wage policy resulted in lower educational premiums. Some support for this thesis is given by Hibbs (1990). A third potential explanation for the decline in the rates of return is that the quality of education has deteriorated, despite the fact that Sweden has one of the highest ratios of educational expenditure to GDP of all OECD countries (Fagerlind, 1991). This may very well be the case, particularly considering that the incentives to acquire human capital have become weaker. If the rate of return on schooling is low, the individual may adjust to this situation to some extent by consuming education rather than investing in human capital. Hence, it is quite likely that human capital investment is endogenous, in the sense that the individuals have adjusted their actual investment in human capital (as opposed to the number of years of schooling) to the institutionally given rate of return.30 Empirical research also shows that there is a positive correlation between formal education and informal human capital investment in the form of on-the-job training (OJT), etc. (Mincer, 1984). At the same time, strong incentives for OJT may be a partial substitute for weak incentives to formal education, and the wage structure

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Magnus Henrekson, Lars Jonung and Joakim Stymne

Table 9.17. Percentage increase in the hourly wage attributable to an additional year of labour market experience (for an individual with no initial experience): Sweden, 1968-91 Study

1968

1974

1981

1984

1986

1988

1991

Bjorklund (1986) Edin and Holmlund (1992)

2.4 3.7

1.1 2.8

1.6 2.3

1.5 2.2

1.9

1.9

2.4

Note: The two studies differ regarding the inclusion of other explanatory variables. The most notable difference is that Edin and Holmlund do not include age among the explanatory variables. This explains why their estimates are larger, although the general pattern is similar.

807060J: 50-

fL |

40H

H 3020100

0-19 20-4 25-9 30-4 35-9 40-4 45-9 50-4 55-9 60-4 Age class Source: Verkstadsforeningen. Figure 9.10 Average hourly wages for blue-collar workers in Swedish manufacturing, 1990: II may also encourage intensive and efficient use of the individual's human capital. As shown theoretically by Lazear (1979,1981) a steep age/wage profile, often called a deferred payment contract, may enhance productivity. Such a wage profile can be important in motivating employees to deliver maximum effort, to continue to invest in human capital and to accept technical change that increases the employer's chances of long-run survival (Henrekson, 1993).

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277

Substantial evidence indicates that the age/wage profile has become considerably flatter since the 1960s. Jonsson and Siven (1986) and Skedinger (1991) document a considerable reduction in the effect of age and experience on the wage for both blue-collar and white-collar workers. This development is also evident from two econometric studies reported in Table 9.17. In particular, the relative wage for youths has increased markedly. Edin and Holmlund (1992) show that, holding other factors constant, the wage of 18-19-year-olds rose from 55 per cent of the level for 35-44-year-olds in 1968 to 80 per cent in 1986. For blue-collar workers in manufacturing, in particular, the age/wage profile has become strikingly flat, as Figure 9.10 illustrates. The flat age/wage profile is in stark contrast to the conditions in many other countries, notably Japan (Mincer and Higuchi, 1988; Andersson, 1992). Mincer and Higuchi also show thatfirmsin Japan with a steeper age/wage profile have a higher rate of productivity growth. In recent years the intensified phasing out of old tayloristically organized production lines has increased the need for continuous OJT in order to achieve a high rate of productivity growth. Investment in human capital is crucial for economic growth. The analysis in this section has shown that the incentives for individuals to invest in human capital, formally or informally, declined in Sweden over time and became very low during the 1970s and 1980s. These incentives were further weakened by the high marginal tax rates on wage income. Furthermore, when the solidaristic wage policy was gradually reformulated into a desire for a general levelling of wages across professions (rather than equal pay for equal work), this had the unanticipated side-effect of a decline in the rate of return on investment in human capital. This is consistent with a specialization away from human capital-intensive commodities. The available evidence suggests that this could be an important explanation for Sweden's slow growth since 1970. 4.8

Investment in R&D

Technical change is not readily incorporated into the basic neoclassical growth model. Technical change is fundamentally a disequilibrium process for which the tools of equilibrium economics are ill-suited. The Schumpeterian concept of creative destruction, in which firms compete with each other to introduce new products, provides more appropriate insights. Creative destruction as a force behind economic growth, with endogenization of technical change, has been formalized only in recent years (see, in particular, Romer 1990; Grossman and Helpman, 1991). Segerstrom (1991) develops a model in which R&D is either innovative or imitative. Firms engage in R&D activities either to invent new products or processes, or to imitate existing products or processes. To see creative destruction as a process in whichfirmsattempt to obtain monopoly rents either by reducing costs relative to competitors or by developing methods to exploit unmet demands (innovation), or else catch up (imitation), has become a useful but problematic approach. Because of the externalities involved in the innovative process, models tend to reach the result that firms' R&D spending is less trian the socially optimal level. There has so far been little empirical testing to evaluate the appropriateness of different theoretical models.

278

Magnus Henrekson, Lars Jonung and Joakim Stymne

Caballero and Jaffe (1993) study the process empirically, using 'data on patents and patent citations as empirical counterparts of new ideas and knowledge spillovers, respectively'. In their paper, the authors estimate rates of creative destruction and of technological obsolescence for the USA. However, this is not followed up by an estimate of the relationship between R&D activities and economic growth. Lichtenberg (1992) estimates the returns to investment in R & D investments in a cross-country study based on a methodology similar to that of Mankiw et al. (1992). However, the results seem tentative. Data of varying quality have been used, and estimated returns to investment in R & D are unreasonably high. Thus, the current state of thinking on investment in R & D and economic growth provides some, but limited, guidance as to the best way of approaching the issue in order to throw light on the Swedish growth experience. The two most striking facts about R&D expenditures in Sweden are their high levels compared to other OECD countries, especially the smaller ones, and their rapid increase between 1970 and the late 1980s. In 1989, expenditure on R & D in the business enterprise sector was close to 2.8 per cent of the domestic product of industry. The same year, countries such as the USA, Japan and West Germany had shares between 2.0 and 2.5 per cent, while smaller countries such as Norway, Denmark, the Netherlands, Austria and Belgium all had shares between 1.2 and 1.6 per cent (Ohlsson, 1992). Relative to other OECD countries, expenditure in Sweden was only average in 1970, when it corresponded to 1.2 per cent. Thus, it more than doubled during the period. The increase in Swedish expenditure on R&D in the business sector far exceeded that of other countries. Interestingly, the share of product R&D (as distinct from process R & D) is high by international standards. This could indicate that Swedishfirmstend to focus comparatively more on innovation than on imitation. A priori, one would expect that the growing importance of R & D would give a payoff in the form of more rapid economic growth. In Sweden's case, however, the obvious question becomes: how are the significant R&D investments consistent with the slow growth performance of the post-1970 period? Ohlsson (1992) notes that, after taking various lags into account, there tends to be a strong correlation between R&D spending and growth in industrial production in individual countries. However, as has been observed previously (see Figure 9.1), industrial production in Sweden fell significantly relative to the OECD average during the post-1970 period. Ohlsson (1992) analyses various potential explanations for this weak relationship between R&D spending and growth in industrial production. He rejects the hypothesis that R&D spending is unproductive: the size of spending predicts well the number of US patents per capita. Instead, he finds that the most likely explanation is that Swedish enterprises do not tend to exploit their inventions domestically, within the country. In fact, net exports of licences during the period have been exceptional. In a non-distorted environment, the sale of licences rather than the domestic exploitation of inventions should not be detrimental to growth. Under the twin assumptions that the revealed behaviour maximizes the firm's profits, and that all the returns of R & D activities are appropriated by thefirm,thefirm'sbehaviour is economically efficient.

Economic growth and the Swedish model

279

However, there are some reasons whyfirmbehaviour may be inefficient. First, the cash-flow consequences of the sale of licences and the implementation of ideas are quite different. In an environment wherefirmbehaviour is short-termist, and geared towards quick payoffs, there would be an excessive share of licence sales. However, the short-termist hypothesis seems to be contradicted by the very fact that R & D spending rapidly increased during the period. Second, the tendency to license the results of R & D may be seen as an indication of higher costs of implementation in Sweden. This hypothesis is consistent with the previously observed high labour costs and high taxation, which increase the return requirements on domestic implementation relative to the export of licences. Third, a consequence of the transfer of licences may be a reduced spillover rate. Given the externalities, the individual firm is unable to appropriate the entire returns on R&D. Such externalities may exist, for instance, if new products or processes that result from R&D activities are eventually copied by competitors, or serve as incentives for further improvements by competitors. In either case, the pressure on costs and continuous improvements in quality would be expected to promote growth. The observation that Swedishfirmsconcentrate more on product than process R & D is consistent with this line of reasoning. In conclusion, the evidence suggests that Sweden has a comparative advantage in R&D activities, but that various mechanisms obstruct the economy from fully benefiting from the potential externalities. The process of creative destruction is stifled. 4.9

Sclerosis

The disappointing performance of most European economies following OPEC I has inspired various explanations based on the concept of sclerosis. Sclerosis stands for the gradual emergence of overall inflexibility and lack of adaptability, which eventually shows up in slow economic growth. However, there is no commonly accepted definition of the concept. The metaphors of'institutional sclerosis' and 'institutional arthritis' were used in the late 1970s and early 1980s by Mancur Olson (e.g. 1983). In the early 1980s, Lindbeck (e.g. 1983:17) applied a similar concept, emphasizing the negative effects on aggregate economic performance of government interventions in a large number of separate markets and sectors: When all these various system changes [i.e policy-induced changes], in the form of market distortions, disincentives, inflexibilities and uncertainties, are considered, it is tempting to speak of emerging arteriosclerosis of Western economic systems, accentuated by the resistance to change and the fights about income shares, by organised interest groups. The term 'Eurosclerosis' has been widely applied to the social ageing process in Europe in the 1980s, which is assumed to account for the poor growth performance of Europe compared to countries in many other parts of the world. The Swedish form of sclerosis has recently been described as 'Suedosclerosis' (see Stahl and Wickman, 1993).31 Corporativism and rent-seeking behaviour of interest groups are stressed by some observers as an important source of sclerosis. This is the main theme of

280 Magnus Henrekson, Lars Jonung and Joakim Stymne

Mancur Olson's analysis.32 Sclerosis arises through government policies influenced by rent seeking. These policies create an incentive structure and institutions that give rise to inflexibilites. Thus sclerosis may be found in all markets and sectors, perhaps most markedly in the labour market, where the strong position given to labour unions through labour market policies, the rules for collective agreements, the reservation wage set by the transfer system, etc. have reduced flexibility and competition, notably in many European economies.33 The debate on sclerosis is a fairly recent one in Sweden, involving primarily commentators on current economic and political issues.34 The issue of sclerosis has so far not induced major research efforts by economic historians or economists. One reason for this is that the concept of Suedosclerosis has been used in a fairly loose sense, which has prevented empirical work. Another reason is that Swedish economists as a rule have been sceptical towards public choice analysis, as it runs counter to the message of orthodox welfare theory, which has held a strong position in Sweden. However, many of the arguments presented in our previous analysis of the ultimate determinants of Sweden's relatively slow economic growth in the 1970s and 1980s may be viewed as aspects of a sclerosis process. 5

Conclusions

Beginning in the late 1860s, the Swedish economy entered a process of rapid modernization, industrialization and internationalization, and one hundred years later Sweden had been transformed into one of the richest countries in the world. Since the early 1970s, however, Sweden's growth performance has been poor compared to other industrialized countries. However they are measured, Swedish annual growth rates have been roughly 1 percentage point below the OECD average over the last quarter century. This unfavourable development has become particularly pronounced in the recession of the early 1990s. Industrial production, which before the 1970s grew at the same rate in Sweden as the OECD average, has since then exhibited a much slower growth rate. From a growth perspective, this pattern makes Sweden a highly interesting case. Swedish postwar economic development is commonly discussed under the heading of the Swedish model. This model is based on the idea of an active state with a broad mandate to intervene to influence the allocation and distribution of resources. The dominant role of the Social Democratic Party since the early 1930s has been a necessary condition for the implementation of this model. Its ideology has been based on a mix of corporativism, welfarism, non-market-oriented regulations, full employment, a large public sector and strong all-encompassing unions. The core question of this study is this: what factors account for the post-1970 deterioration of Swedish economic performance? Or, why has the Swedish model been less successful in generating economic growth than other industrialized countries? A possible hypothesis to account for the growth slowdown is that it is the result of a catching-up effect, a convergence of productivity levels among industrialized economies. The fact that many countries have overtaken Sweden suggests that this hypothesis is insufficient. Several studies verify that the Swedish growth performance cannot be explained in terms of a catch-up process. In consequence, after rejecting \he catch-up hypothesis, we focus" on several alternative explanations, which we

Economic growth and the Swedish model

281

regard as potential 'ultimate' determinants of economic growth. Theory suggests that saving and investment play an important role in the process of economic growth, and therefore we examine capital formation. We note that aggregate saving became significantly socialized during the 1960s as a result of the establishment of the National Pension Fund. The increasing importance of politically controlled investment from the 1960s onwards, substituting for private investment, combined with far-reaching controls on the flow of credit and capital, probably reduced the efficiency of capital formation. The Swedish economy is to a large extent sheltered from competitive pressures. The share of the 'sheltered' sector of the economy grew from around 60 per cent in the early 1950s to approximately 80 per cent in the early 1990s. Much of the expansion during the 1980s took place in the private sheltered sector, especially construction. The decline of the competitive sector is likely to have contributed to a stifling of competitive pressures in the economy. Short-run stabilization measures have had long-term structural consequences, primarily due to their focus on holding down unemployment by a policy of accommodation, largely based on devaluations and expansion of public employment. The main vehicle for maintaining low unemployment has been the expansion of public employment - not the design of labour market policies. A particularly rapid increase in the public employment share occurred in the 1970s. The higher rate of public employment creation in Sweden compared to the OECD during the 1970s and 1980s coincides with the growth slowdown. A corollary is that there is scant empirical support for the commonly held view that labour market policies have contributed positively to economic growth. The public sector has grown rapidly in recent decades and is exceptionally large. Between 1960 and 1990, total outlays of the public sector grew by 30 percentage points of GDP, or twice the OECD total. Estimates indicate that since 1970, Swedish public expenditure growth may account for a decrease in TFP growth of approximately 1.5 per cent per annum compared to the OECD average. From 1950 to 1992, real tax receipts grew at a rate almost double GDP growth. The total marginal tax on labour income grew from around 40 per cent in the early 1950s to between 70 and 80 per cent in the 1980s. Calculations from the mid-1980s show that the resource costs of marginal tax increases at these rates are between 1.5 and 7 times the resources raised. Human capital formation is assigned an important role in recent theories of economic growth. Incentives for human capital formation deteriorated, however, over the past decades. From the end of the 1960s to the early part of the 1980s, the educational premium fell dramatically. Also, the age/wage profile has become flatter since the 1970s, which has reduced incentives for accumulation of human capital in the form of on-the-job training. Investments in R & D account for a larger share of business enterprise expenditure in Sweden than in other OECD countries. This share increased rapidly between 1970 and 1989. However, although the R & D activities have resulted in a number of US patents commensurate with expenditure, there has apparently not been a payoff in terms of growing industrial production. Instead, firms have licensed out production abroad. The most likely reason for this is a comparatively higher cost of implementation in Sweden.

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Magnus Henrekson, Lars Jonung and Joakim Stymne

To summarize this review of domestic factors that contributed to the decline in the growth rate in the 1970s and 1980s, the rise and subsequent size of political intervention in the Swedish economy has gradually reduced the efficiency of and the returns on work, saving and investment decisions. This has resulted both from an increasingly distorted incentive structure and from the fact that a growing fraction of economic decisions are taken in the public rather than private sphere, or are influenced by an institutional structure with strong non-market elements. The public sector has acted as an increasingly opaque veil between price signals and economic decisions, thus reducing the ability of the economy to adapt to shocks and disturbances. The timing of the deterioration of economic performance is accounted for by the accumulation of structural weaknesses that to some extent were already exposed before the oil shocks of the 1970s, but whose severity increased following the shocks (sclerosis). In addition to these domestic reasons for the reduced growth performance of the economy, we suggest that crucial changes in the conditions regarding production and the international division of labour have occurred, and that these changes disfavoured the Swedish model. Comparative advantages that Sweden enjoyed in the nineteenth century - in the form of a high educational level in the population at large and a rich supply of raw materials, which were in great demand and which stimulated the growth of a technologically advanced investment goods industry laid the foundation for a century of sustained economic growth at a rapid rate. Over time, other factors have become increasingly important as driving forces of economic growth. Comparative advantages are continuously acquired through investment in human capital, R & D, product development, organizational change and large overall flexibility. A corollary of this change is that microeconomic conditions are gaining in importance compared to macroeconomic conditions. The institutional set-up that became known as 'the Swedish model' was less effective in providing a growth-inducing framework when faced with the disturbances following OPEC I and II. In his study of the long-term dynamics of the Swedish model, Mancur Olson (1990) attempts to provide answers to the question 'Why isn't the Swedish economy performing worse than it is?' Our answer is that the economy has, in fact, been performing increasingly poorly over time, and that these weaknesses have only gradually become apparent. The major message of this study is that explanations for the comparatively low growth rate in Sweden during the last twenty-five years can be found in the design of economic policies and institutions. This design has not fostered an incentive structure conducive to rapid economic growth.

NOTES This chapter was prepared for the CEPR project 'Comparative Experience of Economic Growth of Postwar Europe'. We are grateful for useful comments and suggestions from Per Lundborg, Rickard Forslid, Anders Forslund and Eskil Wadensjo. Magnus Henrekson gratefully acknowledgesfinancialsupport from Jan Wallanders och Tom Hedelius' stiftelse for samhallsvetenskaplig forskning, and all three authors would like to thank the Institute for Future Studies, Stockholm, for financial support.

Economic growth and the Swedish model 283 1 For an examination of Sweden's long-run economic performance, see Jorberg (1991). 2 The Swedish model and its recent development is considered, inter alia, by Delsen and van Veen (1992), Bergstrom (1992), Lundberg (1985), Weaver (1987) and Samuelsson (1988). Recently, the government commissioned a major inquiry on medium-term economic policy. The final report (SOU, 1993), also known as the Lindbeck Report, contains substantial analysis and critique of the model (see Lindbeck et al, 1994). The 'welfare state' more generally defined is discussed in Lindbeck (1988). 3 See Lindbeck (1975) for a review of Swedish economic policies in the 1950s and 1960s. 4 See, for example, Lindbeck (1983) for a discussion of the productivity slowdown during the 1970s. 5 The EFO model was based on the Norwegian Aukrust model. The two models are commonly classified as the Scandinavian model of inflation. 6 The competitive sector is exposed to international competition. Thus, one can use tradables and non-tradables as synonyms for competitive and sheltered, respectively. 7 Traditionally, Swedish economists have exercised a profound influence on the framing of economic policies. Perhaps economists have had a larger impact on policy making in Sweden than in any other country. This pattern goes back to the founding fathers of Swedish economics: that is, to Knut Wicksell, Gustav Cassel and Eli Heckscher, active during the first three decades of the twentieth century. They made economics a well-known and respected subject in the eyes of the public. They engaged in the policy debate and were highly influential in this respect. See Jonung (1991). 8 Martin (1979: 93) suggests that 'Sweden was the first country in which a Keynesian pattern of policy was implemented.' 9 The economic impact of the counter-cyclical fiscal measures in the 1930s was small, but the intellectual impact was great. The devaluation of 1931, when Sweden left the gold standard, in combination with a programme of price stabilization, explains why the Swedish economy fared fairly well in the 1930s. See Jonung (1979). 10 This argument is stressed by Olson (1982), who suggests that it is easier for countries that lose wars to deregulate their economies than countries that win wars. 11 Belief in the beneficial effects of low interest rates characterized economic thinking. Several arguments were presented in support of low interest rates: a rise in rates would have adverse effects on the distribution of income by raising rents and it might reduce the volume of investments. The low interest rate doctrine was a major driving force behind the credit and foreign exchange controls. They aimed primarily at keeping the rate below the equilibrium rate. During most of the years 1950-80 ex post real after-tax rates were negative, suggesting that the economic policy in a wide sense transferred wealth from saving units to investors. 12 The SNS Economic Policy Group publishes an annual report evaluating economic policies and economic development in Sweden since 1974. The reports have invariably been given a great deal of attention, and their impact on the policy debate has been substantial. 13 Gunnar Myrdal (1944) proposed a policy of'high taxes and low interest'. In this influential paper, Myrdal suggested that high taxes on corporate profits would reduce the demand for capital. This would make it possible to maintain a low

284 Magnus Henrekson, Lars Jonung and Joakim Stymne

14

15 16 17

18 19

20

21 22 23 24 25 26

27 28 29

30

interest rate in order to reduce the cost of borrowing for public investment and for housing. The role of the interest rate as a mechanism for allocating capital was reduced significantly. As a rule, demand management is analysed in a short-run context, separate from considerations regarding the secular behaviour of the economy. Growth is determined by supply-side factors, independent of stabilization policies. The Swedish case calls into question this dichotomy. The Rehn-Meidner model is discussed by Lundberg (1985) and Bergstrom (1992). In order to function, the model requires a strong central union, which most likely explains why LO embraced it. This was most clearly the case during the period of overheating at the end of the 1980s. Swedish industry had difficulties in expanding at home and, therefore, chose to invest abroad during these years. This is an example of industrial 'crowding out'. The movement out of Sweden was influenced by other factors as well. For a description of the Swedish process of wage formation, see Calmfors and Forslund (1990). To our knowledge no estimates exist of the displacement effect of the Rehn-Meidner model. It probably contributed to a deindustrialization process in Sweden, but this process would have taken place regardless of the Rehn-Meidner programme. There are no studies of the effects on growth and productivity resulting from the high labour force participation rate of women in Sweden. A detailed analysis of the labour force participation of men and women in Sweden in a comparative perspective is provided by Jonung and Persson (1993). This line of critique of the policy of devaluations is developed by Henrekson (1991). Expectations of future devaluations remained in force throughout the 1980s after the devaluation of 1982. They contributed to the depreciation of the krona in November 1992. For the UK record, see Crafts (1993). A group of US economists has proposed that Sweden should avoid a fixed exchange rate policy because such a policy is not consistent with domestic priorities regarding full employment. See Bosworth and Rivlin (1987). Swedish stabilization policy also reduced capital formation severely in the 1970s by the large increase in the budget deficit. This effect is analysed elsewhere. See also the conclusion in OECD (1992:65) on the Swedish economy: 'However, the macroeconomic and public employment policies which appear to have shielded the labour market from deflation may well have undermined the long-run dynamism and efficiency of the economy.' Going back to 1950, the ratio of total public expenditure to GDP was among the lowest of all industrial countries at roughly 26 per cent, the same level as Switzerland and the United States. See Hansson and Henrekson (1994c) for an overview of the arguments put forward and for a more extensive review of empirical studies. Calculations by Bjorklund and Fritzell (1992) indicate that the Gini coefficient calculated from individual annual incomes is, in fact, considerably lower after tax than before tax. In Sweden this measure of income dispersion was reduced by 20 per cent as a result of redistributive taxes in the second half of the 1980s. In the USA, the corresponding reduction was between 4 and 6 per cent. Although it should be noted that Edin and Holmlund (1992) argue that the decline in the rate of return to education can be explained by an increased supply

Economic growth and the Swedish model 285

31 32

33 34

of individuals with a tertiary education. However, we find it unlikely that the general tendency towards a sharp drop in education premiums during the 1970s was not to a large extent influenced by ideological factors. This does not preclude the possibility that a free-market wage formation would have led to lower education premiums as well, but we deem it likely that the size of the drop would have been substantially smaller. Meyerson (1985) provided an early account of the sclerosis of the Swedish economy. Olson (1982) stressed the growth-retarding effects of interest groups. Their attempts to accomplish redistribution in their favour reduce the efficiency of the economy. However, large encompassing organizations, such as SAF and LO in Sweden, may actually be beneficial for growth under certain circumstances (see Olson, 1990). The term 'Eurosclerosis' has been applied to the European labour market to describe its lack of flexibility compared to the US labour market, A common feature of the various policy proposals inspired by sclerosis is that reform should not be made in one area or market; it should be a 'broad' programme covering many sectors, in particular concerning the institutional and political framework. This is, for example, the argument of Lindbeck et ai (1994).

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10

Characteristics of economic growth in the Netherlands during the postwar period BART VAN ARK, JAKOB DE HAAN AND HERMAN J. DE JONG

1

Introduction

The postwar development of the Dutch economy is characterized by major changes in structure and substantial variations in growth rates. Some of these changes it has in common with most other European countries, such as the rapid increase in per-capita output and productivity growth during the 1950s and 1960s. All European countries possessed a great potential for catch-up after the devastating effects of the Second World War. However, other aspects of Dutch postwar economic growth are unique, such as the low labour force participation rates in terms of total hours worked, a high ratio of foreign trade to GDP, and an extensive and costly welfare system. In geographic and demographic terms the Netherlands is also exceptional. It is one of the smallest but most densely populated countries on the European continent. There are on average 446 people per square kilometre, and the density is even twice this in the 'Randstad' (the area around Amsterdam, the Hague, Rotterdam and Utrecht), where almost 7 million of the 15.4 million inhabitants live, mostly below sea level. The central proposition of this chapter is that during the postwar period the Dutch economy has gradually fallen behind the rest of what we will call north-western Europe in terms of per-capita income, whereas its productivity level has remained relatively high.1 In section 2 we present some main characteristics of the long-run growth performance of the Dutch economy. This is followed by a chronological account of postwar growth. We look briefly at the legacy of the interwar period (section 3), the Second World War and the period of reconstruction up to the early 1950s (section 4), the 'Golden Age' from 1950 to 1973 (section 5), the period of shocks and slow growth from 1973 to 1979 (section 6), and finally the period of restructuring since the early 1980s (section 7). The notion of rapid productivity growth and slow per-capita income growth is directly related to three specific aspects of the Dutch economy which will be discussed in detail in the final part of the chapter: (1) a labour market which is characterized by high wages and low participation rates (section 8); (2) a strong dependence on the performance of the 290

Table 10.1. Population, gross domestic product, GDP per capita and GDP per hour worked: Netherlands, north-western Europe and the USA, 1913-90 (unweighted average of annual compound growth rates) Gross domestic product

Population Netherlands

NW

1913-29 1929-38 1947-60 1960-73 1973-9 1979-90

1.47 1.23 1.36 1.22 0.73 0.57

0.51 0.53 0.87 0.79 0.21

1913-38 1947-73 1973-90

1.38 1.29 0.63

a

United States

Netherlands

NW

032

1.42 0.73 1.72 1.23 1.01 0.96

3.65 0.33 5.30 4.83 2.68 1.92

0.52 0.80 0.28

1.17 1.48 0.98

2.44 5.07 2.19

Europe

United States

Netherlands

NW

1.99 1.49 5.17 4.42 2.26 2.26

3.10 -0.59 3.54 4.35 2.83 2.51

2.15 -0.89 3.89 3.57 1.93 1.34

1.80 4.83 2.26

1.76 3.94 2.62

1.04 3.73 1.55

Europe

GDP per hour worked

GDP per capita United States

Netherlands

NW Europe

United States

1.46 0.96 4.27 3.70 2.05 1.94

1.66 -1.31 1.78 3.08 1.80 1.54

2.88 -0.12 4.16° 5.25 3.45 1.98

2.10 1.35 4.07fl 4.93 2.81 2.11

2.43 1.55 2.54° 2.90 1.54 0.94

1.28 3.98 1.98

0.58 2.43 1.63

1.79 4.80° 2.50

1.83 4.55° 2.35

2.11 2.74° 1.15

Europe

Beginning year is 1950. Note: North-western Europe includes Austria, Belgium, Denmark, Finland, France, Germany, Netherlands, Norway, Sweden, Switzerland and the UK. Sources: Maddison (1995, 1996). Employment and hours from Maddison (1991, 1995). Maddison's GDP estimates (1913-60) for the Netherlands are from C.A. van Bochove and T.A. Huitker (1987) 'Main National Accounting Series, 1900-1986', CBS Occasional Paper No. NA-017. GDP since 1960 is from OECD, National Accounts, Main Aggregates, various editions. Maddison's employment estimates for 1913-38 are based on estimates of activity rates and unemployment ratios (see Maddison, 1964, 1991). For the period 1950-60 they were supplied by CBS and for the period since 1973 he used data supplied by the Bureau of Labor Statistics. Maddison's estimates on hours before 1987 are based on a detailed accounting procedure (see Maddison, 1991). Since 1987 they are based on hours for full- and part-time workers from J.C.M. Hesemans (1988) 'Ontwikkeling van de arbeidsduur 1982-1987', Supplement bij de sociaal-economische maandstatistiek, no. 3, and updated to later years with estimates of contractual hours from Arbeidsrekeningen with adjustments to actual hours from Sociaal-economisch maandstatistiek.

292 Bart van Ark, Jakob de Haan and Herman J. de Jong Table 10.2. GDP per head of the population and GDP per hour worked: Netherlands, north-western Europe and the USA, 1913-90 Netherlands as a % of NW Europe

1913 1929 1938 1950 1960 1973 1979 1990

Netherlands as a % of the USA

GDP/ capita

GDP/ hour

GDP/ capita

GDP/ hour

100 116 99 104 98 99 98 92

114 135 117 107 106 112 114 112

71 77 80 59 69 74 74 73

75 81 70 49 58 77 87 97

Note: GDP converted by multilateral EKS PPPs for OECD countries for 1990. Sources: See Table 10.1. PPPs from OECD (1992) Purchasing Power Parities and Real Expenditures: EKS Results, 1990, Paris. external sector (section 9); and (3) a relatively high level of public spending and taxation (section 10).

2

The major facts

2.1

Per-capita income and labour productivity

As in most other European countries, growth of per-capita income and productivity in the Netherlands accelerated during the first two decades following the Second World War compared to the first half of the twentieth century. Table 10.1 shows that during the period 1947 to 1973 GDP increased at 5.1 per cent a year on average and per-capita income at 3.7 per cent. GDP per hour worked rose by as much as 4.8 per cent from 1950 to 1973. Dutch growth slowed down after 1973, but Table 10.1 shows that in contrast to north-western Europe as a whole, the slowdown aggravated after 1979. Whereas the GDP and productivity growth rates for the Netherlands were above the average for the eleven north-west European countries in our reference group, the per-capita income growth rates were slightly below the average. This divergence between GDP and per-capita income growth is due to one of the most constant factors of Dutch economic growth during the twentieth century: the relatively fast growth rate of the population. The differences in growth performance between the Netherlands and other countries are also reflected in the comparative levels of per-capita income and productivity in Table 10.2. During the postwar period, the pe/-capita income of the Netherlands fell somewhat below the north-west European average, and its relative position has deteriorated in particular since 1979. On the other hand, productivity levels remained relatively high throughout the postwar period.

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Table 10.3. Distribution of spendable income in the Netherlands, 1959-90

1959 1962 1967 1975° 1983 1990

Ratio of income shares of the 10th and 3rd 10% group

Relative interquartile distance

Theil coefficient

5.4 5.5 4.7 3.6 3.2 3.8

0.81 0.82 0.77 0.68 0.61 0.76

0.26 0.26 0.22 0.16 0.14 0.17

a

Excluding income from owner-occupied dwellings. Source: CBS, Sociaal-economische maandstatistiek, 1993-6, p. 47. Table 10.2 also shows that, compared to the USA, the G D P per-capita performance of the Netherlands improved up to the end of the 1970s. However, this typical catch-up process came to an end during the 1980s, although the relative productivity position compared to the USA improved even further during this period. Table 10.3 shows that the distribution of per-capita income narrowed substantially during the 1960s and 1970s, but it increased slightly after 1983. The Dutch Central Bureau of Statistics provides three measures of income distribution, which all have their advantages and disadvantages (de Kleijn and van de Stadt, 1987): • The ratio of the income shares of the tenth and third 10 per cent groups of spendable income. This measure is relatively easy to interpret: the average income of the highest 10 per cent group is n times higher than average income of the third 10 per cent group. The reason for not choosing income of the lowest 10 per cent group is the rather unstable development of this category. • The relative interquartile distance based on spendable income. This measure takes a larger segment of the income distribution into account than the first measure, but its interpretation is more difficult. • The Theil coefficient based on spendable income, which takes all changes in the income distribution into account. In fact, the three measures show fairly similar trends. On the whole, income distribution can be seen as fairly flat in the Netherlands, which is to a large extent supported by an extensive welfare system (see section 10).

2.2

Sectoral performance

The productivity record for the economy as a whole can be related to the comparative performance of the individual sectors of the economy, and to changes in the output and employment shares of these sectors in the total economy. Table 10.4 shows the change in the employment structure of the putch economy during the twentieth century. Table 10.5 presents the productivity growth rates by sector since 1950. Although the share of manufacturing in employment rose only slightly during the 1950s and 1960s, it was a driving force behind the growth of output and

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Table 10.4. Sectoral shares of employment in the total economy of the Netherlands, 1909-90 (%) Market services

Non-market Other services

Agriculture

Manufacturing

1909 1920 1947

28.4 23.5 19.3

24.2 26.0 27.0

37.9 39.7 42.4

9.5 10.8 11.3

1950 1960 1973 1979 1990

13.5 9.5 5.2 5.0 4.5

27.9 29.2 26.0 21.8 18.4

44.1 47.3

14.5 14.0 11.1 10.7 8.6

31.1 33.2 36.9

26.8 29.9 32.9

Note: Labour input 1909-47 refers to labour force; since 1950 to persons employed, except services (1950 and 1960) which refers to 'man-years'. Sources: 1909-47 from CBS, Negentig jaren statistiek in tijdreeksen, Voorburg; 1950-90, see van Ark (1996). Table 10.5. Value added and labour productivity by sector of the economy in the Netherlands, 1950-90 (annual compound growth rate)

Real value added 1950-60 1960-73 1973-9 1979-90

Agriculture 3.5 3.0 3.6 5.5

Manufacturing 7.6 6.4 0.0 2.2

Real value added per employee Other Agriculture Manufacturing Other 2.1 6.0 5.9 3.7 6.9 6.4 5.1 3.3 3.2 3.3 1.9 1.0 5.4 2.7 1.6 0.0

Source: van Ark (1996). productivity. Productivity in agriculture also rose rapidly, but like in other north-west European countries, its share in output and employment fell throughout the period. The main expansion in labour shares during the 1960s and 1970s took place in the services sector: namely, from 44.1 per cent of employment in 1950 to 69.8 per cent in 1990. Both market services (transport and communication, distribution and the financial sector) and non-market services (mainly health care, education and government) accounted for this rising share. However, the increase in productivity in the services sector, which represents most of the category 'other' in Table 10.5, was much weaker than in agriculture and manufacturing. Therefore, the expansion of services contributed importantly to the overall productivity slowdown of the economy during the 1980s. Table 10.6 shows that in terms of value added per person employed the Dutch performance was better than the average performance of its three big neighbouring countries in agriculture, manufacturing and the residual part of the economy. The advantage was biggest in the agricultural sector, but also quite substantial in

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Table 10.6. Value added per person employed in agriculture, manufacturing and the rest of economy, 1950-90 (Netherlands as a% of France! GermanyI UK and of the USA)

France/Germany/UK = 100

United States = 100

Agriculture Manufacturing Other Agriculture Manufacturing Other 1950 1960 1973 1979 1990

145 167 173 169 161

93 102 123 116 120

117 110 117 115 98

33 40 65 74 80

38 56 82 87 84

64 66 88 95 93

Note: The comparative productivity levels are based on binary comparisons between each country and the United States. The 'other' part of the economy is derived as a residual from comparisons for agriculture, manufacturing and the total economy. The average productivity for France, Germany and the UK is an unweighted average. Sources: Maddison and van Ark (1994) and van Ark (1996). manufacturing. Since 1973 the productivity advantage has become smaller. Only in terms of value added per hour worked has the Dutch productivity advantage not deteriorated (see Table 10.2), which is due to the more rapid decline in working hours in the Netherlands compared to other countries (see next section). 2.3

Labour input and labour cost

As in most other European countries, the total labour force, the number of persons employed and in particular the number of jobs in the Netherlands showed a rising trend over the period under consideration. However, therisein total labour input in the Netherlands - that is, in terms of the total number of hours worked - has been much slower. Table 10.7 shows that the total number of hours worked in the Netherlands even dropped significantly during the 1960s and 1970s. The two factors associated with these trends are the relatively late rise in the participation of women in the labour force, and the overall fall in the number of hours worked per person since the 1960s. In 1950 the average participation rate, defined as the share of the labour force in the total population aged from 15 to 64 years, was 76 per cent for the eleven north-west European countries; by 1987 it was 74 per cent.2 Table 10.7 shows that the correspondingfiguresfor the Netherlands were much lower. Between 1960 and 1979 the labour force participation rates even fell from 67 to 61 per cent, which was mainly caused by a slowdown in the rise of male employment. Between 1979 and 1990 participation rates increased again, primarily because of a rapid rise in the proportion of women in the labour force by 10 percentage points to 39 per cent in 1990. During the same period, the participation rate of men dropped due to the introduction of early retirement schemes and the rapid increase in the number of people who received disability benefits. Annual hours worked per person employed in the Netherlands fell dramatically from 2051 to 1347 hours between 1960 and 1990. This 34 per cent fall over a period

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Table 10.7. Labour force, employment, hours worked and labour force participation: Netherlands, 1913-90 Labour Persons Annual Annual hours force employed hours (000s) per person (m) (000s) (units)

1913 1929 1938 1950 1960 1973 1979 1990

2365 3075 3517 4239 4686 5310 5590 6872

2330 3023 3169 4120 4630 5150 5350 6356

2605 2260 2244 2208 2051 1751 1611 1347

6070 6832 7111 9097 9496 9018 8619 8562

Labour force participation rate (%)

Females as % of total labour force

63.8 62.9 62.6 66.6 66.6 62.4 60.6 67.1

23.9° 24.0* 24.4 22.3 25.9C 29.2 39.2

a

1909. M930. c 1971. Note: Hours are hours actually worked, i.e. adjusted for paid hours not worked (sickness, vacation, etc.). Participation rate is labour force as a % of total population in the age from 15 to 64 years. Sources: Table 10.1, except for female participation, which for 1909-73 is taken from CBS, Negentig Jaar Statistiek in Tijdreeksen, chapter H. of three decades substantially exceeded the average fall of 21 per cent for the eleven north-west European countries over roughly the same period. 3 This was partly due to a slightly higher sickness rate in the Netherlands compared to surrounding countries. However, more important was the greater incidence of part-time work of men and women. In addition, agreements between the Dutch government, employers and unions led to a reduction of the working week to 38 hours on average. The low participation rates and the fall in working hours form an important link between the relatively high productivity level of the Netherlands and its more moderate relative per-capita income. Apart from a relatively large number of people who were not part of the labour force, there have also been many people involuntarily unemployed in the Netherlands. As can be seen from the first two columns of Table 10.8, the unemployment rate in the Netherlands has been high compared to other countries, in particular since 1973. Among other things, the fast growth of the Dutch population (as shown in Table 10.1) put considerable pressure on the labour market, particularly during times of sluggish growth. 4 The open nature of the Dutch economy made wage constraints one of the major issues throughout the period under consideration. Already during the 1930s wage policy was seen as an important instrument to keep cost levels down. Table 10.8 shows that this policy failed during the first two decades following the Second World War. As can be seen from the third and fourth columns of Table 10.8, Dutch real wages increased at a rate just above the north-west European average during the 1950s, and surged ahead of the north-west European average during the 1960s.

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Table 10.8. Average unemployment rates and growth rates of wages in the Netherlands and north-western Europe, 1929-90

Average unemployment as % of the labour force Netherlands NW Europe 1929-38 1950-60 1960-73 1973-9 1979-90

8.0 2.5 1.8 5.6

7.2 2.6 1.7 3.5

9.4°

6.0°

Rate of growth of real gross hourly wages Netherlands NW Europe

Rate of growth of unit labour costs Netherlands NW Europe

4.4 7.6 4.1 0.7

2.6 5.2 5.8 0.6

4.0 5.9 4.2 1.2

3.8 4.5 9.9 4.2

a

1979-89. Note: NW European averages for unemployment are unweighted averages for 11 countries mentioned in Table 10.1; for gross wages (i.e hourly compensation of employees, including tax and premiums paid by employees and employers deflated by the consumer price index) and unit labour costs, the unweighted averages relate to Belgium, Denmark, France, the Netherlands, Norway, Sweden and the UK. Sources: Unemployment rates from Maddison (1991). Wages and unit labour costs from US Department of Labor (1992a). On the other hand, the reduction in wage growth after 1973 - even to less than 1 per cent a year during the 1980s - is quite remarkable, although it should be added that between 1990 and 1992 real wages again rose by 3 to 4 per cent a year. Due to the rapid growth in productivity, the increase in unit labour costs in the Netherlands has been relatively moderate for most of the postwar period. With the exception of the 1960s, labour costs per unit of output in the Netherlands increased less than in neighbouring countries. During the 1980s, the slowdown in wage rises led to only a very small increase in unit labour costs, which substantially helped to keep up the competitive position of the Dutch economy.

2.4

Investment in physical and human capital and joint factor productivity

Table 10.9 shows that, after a period of a rapid increase in investment during the 1950s and 1960s, there was a significant slowdown during the 1970s. Investment accelerated again during the 1980s, in particular in machinery and equipment. The second part of Table 10.9 shows the growth rates of the capital stock, capital intensity and capital-output ratios. The slower growth of the capital stock during the 1970s hardly caused a slowdown in the growth rate of capital intensity. During the 1980s, the growth of the capital stock slowed down further, but this time it led to a significant fall in the growth rate of capital per hour worked. It is of considerable importance to analyse the Dutch performance in relation to that of other countries. Table 10.10 shows that the level of capital intensity in the Netherlands has been relatively high compared to other countries. In 1950 capital per hour in the Netherlands was 75 per cent higher than the average for France,

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Table 10.9. Average growth rates of investment and annual compound growth rates of capital stock, capital intensity and capital-output ratios: Netherlands, 1947-90

Investment (average of annual growth rates) NonEquipment Total residential structures 1947-60° 1960-73 1973-9 1979-90

6.01 4.13 -0.72 0.64

8.80 4.99 2.04 4.47

7.19 4.54 0.70 2.87

Capital stock (annual compound growth rates) NonCapital Capitalresidential stock output capital per hour ratios stock 4.19 4.99 3.37 2.70

3.60 5.36 4.13 2.75

-0.40 0.15 0.67 0.76

a

Capital stock figures are for 1950-60. Note: Investments and capital stock are both on a gross basis, i.e. including depreciation. The capital stock is calculated on the basis of the perpetual inventory method. Sources: Investment and capital stock figures from Maddison (1994, 1995); GDP and labour input, see Table 10.1. Germany and the United Kingdom, and in 1990 it was still 20 per cent higher. The capital stock estimates were derived from Maddison (1994a), who applied the perpetual inventory method by cumulating investments of non-residential structures and of machinery and equipment using asset life assumptions of thirty-nine years and fourteen years respectively. The comparativefiguresfor capital intensity would be affected if the lifetime of assets were in fact different across countries, but there is insufficient evidence to support that view for the countries considered here. To measure the effect of changes in capital intensity on labour productivity over time and between countries, one requires estimates of total factor productivity (TFP). Column (5) of Table 10.11 shows the growth rates of TFP, which are based on a simple Cobb-Douglas production function with constant returns to scale and only two factors or production: that is, labour (employment and average hours) and non-residential capital. Assuming elasticities which correspond to factor shares in 1990, the table shows that until 1979, TFP accounted for more than half of the growth in GDP in the Netherlands. During the 1980s, GDP grew much more slowly than before. What remained in terms of growth was largely accounted for by an increase in the non-residential capital stock, whereas the expansion of employment was largely offset by a fall in working hours per employee. As a result, the contribution of TFP to growth in GDP fell to 39 per cent. Recent contributions to the theory of economic growth have pointed to the possibility that the typical proximate causes of growth, as described above, may play a bigger role than has been assumed until now. It was suggested that the traditional constant returns to scale framework understates the endogenous effects on growth which (depending on which variant of the 'new growth' models is chosen) are effectuated through spillover effects of investments in physical capital, human capital or research and development. As a result, the exogenous effect on growth

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Table 10.10. Capital intensity and total factor productivity in the Netherlands as a percentage of the average for Francel GermanyI UK and the United States, 1950-90

1950 1960 1973 1979 1990

Capital intensity

Total factor productivity

as a % of as a % of USA France/ Germany/UK

as a % of as a % of France/ USA Germany/UK

175 163 140 130 120

46 50 75 83 96

85 87 98 102 102

69 76 87 93 98

Note: Shares of labour and capital input for the calculation of total factor productivity are based on the respective factor shares in GDP for each country in 1990. Sources: Capital stock figures from Maddison (1994, 1995); output and labour input, see Table 10.1. reflected in the growth of TFP will be smaller than suggested in Table 10.11. In the case of the Netherlands, one may argue that investments in human capital and research and development have been more effective than in other countries. For example, an important feature of the Dutch education system is the strong emphasis on full-time vocational education. Most pupils stay in school until they are nineteen years old, and a large proportion proceed to full-time higher education. This implies that a relatively large part of the population possesses high and rather broad vocational qualifications at the moment they enter the labour force. In this respect, Dutch manufacturing employees are even better qualified than those in Germany, as vocational skills in the latter country are primarily concentrated in the lower intermediate segment. Table 10.12 shows the change in the distribution of educational achievements of the Dutch labour force over the past thirty years. Between 1960 and 1971, a shift took place from employees with only basic education to those with lower intermediate education. During the 1970s and 1980s, a rapid shift occurred towards upper intermediate and higher education. Workers with technical skills contribute significantly to the quality of the manufacturing labour force in terms of flexibility (i.e. the ability of workers to perform a large range of activities) and reliability (i.e. their ability to increase the quality of products and the production process), which in turn has a positive effect on productivity.5 Investment in R & D in the Netherlands has also been relatively important in terms of its share in GNP (i.e.R & D intensity). Minne(1992) shows that in 1964 total R & D expenditure in the Netherlands was 2.1 per cent compared to an average of 1.8 per cent for seven north-west European countries.6 In 1988, Dutch R & D intensity was 2.3 per cent compared to an average of 2.4 per cent for north-western Europe. After a correction for the relatively low expenditure on defence R & D and for the sectoral composition of output, the Dutch advantage was bigger: namely, 2.4

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Table 10.11. Decomposition on growth of GDP and the contribution of total factor productivity growth in the Netherlands, 1950-90 (annual compound growth rates) Gross Persons domestic employed product (labour income share)" (1) (2)

1950-60 4.61 1960-73 4.83 1973-9 2.68 1979-90 1.92

0.66 0.46 0.36 0.88

Hours/ person (labour income share)0 (3)

Capital stock (capital income share)" (4)

Total Contribution factor ofTFP productivity to GDP growth (%) (5)

(6)

-0.41 -0.68 -0.77 -0.90

1.84 2.20 1.48 1.19

2.52 2.85 1.61 0.75

55 59 60 39

"Shares of labour and capital input are based on their respective factor shares in GDP in 1990, which were 54 and 46 per cent respectively. Sources: See Tables 10.1 and 10.8. Table 10.12. Education distribution of the Dutch labour force, 1960, 1971 and 1987

Only basic education Lower intermediate education Upper intermediate education Higher education

1960

1971

1987

56 33 7 3

40 40 12 9

17 23 40 21

Note: Lower intermediate education is lower vocational education and lower secondary education (MULO and MAVO). Upper intermediate education is intermediate vocational and higher secondary education (HBS, Gymnasium, HAVO, MBO and VWO). Higher education is higher vocational education (HBO) and university. Sources: 1960 and 1971 from population census; 1987 from CBS, revised estimates of the 'Enquete Beroepsbevolking 1987' in CBS, Sociaal-economische maandstatistiek, 1990, no. 4. per cent compared to a north-west European average of 2.2 per cent. However, it is not easy to establish the impact of the relatively high expenditure on R & D on output growth in the Netherlands. Much of the Dutch R & D expenditure has been spent on basic science rather than on applied research, and was to a large extent absorbed by academic institutions instead of by firms. Furthermore, business expenditure itself was concentrated in industries which were of a relatively low- or medium-tech nature, reflecting the composition of Dutch manufacturing output. Finally, about 80 per cent of business expenditure on R & D was concentrated in the forty largest firms in the Netherlands, and 30 to 40 per cent in a single firm, Philips (Minne, 1992; Caniels and Verspagen, 1992). Despite the importance of education and R & D for economic growth, it is doubtful whether these are the decisive factors in explaining the relatively good productivity performance of the Dutch economy. The clue for the rapid growth of

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labour productivity and the relatively high levels of value added per hour in the Netherlands during the first three decades of the postwar period can be found in the relatively high levels of capital per hour worked. In contrast to the level of labour productivity (see Table 10.2), Table 10.10 shows that the level of total factor productivity in the Netherlands was clearly lower than the average for France, Germany and the UK until the mid-1970s, and has been close to the average since. In the remainder of this chapter, we show in more detail how the main facts on labour productivity, per-capita income and capital intensity established here are related to a slowdown in the rise of labour input and to an expansion of the public sector - in particular, of transfers from government to households. 3

The legacy of the 1930s

On the eve of the Second World War, the Dutch economy was still recovering from the severe shocks it had suffered during the depression years. The Dutch policy of sticking to the gold standard until 1936 seriously affected its competitive position on world markets and thereby the growth record of this small and open economy (see Table 10.1). Firms had to reduce their prices in order to stay competitive, and in particular, open sectors like international shipping and the capital goods sector (ships, machinery) suffered severely. Government policy was directed at lowering the domestic price level and at budgetary restraint. However, at the same time these deflationary policies were counteracted by government support of the agrarian sector. Minimum prices were set for wheat and other agricultural products such as potatoes and sugar, which led to a less rapid fall in consumer prices compared to factory prices. The severity of the crisis forced the government to abandon the traditional free trade policy. From 1934 onwards, various items, such as earthenware, leather and rubber, wearing apparel and textiles were protected by quantitative restrictions on imports. Keesing (1978) and van Schaik (1986) show that this protectionist wave lowered competitive pressures on Dutch industry. Domestic competition was weakened further in 1935 by an act on competition which promoted collusive agreements between firms (de Hen, 1980). These two factors - price support and decreasing competitive pressures - resulted in high cost levels for firms, which prevented the Dutch economy from recovering from the depression after 1933. Although one might have expected inefficient firms to survive in this protectionist environment, labour productivity growth was not in all respects negatively affected. De Jong (1993) estimates that manufacturing productivity increased by 3 to 4 per cent annually between 1930 and 1938, even though the overall productivity growth (including agriculture and services) was slightly negative (see Table 10.1). Because of the downward rigidity of nominal wages, a process of labour-saving mechanization and rationalization took place in manufacturing industry in these years (Keesing, 1978). Between 1930 and 1934, manufacturing employment declined by 30 per cent, and it did not return to the 1930 level before the war years. In contrast to the slowdown in employment, the total labour force continued to increase rapidly throughout the 1930s, which was largely related to the high birth rates during thefirstdecades of the twentieth century (Drukker, 1990). This resulted in a very high unemployment rate. The average unemployment rate from 1929 to

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1938 was 8 per cent (see Table 10.8), but during some years in the mid-1930s it was well into doublefigures.Sluggish demand and strict deflationary policies prevented output from increasing at the rate of growth of the population. After abandoning the gold standard in 1936, the Dutch guilder depreciated by 20 per cent, which was moderate compared to other currencies. The Dutch economy recovered rapidly, supported by war preparations all over Europe. Between 1935 and 1939, total GDP rose by more than 20 per cent and gross non-residential investment increased on average at 6.6 per cent annually. Nevertheless, the international competitiveness of the Dutch economy remained unfavourable because of the relatively high exchange rate of the Dutch guilder. 4

World War II and the reconstruction years

During the German occupation from 1940 to 1945, real GDP in the Netherlands declined by 40 per cent according to recent estimates (van Bochove and van Sorge, 1989). In some sectors, such as machinery, shipbuilding and electrical equipment, the decline was relatively modest in the first instance because production capacity was used and in some cases even extended to meet the German war demand. However, by the end of the war, economic activity in industry and trade was very low due to plunder, the use of compulsory labour outside the Netherlands, and scarcity of raw materials and fuel. In 1944 industrial output was at only 38 per cent of the 1938 level, and in 1945 it was only 27 per cent. Initially it was suggested that about 40 per cent of the total capital stock (machinery, infrastructure, rolling stock, houses, government) had been destroyed, but more recent estimates showed losses at 27 per cent, which is still quite substantial.7 From 1945 to 1950, economic expansion in the Netherlands was very rapid. GDP increased at almost 20 per cent a year, which was significantly faster than any of the other ten north-west European countries.8 Non-residential investments tripled between 1946 and 1950 (Maddison, 1994a) and exports increased 6.5 times (Maddison, 1991). In the present section we will elaborate on the fundamental factors behind this reconstruction experience by looking at the supply-side effects of government policy, Marshall aid and institutional renewal. During the reconstruction years, economic policy was highly centralized. Between 1945 and 1948, postwar scarcity was met by price and import controls, and by rationing raw materials andfinishedproducts, which was in fact a prolongation of the policies already introduced during the war, to keep production costs and the cost of living down (Barendregt, 1993: 37). On top of this, in 1945 came a special act on labour relations. This act ensured the central position of the government in the labour market, and gave it a legal right to intervene in the wage negotiations process through a.so-called Board of Mediators. The most urgent problems facing the Dutch economy immediately after the war were inflation, budget deficits and an increasing deficit on the balance of payments. Excessive money creation and forced savings during the war years had created a large monetary overhang. To combat this problem the government carried out a money reform in the summer of 1945, after which money supply decreased by two-thirds. Budget deficits were very high during the early postwar years, approaching 9 per

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cent of national income. In 1946 and 1947 the national debt was twice as high as national income (CBS, 1955). At the same time, interest rates were kept at a low level of 3 per cent. To limit private spending the Central Bank controlled credit allowances, whereas investment projects were controlled by the Ministry of Economic Affairs. The balance of payments deficit reached 14 per cent of national income between 1946 and 1948. These deficits were caused by a fast-growing demand for imports (as manufacturing industry recuperated strongly), the forced liquidation of foreign investments (for instance, many receipts from investments were lost because of the loss of the Dutch East Indies as a colony) and a deterioration of the terms of trade. Judging from several macroeconomic indicators, the policies of the reconstruction years look relatively successful. Inflation was brought down to 3 to 4 per cent in 1947 and 1948, although it increased again to 10 per cent during the next two years (CBS, 1955). After 1948 budget deficits disappeared and the balance of payments deficits, although fluctuating, decreased to less than 5 per cent of national income; the balance of payments then went into surplus in 1952. After 1949 the national debt decreased in absolute terms. In 1952 the public debt ratio stood at 100 per cent, and it decreased further after that date. However, the rapid growth during the early postwar years should not be interpreted as indicating full recovery. For example, although manufacturing output increased by 56 per cent between 1947 and 1951, labour productivity did not return to the prewar level before 1953 or even 1954.9 Because of price controls and the regulation of imports and exports, producers were hesitant to make capitaldeepening investments. This was reinforced by the policy of wage control, which kept production costs low. At the same time, however, the rapid increase in output growth and the slow rise in labour productivity implied a fast rise in employment, which kept unemployment rates down. 4.1

The role of Marshall aid during the reconstruction years

The Netherlands received in total about a thousand million dollars from the European Recovery Program (ERP). Between 1948 and 1951, Marshall aid accounted for 4.9 per cent of the Dutch national income on average (CBS, 1955: 304). Apart from Austria, this is the highest ratio of Marshall aid to GNP in Europe. Estimates by Tinbergen (1954) and by van der Eng (1987) suggest that, without Marshall aid, the average annual growth of net national income would have been 0.8 percentage points lower between 1947 and 1954: that is, 4.6 per cent instead of 5.4 per cent. Estimates by Eichengreen and Uzan (1992) reveal a much lower additional output growth of 0.11 to 0.13 per cent. However, these estimates may not reveal the full impact of the Marshall Plan on Dutch economic growth. First, without Marshall aid the Dutch government would have been forced to restrict consumption and investment expenditures further because of a shortage of dollars in 1947 (van der Eng, 1987). This would have made the policy for reconstruction even more centralistic than it already was. Second, Eichengreen and Uzan (1992) stressed the importance of Marshall aid (and the impact of the American economic policy regime in general) in terms of facilitating the restoration offinancialstability and the liberalization of production

304 Bart van Ark, Jakob de Haan and Herman J. de Jong

and prices. According to them, the stimulation of investment, the augmentation of the capacity to import and thefinancingof public investment in infrastructure were not the principal channels through which the Marshall Plan stimulated economic growth in Europe. Clearly the increase in output, profits and net investments since 1948 in the Netherlands can largely be ascribed to the policy of economic and trade liberalization (in particular, with Germany). In 1949 the policy of rationing raw materials and manufactured goods was lifted, price controls were relaxed and investments were no longer controlled. This trend towards liberalization was accompanied by a devaluation of the guilder by 30 per cent against the US dollar, which was more then the Belgian franc (12 per cent) or the German mark (21 per cent) in 1949.10 On top of this, the trade liberalization with Germany in 1949 caused a doubling of exports to Germany (the Netherlands' most important trading partner) at one stroke (Clerx, 1986: 54). 4.2

The evolution of the postwar institutional environment

In addition to the effects of the Marshall Plan outlined above, Eichengreen and Uzan (1992) argue that it was also beneficial to economic growth by improving labour-management relations. In a way it did so by focusing on the advantages of productivity improvement. However, the Marshall Plan cannot be seen as the major driving force behind the renewal of postwar institutions in the Netherlands. From 1945 onwards a long-term consensual policy framework emerged in the Netherlands which has its roots in the earlier period, i.e. the depression and war years. It was essentially characterized by a close cooperation between Catholics and Social Democrats and between trade unions and employers' organizations. The Social Democrats had already abandoned their purely socialist ideologies before the war. As an opposition party, they were not able to put into practice the Labour Plan of 1935 which propagated active economic management, selective nationalizations of industries and neocorporatist organization to combat mass unemployment. At the same time, progressive Catholics were inclined to break away from the prewar Conservative-Liberal government coalitions and their deflationary policies. The German occupation period, which was characterized by central price and wage regulation, rent controls and corporatist-like organization, provided a seedbed for the postwar government coalitions of Catholics and Social Democrats. In May 1945, immediately after the war, the Foundation of Labour was created, which was a regular forum for meetings of the three main employers' federations and the three main trade unions. The Foundation's main aim was 'to maintain industrial peace and discipline and raise the living standard of the Dutch population' (Abert, 1969). It was recognized by the government as an official (and until 1950 even the most important) advisory body in all matters of industrial policy. In 1950 the Industrial Organization Act was passed, which originally was envisaged to lay the foundation for a complete corporative organization of the economy. Although this was never realized, the act led to the creation of the Social Economic Council, which replaced the Foundation of Labour as the most influential advisory board of the Dutch government in matters of social and economic policy. It consists of forty-five members, one-third appointed by the employers' federations, one-third appointed by the trade unions, and one-third as

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independent experts appointed by the government. In 1945 the Central Planning Bureau (CPB) was set up under the supervision of Jan Tinbergen. The CPB's main task was to provide technical advice to the government by analysing current economic trends and preparing tentative forecasts. Ever since its inception, the CPB has been the focal point of debate on economic policy in the Netherlands, although the accuracy and effectiveness of the CPB's analyses and forecasts of economic development have been far from perfect (Griffiths, 1980). However, the CPB as well as the Social Economic Council performed a major role in the consensus approach to economic and social policy issues during the postwar period. 5

The 'golden years' from 1950 to 1973

Although the Netherlands had a very high growth of real output during the second half of the 1940s, this was largely the effect of a recovery from the war. It was not until the early 1950s that growth became sustained in terms of a continuous rise in labour productivity which lasted for more than two decades. Between 1950 and 1973, GDP and labour productivity tripled and GDP per capita more than doubled (Table 10.1). The process of long and sustained growth in the Netherlands was mainly set in motion through the growth of the world economy, the overall lowering of trade barriers and the creation of trade blocs such as the Benelux and European Economic Communities (van Zanden and Griffiths, 1989: 210-11). Indeed, exports were the most dynamic part of effective demand. They became an autonomous source of growth through high levels of investments and a positive balance of payments. Exports increased annually by more than 13 per cent during the 1950s and by another 9 per cent during the period 1960 to 1973 (see section 9). Investments played a major role in raising effective demand. Net investments of businesses were as high as 15 per cent of national income during the period 1950 to 1973. From 1947 to 1960 the average annual growth rate of gross investments in non-residential assets was 7.2 per cent, and from 1960 to 1973 it was 4.5 per cent (Table 10.9). Given the different characteristics of the growth process during the 1950s compared to the 1960s, we further the discussion in this section by dividing up the 'golden years' into two subperiods. 5.1

The expansion of the Dutch economy during the 1950s

During the 1950s, the Netherlands emerged as a low-cost producer. Because of the twofold devaluation of the Dutch guilder in 1944 and 1949, relative prices of tradables had dropped by 5 to 10 per cent compared to the prewar period. Furthermore, between 1951 and 1953 real wages had dropped to 30 per cent below the prewar level. Labour productivity increased rapidly, and the comparative level of labour productivity in 1950 was high compared to other north-west European countries, although not as high as during the prewar period (see Table 10.2). As can be seen in Table 10.13 (section 8), unit labour costs in the Netherlands were substantially lower than in neighbouring countries. In 1955 the Dutch market share in world trade was 30 per cent above the 1938 level, and in 1960 it was 45 per cent above.

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Large changes took place in the structure of the Dutch economy during the 1950s. As in other countries, the share of the agricultural sector in the economy declined rapidly, but agricultural productivity rose by 6 per cent (see Table 10.5) because of a shift to capital-intensive and 'high-value-added' products, such as cattle breeding, horticulture and stock farming. The manufacturing sector expanded rapidly, and in this sector labour productivity increased also by 6 per cent per year. The traditionally strong sectors in Dutch industry, such as food processing, metal industry and textiles, were complemented by new activities, especially chemicals and oil refining. Typical market services, such as trade, transport and banking and insurance, greatly benefited from the general rise in industrial activity and international trade, so that output and employment growth was very substantial in these activities as well. However, productivity growth was more moderate in these sectors. Rapid industrialization was also characteristic of Dutch economic policies during the 1950s. The main aims were to create new employment for the rapidly growing labour force, and to enlarge exports. Traditionally, the Dutch economy was seen as being dominated by agriculture and (colonial) trade. The independence of Indonesia (the former Dutch East Indies) in 1949 strengthened the call for industrialization.1 x Between 1949 and 1963 these policies were laid down in eight memoranda prescribing schedules for desired industrial investments by sector. However, as they were not accompanied by specific commitments of both government and large enterprises, the effectiveness of these plans was questionable. Direct government investments in industry amounted to only 2.5 per cent of total gross industrial investments between 1948 and 1963.12 In addition, specificfiscalpolicies of the government influenced investments and output growth by creating a tax structure in which retained company profits were less taxed than dividends. In practice, 60 to 80 per cent of investments in industry were financed out of retained profits (Dercksen, 1986: 136). The industrialization effort was accompanied by a national policy of wage restraint, which has attracted much attention in the literature on early postwar growth in the Netherlands. From the early 1950s onwards, wage restraint was a standard policy goal of Dutch governments (Hartog and Theeuwes, 1993: 82). This income policy consisted of direct government directives concerning the general wage level, and a policy of wage coordination to bring about a wage structure primarily based on the type of worker rather than on the performance and profitability of different sectors (Driehuis, 1975: 656). The wage formation process was coordinated through several negotiating bodies, including the Board of Mediators, the Foundation of Labour and the Social Economic Council.13 Within this corporatist structure, negotiations between employers' organizations and trade unions were institutionalized at a central level. It is questionable how effective the restrictive wage policies, which eventually broke down at the beginning of the 1960s, were in terms of slowing down the rise in wages. Until 1954 wages rose in accordance with the cost of living index, and for the rest of the 1950s average real wages increased slightly more than labour productivity (see Table 10.8). Econometric analysis by van Hulst (1984) shows that, in the absence of wage controls, the rate of change would not have been very different from the actual rise, although this view is challenged by Dercksen and Woltjer (1985).

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An important motivation in restraining wages was to strengthen the competitive position of the Netherlands on the world market. Section 9 on the external sector shows that the Netherlands was quite successful in keeping down the relative labour costs per unit of output during the 1950s. In 1950 Dutch wages were more than a quarter below the levels in France and the UK and slightly lower than that in Germany. By 1960 wage levels in the Netherlands were about 20 per cent below the average of its three big neighbouring countries (see Table 10.13). Although it is difficult to quantify, it may be concluded that growth during the 1950s was of a capital-widening nature. Investment led to the expansion of production capacity and to a significant rise in the number of hours worked (see Table 10.7). Profit rates were generally high during this period, which may have prevented labour-intensive branches in manufacturing industry from substituting labour for capital and from applying economies of scale. 5.2

Capital deepening during the 1960s

The second decade of the 'Golden Age' showed even slightly higher growth rates of GDP, GDP per capita and productivity than the 1950s, but an analysis of the underlying forces explaining the growth performance suggests that important changes occurred in comparison to the previous period. One major factor is the substantial rise in labour costs and the simultaneous decline in competitiveness and profitability. Between 1960 and 1973 real gross wages rose by 7.6 per cent a year, which was much more than in the other north-west European countries (see section 8). The rise in labour costs was due to three simultaneous developments around 1960: (1) increasing shortages on the labour market; (2) the reduction of the official working week to forty-five hours in 1960-1; and (3) the revaluation of the Dutch guilder by 5 per cent in 1961, which increased the level of labour costs compared to other countries. From 1961 onwards, the rise in real wages per employee exceeded the advance in labour productivity. The labour market became tight, with registered unemployment numbering only one-quarter of the registered vacancies. In this situation the trade unions began to pay more attention to the direct and specific interests of their members (de Wolff and Driehuis, 1980). In 1964 it became clear that the leaders of the central trade unions were not able and willing any more to call for restraint, and the early postwar income policiesfinallybroke down. Average real wages rose more than 15 per cent, which was about twice as much as the rise in previous years. Gradually the government made less frequent use of its legal right to intervene in the wage negotiation process. With the Act on Wages (1970) a regime of free wage negotiations prevailed. Rising labour costs during the 1960s also changed the nature of investments from those complementary to labour input expansion to those which substituted capital for labour. In manufacturing, investments increased even faster than during the 1950s: at 4.7 per cent per year compared to 3.8 per cent during the 1950s (van Ark, 1993). However, for the economy as a whole the rise in investment (and particularly in equipment) slowed down (see Table 10.9). Simultaneously to the rise in gross wages, the wedge between gross and net wages increased as well.

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The Dutch Central Planning Bureau (CPB, 1976:160) estimated that profitability declined significantly during the 1960s. This decline was explained by vintage models for the Dutch economy from the CPB, which linked rising labour costs to premature scrapping of old equipment and its replacement by new vintages of equipment with lower labour requirements (see also section 8). In a drive towards rationalization, and supported by permissive anti-trust legislation, the first wave of mergers and concentration of businesses took place at the end of the 1960s.14 Asfirmsize in the Netherlands had traditionally been small, this was seen partly as a way to gain economies of scale and to reduce production costs, and partly as a way to explore new (foreign) markets, to facilitate the financing of new investment and to support large-scale research and development projects. Despite the tensions in the labour market, increased efforts towards capitaldeepening investments and declining profitability, aggregate demand factors and especially exports continued to facilitate rapid output growth during the 1960s. Between 1963 and 1973 the volume of merchandise exports increased by 12 per cent per year, whereas sales on the domestic market rose by only 3.5 per cent. As unit production costs rose by 3 per cent per annum between 1963 and 1973, exporters had more difficulty in remaining competitive. Export prices therefore increased only 2 per cent per year, which was partly compensated for by higher increases in domestic prices. As a result, foreign suppliers increasingly penetrated the Dutch home market. Changes in the production structure of the Dutch economy were different from those in the 1950s. First, the discovery of natural gas in 1963 and its subsequent exploitation raised the output share of mining considerably, despite the closing down of the coal mines. Initially, policy-makers aimed at rapid exploitation of the gas reserves, since energy prices were expected to fall and nuclear energy was supposed to become available in the near future. Consequently, gas prices were below their oil price equivalent at the world level. This policy stimulated a rapid growth of energy-intensive industries, such as chemicals, oil refining, steel and horticulture. Estimates of Magnus (1979) for the period from 1950 to 1976 suggest that energy was a substitute for (unskilled) labour and complementary to capital. So the availability of natural gas contributed to the rise in labour productivity and capital intensity in the Netherlands. Furthermore, natural gas exploitation is itself characterized by very high labour productivity, which also caused a rise in the overall productivity performance. A second specific element of the structural change during this period is that the rise in labour costs prevented the traditionally labour-intensive industries from expanding further as they did during the 1950s. For example, in textiles, which were traditionally very strong in the eastern part of the Netherlands, competition with low-wage countries became very strong, and led to the virtual elimination of this industry. Agriculture was increasingly characterized by mechanization and rationalization, which was further supported by EC subsidy schemes. Finally, employment in the non-market sector, such as government, education and health care, expanded rapidly during the 1960s (see Table 10.4). This trend was accompanied by an enormous rise in public expenditure.

Economic growth in the Netherlands 309 6

Shocks and sluggish growth during the 1970s

Since the early 1970s, growth in GDP per-capita income has slowed down in the Netherlands, as in most other north-west European countries. Nevertheless, the Dutch performance compared to these other countries did not deteriorate during the period in terms of per-capita income, and it even improved slightly in terms of labour productivity. On the other hand, the growth rate of investments and capital stock declined sharply. In 1979 the level of total factor productivity of the Dutch economy was virtually the same as the average for France, Germany and the UK (see Table 10.10). Annual hours worked declined substantially from 9018 million hours in 1973 to 8619 million hours in 1979, despite an expansion of the labour force, which exceeded that of most other north-west European countries. The decline in hours worked was due to both a decline in the participation rate and a reduction in the number of annual hours worked per employee (Table 10.7). At the same time, the Dutch unemployment rate increased sharply during this period The slowdown of the early 1970s can be partly ascribed to an exhaustion of the possibility for catch-up with countries at the productivity frontier (see Crafts, 1992), but it is important to look in more detail at some of the specific features of the Dutch economy during the 1970s. First, compared to other countries the 1973 boom in the Netherlands was not excessive. Second, due to the natural gas resources, the oil price rise did not affect the terms of trade as much in the Netherlands as in countries which were more dependent upon oil imports. Third, private and public consumption during the 1970s continued to rise rapidly. After thefirstoil crisis, domestic gas prices were more or less raised to world price levels. The policy towards the exploitation of natural gas shifted from rapid depletion to long-term conservation. Nevertheless domestic output of natural gas increased from 2.7 per cent of GDP in 1973 to 6.4 per cent in 1979 (Maddison, 1982b), which led also to a substantial rise in government receipts. These revenues have mainly been used to finance government transfers to households (see also section 10). It is in relation to the specific role of natural gas in the Dutch economy that one came to speak of the 'Dutch disease'. It was claimed that the rise in natural gas exports caused an appreciation of the guilder, which put the traded goods sector in a disadvantageous position compared to the non-traded goods (and services) sector. This would also lead to a rise in prices of non-tradables compared to tradables. Indeed, Kremers (1986) found that, whereas growth in the traded and non-traded goods sectors moved more of less in tandem before 1973, the decline in the tradables sector was generally stronger than that in non-tradables after the oil crisis. However, the divergence in development between the tradable and non-tradable sector can also be explained otherwise. Due to the openness of the Dutch economy, the decline in world trade which followed the oil crisis hit the economy relatively hard. Higher consumer prices due to oil price increases were translated into higher nominal wages, and profits were squeezed, especially in sectors which were more exposed to foreign competition. The non-traded sector is*not confronted with the same level of competition, so it was less affected by the first oil shock. Since there has been no formal empirical research into the relationship between

310 Bart van Ark, Jakob de Haan and Herman J. de Jong

the exports of natural gas and the development of the real exchange rate, it is not clear that there is a direct link between the two. It is questionable whether the Dutch guilder was indeed overvalued during the 1970s. A comparison of the exchange rate between the guilder and the Deutschmark with purchasing power parity as calculated by the OECD shows that the relative price level in the Netherlands was already the same as in Germany by 1974, and since then it has fallen continuously to a level 15 per cent below that of Germany. Furthermore, a recent study by Brakman et al. (1991) finds only limited support for the view that the guilder was overvalued during the 1970s. The evidence for the existence of a 'Dutch disease' is therefore not very strong. The oil crisis was not the only shock that hit the Dutch economy during the 1970s. There was also a labour supply shock. As a result of the rapid population growth during the 1950s, large cohorts of school-leavers entered the labour market. In addition, the participation of women in the labour force increased rapidly, although this was partly offset by diminishing participation by males offifty-fiveand older due to generous disability benefits and (later on) the introduction of provisions for early retirement schemes. As a result, the Dutch labour force grew significantly faster than in most other north-west European countries during the period 1973-9. The rise in unemployment was also higher than in neighbouring countries. It has been widely claimed in the Netherlands that the increase of real wage costs (see Table 10.8) during the 1960s and early 1970s squeezed profits, and played a major part in explaining the rise in unemployment and the slowdown in investment growth.15 Furthermore, the continuous expansion of the non-market sector during the 1960s and 1970s (see Table 10.4) not only pushed up labour costs, but also led to a rise in taxes and social contributions. Supported by the outcomes of CPB models on the relation between rising labour costs, declining profitability and premature scrapping of equipment (see section 8), Dutch economic policy became once again focused on wage moderation and also on stabilization of the level of taxes and social security contributions (see section 10). However, these policy targets were only partially met during the 1970s. Although the growth of real wages was dampened in comparison to the previous period, it was not significantly lower than in neighbouring countries. In, 1979 the level of unit labour costs in the Netherlands was even somewhat higher than the average for France, Germany and the United Kingdom. Between 1973 and 1979 the government intervened three times by way of a wage control measure, but the overall slowdown in the growth of real wages was partly offset by a simultaneous rise in the legal minimum wage (Hartog and Theeuwes, 1993). Furthermore, after the first oil crisis in 1973, Dutch central government pursued expansionaryfiscalpolicies to maintain aggregate demand. Public spending increased very rapidly during 1973-4, in part because of the sharp increase in unemployment. After a brief period of stabilization in 1975-7, government spending started to rise again until 1983, when the central government's budget deficit had increased to 10 per cent of net national income. The view is widely held that stagnating world trade in combination with real wage increases and an oversized public sector are the most important explanations for the sluggish economic performance of the Dutch economy during the 1970s. However, there is an alternative, though not necessarily incompatible, explanation. According to a report by the Scientific Council on Government Policy (Wetenschappelijke

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Raad voor het Regeringsbeleid, 1980), the Dutch industrial sector had become weak, and had lost ground both in traditional and in new, technologically advanced areas. Indeed, the decline in output and productivity growth in some of the strong sectors of Dutch industry - like oil refining and chemicals - exceeded the average rate of decline (van Zanden and Griffiths, 1989: 269). In contrast, productivity growth in the agricultural sector was relatively high during this period, and the fall in total labour input in the Dutch economy led to an above average productivity growth compared to the rest of north-west Europe. 7

Continuity and change during the 1980s

In many respects, developments after 1979 were in line with those of the previous period, but the acuteness of the problems became more clearly visible. Growth rates of GDP, GDP per capita and labour productivity dropped well below the average for north-western Europe (Table 10.1). Between 1979 and 1990, GDP per capita in the Netherlands dropped from 98 per cent to 92 per cent of the north-west European average (Table 10.2), although the Dutch productivity level remained substantially above the average. During this period the labour force increased considerably, due to a higher participation rate, which reflected the rapid rise in the Dutch female participation rate from a traditionally low level (Table 10.7). The number of persons employed increased from 5.3 million in 1979 to 6.4 million. Because of accelerated decline in the annual hours worked per person, total labour input continued to fall, although at a less rapid rate than during the 1970s. In any case the increase in employment was not sufficient to match labour supply, and consequently the unemployment rate was higher than in the previous period. The second oil shock and the recession of the early 1980s hit the Dutch economy harder than the first oil shock in 1973. In 1981 and 1982 economic growth even turned negative. High real interest rates, which resulted from restrictive monetary policies in most industrial countries to combat inflation, severely affected business sector investment as the dependency on external borrowing increased during the 1970s (van Zanden and Griffiths, 1989: 259). The recovery of the second half of the 1980s was to a considerable part the result of wage moderation. Central agreements between employers and unions in 1982 and 1984 marked the beginning of an era in which the government abstained from its legal right to intervene in the wage negotiation process, and in which the Dutch economy shifted further towards decentralizing the labour market. At the same time, the need for wage moderation was repeatedly stressed by government, employers' organizations and trade unions. Real wages increased only very slowly, at less than 1 per cent a year on average between 1979 and 1990 (Table 10.8). Wage differentiation between various sectors remained very low compared to other countries. Wage moderation led to an important improvement in profitability and investment levels. Indeed, during the period 1979-90 the annual growth rate of investment in non-residential assets amounted to 2.9 per cent, as against 0.7 per cent during the period 1973-9 (Table 10.9). During the 1980s, the legal minimum wage level was not fully adjusted to the rise

312 Bart van Ark, Jakob de Haan and Herman J. de Jong

in average wages. In 1984 minimum wages and benefit levels were cut by 3 per cent, and they remained the same in nominal terms until 1989. However, by international standards the legal minimum wage is still relatively high (OECD, 1993: 13). The minimum wage level is important since it is also the cornerstone of the social security system. Single-income families which are out of employment are entitled to a net benefit which at least equals the net minimum wage. As this lowers the incentive for seeking work which pays approximately the minimum wage, high rates of unemployment and non-activity can coexist with vacancies for unskilled workers. In return for wage moderation, the unions bargained for a reduction of working hours as a means to combat unemployment. As this type of bargaining was repeated almost every year throughout the decade, average annual hours worked per person dropped to very low levels in comparison to other countries. After the second oil shock,fiscalpolicy was again expansionary during the early 1980s, although this was not so much deliberate policy as the outcome of lax fiscal discipline. Wellink (1987:346) argues that the second oil shock and the slow growth in world trade prevented policy-makers from moving away from the strong Keynesian tradition in the Netherlands to more sober policies. The policy change was further retarded because of increasing government revenues from the sale of natural gas. Only during the second half of the 1980s did policies become more focused on increasing labour force participation, reducing the budget deficit and social welfare benefits in particular, and reducing the size of the public sector in general. Following cuts in social security benefit levels, current policy aims at changing the terms of entry for people claiming benefits, but there are no clear indications yet of a rise in labour input. In 1988 the so-called Investment Tax Credit (WIR) was largely repealed. For compensation, the rate of corporate income tax was reduced from 42 to 35 per cent. The WIR was introduced in 1977 as an instrument for government to influence investment decisions. Most investments in business assets (including patents and know-how) by firms and the self-employed qualified for WIR. In addition to the basic investment credit - which amounted to 12.5 per cent of the sum invested investors were entitled to several special investment tax credits if investments met certain criteria, like a certain degree of energy saving or a limitation in environmental pollution. One may question the effectiveness of the WIR. Although macroeconomic estimates suggest that the WIR stimulated investments, microeconomic analyses suggest that the WIR had only limited effects on investment decisions (de Kam, 1988:88). 8

Labour market and wage policies

In the previous sections we described in detail how the centralized wage policy in the Netherlands of the 1950s and the 1960s gradually evolved into a system in which free wage negotiations prevailed. We also showed in Table 10.8 that the growth of gross real wages was hardly different from the rest of north-western Europe during the 1950s, that it grew substantially faster during the 1960s, and that real wage growth was only significantly lower than in the other countries during the free wage negotiations regime of the 1980s. In this section we will take a closer look at the relation between the functioning of the labour market, wage policies and the growth performance.

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Table 10.13. Labour costs, labour productivity and unit labour costs in manufacturing: the Netherlands compared to its three major trading partners (France, Germany and the United Kingdom -100), 1950-90 Average of France, Germany and UK = 100

1950 1960 1973 1979 1990

Hourly labour compensation*

Value added per hour worked*

Unit labour costc

80 82 134 144 117

97 106 133 135 136

88 82 93 101 78

a

Converted to common currency at exchange rate. Converted to common currency at industry of origin PPP. c The average of Dutch trading partners was obtained by weighting the share of Dutch exports to each of these countries for each of the years. The ratio of the first two columns therefore does not equal the third column. Sources: Hourly compensation from US Dept of Labor (1992a; 1992b); manufacturing productivity levels from van Ark (1993), van Ark and Pilat (1993) and van Ark and Kouwenhoven (1994). b

Table 10.13 shows the relative levels of output per hour, hourly labour compensation and unit labour costs in Dutch manufacturing compared to that of its three big neighbouring countries, France, Germany and the United Kingdom. In 1950 Dutch gross wage levels were about 20 per cent lower than the average for France, Germany and the UK. They went up slightly during the 1950s and in particular during the 1960s and 1970s. In 1979 Dutch gross wages were 44 per cent higher than in the three neighbouring countries. However, because of the high productivity performance in Dutch manufacturing, the level of labour cost per unit of output was only slightly above the average for France, Germany and the UK in 1979. The very successful moderation of the rise in hourly compensation in the Netherlands during the 1980s led to a remarkable improvement in the unit labour cost performance of Dutch manufacturing. At the end of the 1980s, the Dutch unit labour cost position compared to France, Germany and the UK was even better than during the 1950s or 1960s. Presently, the common judgement on the central wage control during the first two decades after the Second World War is that it dragged on too long and stifled growth of per-capita income and consumption (Hartog and Theeuwes, 1993:83). It may also have prevented women from entering the labour market during that period, although there were major institutional obstacles to this as well (de Neubourg, 1987). The increasing tightness of the Dutch labour market during the 1960s undermined the effectiveness of wage control and made an end to the position of the Netherlands as a low-cost producer. The influx of foreign labour from Mediterranean countries

314 Bart van Ark, Jakob de Haan and Herman J. de Jong

was not enough to ease the tension on the labour market, and participation rates of women in the labour force stayed persistently low. By 1973 wage levels in the Netherlands were well ahead of those of its major trading partners. During the 1970s a major debate took place in the Netherlands on the contribution of rapid wage increases to the stagnation of economic growth. First, there was a focus on the mechanics of the system of wage determination in the Netherlands during the 1960s, which is generally known in the literature as 'wage leadership' or 'key bargaining'.16 Negotiations on wages started in the highproductivity manufacturing industries like the metal and chemical industries, and were followed by negotiations in other branches where productivity growth was more moderate. Driehuis (1975: 669) showed that this system of key bargaining caused an almost equal rise in gross wages in various sectors of the economy during the 1960s. However, it led to a rapid increase of unit labour costs in sectors with sluggish productivity growth. This gave rise to a wage-price spiral and to a shakeout of labour in industries which had lost their competitive advantage, especially 'traditional' manufacturing industries, like textiles, shoes and clothing. On the other hand, many service industries, which faced less competition, could pass on higher labour costs to the consumer through higher prices. This hypothesis also contributes to our understanding of the stagflation period during the 1970s, when structural unemployment and inflation arose from the unevenness of labour productivity growth in an environment of key bargaining. The second hypothesis on the relation between wages and the stagnation of the Dutch economy in the 1970s and 1980s came from den Hartog and Tjan (1974) in a CPB model of the private sector of the Dutch economy. This model shows that the rise of real labour costs during the 1960s induced premature scrapping of equipment and led to a replacement by modern and more capital-intensive equipment. Because of the higher productivity of these younger vintages of equipment (caused by embodied technical progress), the growth rate of investments would need to accelerate to maintain the same level of employment. However, as the growth of investments slowed down after 1971, this resulted in a lower-capacity demand for labour, which led to structural unemployment. Vintage models in various forms have played a central role in the discussion on the performance of the Dutch economy during the 1970s and 1980s. However, it is questionable whether rising labour costs did trigger off more capital-intensive investments. The rise in real wages was already much slower during the period 1973-9 than during the period 1960-73, and compared to the neighbouring countries the already relatively high level of capital intensity did not rise further during this period (see Tables 10.8 and 10.10). In the early 1980s, the importance of central wage negotiations diminished. Although there were still annual discussions between employers' organizations and trade unions at central level, the negotiations about wages and other conditions of employment were decentralized. The emphasis in these negotiations shifted from wages to other topics, such as shortening of labour time and programmes for vocational training. Under the influence of high and increasing unemployment, there was a great willingness on the part of the unions to exchange pay demands for a reduction in labour time per person, with the aim of creating new employment. However, although there was a significant rise in the number of persons employed

Economic growth in the Netherlands 315 Table 10.14. Exports and export surplus as a percentage of GDP, export volume and terms of trade in the Netherlands, 1929-90

1929 1938 1950 1960 1973 1979 1990

Exports as % of GDP at market prices

Exports minus imports as % of GDP

Exports volume index (1973 = 100)

Terms of trade index (1973 = 100)

43 29 42 48 47 49 57

-7 -3 -7 2 3

12 10 T 33 100 119 184

107 107 105* 94 100 94 96

_ j

5

a

1948. Note: Terms of trade index equals the deflator for exports divided by the deflator for imports. Sources: See G D P sources of Table 10.1.

during the 1980s, the number of total hours worked increased only moderately. On the whole there was a larger expansion of leisure than of labour time, resulting in an economy characterized by a relatively high level of labour productivity and a relatively low level of per-capita income.

9

The performance of the export sector and exchange rate policy

In previous sections we showed that exports have been an important source of growth of the Dutch economy throughout the period under consideration. The Dutch economy is one of the most open in the world. Table 10.14 shows that exports (i.e. merchandise and non-merchandise exports, including re-exports) account for nearly half of GDP, and since the early 1980s for more than half.17 Export volume increased rapidly during the first two postwar decades, and fell somewhat during the downturn of the 1970s. The composition of exports changed significantly. In 1950 agriculture and food processing accounted for almost 30 per cent, but their share had decreased to 17 per cent by 1973. The share of chemical exports (including re-exports) rose substantially throughout the period. Particularly important were the exports of natural gas, which were negligible at the end of the 1960s, but accounted for more than 12 per cent of total exports (in current prices) by the early 1980s. The dependence of the Dutch economy on the performance of the world economy is most strikingly shown in Figure 10.1, which compares the annual growth rates of GNP in the Netherlands with that of world trade volume. Although the fluctuations of GNP are less, the two measures are clearly strongly related. It is. therefore understandable that the two issues at the top of the policy agenda in the Netherlands were directly related to the performance of the foreign sector: that is, a

316 Bart van Ark, Jakob de Haan and Herman J. de Jong 20

i

Growth of world trade volume

1955

1960

1965

1970

1975

1980

1985

1990

Source: Central Planning Bureau.

Figure 10.1 Growth rates of real GNP in the Netherlands and the world trade volume, 1951-94

stable exchange rate and maintaining competitiveness through high productivity and low unit labour costs. The Dutch central bank has always given high priority to stable exchange rates. This policy has also been subscribed to by governments of various signature. Exchange rate stability centres on the rate vis-d-vis the Deutschmark partly because Germany was the principal trading partner of the Netherlands, but also because of the German postwar reputation as regards achieving price stability (see Wellink, 1989: 393). After the demise of the Bretton Woods system, the Netherlands participated in the 'Snake' arrangement, and later on joined the Exchange Rate Mechanism (ERM) of the European Monetary System. The policy of maintaining a stable guilder/ Deutschmark exchange rate has been quite successful. During the 1970s and during the starting phase of the ERM, the Dutch guilder was devalued three times, but during the 1980s the guilder was devalued against the Deutschmark only once (in March 1983). Given its priority for a stable exchange rate, the Nederlandsche Bank was firmly opposed to this latter devaluation. The central bank argued that it was unlikely that a devaluation would lead to a permanent improvement of the competitive position of the Dutch economy, since rising import prices are generally transmitted into higher nominal wages. However, government - which has the final say in exchange rate matters - decided at that time to devalue the guilder. Despite these devaluations, the effective exchange rate of the guilder generally appreciated after 1973, which helped to stem inflationary pressures in the Netherlands. Indeed, Dutch inflation has been among the lowest in Europe in the past decades, sometimes even below the inflation rate of Germany. Due to the exchange rate

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policy and the openness of Dutchfinancialmarkets, interest rates in the Netherlands are primarily determined by interest rates in its neighbouring country. German and Dutch interest rates - both long-term and short-term rates - have moved closely together (de Haan et al, 1991). The Dutch long-term rate is generally slightly above the German rate, whereas the short-term interest differential, being the central bank's prime exchange rate policy instrument, depends upon the position of the guilder vis-a-vis the Deutschmark. According to various scholars, the openness of the Dutch economy has created a wedge between the performance of the 'external sector'- that is, those industries which compete on the world market - and that of the 'domestic sector' which is not exposed to international competition. The capital-intensive nature of the external sector in combination with the competitive pressure to reduce labour costs released a large number of people tofindemployment in the domestic sector. Kremers (1991) argues that the domestic sector of the Dutch economy has not been able to absorb this expansion in labour demand because of various rigidities - like a high marginal and average tax wedge, too high a level of social assistance and stringent legislation on labour contracts.18 A further investigation shows that there is no evidence that the rise in the number of employees in the domestic sector of the Netherlands has been slow during the 1980s. In fact the number of jobs in the domestic sector increased quite rapidly, although the rise in the total number of working hours was less because much of the expansion concerned part-time jobs. On the other hand, a big gap has been created between the domestic and international sector in terms of labour productivity performance. Whereas the international sector of the Dutch economy now has one of the highest productivity levels in the world (see also Table 10.6), the level of labour productivity in the domestic economy was not so good compared to neighbouring countries (van Ark et al., 1993).19 The worse productivity performance of the domestic sector compared to the external sector is partly a general phenomenon related to the structure of activities. The domestic sector consists mainly of service industries where productivity growth is almost by definition slower than in goods-producing industries, which are mostly part of the external sector. However, in the specific case of the Netherlands comes the additional effect that the rise in labour input in the domestic sector consisted mainly of part-time jobs in combination with labour time shortening and early retirement of full-time workers, which was not accompanied by a rise in labour productivity proportional to that of full-time workers. 10

The public sector and economic growth

Until 1960 the public sector in the Netherlands was not particularly large in comparison to many other West European countries. Table 10.15 shows that public spending amounted to almost 39 per cent of net national income (NNI) in 1960. However, at the end of the 1980s, the share of government spending in national income stood at almost 62 per cent. Within Europe, only Sweden and Denmark have a public sector of similar size. The call for a more limited role of government in the economy is often related to the argument that a large government hampers growth. In recent endogenous

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Table 10.15. Government expenditure in the Netherlands as a percentage of net national income, 1955-90 Consumption Investment 1955 1960 1965 1970 1975 1980 1985 1990

15.6 14.7 16.8 16.7 19.2 19.9 18.0 16.7

3.2 3.7 4.4 4.4 3.5 2.8 2.2 1:8

Current transfers0

Interest payments

Other

Total

12.4 (8.0) 13.1(11.2) 16.9 (15.5) 20.1 (18.4) 28.5 (25.7) 32.7 (29.2) 34.4 (30.4) 33.1 (30.4)

2.6 3.0 2.6 3.2 3.3 4.1 6.9 6.5

3.9 4.2 4.4 4.1 4.5 5.2 5.0 3.5

37.7 38.7 45.1 48.5 59.0 64.7 66.5 61.6

a

Transfers to households are shown in parentheses. Source: Ministry of Finance, Budget Memorandum 1990.

growth models, government spending generally has two effects: (1) a higher tax rate may reduce growth, and (2) larger government spending may increase productivity. According to Barro (1989a: SI09), 'typically, the second force dominates when the government is small, and the first force dominates when the government is large'. Unfortunately, the empirical evidence that is currently available to shed light on the importance of marginal tax rates in determining growth is sparse. Recently, Easterly and Rebelo (1993) concluded in a cross-section analysis that the evidence that tax rates matter for growth is very fragile. This empirical fragility contrasts sharply with the robustness of the theoretical predictions, as most growth models predict that income and investment taxes are detrimental to growth. In a cross-section analysis of economic growth, Grier and Tullock (1989) and Barro (1989b) report a negative relationship between the rise in government consumption and economic growth, but other authors contest the existence of such a relationship (Kormendi and Meguire, 1985; Andres et a/., 1993). Furthermore, Levine and Renelt (1992) conclude that the results of Barro (1989b) are not robust to the inclusion of other macroeconomic indicators. In the remainder of this section we discuss the various arguments put forward to explain the relationship between the size of the public sector and the rate of economic growth in the light of the Dutch experience. We look specifically at the impact of government spending and revenues on the supply of labour and capital. 10.1 Government expenditure Table 10.15 shows the various categories of government expenditure in the Netherlands as a percentage of NNI from 1955 to 1990. It shows that the major reason for the rapid rise in total public outlays has been the redistribution of an increasing proportion of national income through an impressive array of social security programmes.

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319

The high level of inactivity in the Netherlands is reflected in an expanding public sector. Transfers to households, which primarily consist of social security benefits, increased from 8 per cent of NNI in 1955 to 30 per cent in 1990. This remarkable growth has been boosted by both volume and price effects. Between 1960 and 1985 the total number of benefit recipients increased by a factor of 2.5. The swelling number of recipients of disability benefits is particularly striking. For example, entitlements to disability benefits increased from 215000 in 1970 to more than 900000 in 1985. Between 1960 and 1980 the level of the benefits increased rapidly, both in terms of constant guilders and relative to per-capita income in the Netherlands (de Kam, 1988: 33). According to Haveman (1985), the major economic gain from the welfare state is the reduction in the uncertainty faced by individuals. In other words, the welfare state contributes to social cohesion. Due to welfare state income redistribution programmes, Dutch income distribution is fairly flat (see Table 10.3). Recent research has suggested that income inequality hampers economic growth in democratic states (Persson and Tabellini, 1992). Although the Dutch welfare state may have furthered economic growth in this respect, the high level of social security spending and the corresponding high level of taxes may also have negatively affected economic growth, by reducing the supply of labour and capital. Wolfe et al. (1984) estimated that the increased generosity of public income transfers in the Netherlands reduced the labour supply during the period 1974 to 1980 by 17 per cent: that is, on average by 2.7 per cent per year. Other studies find less clear-cut evidence. In a review of nine studies on the sensitivity of unemployment duration to benefit levels, Groot (1992) finds only one study which unequivocally shows a significant effect, while in five studies the effect is not significant. Groot concludes that there are at best low duration elasticities of benefit levels, but that eligibility requirements may be important. It is with respect to eligibility requirements that the Dutch experience differs most from that of neighbouring countries. For example, insurance for disability of workers was introduced by the Disability Insurance Act (WAO) of 1967. It provided employees with benefits up to 80 per cent of wages (in 1985, cut to 70 per cent), paid indefinitely until the age of sixty-five. In 1976 the General Disability Benefits Act (AAW) extended coverage at a fixed premium level to persons outside the labour force. Entitlement arose when a person lost income due to being unable to work in any 'commensurate' employment. The cause of the disability was immaterial as no distinction was made between risque social and risque professionel. Furthermore, there was no minimum insurance period required. The level of the benefits depended on the degree of loss of earnings capacity: no benefit for under 15 per cent disablement, rising to a full benefit for 80 per cent or more disablement. However, in practice disability programmes were an attractive option, for employers and employees alike, to cut down on less productive labour. Especially during periods when economic growth faltered, older workers with more or less serious impairments became easy targets for layoffs. Partially disabled applicants were often treated as if they were fully disabled (Aarts and de Jong, 1992). Analysis of micro data has suggested that 30 to 50 per cent of disability payments in the Netherlands represented hidden unemployment rather than true disability, and some observers suggest that the true proportion may be even higher (OECD, 1993).

320 Bart van Ark, Jakob de Haan and Herman J. de Jong Table 10.16. Tax revenues in the Netherlands as a percentage of gross domestic product, 1965-89

'.Property

Total Social security taxes contributions

1L.5 11.3 L.O 1L6 11.6 L.7

10.2 13.2 16.8 17.4 19.9 18.9

Taxes on:

1965 1970 1975 1980 1985 1989

Corporate income

Goods and Personal services income

2.7 2.5 3.4 3.0 3.1 3.5

10.4 10.6 11.6 11.5 12.0

9.5

9.2 10.1 11.8 12.0 8.7 9.7

33.2 37.6 43.7 45.8 44.9 46.0

Source: OECD, Revenue Statistics, various issues.

Recently, measures have been taken to stop the rise in disability entitlements by reducing benefit levels and increasing the effort to re-employ people with limited disablement. Another category of government spending which may be relevant for economic growth is capital spending. It follows from Table 10.15 that investment as a share of total expenditure by the government decreased during the 1970s and 1980s. According to estimates of Aschauer (1989), the productivity slowdown in industrial countries is at least partly caused by the overall decline in public capital formation. However, Aschauer's claim that a decline in public capital formation causes a large decrease in private capital formation has been criticized on various grounds (see, for example, Ford and Poret, 1991; Sturm and de Haan, 1995). The decline in government investment in the Netherlands no doubt also reflects demand-side pressure (for example, less construction of schools due to demographic changes) and saturation effects (for example, the finishing of the Delta Works). 10.2

Government

revenues

Table 10.16 shows that total tax revenues of government as a percentage of G D P increased by about 13 percentage points between 1960 and 1989. The share of social security contributions in the aggregate tax revenue increased to reach 41 per cent in 1989. Income transfers through social security programmes in the Netherlands are almost exclusively financed by way of contributions on a pay-as-you-go basis. High levels of taxation may lead to high marginal and average tax wedges. 20 McKee et al. (1986) present estimates for the marginal and average tax wedges on labour use for eight OECD countries in 1983, taking wages of the average production worker as the benchmark income level. According to their estimates, the marginal tax wedge on labour income in the Netherlands amounted to 73 per cent, which was by far the highest level in their sample of countries. The average tax

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321

wedge (including taxes on consumption) for the Netherlands was 48 per cent, which is comparable to that in Italy, Belgium and France, but higher than the average wedge in Germany, Japan, the UK and the USA. Krapels and van Ravestein (1987) present estimates of the average and marginal tax wedge on labour use for the Netherlands for the period 1960 to 1985, but they only take social security contributions and personal income tax into account. Their estimates show that the average wedge for a production worker doubled between 1960 and 1985 to reach a level of 42 per cent. The marginal wedge nearly tripled from 23 per cent to 63 per cent of labour costs. It has been claimed that these high average and marginal rates of taxes and social security contributions on income reduced labour supply in the Netherlands, but again there is only limited empirical support for this. Theeuwes (1988) concludes that supply elasticities of different types of labour vary widely. For males the average supply elasticity is 0.07, while the average income elasticity is — 0.07, which implies an inelastic labour supply. However, the female labour supply is clearly influenced by the degree of taxation. The average supply elasticity is 1.39 and the income elasticity amounts to —0.16. A high level of taxation may also affect the demand for labour and investment growth. There is ample evidence that wage earners partly offset higher taxation by claiming higher gross wages (see, for example, Knoester and van der Windt, 1987). According to the vintage models of the CPB discussed above, the shift on taxes on labour from employees to employers led to higher real labour costs, which in turn affected both the type and level of investment and the demand for labour. Although the degree of shifting of taxes and social security contributions has not been stable over time (Brunia and Kuper, 1990), the growth of the public sector is often regarded as one of the driving forces behind excessive labour costs. The extent to which taxes on capital income reduce savings is controversial. Some authors have estimated the marginal and average tax wedge on capital income, but these estimates vary widely so that it is hard to reach clear conclusions (de Kam, 1988: 56). Finally, a specific feature of the Dutch tax system concerns pension savings. Employer contributions to pension funds are exempt from income tax and are deductible under corporation income tax, while employees can fully deduct their contributions from taxes. Moreover, pension funds are exempt from tax as they accumulate the returns on assets they hold. This tax treatment of pension saving has fundamentally altered the pattern of household saving in recent decades. Most saving by Dutch households now consists of pension savings, and the Netherlands' savings ratio is one of the highest among the OECD countries (Bakker, 1993). In contrast to these funded pension arrangements, the provisions for early retirement which were introduced during the 1980s are financed on a pay-as-you-go basis. From the foregoing analysis, various conclusions can be drawn. The high level of inactivity in the Netherlands is reflected in the growth of the public sector, which is to a considerable extent explained by a rising number of social security benefit recipients, notably disability benefit recipients. The evidence on the direct impact of the expanding public sector on the rise in GDP is not conclusive. There

322 Bart van Ark, Jakob de Haan and Herman J. de Jong

is only mixed evidence that generous benefits and high taxes on labour have led to lower labour supply, although there is more support for the view that the high tax burden has affected both the level and type of investment. The high level of taxes on labour has probably contributed to the capital-intensive character of the Dutch economy. 11

Conclusions

This chapter has shown that, in comparison to other countries in north-western Europe, the growth and level of productivity in the postwar Netherlands have been relatively high, in combination with a slower rise and lower level of per-capita income. The underlying forces explaining the remarkable productivity performance have shifted over time. During the 1950s, growth was based on capital-widening investments, rapid technological change and expanding labour input, which was employed at relatively low costs. During most of the 1960s and 1970s, productivity improvements were mainly based on capital-deepening investments in combination with a decline in total hours worked and rising labour costs. The rising labour cost during the 1960s was associated with a strong fall in total hours worked, a fall in labour force participation rates and a rapid decline in annual working hours per person. During the 1970s, the fall in total hours continued, but a moderate turnaround occurred during the 1980s mainly because of a rapid rise in part-time (female) labour. On the other hand, early retirement schemes and generous social security schemes prevented labour input from expanding faster. These developments led to the expansion of the non-active population of working age. The rise of the public sector also led to a shift in the tax burden on to employers, which in itself hampered further growth. By maintaining relatively high levels of labour productivity, the Dutch economy remained competitive in terms of unit labour costs with the exception of the late 1970s. These high productivity levels were due partly to the high level of vocational education of the Dutch labour force, but mainly to the capital-intensive nature of the Dutch economy compared to neighbouring countries. In terms of total factor productivity, the Dutch performance has not been exceptionally good. The late 1980s were characterized by some reforms in economic policy in the Netherlands. The growth of wages was tempered more than in any previous postwar decade, government deficits were significantly reduced and the social security system underwent various changes to reduce the ratio of the non-active to the active population. NOTES We benefited from comments and suggestions for improvement made by Nick Crafts, Rainer Fremdling, Flip de Kam, Jeroen Kremers, Angus Maddison, Gianni Toniolo and Jan Luiten van Zanden, and by participants in the CEPR seminar on country studies (11-12 June 1993, Lund) and the Economic History Seminar at the University of Groningen. We are also grateful to Remco Kouwenhoven and Erik Monnikhof for statistical assistance.

Economic growth in the Netherlands 323 1 We take north-west Europe (which consists of Austria, Belgium, Denmark, Finland, France, Germany, the Netherlands, Norway, Sweden, Switzerland and the UK) rather than 'OECD Europe' as our reference group. It bears out more clearly the change in the relative performance of the Netherlands to countries in the same per-capita income league. 2 Derived from Maddison (1991: tables C.3 and C.4). 3 See Maddison (1991: table C.9). 4^ Estimates of unemployment rates are difficult to compare in an international perspective because countries use different methods, and frequently change their procedures. In order to maintain comparability between countries and over time, we followed Maddison in using 'the percentage of the labour force which was not in employment', which is also comparable to the estimates in the OECD Labour Force Statistics. However, recent CBS estimates show higher average unemployment rates for the Netherlands, i.e. 10 per cent between 1979 and 1988, and 14.2 per cent between 1929 and 1938 (den Bakker and van Sorge, 1991). 5 See Mason et al. (1992) for a study of the relationship between vocational training and productivity on the basis of plant comparisons between the Netherlands and the United Kingdom. On the basis of a cross-section comparison, O'Mahony (1992) also showed the significant contribution of differences in average skill levels of the workforce on the comparative productivity levels by industry in Germany and the United Kingdom. 6 The countries were Belgium, France, Germany, the Netherlands, Switzerland, Sweden and the UK. 7 See van Zanden and Griffiths (1989: 186). The downward adjustments were mainly made because damages to agrarian and industrial capital were not as large as the earlier findings suggested. If inventory losses were excluded, the percentage of war damage would be lowered to about 17 per cent. Maddison (1994) assumes Dutch war damage to have been 10 per cent of pre-1946 investment. 8 See Maddison (1995). The average annual compound growth rate of the eleven north-west European countries was 9.7 per cent a year between 1945 and 1950. The German growth rate relates to 1946-50 and was 17 per cent a year, which is also less than the Dutch growth rate. 9 If labour productivity had increased during the 1940s at an average rate of 2 per cent, the level of manufacturing productivity in 1953 would have been 40 per cent higher than the 1938 level, instead of equalling it (de Jong, 1993). 10 This was, in effect, the second 'postwar' devaluation. In 1944 the Dutch guilder was devalued by 30 per cent against the dollar. 11 In fact it is questionable whether the Netherlands was so typically a services economy during the first half of the twentieth century, as industrial expansion was quite strong during the interwar period and the industrial sector at that time already accounted for a fair share of total employment (van Zanden and Griffiths, 1989). 12 Dercksen (1986:151). Including utilities, the share of government investment in total investment amounted to more than 24 per cent. 13 On the institutional set-up and the functioning of this system, see Abert (1969) and Haas (1960). 14 The 1958 Act on Economic Competition allowed agreements to diminish competition, unless it was explicitly forbidden, which was a relatively permissive arrangement compared to the anti-trust legislation that prevailed in other European countries and the United States. In 1960 there were 875 officially registered collusive agreements in the Netherlands (Barendregt, 1991: 33).

324 Bart van Ark, Jakob de Haan and Herman J. de Jong 15 However, as pointed out by Maddison (1982), OECD figures for that period showed higher profits in the Netherlands than in other countries. 16 For a review of this literature, see Eckstein (1964), Mulvey and Trevitchick (1974) and Driehuis (1975). 17 Maddison (1991: table F7) shows that of the OECD countries only Belgium has a higher exports/GDP ratio than the Netherlands. 18 The Netherlands is one of the few OECD countries where employers need to seek prior administrative authorization before dismissing workers. Fixed-term contracts exist, but they automatically become permanent as soon as an employment relationship is extended beyond the term of thefirstfixed-term contract. This may be an explanation for the wide existence of Temporary Employment Agencies in the Netherlands. In 1991,1.9 per cent of workers had a temporary work assignment, which is more than in Belgium, Denmark, France, Germany or the United Kingdom. This form of labour contract is completely flexible, since either the worker or the employer can terminate the assignment at any time without notice. See OECD (1993) for further details. 19 Table 10.6 shows that the productivity performance of the 'other' part of the Dutch economy is also relatively high compared to other countries, but the reader is reminded that this residual estimate also includes the mining sector, in which Dutch productivity is very much higher than in the three neighbouring countries because of the large natural gas industry. 20 The average tax wedge is defined as the difference between pre-tax and after-tax income, while the marginal wedge is defined as the difference between a pre-tax and after-tax change in income. REFERENCES Aarts, L.J.M. and P.R. de Jong (1992) Economic Aspects of Disability Behaviour,

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O'Mahony, M. (1992) 'Productivity and human capital formation in UK and German manufacturing', NIESR Discussion Paper No. 28, London. Persson, T. and G. Tabellini (1992) 'Growth, distribution and polities', European Economic Review, 36, pp. 593-602.

Schaik, A. van (1986) Crisis en protectie onder Colijn, Amsterdam: Free University. Sturm, J.E. and J. de Haan (1995) 'Is public expenditure really productive? New evidence for the US and the Netherlands', Economic Modelling, 12, pp. 60-72. Theeuwes, J.J.M. (1988) 'Arbeid en belastingen', in Belastingen en Belastinghervor ming, Preadviezen van de Koninklijke Vereninging voor de Staathuishoudkunde, Leiden: Stenfert Kroese. Tinbergen, J. (1954) The significance of the Marshall Plan for the Netherlands economy', in Road to Recovery: The Marshall Plan, its Importance for the Netherlands and European Cooperation, The Hague: Ministry of Finance.

US Department of Labor (1992a) 'International comparisons of manufacturing productivity and unit labor cost trends, 1950-1991', Bureau of Labor Statistics, Washington, DC. (1992b)'International comparisons of hourly compensation costs for production workers in manufacturing, 1991', Bureau of Labor Statistics, Washington, DC. Wellink, A.H.E.M. (1987) 'De ontwikkeling in de jaren zeventig en tachtig en enkele daaruit te trekken lessen', in A. Knoester (ed.), Lessen uit het verleden, Leiden: Stenfert Kroese. (1989) 'Dutch monetary policy in an integrating Europe', in N. Bub, D. Duweudag and R. Richter (eds.), Geldwertsicherung und Wirtschaftsstabilitdt,

Frankfurt: Knapp. Wetenschappelijke Raad voor het Regeringsbeleid (1980) Plaats en toekomst van de Nederlandse industrie, The Hague: Staatsuitgeverij. Wolfe, B., Ph. de Jong, R. Haveman, V. Halberstadt and K. Goudswaard (1984) 'Income transfers and work effort: the United States and the Netherlands in the 1970s', Kyklos, 37, pp. 609-37. Wolff, P. de and W. Driehuis (1980) 'A description of post war economic

328

Bart van Ark, Jakob de Haan and Herman J. de Jong

developments and economic policy in the Netherlands', in R. Griffiths (ed.), The Economy and Politics of the Netherlands, The Hague: Nijhoff. Zanden, J.L. van and R.T. Griffiths (1989) Economische geschiedenis van Nederland in de 20e eeuw, Utrecht: Aula.

11

Portuguese postwar growth: a global approach JOAO L. CESAR DAS NEVES

1

Introduction

Portugal represents a unique reality in the postwar European economic scene. This is evident once you compare the Portuguese situation to the other European countries. A small, peripheral country, Portugal had started its industrialization process by the mid-twentieth century. The physical conditions and the time gap created many divergences with the common European economic story. Moreover, the evolution of the Portuguese political situation created a different social-political structure from mainstream Europe. This chapter attempts a simple and stylized picture of the Portuguese economic reality. The analysis is mainly based on the interpretation of the empirical data available. The economic facts and policies are presented only as a side element, their effects discussed by the results one can identify in the data. The chapter is divided into three main sections. In section 2, the institutional framework and the data are set out, along with some general trends. In section 3 a more detailed analysis of the period after 1945 is conducted. The period is divided into subperiods, and the description of the facts takes second place to the interpretation of the data. Section 4 deals with some special themes of Portuguese growth which arise in the discussion in previous sections. The effects of some institutional elements, external relations and human capital are briefly sketched. A brief conclusion finishes the chapter. The analytical framework which guides the analysis is the economic theory of the growth process, especially 'new growth theory'. This explains some of the options taken in the study, like the stress placed on institutional issues, external relations and education and human capital elements. 2

Postwar growth: the setting

The study of the postwar Portuguese economy is the study of Portuguese 'take-off'. During the postwar years, Portugal grew strongly and transformed its economy 329

330 Joao L. Cesar das Neves

into a modern industrial economy. The country was considered one of the best examples of'Golden Age' growth by international organizations.1 The main institutional element of Portuguese postwar structure was the regime derived from the 1926 revolution. This revolution generated the 'Estado Novo', a dictatorship which dominated the country for forty-eight years between 1926 and 1974. This fact is essential for an understanding of the Portuguese experience and also of the unique elements which were referred to in the introduction. In Portugal, the turbulent years of the 1930s and 1940s were ruled by the same political model and structural framework as the Golden Age of the 1950s and 1960s. This gave the Portuguese a strong sense of purpose and direction, but at the same time eliminated considerable flexibility and innovation. The influence of this strongly authoritarian but pragmatic regime, and especially of the man who embodied it, Professor Antonio de Oliveira Salazar, was very large in the history of the contemporaneous and subsequent periods. But there is a different historical influence, which came from a more remote period. Political instability and opposing doctrines dominated the country for most of the nineteenth century and the first decades of the twentieth. The two ghosts of authoritarianism and turmoil dominate Portuguese sociopolitical life. 2.1

The institutional legacy of the 1930s

The main legacy of the 1930s derives from the fact that the regime which was to rule the country from 1926 to 1974 defined its basic institutional structure during that time. Its political constitution, voted in 1933, and many of its fundamental economic laws date from this period. This was the structure which supported postwar growth; a brief reference must be made to it.2 The regime adopted the doctrine of 'corporatism' then in fashion. Social and professional groups were integrated into official organizations which were supposed to represent their interests inside the system. The unions and the employers' confederations were thus part of the formal state structure. This was supposed to avoid 'class struggle'. The organizations of both workers and employers were intended to work as lobbyists of the government. In fact this meant that they were controlled by the dictatorship, and used as instruments of its policy. In one respect, these 'corporatist institutions' had an important role. After some preliminary attempts, the regime had adopted by the mid-1930s a policy called 'industrial conditioning'. This was a licensing system, by which each new firm needed a government authorization to enter any market. An old firm also needed a licence to change installed capacity. The process of getting the necessary licence included consultation of the 'corporatist institutions' of the interested market. The real economic impact of such a system was different in different markets.3 Nevertheless, it is possible to say that, along with the rest of the 'corporatist system', the internal protectionism it imposed reduced the innovation and theflexibilityof the economy. As side effects, the corporatist system also helped the concentration and cartelization of the economy, and the creation of a few big industrial groups, which also had strong banking and financial connections. Through its involvement in a

Portuguese postwar growth

331

very centralized incomes policy, 'corporatism' also contributed to financial stability, through wage control. As a result of this structure, during the postwar years the country acquired a dual industrial structure. On one hand there were some light technological industries which had an export-oriented strategy and thrived mainly because of low wages. Textiles are the main example. The rest of the industrial sector was protected, both internally and externally, although this protection receded as time went by. In agriculture the structure was more or less the same, but it dated from a much earlier period. Traditionally, some products had strong international markets. Wines,4 cork, olive oil and wool were old Portuguese exports. Their producers were defenders of free trade and international integration of the Portuguese economy. One the other hand, the producers of the other agricultural products, mostly grain, were traditionally protectionist. The rural emphasis of Salazar's regime was shown in the 'wheat campaign', a strong effort, from 1929 to 1937, to promote grain production. As natural soil conditions were not very favourable to this effort, the real reasons for the campaign were political. It was a clear example of the self-sufficiency doctrine of the regime. The results of the campaign were not very important, but it became a symbol of future Portuguese agricultural policy. The fight between free-traders and protectionists, along with the fight between colonialists and Europeans and the fight between 'industrialists' and 'ruralists' were part of the narrow political equilibrium of the regime in the decades to come. All of these structural elements could be directly related to the legacy of the 1930s. Protectionism was also the main element of the Colonial Act of 1930. The attempt to reserve the market in the African colonies for industrial products of the mainland was tied to the effort to promote agriculture production in the colonies, which would provide Portugal with raw materials. Colonial preference (especially for cotton and sugar) was already reflected in the structure of customs duties. Planning was another element which, although still tentative, was to be an important line in future policy. Infrastructure promotion was to be the main element of Portuguese planning. By 1935, the government approved the first plan, a fifteen-year programme of public investments called the Economic Reconstitution Law. As was to be expected, considering the international situation, defence expenditure occupied half of the money available. Of the rest, agriculture (31 per cent), transport infrastructure (27 per cent) and telecommunications (9 per cent) were the most important sectors. The Capital Nationalization Law is also a very significant piece of legislation. It strongly limited and, in some cases, forbade foreign direct investment in certain sectors. Although it was a part of the general protectionist approach, the real significance of this law can be understood only if one takes into account the traditional strategic importance of some external investments. Foreign, mostly British capital dominated sectors such as 'port wine' exports and railways.5 The law thus had a strong political motivation. The institutional legacy of the 1930s was therefore mostly directed towards securing social peace and protecting productive activities. But the fact that Portugal was a small economy never allowed for the building of a real economic autarky. The

332 Joao L. Cesar das Neves Table 11.1. Average per-capita product of the world countries in relation to Portuguese per-capita product (PPP values) Average per-capita product (Y) relative to Portugal of:

1950 1960 1970 1980 1990

All world countries

Countries with Y values above P

EEC average

2.3 1.4 1.2 0.9 0.9°

2.8 2.4 2.2 1.9 2.1"

_ 2.7 2.1 1.9 1.9

1988.

dialectic between economic realism and protectionist doctrine was to evolve during the postwar years to create a strongly dual economy.

2.2

Main trends

The behaviour of the Portuguese economy follows a few simple lines after 1945. The country entered a clear 'take-off' after 1950, with two significant recessions, one in the mid-1970s and one in the mid-1980s. Real product was multiplied by a factor of seven from 1945 to 1992. This important growth achievement was also significant when compared with the behaviour of the world economy in the period. Taking Summers and Heston's (1991) world GDP sample, the ranking of the Portuguese economy may be used to characterize the 'convergence' process of Portugal. The main results of this comparative framework6 in the period 1950-88 are as follows: • Portugal in 1950 was in a roughly middle-ranking position. By 1985 it had attained a position two-thirds up the list. • The Portuguese trajectory occupies a region clearly below most of developed Europe and North America and clearly above sub-Saharan Africa and South Asia. • Portugal overtook most of Latin America and the Middle East during this period. The ratio of the average world per-capita products,7 presented in Table 11.1, to Portuguese per-capita product is a measure of the rate of convergence of Portugal. Figure 11.1 depicts the trajectory of Portuguese convergence, both in relation to the whole Summers and Heston sample and relative to the countries which, in each year, showed per-capita GDP above Portugal, and also in relation to the EEC average. There was a clear growth trend in the Portuguese economy up to the early 1970s. By then, Portugal had attained the level of the world average and was above half of the EEC average. Ever since 1974, Portugal has kept this relative level, fluctuating around it. Table 11.2 presents some preliminary results which characterize the growth process. It shows a 'growth accounting' exercise, highlighting the main elements of quantitative development.8 The period was divided into five phases.9

Portuguese postwar growth 333 z.o 2.6-

v

-

S

"

N ^

-

\ \

2.4 -

"

2.2 - \

^

-

" \

\ s Above

\

2.0-

/

\

*"

\ EEC'*

1.8 1.6 -

\ Total

1.41.2 1.0 0.81950

1955

1960

1965

1970

1975

1980

1985

1990

Figure 11.1 GDP per capita relative to Portugal, average, 1950-90 (total; above Portugal; EEC) Table 11.2. Growth accounting for phases: Portugal, 1952-91

gy gk gi gic gkc sres

1952-8 3.7759 3.2278 0.3311 0.1647 1.6221 1.9868

1959-65 6.1480 6.1913 0.0083 0.0097 3.1459 2.9918

1966-73 7.2375 7.0361 1.5876 0.8456 3.5002 2.8866

1974-9 3.4666 ' 4.4494 1.5954 0.9370 1.7940 0.7234

1980-91 2.4563 3.3075 1.5162 0.8190 1.5108 0.1188

Note: gy, gk, gl - growth rates of product (y), capital (k) and labour (/). glc9 gkc growth rates of the contributions of labour and capital, sres - Solow residual.

Total growth rates of product, labour and capital are presented, along with average productivity growth rates. Labour and capital contribution to growth are also calculated.10 The difference between total factor contribution and product growth is currently referred to as the Solow residual. It is used as a rough measure of the effects on the growth process of 'technology', taken in a very broad sense. This table highlights the subperiod from 1959 to 1973 as the 'Golden Age' of Portuguese growth. Capital productivity followed very closely the behaviour of total GDP and maintained the first place as an 'engine of growth'. Labour productivity is only significant after 1966 and maintains its role even after growth

334 Joao L. Cesar das Neves Table 11.3. Sources of output growth in Portugal, 1959-74

Final demand Exports Import substitution Final imports Intermediate imports Technical coefficient

1959-64

1964-70

1970-4

85.1 17.2 0.9 2.0 -1.1 -3.2

70.8 20.8 0.7 -0.8 1.5 7.7

94.2 22.5 -11.3 -6.6 -4.7 -5.4

Source: Cravinho (1982). reduction in the mid-1970s. The Solow residual was very important in the initial period and through the Golden Age, being reduced after 1974. Another approach to characterize growth can be seen in Table 11.3. For the Golden Age of Portuguese growth (1959-1974), Cravinho (1982), in one of the few studies of Portuguese sources of output growth, identifies the role of several factors. Using a simple calculation with input-output matrices, the total growth rate is decomposed into several elements. The role of internal demand was always dominant, even if Portugal is considered a small open economy. Nevertheless, exports had an important and slightly rising role. Import substitution, which was never significant, shows a large drop in the last subperiod. Other elements of the economic picture must also be assessed in the main trends. Nominal stability was very important in the period after the war. From 1947 to 1973 the average inflation rate was 3 per cent. After 1973 this situation changed, with average inflation from 1973 to 1992 above 18 per cent. Sectorial restructuring of the Portuguese economy in the last fifty years was very strong. The reduction in the share of agriculture was a constant from 1890 onwards, but accelerated after 1950. The share of product in agriculture was above 38 per cent in the immediate postwar years and is below 12 per cent today. Industry and services shared the increase. There is a clear industrialization surge after 1930. The services sector has taken the lead after 1970. There was also a global trend towards the opening of the economy. After a bout of closing in the 1920s, the general movement was resumed in the 1950s, but especially after 1970. The degree of openness of the economy has been accelerating since the mid-nineteenth century, on both the import and the export side, although with a larger variation in imports. Public finances were under control until 1974, with public debt and deficits manageable. The late 1970s and the 1980s had a large impact on public finances, unbalancing the trajectories. From the early 1980s onwards public debt rose above 60 per cent of GDP. The general pattern of Portuguese postwar (1952-91) business cycles is described in Correia et a/. (1992). Neves (1994) divides the period 1952-91 into two subperiods, thus isolating the Golden Age from the following period. According to these works, the Portuguese business cycle conformed with the general patterns of the literature.11 The main difference is an increased volatility in

Portuguese postwar growth

335

all the real variables in Portugal, which was more than double the average volatility in the OECD countries. This is explained both by the relative backwardness of the Portuguese economy12 and by the specific shocks in the postwar period. The main elements of the general pattern of business cycles are maintained in both periods. The volatility of all nominal variables is greater than output. Volatility is greater in the Golden Age for GDP, public consumption, exports, employment and capital stock. The other variables, especially investment, increased in volatility after the Golden Age. Most of the real variables are pro-cyclical and most of the nominal variables are counter-cyclical (so much for the Phillips curve!) in both periods. All other statistics of the cycle are in line with the cross-country evidence. Not surprisingly, Portuguese fluctuations seem to be closest in pattern to those of other small open economies, such as Switzerland and Canada, and to those of other European economies, such as the UK, Germany and Italy. In short, this is the broad picture of the economic evolution of Portugal in the last century and a half: a small open country which only started 'modern economic growth' during the Golden Age of the 1950s and 1960s, changing then from an old rural economy to a modern structure. This was done without large financial instability and with a clear option for openness. 3

Postwar growth: the phases

To study postwar growth, the period is divided into several phases, and general data characterizing each of the phases are analysed. The classification13 considers five periods, depicted in Figure 11.2: • The first is the period immediately after the war, from 1946 to 1958. The stabilization of the economy after the war shocks and the preparation for the big industrial surge were the main tasks. • From 1958 to 1965 the country entered the first part of the Golden Age. Growth and structural transformation were at a strong pace, along with internationalization. Colonial war started. • The second part of the Golden Age, from 1966 to 1973, registered the larger growth rates, but also made clear the limits of the institutions to support this strong transformation. • 1974 to 1979 was the revolutionary phase. To add to the international economic turmoil, internal institutional and political transformation created a modern democratic regime. • The last period, after 1980, suffered all the problems and advantages of the world economy in the 1980s. After the revolution, both the economy and the institutions were stabilized. An important recession occupied the early 1980s, but after 1986 the joining of the EEC started a strong restructuring period, which is still in progress. 3.1

Basic data

Data for each of these subperiods are shown in Tables 11.4 to 11.8. Table 11.4 shows the data on growth and political stability. The average annual growth rate and its

336 Joao L. Cesar das Neves 7.2-j 7.06.86.66.46.2Log per-capita output HPtrend

6.05.8 A 5.65.45.2 1945

I 1950

1955

1960

1965

1970

1975

I 1980

1985

1990

Figure 11.2 Log per-capita output, HP trend and subperiods, 1945-91

standard deviation are presented, along with a measure of the business cycle (the standard deviation of per-capita GDP, detrended with the Hodrick-Prescott (HP) filter)14 and the unemployment rate, this last only after 1960. Political instability is measured by the number of new governments per year. The inflation rate as measured by a production price index, the GDP deflator, is also presented. Table 11.5 presents data on the evolution of the size of exports and imports and some main external balances. The escudo devaluation, both against the British pound (£) and the US dollar (US$) is shown in Table 11.6. By deflating the nominal rate with price indicators of the countries involved,15 it is possible to have a measure of the real devaluation. Data in Table 11.7 present the public debt trajectory. The shares of demand components are registered in Table 11.8 for the end years of the subperiods. These tables try to provide a clear and global picture of Portuguese postwar growth. The next sections attempt an interpretation of the data in connection with the institutions and policy options involved. 3.2

Reconstruction of stability, 1946-58

For a small and open neutral country, the war created some important economic problems. The country, in spite of having stayed out of the war, entered a recession after 1942, which was accompanied by inflationary problems (an inflation rate of 17.7 per cent in 1942, and 10.6 per cent in 1943). A very similar picture had emerged in World War I, but then with deeper and more serious consequences.16

Portuguese postwar growth

337

Table 11.4. Growth, unemployment and political instability in Portugal, 1946-91 Business GDP growth rate cycle std deviation (%) 1946-58 1959-65 1966-73 1974-9 1980-91

0.0237 0.0069 0.0511 0.0435 0.0357

4.1196 6.2220 7.4930 3.3922 2.7552

Unemployment rate (%)

No. of governments

— 2.1472° 1.8327 6.1136 8.0516

0.0000 0.0000 0.1250 2.0000 0.5833

GDP deflator growth rate 1.8045 1.8816 4.9511 19.2676 17.5151

1

1960-5.

Table 11.5. Portuguese external relations, 1948-91 (%) Shares in G D P (Y) 1948-58 1959-65 1966-73 1974-9 1980-91 a

Exports/ Y Imports/ Y

Trade balance

Transfers account

Current account

Capital account 0

17.1365 19.6867 23.5407 20.7052 32.2799

-4.498 -6.120 -5.428 -13.025 -10.343

2.615 3.567 7.474 8.002 10.334

-0.053 -2.309 2.591 -5.399 -2.944

0.119 0.889 0.545 1.686 5.145

21.6344 25.8069 28.9682 33.7299 42.6228

Medium- and long-term capital entries.

Table 11.6. Portuguese exchange rates, 1946-91 (%)

1946-58 1959-65 1966-73 1974^9 1980-91

Nominal devaluation

Real devaluation

esc./£

esc./US$

esc./£

esc./US$

-1.6035 -0.0718 -3.6252 9.9018 7.5860

1.1640 -0.0005 -2.0355 12.5893 9.2572

1.5089 0.4351 -4.4536 2.5811 -0.4563

3.2660 -0.9580 -4.4221 -1.5188 -0.9043

As war restrictions ended with the conflict, imports were possible again. The government decided to use the reserves accumulated during the war (1941 to 1943 were the only years after 1833 where a positive trade balance was recorded) to ease the situation and especially to influence the price level. Imports in real terms rose by 52.4 per cent in 1946 and 34.3 per cent in 1947. The effect of this supply shock on the price level is shown by the inflation rate. This indicator fell from 11.2 per cent in 1946 to 2.5 per cent in 1947 and to -1.2 per cent in 1948, and it stayed at a low level thereafter. For the whole period 1946-58, product inflation was 1.8 per cent a year and consumer prices rose 0.6 per cent every year.

338 Joao L. Cesar das Neves Table 11.7. Portuguese government debt, 1946-91 (%) Shares in GDP

1946-58 1959-65 1966-73 1974-9 1980-91

Public debt/r

External public debt/r

23.9823 24.6900 21.6513 27.8217 60.8658

1.7154 5.1500 5.6663 5.9883 14.5900

Table 11.8. Portuguese demand shares, 1952-90 (%) M 1952 1958 1965 1973 1979 1985 1990

77.92 75.86 72.93 69.33 67.47 64.15 67.91

7.36 7.70 9.51 10.83 14.99 16.58 16.79

18.57 21.34 25.79 32.84 26.73 21.97 28.37

15.36 15.98 20.42 25.63 24.55 32.41 43.20

19.21 20.88 28.64 38.63 33.75 31.86 56.27

Note: C = consumption, G = government expenditure, / = investment, X = exports and M = imports.

The government's attitude revealed, once again, the priority given by the regime to nominal stability. This had been its initial purpose and its great success in the late 1920s, when it took power. But this priority was about to change. In the postwar years a new political priority was adopted. After the emphasis on stability in the 1930s, 'progress' was to become the key word of the regime. The country had suffered considerably from external dependence during the war. This had shown the strong need for industrialization. And the international climate could not have been more favourable. The Golden Age of world growth was about to start, and Portugal was to enter it with full commitment. In 1945 the government presented the Law of Industrial Fomentation and Reorganization, which was to define the priorities of growth policy. The law defined a protectionist and import substitution philosophy, with priority given to manufacturing industry. This corporatist approach allowed the government to impose concentration in some sectors and to promote directly some 'basic industries'. The / Piano de Fomento or First Fomentation Plan was to be the start of a series of policy instruments which were to guide growth for the next twenty years. This one referred to the period 1953-8. It began as a public programme, with no general guidelines for the rest of the economy, but this was going to change as time went by. Most of the funds for the six years17 were directed towards investment in infrastructure. Electricity (41.2 per cent) and transport and communications (26.8

Portuguese postwar growth

339

per cent) were the two sectors with the biggest shares. Basic industries (18.5 per cent) and agriculture (10.8 per cent) followed. 'Industrial conditioning' rules were changed in 1952. Along with an effort to speed up the bureaucratic process, the philosophy of the system tried to emphasize technical questions and reduce political intervention. In particular, the purpose of the regulation was to assure that minimum technical size was achieved in every new productive unit. This eased somewhat the restrictions and the discretionary powers of the law over industry. As a result, the period from 1946 to 1958 was a growing phase, preparing for the big surge of the 1960s. Total GDP grew by more than 4 per cent, but still with a high standard deviation (2.3 per cent). Detrended GDP also shows a large standard deviation (2.4 per cent). The shares of the sectors were already showing an important transformation. The agriculture share dropped from 41 per cent of GDP in 1938 to 31 per cent of GDP in 1958, while the industry and services sectors occupied the difference. Demand structure, after the influence of the war, kept a general stability. The only real difference is the rise in investment from 18.6 to 21 per cent of GDP from 1952 to 1958, accompanied by a fall in consumption to 76 per cent. The general strategy of the exchange rate policy was very clear. Portugal joined the Bretton Woods system only in 1960, but enjoyed nominal exchange rate stability from the early 1950s. Strong trade growth is connected with an important real devaluation, especially against the dollar (3.3 per cent a year). Public finance was kept under control, with a deficit below 1 per cent of GDP and public debt around 24 per cent. External debt was almost all paid. Monetary growth was moderate (3.6 per cent) considering the real growth achieved. 3.3

A two-phased Golden Age: 1959-65 and 1966-73

From 1959 to 1973 most of the new structure of the Portuguese economy was created. Product almost trebled in these years. Agriculture, which contributed 34 per cent of GDP and occupied 43 per cent of the population in 1958, was down to 16 per cent of total product and 34 per cent of population by 1973. Openness to external trade (imports + exports) rose from 41 to 56 per cent of GDP. The institutional structure was kept more or less the same during the whole period. In simple terms, one can say that the 'industrialists' and 'free-traders' had the upper hand, but the presence of 'ruralist', protectionist and colonialist lobbies was very clear. The sickness (1968) and death (1970) of Salazar had no immediate effect on the regime. The effort to liberalize the internal political system by his successor, Marcello Caetano, failed. Three economic plans were applied during the period from 1959 to 1973. They evolve from a mere catalogue of public investments to a more global and integrated approach. The data involved and the options taken by these plans are presented in Table 11.9.18 As time went by, the options structure of the plans became clear. The emphasis was on industry, the (regulated) private sector and external relations. In the Second Plan, it is clearly stated that agriculture is seen mainly as a means of support to industry. Foreign capital and cooperation with foreign firms were more and more

340 Joao L. C6sar das Neves Table 11.9. The Pianos de Fomento

Total investment (109 esc.) % GDP of first year" % GFCF of first year0 Percentage applied in: Agriculture, fishing Industry Energy Transport and communications Teaching, research Tourism Health Housing a

1st Plan (1953-8)

2nd Plan (1958-64)

Intercalary Plan (1965-7)

3rd Plan (1968-73)

7.6 15.2 93.4

21 33.3 180.8

35.5 64.4 315.4

122.2 83.4 366.1

17.0 11.6 34.6

17.3 27.4 21.4

8.0 43.0 16.0

15.1 25.2 14.7

32.1 2.1 _ -

30.8 3.0

18.0 2.5 2.8 1.0 5.4

22.2 4.6 9.7 1.9 6.6

-

The values for the Intercalary Plan were doubled, due to the halving of its period.

accepted, and were even promoted by the last two Pianos de Fomento. Another important element is the inclusion of 'social aspects' in the investment plans. From 1965 onwards, the plans considered elements like 'housing' and 'health' as important to economic progress. 'Technical education' had been present from the start in the development framework, although receiving a small percentage. All these aspects show a reduced, but clear awareness of the 'human capital element' in the growth process. This internationalization was at the same time being promoted through other means. Portugal had been a founding member of the OECD* in 1948. In 1960 it joined the World Bank and the IMF, and in 1962 it joined GATT. But, most important of all, Portugal was a founding member of EFT A in 1960. Enjoying a special statute (under annexe G of the Stockholm Convention), Portugal gained considerably from the lowering of foreign trade barriers. However, the fact that the special situation allowed protection in some sectors perpetuated old vices in some parts of the economy. Nevertheless, its participation in EFTA was an important contribution to the general development process of the country. An event with great political implications but relatively small economic impact was the start of colonial war in early 1960 in Guinea, Angola and Mozambique. With a large effect on both the internal and external image of the regime, the war had its foremost economic impact on the public deficit, which was nevertheless under control by the mid-1960s. These two subperiods had the greatest effect upon growth. Yearly rates above 6 and 7 per cent respectively for a total of fifteen years were enough to have a strong impact on economic welfare. Of these growth rates, capital accounted for around 50 per cent. Technology, which accounted for 49 per cent in the first period, leaving no role for labour, dropped to 40 per cent in the second, allowing labour a small place. Unemployment was kept around or below 2 per cent.

Portuguese postwar growth

341

Exports and imports continued to accompany growth. In the latter phase, both grew by nearly 10 per cent. Customs duties dropped once more. In the latter period they were around 8 per cent of the cost of total imports. The current account was positive during the second part of the Golden Age. The main cause was income transfers from emigrants, which caused a balance in transfers of 3.6 per cent from 1959 to 1965 (above the current account deficit) and a remarkable 7.5 per cent of GDP in the latter period. At 4 per cent of GDP, medium- and long-term capital entries were at last significant after 1966. Nevertheless, direct foreign investment was still minimal. Emigration is significant during the whole period, but it accelerates in the second subperiod. From 1966 to 1973 an average of almost 2 per cent of the total population emigrated each year. The sectorial structure was strongly modified during the Golden Age. Agriculture continued its secular fall. Industry gained a bigger share, along with public utilities (electricity, gas and water) and building and construction. The sum of these three industrial sectors was 42 per cent of GDP, 43 per cent of total capital and 34 per cent of total employment by 1973. The share of services decreased during the first part of the industrialization effort, only increasing its share of employment. But its recovery started soon afterwards. Capital keptfirstplace as growth engine in every sector,19 except agriculture from 1959 to 1965, which was dominated by technological progress measured by the residual. Solow residuals were very important in every sector (except in agriculture from 1966 to 1973, which was negative). Industry and services thus had a general pattern which is very similar. Agriculture started growing and therefore changed its growth pattern. The development wasfinancedby the state and by a few big banks, owned by a few big economic groups. This fact, along with nominal stabilization, generated a fixed and low interest rate throughout the period. The discount rate of the Bank of Portugal was 2 per cent from 1944 to 1965 and 2.5 per cent from 1965 to 1970. Thus, an important element in Portuguese 'take-off' was cheap capital. This created a relative price situation favourable to capital-intensive technologies. It is clear that only emigration and military enrolment for colonial war prevented unemployment from rising. The exchange rate policy created an important appreciation of the escudo in nominal terms. After 1966 the escudo was also revalued by more than 4 per cent a year in real terms against both the pound and the dollar. Public finance suffered a big shock from the colonial war, which lasted until the mid-1970s. The public deficit rose to 2 per cent of GDP in the first subperiod. But there was a strong effort to control this deficit, and it was reduced back below 1 per cent in the second part of the 1960s. Public debt, which had risen slightly, even fell below the level of the immediate postwar years. Nevertheless, the rise in public external debt in the early 1960s, from 1 per cent to 5 per cent, was never reduced again. Inflation, which was very low and stable for the first phase, rose as time went by. The early 1970s already showed a worrisome financial instability. Money indicators show a clear acceleration during the period. Money velocity was, nevertheless, kept almost fixed, while banking intermediating gained an increased role with a money multiplier around 3.5.

342 Joao L. Cesar das Neves

Income shares were almost the same for wages and profits, with wages slightly below 50 per cent. This is a strange situation if compared with the traditional 60:40 split, favourable to wages, in developed economies. In personal disposable income (PDI), emigrant remittances contributed an average of 8 per cent, while taxes were still very low, around 5 per cent of PDI. Demand structure was also very much influenced by the growth process. Consumption, which represented 76 per cent of GDP in 1958, entered a long fall which lasted until the mid-1980s. By 1965 it already represented only 73 per cent, and by 1973 it had fallen to 69 per cent. Most of this fall was related to an increase in investment share, which rose from 21 per cent in 1958 to 33 per cent in 1973. Government consumption was also increased, by 3 percentage points to 11 per cent. By 1973 , after a few years with growth rates above 10 per cent, GDP had more than quadrupled since 1958. 3.4

Shocks, stagnation and inflation, 1974-9

The 'carnations revolution' of April 1974 was the peaceful downfall of a 48-year-old regime. A new parliamentarian and democratic system followed. Political confusion lasted for a couple of years, but the new institutions were in place soon after. The situation was never comparable to the turmoil earlier in the century. By 1976 a new constitution was in place, thefirstone after the 1933 'Estado Novo' constitution. The new constitution had many principles of a collectivist nature, and strong communist influences. A large part of the productive sector was nationalized in 1975. In particular, all the financial sector became state run. At the same time, as wage increases were forced by law and prices were frozen, most of the private sector was close to bankruptcy. The way to ease the situation was to turn to the cheap credit offered by the public banks, which thus acquired control of much of the productive sector. This could be seen as an indirect nationalization of the economy. In agriculture, the lands were directly occupied for political purposes. These occupations, along with some serious measures to solve age-old problems in rural structure, were the themes of the 'agrarian reform' initiated in 1975. The long process of eliminating the effects of the revolution on property and production started after 1976. After the turmoil years of 1974-5, the actual policies were much more market oriented than constitutional principles suggested. Nominal exchange rates were kept fixed from 1974 to 1976 in spite of the confusion on world markets. Public deficits soared to 9 per cent of GDP in 1976. The external accounts situation of the country deteriorated very quickly. The current account deficit rose from 2.7 per cent in 1973 to 7.4 per cent in 1976, while the trade deficit was 13.6 per cent of GDP in 1976, against 7 per cent in 1973. To add to these problems, the decolonization of the African territories brought to Portugal almost half a million people from 1973 to 1976, a rise in total population of 5.6 per cent in three years. This is the only period of the twentieth century when a significant net immigration was registered in the country. An average of 1 per cent of the population entered the country during each of the seventeen years from 1974 to 1990. Debt crisis created the need to make a lending agreement with the International

Portuguese postwar growth

343

Monetary Fund, the first in Portuguese history. The classical stabilization plan, which included strong monetary and budget control and devaluation of the currency, worked very well. By 1979 the current account had a deficit of just 0.2 per cent. But the squeeze had been done mostly in the private sector, as the public deficit was kept around 10 per cent. Public debt rose from 18.2 per cent of GDP in 1973 to 35.6 per cent in 1978. The next year witnessed a debt reduction to 24.5 per cent in 1979, but afterwards the rising trend was resumed, up to 75 per cent in 1988. For this reason, among others, inflation never came down to the levels before the revolution. Inflation, which kept artificially low during the turmoil (16 per cent in 1975-6) rose to more than 26 per cent in 1977, stabilizing around 19 per cent in 1979-81. Inflation in the period 1974-9 rose to an average of 19 per cent on producers' prices and 24 per cent on consumer prices. The facts concerning the real results of the period were clear. After the revolution, the growth rate dropped to a still very considerable 3.4 per cent average between 1974 and 1979. But volatility was increased to a very high level. Unemployment at above 6 per cent and political instability, with an average of two governments a year for the six years, were also important elements. Export and, especially, import growth rates fell steeply. They grew at 2 and 0.4 per cent respectively. Foreign protection as measured by custom duties fell once again, to 5 per cent of imports. The current account balance dropped to a dangerous deficit of 5 per cent of GDP, in spite of an extraordinary positive balance in the transfers account, over 8 per cent of GDP. This value was attained in a period when emigration was reversed. The phenomenon of net immigration in a traditionally emigrating country is somewhat strange. It is important to note that it had also happened after the 1926 revolution. But the real cause of such a dramatic change was now the referred return of people from the ex-colonies. External capital was an important element of the economy. Middle- and long-term capital entries represented almost 5 per cent of GDP. But, once again, this was directed mainly to public consumption. Direct foreign investment continued to be negligible. The sectorial structure continued its change during the period, the main difference being the stagnation in industrial share and the fall in construction. The strong nominal devaluation of the escudo, after IMF intervention (an average of 10 per cent a year against the pound and 12.6 per cent against the dollar), was eroded by inflation. This even created a real appreciation against the dollar of 1.5 per cent a year, while there was a 2.6 per cent depreciation against the pound. Portugal adopted a 'crawling-peg' in 1977, which is one of the best examples of success of this regime in the world. It was maintained, with small changes, until the early 1990s. The revolution created a big boost in fiscal expenditures, which rose by 12 per cent on average every year. Revenue also rose considerably (4.6 per cent a year), but only maintained its share of GDP. The rise in expenditures created a significant deficit of 7 per cent of GDP. The share of external public debt on GDP was kept fixed, while internal debt rose 5 percentage points, to 27 per cent of GDP. Monetary policy was eased, and the monetary base rose by 21 per cent a year on

344 Joao L. Cesar das Neves

average. Money indicators (Ml and M2) nevertheless kept their growth rates. This caused both a constant multiplier and a doubling of money velocity. The most spectacular effect of the revolution was in income shares. The 60:40 partition was achieved in a few years. Wages gained a full 10 percentage points of national income. This is possibly the clearest sign of the effects of the institutional changes of the revolution. In private disposable income, the most important change was the doubling of the share of internal transfers, as social security changed its role and influence. The rises in both unemployment and unemployment benefits were also important elements. The fall in emigration had no impact on the size of external transfers, which actually rose to 8.3 per cent of disposable income. Consumption share continued to fall, to 67.5 per cent in 1979. Investment, eroded by political instability, reduced its share by 6 percentage points from 1973 to 1979. Government consumption swallowed most of the difference, rising to a remarkable 15 per cent of GDP. 5.5

The eighties, the EEC and the new Golden Age, 1980-91

The easing up of stringent measures, as external balance was achieved in the late 1970s, had some important consequences. The decision to expand the economy while the whole world was suffering from the second oil shock had disastrous effects on the recent and fragile external equilibrium. By 1983 external problems were again acute and a new IMF stabilization programme was in place, creating a new recession in 1983-5. But the most important element of the 1980s was entry into the EEC, along with Spain in 1986. The opening up of the sectors untouched by early liberalizations and the deepening of European integration were, and still are, crucial elements in Portuguese growth. One may talk about the start of a second Golden Age for the Portuguese economy after 1986. The fact that full political stability was achieved in 1986 is also very important. That year saw thefirstone-party majority since the revolution and the beginning of the government of Cavaco Silva, which was to be the longest democratic government of the last two centuries. In 1982 and 1989, revisions of the 1976 constitution eliminated most of the collectivist principles. In particular, private banking and insurance were once again allowed in 1982. A privatization programme, according to the European fashion of the period, started in 1989 and is still under way. The 1980s were a time for consolidating the institutional changes of the democratic regime and for stabilizing society. The growth rate (2.8 per cent) was lower than the one in the revolutionary period, but there was also a smaller volatility. Nevertheless, this average rate hides two very different periods. The first six years (1980-5) had a rate of less than 1 per cent, while after 1985 the average rate was above 4 per cent. This cycle can be seen in many other variables. Unemployment increased its average level to 8 per cent. Nominal problems were also present. Inflation was now smaller but more volatile than in the 1970s. It rose in the first part of the 1980s and declined after that. The growth rate of foreign trade was even higher than the spectacular rates of previous periods. Exports rose to a share of 32 per cent of GDP, while imports

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345

gained 10 percentage points, to 42 per cent of GDP. Total openness of the country (exports + imports)/GDP - was 73 per cent in 1991. Protectionism was almost non-existent on average terms, with import taxes representing only 1.6 per cent of total imports. The trade balance was on average 10 per cent of GDP, but the current account deficit fell to 2 per cent of GDP a year. Capital movements were liberalized in this last period. Foreign direct investment was, at last, an important element of the Portuguese economy. The average of 1.6 per cent of GDP for the whole period hides a strong rising trend which achieved 4.6 per cent in 1991. In this last period, sectorial transformation continued its secular path. Industry share stagnated, along with that of construction, but industrial capital share fell. In real terms, the escudo was revalued (0.45 per cent a year to the pound and 0.9 per cent to the dollar). In 1992 Portugal joined the Exchange Rate Mechanism of the European Monetary System (EMS). This mechanism replaced the crawling-peg regime which had been used since the mid-1970s, and created a new era of exchange rate policy for Portugal. On average, public finance was less controlled, but the two halves of the 1980s witnessed very different behaviours. Nevertheless control was lost on public debt, which rose to 60 per cent from the 27 per cent level of the revolutionary period. External public debt more than doubled to 14.6 per cent. The most important point was, nevertheless, that public sector weight in the economy was dramatically increased. The share of public expenditure in GDP had been on a rising trend throughout the century. But in the 1980s government absorbed the means to spend 31.4 per cent of GDP on average. This is a dramatic jump from the 23.3 per cent of the second part of the 1970s. Money growth was increased substantially, and money velocity rose to 3.4, a level comparable only to thefirstpart of the century. The weight of banking intermediating was increased once more. The jump in factor income distribution which was registered in the 1970s was somewhat reversed during the 1980s. The wage share fell 6 percentage points to 54 per cent, a level which was maintained through to 1991. Both internal and external transfers increased their weight in personal disposable income. The first fact, along with the rise in importance of direct taxes, is a sign of convergence towards the pattern of more developed economies. Demand structure was much influenced by the economic cycle of the 1980s. In the depth of the 1985 recession, consumption was at a secular low of 64 per cent of product, while investment had fallen once again to a share of just 21 per cent. Public consumption had managed to increase from the very high point of 15 per cent in 1979 to almost 16.6 per cent. But 1991 things were more or less back to normal. Investment had recovered to a more comfortable 28 per cent of GDP, and consumption was back to its (low) 1979 level of 68 per cent. But government consumption, on a rising trend, had gained a few percentage points. The liberalization of the foreign goods, services and capital markets, inside the EEC '1993 programme', is one of the most important elements which creates the possibility of a new Golden Age in the 1990s. Exchange rate stability inside the EMS and the development-of a modern financial sector are also relevant

346 Joao L. Cesar das Neves factors. Development levels and the productive structure are witnessing strong changes.

4

Some particular themes

From the discussion in the previous sections, it is possible to isolate some elements which could be considered the 'idiosyncratic' themes of the Portuguese growth process. This section will attempt a brief characterization of these elements and a preliminary assessment of their influence on the growth process. 4.1

Institutions and policies

Thefirstspecific item of Portuguese postwar growth is the institutional framework. During most of the period (until 1974), and particularly during all of the Golden Age, the country was under a dictatorship. This dictatorship took a very interventionist attitude, with 'industrial conditioning' and discretionary protectionist measures. As a result, the country was always under the influence of a paternalistic state, whose share of GDP increased continuously. Was this an 'economically benevolent dictatorship'? The evidence is mixed, but large negative effects from the authoritarian regime can be identified. As was said above, the impact of the economic policy of the regime was very strong. Some elements must be considered positive. The social and political peace and nominal and financial stability which the regime promoted, especially when compared with previous periods, were very important for the creation of an environment favourable to growth. Also the stress placed on infrastructure created some positive production shocks through the economic system. At the same time, the strong regulation and the increasing size of the government sector proved to be a paralysing and suffocating influence, especially in the final stages of the Golden Age. In the 1930s and during the war, the pacification of the country after decades of social-economic turmoil, and the lack of experienced entrepreneurs, may be seen as justifications for the intervention. During this period, when most of the damaging distortions were still not very prominent, there is reason to consider that the intervention was beneficial to growth. In a second period, in the 1950s and early 1960s, the 'industrialist' drive of the government and the effect of international liberalization (EFTA) promoted the modernization of some enterprises, although in a controlled fashion. As in every other interventionist process, one can identify wise decisions and big blunders. By the late 1960s there was a growing sense of the obsolescence of the regime. Most of the rules and regulations had fostered large distortions. Some of the entrepreneurs were by now used to rent seeking, and the most dynamic ones resented intervention. The economic and (mostly) political burden of the colonial war only added to this decaying picture. It is possible to speak of an 'exhaustion' of the economic model.20 The sudden regime change in 1974 created important shocks which disturbed the second half of the 1970s. The newly found freedom of initiative for entrepreneurs was limited by a fresh interventionist attitude. The attempt to create a socialist

Portuguese postwar growth

347

economy in 1974-5 failed in the end, but succeeded in damaging some of the structure inherited from the Golden Age. By 1986, with a stable democracy and receding intervention, the entry into the EEC created a new impulse for growth. Infrastructure improvements paralleled the increases in competition, both external and internal. The coming years will determine if Portugal is able to make the final jump towards a 'western-style' economy. One of the most important results of this general policy was the 'dualistic' structure noted above. Some subsectors, in both manufacturing and agriculture, were strongly integrated into international markets, taking a competitive attitude. The 'industrial conditioning' also applied to them, but with a smaller impact due to external competition. At the same time, other subsectors were shielded from competition, both internal (through regulation and 'conditioning') and external (through tariffs and quotas). This is one of the most important reasons for studying the impact of external relations. 4.2

External relations

Portugal is a small open economy. This made economic openness a constant and very important element throughout the Portuguese economy. Portuguese history, strongly tied to the discoveries of the fifteenth and sixteenth centuries, and the colonial empire which derived from them, only underlined this aspect. Portuguese economic foreign relations have several important elements. Trade, emigration, capital flows and monetary aspects are among the most important. General trends in all these areas were noted in earlier sections. In particular, the strong impact of the behaviour of exports and imports, emigration and the exchange rate was indicated. The reduced influence of external capital on growth in the early postwar years was also observed. This section will deal with two special aspects of external relations. Thefirstis the structure of foreign trade, a central element in Portuguese growth. The second is the emigration phenomenon. The other aspects, monetary elements and the (small) role of capital flows in the balance of payments, have already been referred to. Tables 11.10 to 11.13 show a brief sketch of the Portuguese foreign trade structure. Portuguese imports and exports are ventilated through types of traded products and trading partners. A few interesting elements should be noted in this area. Discussing the distribution of trade across sectors, one should stress the fact that 1965 seems to be the turning point of the structure. After 1965 there is a strong fall in the exports of primary products and foodstuffs. A type of primary product which kept its importance is cork, included in sector 5. From 1965 onwards, textiles, clothing and footwear dominate Portuguese exports. This shows clearly that Portuguese exports, during the 1950s and early 1960s, changed from an agricultural base (wines, olive oil, cork, etc.) to light industry. Lately, machinery and transport equipment have gathered some strength. 1979 is the exception in a clear rising trend. This means that the new Golden Age of the 1990s, if it materializes, could bring a change into higher-technology industry. Imports show an earlier dependence on primary products, which was eroded in later years (except for 1979 and 1985, where the crisis reignited the need for primary

348

Joao L. Cesar das Neves

Table 11.10. Portuguese exports by sector, 1938-90 (% of total exports) Sector

1938 1947 1952 1958 1965 1973 1979 1984 1990

1 Farm produce 1 98 , 97 R 2Minerals and metals f 2 8 6 2 7 ' 8 J 3 Foodstuffs 51.8 30.4 4 Textiles, cloth and footwear 10.4 19.3 5 Hides, wood, cork and paper 6 Chemicals 7 Machinery \ 8 Transport equipment J 9 Miscellaneous 8.4 20.9

_,,

9_^ 25 6

4.8 8.6 21.6

3.5 6.1 15.4

2.5 10.4 11.3

1.7 9.5 9.6

2.3 9.4 5.0

14.8 15.7 25.8

29.9

32.8

32.9

37.5

18.0 6.8 3.0 0.4 11.0

15.4 5.4 10.8 2.4 11.3

16.7 5.6 8.3 3.8 8.5

14.9 6.7 12.4 4.7 7.6

12.7 3.9 12.9 6.8 9.5

366

' 28.7 31.9

-

17.2 23.1

Table 11.11. Portuguese imports by sector, 1938-90 (% of total imports) Sector

1938 1947 1952 1958 1965 1973 1979 1984 1990

1 Farm produce j 4 ? 2 4 Q 6 5Q 6 -Q1 11.2 11.5 13.1 15.1 8.5 2 Minerals and metals j 4 Ll 4 U 0 ^ ™A 20.8 15.7 28.6 35.6 17.9 3 Foodstuffs 17.7 23.7 11.8 9.2 5.8 5.6 3.7 3.3 2.3 4 Textiles, cloth and footwear 4.6 3.7 2.6 2.8 15.5 12.5 7.5 7.9 10.8 5 Hides, wood, cork 5.5 and paper 3.2 3.7 3.6 3.0 7.2 6 Chemicals 8.0 9.2 8.5 7.4 17.6 18.8 16.7 13.1 22.7 7 Machinery 1 7.2 14.2 8 Transport equipment j 9.2 12.7 9.0 9 Miscellaneous 13.9 9.8 9.6 9.7 9.7 11.4 8.9 6.7 9.8 Note: Before 1965, sectors 1 and 2 and part of 5 are considered together under the heading 'live animals and raw materials'. Sectors 7 and 8 are also added together before 1965. imports). A strong rise in machinery imports can be associated with the two 'golden ages' of the 1960s and early 1990s. The geographical trade pattern has some interesting elements. The OECD dominates Portuguese external trade at every point in time. Among its countries, it is interesting to see that the EEC after 1958 was always above EFTA. Although EFTA is a smaller area, this could be considered somewhat paradoxical for an EFTA founding member. Colonies (ex-colonies after 1975) never had any significant weight, except in the 1950s. Angola was even the chief importer of Portuguese products in 1958. The best customer was the United Kingdom, only surpassed by the USA, Germany and Angola at some points. Germany and France have gained some ground lately. As suppliers, Germany was number one, followed by the United Kingdom and USA. Some countries are noticeable by their absence. Spain, the 'big neighbour' did not

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349

Table 11.12. Portuguese exports by country, 1938-90 (% of total exports)

OECD EEC EFTA Colonies UK Germany France Belg./Lux. Spain Italy USA Sweden Switzerland Argentina Brazil Japan Angola Mozambique

1938 — 12.0 20.7 13.1 8.3 4.8 4.8 5.8 5.3 1.7 1.0 0.7 5.6 5.4 5.0

1947

1952

1958

1965

1973

1979

1984

1990

— 26.3 14.7 0.3 2.4 9.8 1.8 1.0 11.5 2.6 1.6 1.4 6.4 11.4 10.7

— 25.9 12.2 6.3 4.2 4.0 0.7 3.4 14.5 1.7 1.0 1.2 3.6 14.4 7.9

48.1 27.4 11.3 7.7 6.6 3.7 0.7 4.2 8.3 2.3 1.3 0.5 1.1 16.0 7.9

64.6 20.7 27.4 25.0 17.6 8.1 4.6 2.4 2.7 2.9 10.6 3.4 1.8 0.2 0.3 0.7 14.1 8.2

78.8 48.6 13.8 14.8 23.8 7.5 5.2 2.8 2.2 3.2 9.8 5.6 2.9 0.1 1.0 1.8 7.2 5.0

81.0 56.2 12.6 6.2 17.8 12.3 9.7 3.2 2.9 5.9 6.1 4.8 3.4 1.1 1.1 3.3 0.6

83.8 57.4 10.5 4.4 15.4 13.7 12.4 3.3 4.4 4.3 8.8 3.6 2.4 0.9 3.0 0.8

90.9 73.6 10.2 3.4 12.1 16.7 15.5 3.1 13.3 4.1 4.8 4.1 1.9 0.3 1.0 2.5 -

Table 11.13. Portuguese imports by country, 1938-90 (% of total imports)

OECD EEC EFTA Colonies UK Germany France Belg./Lux. Spain Italy USA Sweden Switzerland Argentina Brazil Japan Angola Mozambique

1938 — 10.2 17.1 16.8 6.1 6.8 0.5 1.9 11.6 1.7 1.9 1.4 2.1 5.0 3.3

1947 _ 7.9 11.9 0.5 4.1 6.0 1.5 1.3 31.6 3.2 4.0 4.5 3.5 3.3 3.0

1952 — 15.3 15.9 7.3 4.7 10.6 0.8 1.9 13.7 2.1 2.7 0.2 0.6 6.6 6.3

1958

1965

1973

1979

1984

1990

64.3 14.7 12.9 17.6 7.7 7.3 0.4 3.7 7.0 2.7 3.2 0.3 0.8 4.9 7.7

70.4 34.9 21.7 13.8 13.0 16.3 7.5 3.4 2.7 5.1 8.1 2.5 3.5 0.6 0.7 0.2 7.8 5.0

76.6 44.9 11.6 10.1 11.4 14.4 6.9 2.9 5.4 5.2 8.2 4.5 4.2 1.3 2.9 4.2 6.4 3.0

73.3 42.4 7.8 2.2

66.3 35.9 5.2 0.7 6.8 10.1 8.0 2.1 7.2 4.7 13.4 1.1 1.8 2.5 0.5 0.1

83.3 69.0 6.4 0.4 7.6 14.3 11.5 4.1 14.3 10.0 3.9 1.4 2.1 1.6 2.7 0.3 -

9J

12.6 8.6 2.8 5.8 5.1 11.7 2.2 3.5 1.0 2.8 0.2 0.6

Note: In some years, some countries are not presented in the statistical source. These cases correspond to very low values of the variable.

350 Joao L. Cesar das Neves Table 11.14. Postwar emigration from Portugal, 1946-91

1946-58 1959-65 1966-73 1974-9 1980-91 a

Net emigration/ total population

Total emigration/ total population

0.5852 0.9835 1.6959 -1.0607° -

0.3228 0.4407 0.8025 0.2636 0.1040

1974-81.

have an important presence until their joint entry into the EEC. After that, by 1991, Spain had become the main Portuguese supplier, along with Germany. Brazil, the 'big brother', never had any real weight. These can be said to be the most important aspects of commercial relations in Portugal. The high and rising importance of foreign trade in the Portuguese economy gives considerable influence to the patterns which have been identified. The relations between trade flows and growth is very clear. The increasing export drive in the low-technology industrial sectors, which were the most dynamic in the Portuguese economic structure, is a sign of this influence. The structural change of the economy is also clearly related to the increase, diversification and restructuring of external trade. The role of exports is clearly increasing throughout the period, while the strategy of import substitution, still significant in the early part of the Golden Age, is being reversed. If the role of trade is clear, the importance of emigration in economic development has always been a controversial subject. The size of the phenomenon cannot be overemphasized. Table 11.14 shows its importance clearly. Almost a third of the natural growth of the population was, on average, absorbed by emigration in the twentieth century. The impact of emigration on Portuguese economic development is not clear. Was it a good bargain for Portugal to sell the human capital of the emigrants in return for their remittances? Several opposing answers have been given to this question. In a recent paper, Maria Baganha (Baganha, 1993) tries to evaluate the problem. The average lack of professional qualifications of the emigrants and the scarcity of savings in the country point to a positive answer. As was noted above, the technological combination chosen by the regime in the Golden Age of the 1950s and 1960s also relied strongly on the emigration valve.

4.3

Human capital

Human capital is one of the main and more complex engines of growth. New growth theory 21 has specifically emphasized this element in its analytical structure. This brief section, due to the complexity of the concept and its measurement and identification problems, tries to access it in a simple and crude way. The lack of relevant data and the small number of studies in this area force an indirect

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351

Table 11.15. Portuguese adult illiteracy rate, 1940-91 (%)°

1940 1950 1960 1970 1980 1991

49.0 40.4 30.3 25.6 18.6 12.7

a

1940-60, percentage of illiterates over seven years old; 1970-91, percentage of illiterates over ten years old. Source: Neves (1994).

Table 11.16. Rates of return to education and job training in Portugal, 1977 and 1985 (%) Rates of return of education 1977 1985

Total

Men

9.1 10.0

7.5 9.4

Rates of return of job training General

Specific

Women Total

Men

Women Total

Men

Women

8.4 10.4

2.0 2.7

2.6 2.6

1.2

1.3

2.7

1.3

Sources: For 1977, Psacharopoulos (1981); for 1985, Kiker and Santos (1991).

assessment and a very stylized approach. Nevertheless, the importance of the topic justifies its inclusion. The situation in the early 1940s was very primitive. Table 11.15 presents this picture through the adult illiteracy rate, which was almost 50 per cent by 1940. The intense reduction of this rate shows clearly the results achieved during the whole period. There was a large effort in education and professional training from the 1950s onwards. The presence of this element in the Pianos de Fomento was referred to above. All the indicators show a steady and important evolution towards a more educated, trained and culturally aware population. The effort in primary and secondary education was evident from the late nineteenth century. Higher education was improved during the Golden Age, but only after the 1974 revolution did a real generalization of access to university begin. The situation is still not a good one, and education remains a priority of present development efforts. One of the reasons has to do with teaching quality, which the indicators hide. The assessment of the real impact of human capital in Portuguese economic growth is much more difficult. One way of doing this is through the calculation of a Mincerian 1974-type specification of the earnings function. This estimates the

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Joao L. Cesar das Neves

marginal rates of return of education, specific job training and general job training. Two such studies were conducted for Portugal, for 1977 and 1985, and are present in Table 11.16. The general Portuguese rates of return of education and job training are very similar to countries of the same (middle) level of development. The results, and especially the general rise in the rates of return from 1977 to 1985, indicate the very important role of human capital in Portuguese development. 5

Conclusions

This chapter has tried to sketch the main characteristics of the Portuguese development process. This development created strong and deep changes in the country. Per-capita product increased more than tenfold in the last 150 years, and almost sevenfold since the war. Sectorial structure was revolutionized. The country was integrated into the world economy in a completely different way. As was highlighted in the study, elements like institutions, human capital and external relations were as important as capital accumulation or labour growth in explaining this extraordinary process. 'New growth theory' thus had a very clear field of analysis and application in Portuguese development. Some remarkable lessons about the importance of political stability, education and foreign influences can and should be drawn from this experience. On those lessons depend future Portuguese growth and, in particular, the realization of a second Golden Age until the end of the century. NOTES I wish to thank Professors Nicholas Crafts, Gianni Toniolo, Isabel Correia and Pedro Teles for the revision of and valuable comments on a previous version of this chapter, and Maximiano Pinheiro, Nuno Valerio, Miguel Gouveia, Maria I. Baganha, Joao Confraria and Sergio Rebelo for precious contributions to the data bank and to analytical options. The usual disclaimer applies. 1 See Chenery and Syrquin (1975: 100) and Baum and Tolbert (1985: 189), two books from the World Bank which include Portugal among the great postwar growth successes. 2 See Rosas (1986), Cruz (1988) and Nunes and Brito (1992) for brief descriptions of these institutional arrangements, and for large reference lists. 3 See Brito (1989) and Confraria (1992) for detailed discussions of the implications of 'industrial conditioning'. 4 These wines were the ones used by David Ricardo in the famous example in chapter 7 of his 1817 Principles. 5 This, along with the fourteenth-century alliance between Portugal and England, the oldest in the world, made Lenin, in his only reference to Portugal, name it as a case of a 'semi-colony' (see Lenin, 1939: chapter 6). 6 See Neves (1994) for details of calculations and further results. 7 This average is a simple average of the values considered. Another possibility, not considered, would be to use an average weighted by the population of each country. This measure would be equivalent to dividing Portuguese per-capita product by per-capita world product. 8 Data sources are mainly Nunes et aL (1989) and Banco de Portugal (1977-85).

Portuguese postwar growth 353

9 10 11

12

13 14 15 16

17

18

19 20 21

Sources and manipulation for the main tables of the paper are presented in Neves (1994). See below, section 3.1. Factor contribution in one year is calculated by simply multiplying its growth rate by its share in total income in that year. According to Correia et al (1992), the main results are: investment is two to three times more volatile than output, while consumption is less volatile than output; there is a positive correlation between consumption, investment, output and labour effort; and all of these variables show significant serial correlation. Correia et al (1992) states that in the Summers and Heston (1984) cross-country data set, the standard deviation of real GDP growth for the poorest one-third of countries is 50 per cent higher than the same standard deviation for the richest one-third of countries (5.7 per cent versus 4 per cent). This classification is based in Moura (1969:17-31). For the period after 1974 the phases considered are divided by the peak in 1979, between the two clear cycles which dominated the period from 1974 to 1991. See Hodrick and Prescott (1980). The parameter X of the filter was put to 400. For a similar treatment of the same series, see Correia et al (1992). The consumer price indices for the UK and the USA were the ones in Maddison (1982). For Portugal, the data used are the CPI in Neves (1994), using GDP deflator data to extrapolate the series before 1947. From 1910 to 1921 Portugal had a deep depression, with strong inflationary elements. According to data in Nunes et al. (1989), the peak (1910) to trough (1921) GDP fall was 45 per cent, with prices rising tenfold from 1916 to 1924. Lains and Reis (1991) provide a critique of these figures. The plan included 7.6 billion (109) escudos for the six years, a value almost equal to total gross fixed capital formation for 1952 and 15.2 per cent of GDP in 1953. But the investment amount of the plan was to be extended in 1955 to 9.7 billion and in 1957 to 11.5 billion, which was then more than total GFCF for 1957. See Nunes and Brito (1992: 323). The data here presented are for final execution. Table 11.9 below presents original intentions. Sources of the table are Nunes and Brito (1992) and Presidencia do Conselho (1968: Annexe, map I). Data presented refer only to the original intentions of the plan and to investments in continental Portugal and the Atlantic islands, but not in the colonies. These calculations, derived from Table 11.2, use the available sectorialization of the growth rates and income shares. These numbers should be approached with the care of a preliminary estimation. Moura (1969:1.2.3). See Lucas (1988) for a seminal paper.

REFERENCES Baganha, Maria I. (1993) 'As Correntes Emigratorias Portuguesas no seculo XX, mimeo., Universidade Aberta, Lisbon. Banco de Portugal (1977-85) Relatorios do Conselho de Administra$ao, Lisbon. Baum, W.C. and S.M. Tolbert (1985) Investing in Development: Lessons of World Bank Experience, Washington, DC: World Bank and Oxford University Press. Brito, J.M. Brandao de (1989) A Industrializa<;ao Portuguesa no Pos-Guerra (1948-1965): 0 Condicionamento Industrial, Lisbon: Publicacoes Dom Quixote. Chenery, H. and M. Syrquin (1975) Patterns ofDevelopment 1950-1970, Washington,

354 Joao L. Cesar das Neves DC: World Bank and Oxford University Press. Confraria, J. (1992) Condicionamento Industrial: Uma Andlise Economica, Lisbon: Direccao Geral da Industria. Correia, I.H., J. Neves and S. Rebelo (1992) 'Business cycles in Portugal: theory and evidence', in J.F. do Amaral, D. Lucena and A.S. Mello (eds.), The Portuguese Economy Towards 1992, Boston, MA: Kluwer Academic Publishers. Cravinho, J. (1982) 'Sources of output growth in the Portuguese economy (1959-1974)', Estudos de Economia, 2 (3), pp. 271-89. Cruz, M. Braga da (1988) 0 Partido e o Estado no Salazarismo, Lisbon: Editorial Estampa. Hodrick, R. and E. Prescott (1980) 'Postwar US business cycles: an empirical investigation', Discussion Paper No. 451, Carnegie-Mellon University. Kiker, B.F. and Maria C. Santos (1991) 'Human capital and earnings in Portugal', Economics of Education Review, 10 (3), pp. 187-203. Lains,P. and J. Reis( 1991)'Portuguese economic growth, 1833-1985: some doubts', Journal of European Economic History, 20 (2), pp. 441-53. Lenin, V.I. (1939) Imperialism, the Highest Stage of Capitalism, New York: International Publishers. Lucas, R.E. (1988) 'On the mechanics of economic development', Journal of Monetary Economics, 22, pp. 3-42. Maddison, A. (1982) Phases of Capitalist Development, Oxford: Oxford University Press. Moura, F. Pereira de (1969) Por Onde Vai a Economia Portuguesa?, Lisbon: Publicacoes Dom Quixote. Neves, J. (1994) The Portuguese Economy in the Nineteenth and Twentieth Centuries: A Picture in Figures, Lisbon: Universidade Catolica Editora. Nunes, A. and J.M. Brandao de Brito (1992) 'Politica economica, industrializacao e crescimento', in F. Rosas (ed.), Portugal e o Estado Novo (1930-1960), vol. XII of Nova Historia de Portugal, ed. by J. Serrao and A.H.O. Marques, Lisbon: Editorial Presenca. Nunes, A., E. Mata and N. Valerio (1989) 'Portuguese economic growth 1833-1985', Journal of European Economic History, 18 (2), pp. 291-330. Presidencia do Conselho (1968) / / / Piano de Fomento para 1963-1973: Projechoes do Desenvolvimento Economico e Social; Financiamento, Imprensa Nacional de Lisboa. Psacharopoulos, G. (1981) 'Education and the structure of earnings in Portugal', De Economist, 124 (4), pp. 5 3 2 ^ 5 . Ricardo, D. (1817) Principles of Political Economy and Taxation, in P. Sraffa (ed.), The Works and Correspondence of David Ricardo, vol. 1, Cambridge: Cambridge University Press, 1951. Rosas, F. (1986) O Estado Novo nos Anos Trinta, Lisbon: Editorial Estampa. Summers, R. and A. Heston (1984) 'Improved international comparisons of real product and its composition: 1950-1980', Review of Income and Wealth, 30 (1), pp. 207-62. (1991) 'The Penn World Table (Mark 5): an expanded set of international comparisons, 1950-1988', Quarterly Journal of Economics, 106 (2), pp. 327-68.

12

Growth and macroeconomic performance in Spain, 1939-93 LEANDRO PRADOS DE LA ESCOSURA AND JORGE C. SANZ

1

Introduction

Spain's growth over the last four decades constitutes a distinctive case in postwar Western Europe. This was largely due to the acceleration of the 1960s and early 1970s, which could be partially attributed to delayed reconstruction. Before 1960, autarky was the rule and Spain's performance appears disappointing from a catching-up perspective, since its rate of growth fell short of the potential one implied by the country's backwardness. Two phases can be distinguished after Franco's death: one of economic retardation and political instability during the years of transition to democracy (1975-85), which coincided with the oil shocks; and another of return to fast growth after Spain became a member of the EC (1986), which ended with the recession of the early 1990s. In this chapter, Spain's economic growth since the Civil War (1936-9) is assessed. After presenting trends in aggregate performance within a comparative growth accounting framework, institutional and macroeconomic features in the main postwar phases are explored as ultimate historical explanations for Spanish performance. 2

Spain's economic performance in the long run

After negligible growth in real GDP per head during the early nineteenth century, a sustained gain in product per head took place up to World War I (Table 12.1). New annual estimates emphasize the acceleration of growth between 1850 and 1890, particularly during the free-trading years (1860s to 1880s), and the slowdown that followed the tariff of 1891 and the suspension of the peseta's gold convertibility (Prados de la Escosura, forthcoming). The financial costs of the independence wars of Spain's last colonies (Cuba, Puerto Rico and the Philippines) also contributed to slackening economic growth. The early twentieth century witnessed an acceleration in the rate of growth. A phase of remarkable acceleration in per-capita growth and structural change took place from 1913 to 1929, followed by the 1930s depression, in which real product per 355

356

Leandro Prados de la Escosura and Jorge C. Sanz

Table 12.1. Comparative performance of Spain's real GDP per head, 1850-1993 (log-linear adjusted growth rates)

1850-90 1890-1913 1913-29 1920-38 1950-60 1960-73 1973-93 1850-1913 1913-50 1950-93 1913-60 1960-93 1913-93 1850-1993

Spain

Italy

France

Germany UK

USA

1.3 0.8 2.0 1.5" 3.5 6.3 2.0 0.9 0.3 4.1 0.7 3.6 2.5 1.5

0.4° 1.5 0.9 1.5 4.7 4.3 2.3 0.7c 0.6 3.5 1.2 3.0 2.6 1.9d

1.3 1.4 2.7 1.3 3.5 4.2 1.7 1.3 0.6 3.0 1.4 2.6 2.5 1.7

1.4 1.7 1.8 2.6 6.7 3.4 1.9 1.5 1.5 3.1 2.1 2.4 2.8 1.9

1.6 2.1 2.0 -0.2 1.0 2.6 1.6 1.7 1.8 1.8 1.9 1.8 1.9 1.7

1.2 0.9 -0.5 1.5 2.2 2.4 1.8 Ll l.l :>.l 1.2 1.9 L.7 L2

Source: Prados de la Escosura (1995). 1861-90. b 1920-35. c 1861-1913. d 1861-1993.

a

head fell at —0.4 per cent annually between 1929 and 1935. * Finally, the new evidence points to a fall in the level of economic activity per person, as a result of the Civil War (1936-9), at a compound annual rate of — 3.4 per cent between 1935 and 1940. The reconstruction period was longer in Spain than in Western Europe and lasted until the 1960s, resulting in the level of income per head for 1929 (the highest for the pre-Civil War ear) only being reached again in 1954.2 Autarky presided after the end of the Civil War for a period of twenty years. After the economy practically stagnated in per-capita terms during the 1940s (0.2 per cent), the 1950s witnessed a substantial growth per head as isolation was gradually relaxed.3 However, a remarkable acceleration took place after the major policy reform of 1959, and this lasted until 1975.4 The post-Franco years were of faltering growth, with a yearly rate of 0.9 per cent per head between 1975 and 1985. Then, following the admission of Spain into the EEC, a return to the trend of the Golden Age took place up to 1990 (with per-capita income growing at 4 per cent), only to slacken again at the beginning of the 1990s. In short, in early twentieth-century Spain, sustained growth took place up to the Great Depression, when it was abruptly interrupted by the Civil War, from which recovery was slow under Franco's economic autarky. Fast growth in the Golden Age, resulting to a large extent from the post-bellum reconstruction, ended abruptly after Franco's death (1975), which coincided with the first international oil crisis. With Spain's admission into the EEC (1986), an intense, short-lived recovery took place, before a return to slackening growth in the early 1990s. When Spain's economic performance is placed within the international context,

Growth and macroeconomic performance in Spain, 1939-93

357

& uuu 20 00015 00010 000 -

" y~\

5000 -

«»'%M, rf

y

' y

France;'

Spain \ t ;

/

y ^

. . — • • •

r \"

"Zs 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 Source: Prados de la Escosura (1995).

Figure 12.1 Spain's real GDP per head: comparative performance, 1850-1993 (1990 Geary-Khamis dollars)

several distinctive features emerge (Table 12.1). The remarkable increase in Spain's real per-capita income, over tenfold since the mid-nineteenth century, represents only a moderate pace of growth when it is compared to continental Europe's industrial nations. Spain's economic growth departed from a lower stand-point in terms of output per person, having stagnated over much of the early decades of the nineteenth century. By contrast, Western European nations industrialized, leading to a deterioration in Spain's international position. Thus, it intuitively appears that the (unconditional) convergence hypothesis, according to which growth rates correlate inversely to departing levels, does not seem to apply to Spain's historical experience prior to 1960. In the search for differentials in Spanish economic performance, several significant periods emerge. From the mid-nineteenth century up to the Spanish Civil War (1936), only the moderately free-trading decades of the 1860s to the 1880s and the 1920s represent a mild attempt to catch up with Western European industrial nations. In the late twentieth century, the period 1960-75 is a major step in closing up the gap. Conversely, three periods appear to be responsible for the widening gap between Spain and the advanced Western European nations: 1890-1913,1939-59 and 1975-85. The turn of the century seems to have been a lost opportunity for closing the gap, as comparison with other late comers such as Giolittian Italy, Sweden and Russia suggests (Prados de la Escosura, forthcoming). Economists and historians usually stress Spain's poor economic performance under autarky (1939-59), in particular during the 1940s. It appears, however, that the 1950s, a decade of generalized growth in Western Europe, could be associated in Spain with

358

Leandro Prados de la Escosura and Jorge C. Sanz

incomplete catching up, as the comparison with Germany and Italy tends to suggest. In the 1950s, as forces making for growth and convergence were stronger, those countries like Spain that failed wholly to catch up seem to have paid a heavier penalty than would have been the case in phases of slowing down. Countries such as Spain which remained closed and did not compete in international markets could not share the productivity growth benefits deriving from the leading nations (Baumol, 1986). Nevertheless, when the Civil War is excluded, the largest loss in relative levels of income per head (but not in productivity, due to high unemployment) emerges from the years between Franco's death (1975) and Spain's admission to the European Community (1986). Systematic historical research on the period is lacking and only superficial explanatory hypotheses relating poor performance to the difficult transition to a democratic regime have been proposed. However, deeper institutional reasons seem to have been at work, such as an overregulated, heavily protected economy which was cut off from the international market (see sections 7 and 8 below). Resource endowments in the postwar period provide some clues about Spain's growth. Physical and human capital accumulation was significant in the post-1950 era, while labour expanded only slowly. Employment grew at 0.8 per cent annually between 1955 and 1974,5 to decline, over the following two decades, at —0.5 per cent, while the labour force expanded at 0.7 per cent. Educational attainment, as measured by the average years of schooling, grew at an average annual rate of 2.2 per cent in the period 1950-75, and at 1.7 per cent per year from 1975 to 1985 (Barro and Lee, 1993). In turn, gross fixed capital stock grew faster than output from 1950 to 1973, and the differential growth rates widened thereafter (Hofman, 1993a).6 In the period 1950-73, capital deepening (i.e. increase in capital stock relative to population) took place at an annual growth rate of 5.7 per cent for non-residential capital stock, and even more rapidly for machinery and equipment (8.6 per cent). Although such a process continued over 1973-89, it slowed down for non-residential capital (to 4.5 per cent) and, especially, for machinery and equipment (down to 3.7 per cent).7 A rapid catching up in terms of non-residential capital endowment per head occurred up to 1973, decelerating thereafter (Hofman, 1993b; Maddison, 1993).8 Given the role attributed to capital in machinery and equipment, as carriers of new technology (De Long and Summers, 1991), its slackening after 1973 could be associated with lower joint factor productivity growth.9 A look at the sources of growth can help us to assess the proximate determinants of postwar Spanish performance. For the period 1965-90, an estimate has been carried out by Suarez (1992), who relaxed usual assumptions about constant returns to scale, perfect competition and exogenous technical progress.10 At the economy's aggregate level, however, Suarez found evidence of non-increasing returns to scale. Table 12.2 summarizes his results.11 Total factor productivity dominates Spanish economic growth in the long run, complemented by capital's contribution. Only after Spain's admission into the EEC (1986) did labour make a significant contribution to growth, offsetting total factor productivity's sluggish growth after 1975. Labour destruction in Spain represented a significant brake to growth over the decade after Franco's death. Deep changes in the composition of output and employment, together with a dramatic increase in R & D activities, help to explain total factor productivity growth up to 1975 (and TFP deceleration thereafter, when

Growth and macroeconomic performance in Spain, 1939-93 359 Table 12.2. Sources of Spain's economic growth, J965-90 1965-74 6.48 1 Real GDP growth 0.72 2 Labour 3 Contribution to GDP growth 0.42 9.82 4 Capital 5 Contribution to GDP growth 2.25 3.81 6 Total factor productivity 6.5 7 (3) as % of GDP growth 34.7 8 (5) as % of GDP growth 58.8 9 (6) as % of GDP growth

1975-85

1986-90

1965-90

1.37 -1.62 -0.90 3.46 0.66 1.61 -65.7 48.2 117.5

4.41 3.00 1.69 5.28 1.40 1.32 38.3 31.7 30.0

3.89 0.15 0.10 6.21 1.41 2.38 2.6 36.2 61.2

Source: Suarez (1992). Table 12.3. Relative growth of Spain's real GDP per head, 1950-85 (Spain's deviations from OECD growth)

Actual growth deviation Less Cyclical bias Catch-up = Adjusted growth deviation Less Employment deepening Capital deepening = Unexplained growth deviation

1950-60

1960-73

1973-85

0.89 -0.15 1.13 -0.09 0.21 -0.25 -0.06

2.15 0.45 0.90 0.80 -0.11 -0.27 1.18

-0.31 0.22 0.42 -0.95 -1.27 -0.24 0.56

Source: Dowrick and Nguyen (1989). structural transformation slowed down until 1985). Empirical research within the on-going debate on convergence and catching up has provided evidence on the case of Spain. Thus, Spain's economic performance can be analysed using a convergence equation. Dowrick and Nguyen (1989) have tested whether post-1950 convergence within OECD countries is explained by total factor productivity catching up, or just by the growth of factor intensities, with their results supporting the former. Their individual country data set includes evidence for Spain which is presented in Table 12.3. Each country's deviations from OECD trend growth, after being adjusted for catching up, are decomposed into capital and employment deepening (i.e. relative to population growth) and unexplained growth. Dowrick and Nguyen's unexplained residual accounts for more than half of Spain's differential growth in the 1960s and early 1970s, and exhibits the opposite sign (doubling the size of the actual growth deviation) for the period 1973-85. Such an outcome could provide enough grounds to dismiss the exercise on the basis of its low explanatory power. However, the story that emerges from it, when the unexplained growth deviation is associated with joint factor productivity, seems to be a plausible one, as it is consistent with the evidence already present in Table

360 Leandro Prados de la Escosura and Jorge C. Sanz Table 12.4 Differential growth of Spain s real GDP per head, 1965-90 (with respect to the OECD average) 1965-75 1.19 A Growth differential due to: 0.28 B Initial income per head -0.07 C Real investment/GDP -0.12 D Human capital E Population growth 0.00 F Solow factors (B + C + D + E) 0.09 G Inflation -0.15 H Money growth 0.59 I Variance inflation 0.08 0.44 J Exports growth K Lagged public deficit/GDP 0.00 L Macroeconomic performance (G + H + I + J + K) 0.96 M Unexplained residual 0.15

1975-85

1985-90

-1.31

1.69

0.23 -0.16 -0.02 -0.01 0.04 -0.25 0.00 0.26 0.15 -0.08

0.30 -0.10 0.02 0.02 0.24 0.07 0.50 0.37 -0.30 0.05

0.07 -1.43

0.68 0.77

Note: Average GDP per head growth in the OECD, 1965-75, 3.35 per cent annually; 1975-85, 2.05 per cent; 1985-90, 2.45 per cent. Source: Andres et ai (1994). 12.2, stressing the role of TFP in Spain's growth. Thus, according to Dowrick and Nguyen, catch-up accounts for the differential trend growth in the 1950s, and for half of it in the 1960s and early 1970s and, in turn, prevented a poorer performance from the 1973 oil shock onwards. When compared to OECD adjusted giov/th, Spain performed slightly below the average in the 1950s, with the increase in employment (relative to population) offsetting the low investment ratio per head. Since 1960, total factor productivity was the only positive contribution to adjusted growth as a result of poor capital and employment deepening.12 In fact, TFP growth (including a reallocation of resources away from agriculture) was not enough to maintain convergence towards the advanced nations after 1973, particularly as massive employment destruction took place from the late 1970s. However, despite the usual association between the unexplained residual and total factor productivity, economists remain dissatisfied and try to take a closer look at the Solow residual. In a recent paper, Andres et al. (1994) have differentiated between Solow elements (derived from an augmented Solow model with human capital) and macroeconomic performance in OECD countries' growth since 1965.13 Table 12.4 presents their results for Spain, showing positive deviations in OECD growth up to 1975 and from 1985 onwards, a negative deviation for the 'transition to democracy' decade, 1975-85, and in all periods a positive catch-up term and negative contributions of factor endowment growth. These results tend to support findings from a previous exercise (Table 12.3). As can be gathered from Table 12.4, macroeconomic performance,-and the unexplained residual that can be associated with TFP growth, account for most of Spain's differential growth.14 Prior to 1975,

Growth and macroeconomic performance in Spain, 1939-93

361

macroeconomic behaviour seems to explain most (80 per cent) of Spain's positive deviation from the OECD average growth, with money and exports growth as its main factors. However, in the transition years from dictatorship to democracy, macroeconomic instability (high inflation, unbalanced budget) led Spain to underperform. Finally, after Spain became a member of the EEC (1986), macroeconomic performance (lower inflation and money, but not export, growth) contributed to a positive growth differential (up to 40 per cent). It may be concluded, then, that the analysis of proximate determinants of growth largely confirms, and extends, the more descriptive evaluation carried out earlier in the paper. In the rest of it, a closer look at the main phases of macroeconomic performance can illuminate the search for ultimate causes of growth, in which the role of incentives provided by the institutional framework appears to be determinant. 3

The legacy of the 1930s and the Civil War (1936-9)

The impact of the Great Depression on Spain is not only a major economic but also a political and social issue, as it coincided with the instauration of Spain's Second Republic (1931), after more than half a century of constitutional monarchy that ended in a bloody civil war. Was the depression a significant cause of the political and social unrest? Did economic policies exacerbate the political and social climate, leading to civil strife and, eventually, to a military uprising? Historical studies have tended to confirm contemporary perceptions of a relatively mild impact of the depression, as the relatively moderate decline in factor returns and prices would suggest (Comin, 1987). It has been argued, however, that a shift towards a restrictive budget policy and the interruption of public works, together with uncertainty about the new political regime, were major causes of the crisis of the 1930s in Spain (Palafox, 1986, 1991). Legal changes favourable to the trade unions, such as the reduction in the number of hours worked (Soto, 1989), might have reduced incentives forfirmsto invest under the Republic (Comin, 1994). Another view points to a tighter link to the international depression through the external sector, aggravated by inadequatefinancialand monetary policies (Hernandez Andreu, 1980, 1986). A look at the latest empirical evidence tends to confirm the idea of a milder impact of the depression on Spain, given the small decline in the level of real GDP per head (Prados de la Escosura, 1995), while outwardly oriented sectors suffered a deeper impact (Comin, 1987). Moreover, recent research suggests a less important role for the government in the economy, given its size, the policy instruments available and the dominant ideologies in Spain at the time. Policies, both monetary and fiscal, were not restrictive but the opposite, as the budget was used as an anti-cyclical instrument offsetting the decline in private investment and exports (Martin Acena and Comin, 1984; Garcia Santos and Martin Acena, 1990). What caused the Civil War of 1936-9 then? A consensus appears to exist pointing to non-economic causes. However, expectations after the collapse of the monarchy were not fulfilled, as proposals for land reform, industrial relations legislation and welfare improvements were not completed or enforced, leading to social unrest and a military coup d'etat (Martin-Acena, 1994; Palafox, 1991). Finally, given the vigorous growth during the interwar period, it could be boldly suggested that the

362

Leandro Prados de la Escosura and Jorge C. Sanz

Spanish Civil War might be represented as a redistributional conflict resulting from the social and political tensions of an earlier rapid growth period, rather than from poverty and economic stagnation as has been advocated by historians. The impact of the Civil War on production factors and institutions was not negligible. War affected the endowment and proportion of production factors, although, when compared to the wider European post-World War II experience, Spain's physical capital was probably damaged to a much lesser extent than its human capital. Industrial areas were hardly affected by war destruction, which concentrated on residential construction, the transportation network and livestock (Malefakis, 1987; Barciela, 1986; Catalan, 1992). In turn, postwar exile and internal repression removed a large proportion of human capital (Lopez Garcia, 1991). The postwar increase in the human-physical capital ratio, apparently a feature common to most war-damaged countries and one which might have made a significant contribution to reconstruction, through an increase in the productivity of capital (Dumke, 1990), hardly took place in the case of Spain, and helps explain the country's poorer performance during the 1950s.15 4

Reconstruction: Spain under autarky, 1939-59

A major difference between Spain and the rest of post-1945 Western Europe (if Salazar's Portugal is excluded) was Franco's dictatorship, which emerged from the Civil War and lasted until 1975. The dictatorship presided over a four-decade period in which a clear distinction can be made between autarky and outward-looking development, with the 1959 stabilization plan as a turning point (although clear differences are noticeable between the 1940s and 1950s). Franco's political regime may be defined as an authoritarian system based upon a limited pluralism of political groups around the dictator, who behaved as a maximizer of power (time and quantity) under constraints derived from internal political and economic conditions and the international context (Gonzalez, 1979). Although not without a background,16 Franco's regime was a distinctive one, in which fascism and traditional authoritarianism blended from its very beginning. However, the autocratic regime evolved enough to adjust from isolation and self-sufficiency, in which the economy grew at below potential - even during the recovery of the 1950s (Table 12.3) - to a cautiously outward-looking economy reaping opportunities to reduce the technological gap with advanced European nations (Donges, 1971). Thus, the extent to which fast growth under Franco after 1960 may be attributed to the dictatorship's economic policies and social stability is a still debated issue. Had it been the case, a painfully achieved, stable institutional framework might have provided permissive elements for economic development, such as an improvement in the definition and enforcement of property rights, a reduction in transaction costs, and a paternalistic attitude on the part of the state, gradually moving away from absolute interventionism during the 1950s (Gonzalez, 1979, 1989/90; Martin Acena, 1994). To elucidate whether there was a causal link between Francoism and growth and catching up, macroeconomic performance under the dictatorship will be surveyed and its main policies discussed below. However, some caveats about the beginnings of Franco's dictatorship are required.17 Uncertainty about its viability after World War II led Franco's regime to give priority to immediate political

Growth and macroeconomic performance in Spain, 1939-93

363

stability over any other competing goal, even though such a choice would condition subsequent growth through a misallocation of resources. This strong constraint provided, in turn, a specially advantageous position to those (already powerful) small groups and coalitions which, in exchange for support to the dictatorship, would derive rents from the public sector and even control the state's economic decisions (Fraile, 1991, 1993). After the Civil War, the new economic authorities decided to follow a new scheme of autarkic development. Such a choice, favoured by the new authorities' ideology, was conditioned by the international isolation that followed the Axis powers' defeat in World War II. A widely accepted perception of Spain as a backward, non-industrialized society, in which both private firms (because of the lack of entrepreneurship) and the government (through free trade policies) had failed to promote industrialization, led to a view of the new totalitarian state as the only institution able to achieve Spain's sustained growth and catching up through economic intervention (Martin Acefia and Comin, 1991). In postwar Spain, as in the rest of Europe after 1945, government intervention was perceived as a crucial instrument for the post-bellum recovery. World War II and the United Nations' boycott (1946), plus the exclusion from reconstruction plans and international organizations such as Marshall Aid and Bretton Woods, reinforced nationalistic tendencies towards self-sufficiency, although the Cold War gradually relaxed Spain's isolation throughout the 1950s.18 Eagerness to embrace regulation and state intervention was a common feature of postwar Europe, counterweighted by the Marshall Plan, which in turn provided the environment for a pro-market economic policy (De Long and Eichengreen, 1993). Although American aid started in 1951 and led to influential economic and military agreements in 1953, Spain's case provides support for the counterfactual proposition that, had the Marshall Plan not been enforced, product and factor market controls, quotas and foreign exchange rationing would have dominated economic policies. In fact, government intervention and planning in Spain aimed at reaching economic self-sufficiency, including technological independence - once the expectations of technological transfers from Nazi Germany vanished (Lopez Garcia, 1991) - regardless of the opportunity cost involved. Nevertheless, Spain obtained $1.1 billion from the US government over 1951-9, which amounted to 18 per cent of the goods and services imported during these years (or 1.6 per cent of GDP). Had Spain received the $676 million aid in a single year expected from the Marshall Plan by the Francoist authorities, it would have represented over 20 per cent of GDP in 1949 (Donges, 1976; Prados de la Escosura, 1995). The need to rely on a coalition of nationalistic and fascist elements during the initial uncertain stages of the new regime conditioned the dictatorship's industrial policy, aggravated by the lack of managerial and engineering skills needed to carry it forward. Industrialists, who had opposed the Republic's welfare and redistributive policies, adopted a hesitant attitude towards Franco's regime in its early stages. Thus, the lack of human capital, on the one hand, and the new regime's urge to industrialize, on the other, made strategic factors of asymmetrical information and the flow of personnel from private industries to interventory agencies, eventually leading to the capture of these agencies by interest groups (Fraile, 1993). The autarkic model of development was built around a policy of protectionism

364 Leandro Prados de la Escosura and Jorge C. Sanz 0.25-. 0.20-

-0.05 -

-0.10

i i i i i i i i i i i i i i i

i i i i i i i i i i i i i i i i i i • » i • ' • '

i • • • •

i •

1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 Source: Prados de la Escosura (1995).

Figure 12.2 Rate of inflation: Spain, 1929-93 (calculated from the GDP deflator)

which persistently aimed at import substitution, using two basic tools: quantitative restrictions and exchange controls. Indiscriminate protectionist policies had deleterious effects on Spanish economic performance, according to most economists and historians. The exchange control policy implied the imposition of an official fixed exchange rate within a context of persistent inflation differentials between Spain and its commercial partners, which constituted a permanent strain on the Spanish currency towards revaluation.19 The appreciation of the real exchange rate of the peseta implied a drag on exports and a stimulus to imports, and tended to exhaust foreign reserves. Such a tendency could not be compensated in the 1950s either by the multiple exchange rate system,20 or by the 'special accounts'.21 Bilateral trade agreements (quotas by country and product) and a trade licensing system were an alternative that resulted in high costs, in terms of efficiency, by providing the appropriate environment for rent seeking and corruption. A foreign exchange black market developed and the Spanish currency experienced substantial depreciation. The imposition of a top limit for foreign investments in Spanish industry (25 per cent of the capital of thefirm)was a complementary procedure to prevent national firms from falling under the control of foreign capital. A proximate measure of the import substitution bias induced by trade controls can be gathered from the ratio of domestic to c.i.f. prices for imported goods. According to Donges (1971), such a ratio multiplied by 2.5 between 1948/9 and 1958/9. Import substitution took place mainly among consunier goods, and to a lesser extent among intermediate and capital goods. The contribution of import substitution to output growth represented, for consumer goods, 75 per cent in the 1940s and 60 per cent in the 1950s, while for intermediate and capital goods it

Growth and macroeconomic performance in Spain, 1939-93

365

1.30 -i

1.25 -

1.20 -

1.15 -

1.10 -

1.05 -

1.00 1950

1955

1960

1965

1970

1975

1980

1985

1990

Source: Summers and Heston (1993: PWT5.5).

Figure 12.3 Relative price of capital goods: Spain, 1950-90 (ratio of investment to PPP price level of GDP)

provided 70 and 49 per cent of its increase in the 1940s, and 24 and 106 per cent in the 1950s respectively (Donges, 1976: 155). Inward-looking policies created serious bottlenecks for industrialization, as traditional export earnings collapsed and the scarcity of foreign exchange put a brake on industrial growth by restricting the supply of raw materials and capital goods. Firms, usually small and relying on obsolete techniques, acted below full productive capacity due to shortage of inputs (or the uncertainty in obtaining them) and did not take advantage of economies of scale. In short, import-substituting industrialization (ISI) resulted in low organizational levels and low technical efficiency. Another major feature of Spanish autarky was a systematic policy of government intervention and regulation of the economy. The state controlled every step in economic activity through a licensing system for starting and enlarging industries. The authorities also regulated prices for commodities considered vital for industrialization, and controlled the evolution of nominal wages in the labour market. A rationing system was introduced and remained in use until the early 1950s, while at the same time government agencies took control of food distribution (Barciela, 1986), and price regulations for agricultural and industrial goods were established (although the latter were relaxed in the 1950s) (de la Dehesa et ai, 1991). Distortion in intersectoral terms of trade contributed to diverting resources from agriculture to industry in an attempt to foster industrialization. In addition, protection and internal regulation forced relative prices of capital goods upwards, resulting in a lower rate of investment for a given level of savings and, consequently, reducing the rate of growth of the Spanish economy.22

366

Leandro Prados de la Escosura and Jorge C. Sanz 2.5 i

0.0-

-2.5 -

-5.0 -

-7.5 -

-10.0 1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

a

Including central government. Sources: Comin (1993); MEH, MOISSES model; Prados de la Escosura (1995).

Figure 12.4 Budget balance of central government and public administrations: Spain, 1940-93 (% of GDP)

A strategic instrument for government intervention was the Instituto Nacional de Industria (INI), founded in 1941 and replicated from the Italian IRI, which organized and directed public investment in the 1940s and 1950s, and still today provides a powerful instrument of industrial policy. Both the failure of post-Civil War attempts to promote private investment through government incentives and the political uncertainty of the Second World War led Franco's pro-Axis government to shift to direct intervention in economic activity. INI was established to coordinate a fast, self-sufficient industrialization through a programme of investments in public infrastructure and the creation of strategic industries (including defence), involving high capital requirements, high risk or short-run low profits. INFs intervention included a great variety of activities, ranging from basic services to manufacturing and mining, but under autarky it specialized in the production of energy and intermediate goods, responding to the economy's bottlenecks and contributing to national defence. INFs role in postwar industrialization has been critically evaluated. In short, it has been argued that, while INI eliminated bottlenecks with its heavy investment, it was an instrument of inward-looking strategy that led to a misallocation of resources (Martin Acefia and Comin, 1991). A differential feature in Spain with respect to the economic measures followed in most postwar Western Europe countries was the maintenance of a pre-Keynesian fiscal policy. In fact, Franco's cabinets kept orthodox ideas about a balanced budget and the control of public expenditure (which was achieved in the 1950s), while

Growth and macroeconomic performance in Spain, 1939-93

367

-5 I 1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

Sources: Chamorro et al (1975); MEH, MOISSES model; Prados de la Escosura (1995).

Figure 12.5 Current account balance: Spain, 1940-93 (% of GDP at market prices)

sticking to economic nationalism and intervention. In fact, neither full employment nor income redistribution policies were enforced in the post-Civil War era. Under autarky, the government budget did not contribute to raising effective demand by establishing unemployment benefits, no progressive income tax was applied, and automatic stabilizers were not introduced until the 1950s. Government budget expenditure on public works, education, health, housing and social insurance was of little significance in the post-Civil War years. In fact, social transfers and education remained on average below 10 per cent of total central government expenditure until 1950, and below 15 per cent until the mid-1960s (Comin, 1994). A full quantitative evaluation of the consequences of such a policy, as opposed to a Keynesian approach, is still awaited, but it is considered to have reduced economic growth (Comin, 1992). A constant disequilibrium in the market between supply and demand, which provoked a persistently high rate of inflation, emerged as a consequence of price regulation. In an attempt to soften this continuous price strain, the authorities decided to allow gradual import increases, which worsened the current account balance (de la Dehesa et al, 1991). In the 1950s, imports of goods represented 11.7 per cent of GDP, while exports were only 6.5 per cent (Prados de la Escosura, 1994).23 Growing disequilibria in the external accounts in the late 1950s (Chamorro et a/., 1975) would lead to reconsideration of self-sufficiency and, eventually, to the end of autarky.24 The economics of early Francoism can be summarized, therefore, as an attempt to achieve rapid industrialization based upon indiscriminate import substitution, with severe restrictions on imports and capital inflows, a complex exchange rate

368

Leandro Prados de la Escosura and Jorge C. Sanz

Table 12.5. GDP and employment composition: Spain, 1929-93

Output Agriculture Industry Construction Services Expenditure Private consumption Investment Government consumption Net exports Employment Agriculture Industry Construction Services

1929

1940

1950

1960

1975

29.2 25.2 7.8 37.8

32.7 19.3 4.0 44.0

30.7 23.5 3.4 42.4

23.6 30.9 3.9 41.6

10.1 30.3 8.1 51.5

6.0 29.4 6.3 58.3

3.5 25.6 8.3 62.6

76.7 16.6

78.4 7.1

72.9 14.7

69.8 19.4

65.1 28.5

65.0 18.8

64.7 21.2

10.3 -3.5

17.6 -3.1

11.0 1.4

8.7 2.1

10.1 -3.8

14.0 2.2

16.0 -1.9

47.7 28.3 3.4 20.6

52.5 2.3 4.0 23.2

50.0 20.2 5.5 24.3

42.3 21.8 6.7 29.2

23.8 27.3 9.7 39.2

18.2 24.5 7.3 50.0

9.9 22.4 9.4 58.2

1985

1993

Source: Prados de la Escosura (1994). structure, internal regulation and direct intervention. This set of policies led to a highly overvalued currency, a current account deficit, low reserves of hard currency, inflation (consumer prices increased by an average of 13 per cent per year in the 1940s, and 10 per cent in the 1950s), and a small and inefficient industrial sector. A clear distinction should be made, however, between the 1940s and the 1950s, as the latter witnessed fast G D P growth per head together with a significant transformation in productive structure (Tables 12.1 and 12.5). In the 1950s, substantial changes took place in agriculture, where labour productivity increased while its relative size shrank in terms of both output (at — 2.6 per cent annually) and employment (at —1.7 per cent), leading to a fall in its relative labour productivity. The absolute reduction of the labour force in the agricultural sector represented 0.5 million workers, while it has been estimated that around one million workers emigrated from agriculture in the 1950s (Leal et al.y 1975). Meanwhile, total investment doubled its 1940s average share in G D P (10 per cent). It has been argued that the first industrializing push in the 1950s was a prerequisite for the fast growth of the 1960s, since human and physical capital accumulated and the domestic market expanded under protection (Gonzalez, 1979). In fact, capital deepening took place, with the stock of physical capital per head growing at 3.2 per cent yearly (or increasing by more than one-third), while non-residential capital per person grew at 4 per cent per year, an increase of 50 per cent (Hofman, 1993b).25 Meanwhile, the average years of schooling for people over 25 years old rose from 2.7 years in 1950 to 3.4 in 1960 (Barro and Lee, 1993). Industrialization, however, depended exclusively on internal demand, and the ability of Spanish firms to reach external markets was very low. Actually, commodity exports, after the postwar boom (1947-53) in which they rose to 8 per

Growth and macroeconomic performance in Spain, 1939-93

369

cent of GDP, fell to 5 per cent for the rest of the decade. By 1960, manufactured exports had hardly reached one-quarter of total exports and represented 7 per cent of industrial output. Moreover, volatility in import capacity due to scarcity of export earnings made investment risky, leading to a lower rate of capital accumulation (Donges, 1976). In turn, restrictions on foreign capital inflows made investment dependent almost exclusively on domestic savings. In addition, investment was penalized by high relative prices for capital goods, slowing down GDP growth. Lacking the capacity to import the necessary inputs and technology, firms suffering from insufficient capital, obsolete equipment and old vintage technology were unable to compete in international markets. In the 1950s, Spain did not have access to innovation and technology through international trade in competing products, and as a result it was prevented from fully sharing the benefits of fast productivity growth in Western Europe. 5

The Golden Age: years of accelerated growth, 1959-75

In the late 1950s, the autarkic system imposed by the Francoist authorities after the Civil War collapsed. The need to put an end to Spain's isolation at the time of the Treaty of Rome (1957), and to restore internal and external balances, led to a drastic change in economic policy at the turn of the decade. Although Spain started a mild opening in the early 1950s, associated with the bilateral agreements with the USA, the pressure to open the economy increased as Spain joined the International Monetary Fund and the World Bank (1958) and the OEEC (1959). The creation of the Common Market (1957) and the introduction of external convertibility in Western European industrial countries (1958) provided a favourable atmosphere for growth. This helped a new cabinet in Spain to introduce a pro-market policy, but not without a clash within the Franco regime between pro-market and autarkic groups (Anderson, 1970). The policy outcome of establishing links with international economic organizations was a most ambitious project of liberalization that began with a stabilization plan in 1959 (Fuentes Quintana, 1984). A gradual opening and factor mobility (capital inflows and labour migration) were achievements of the new pro-market orientation, while the lack of structural reforms affecting the tax system and labour andfinancialmarkets represented its main shortcomings (Donges, 1971). The economic reform included specific measures aimed at controlling the growth of internal prices and achieving budget balance (Fuentes Quintana, 1989). Among the different measures passed to control inflation, it is worth mentioning the prohibition onfinancingthe government deficit through monetization of the public debt.26 Additional constraints were imposed on the loans drawn by the private sector from the banking system.27 The government also decided to control public expenditure through orthodox fiscal policies centred around a balanced budget, and to raise the prices of certain goods (petrol, tobacco) and services (telephone, public transport) supplied by state monopolies, in an attempt to close the gap between official prices and their real costs of provision (de la Dehesa et ai, 1991; Comin, 1994). A second package of measures aimed at the gradual opening of the Spanish economy to the international markets, while preserving the external equilibrium. The system of multiple exchange rates developed under autarky was abolished, and

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the peseta was devalued by 43 per cent in an attempt to improve export competitiveness (Donges, 1976: 59). A gradual process of import liberalization was initiated by making flexible the different trade regimes effective under autarky.28 A new tariff in 1960 eliminated quantitative restrictions on 90 per cent of imports and marked the return to the use of ad valorem duties, as opposed to quotas, as a protectionist instrument.29 The new tariff, still a protectionist one, tended to be biased in favour of consumer goods and had a cascading effect on customs duty rates, so effective protection was usually higher than nominal protection. Reforms of the 1960 tariff during the following years reduced effective protection (and its unequal distribution) sharply, from 77.2 per cent in 1962 to 38.4 per cent in 1968 (Bajo and Torres, 1990).30 These measures were complemented by allowing a controlled inflow of foreign long-term capital that, according to Donges (1976), averaged an annual 7 per cent of capital formation over 1960-8.31 The stabilization plan proved most successful after a first year of adjustment, in which the severe measures adopted had a negative impact on economic activity (real income per head fell by 2.7 per cent in 1959) (Prados de la Escosura, 1995). The success of the stabilization plan was probably helped by the ban on free trade unions, which avoided wages claims after the severe devaluation in 1959 (Donges, 1976: 62). Inflation declined from around 12 per cent in 1957-9 to 2.3 per cent for 1959-61 (Comin, 1993). Meanwhile, the (commodity) trade deficit shrank from 7 per cent of GDP in 1957/8 to 3.2 per cent in 1961, and the current account cast a positive balance for 1960 (3.7 per cent of GDP) (de la Dehesa et ai, 1991). The increasing number of tourists and the inflow of foreign capital, together with the return of Spanish capital from abroad, led to the appreciation of the peseta over the official rate of exchange, the disappearance of the black market, and the consequent declaration of external convertibility for the Spanish currency in 1961. As an outcome of the reforms, exports of goods and services experienced a sustained growth over the 1960s and early 1970s, raising their share of GDP from 5.8 per cent in 1959 to 10.7 per cent in 1974. In turn, a higher degree of openness was achieved as exports plus imports grew from 13.9 per cent of GDP to 29.5 per cent during the period (Chamorro et ai, 1975; Prados de la Escosura, 1994). Meanwhile, foreign investment constituted an average 5.8 per cent of fixed capital formation over 1959-74, of which 44 per cent was direct investment, and 74 per cent of it went to manufacturing (Donges, 1976: 108). Since 1964, government intervention in economic activity was reoriented through successive four-year planes de desarrollo (development programmes). The plans, inspired by post-1945 France's planification indicatif, lasted until 1975. The planes allocated a prominent role to privatefirmsas the engine of economic development, but maintained government intervention in economic activity by means of market regulation, public investment and enterprises, and direct intervention in specific economic sectors. Planification indicatifwas implemented through a wide variety of measures, such as public subsidies, tax reliefs, tariff advantages and preferential access to official credit. The planes have been considered a setback for Spain's liberalization and associated with a deceleration in the rate of economic growth (Gonzalez, 1979). It is still debated why the government proceeded so cautiously in dismantling trade barriers and regulations. One explanation is based on the social costs in terms of output and employment derived from a sudden opening up

Growth and macroeconomic performance in Spain, 1939-93

371

(Spitaller and Gali, 1992), which complements another one based on the pressure exerted by interest groups (Fraile, 1993). A last attempt to liberalize the economy took place under the dictatorship in 1970, linked to the preferential agreement with the EEC. However, it was cut short by the first oil shock (1973) and the death of Franco (1975) (de la Dehesa et ai, 1991). In such a context of cautious outward-looking policies under close government supervision, accelerated growth and structural change proceeded in Spain, as a lagged response to the 1950s Western European experience of reconstruction and catching up, prevented by autarky at the time. Spain's economy grew and diversified between 1959 and 1975 (Tables 12.1 and 12.5), while efficiency improved remarkably. Between 1965 and 1975, total factor productivity rose at an annual rate of 3.8 per cent for the whole economy (Suarez, 1992; Myro, 1983), while TFP in agriculture and industry grew at 2 and 6 5 per cent, respectively (San Juan, 1987; Gandoy, 1987).32 A deep reallocation of resources took place. Agricultural share in GDP fell from almost one-quarter of GDP in 1960 to less than 10 per cent by 1975 (that is, at an annual rate of — 6 per cent), while its contribution to employment shrank from over 40 per cent to below a quarter of the total labour force (at — 3.8 per cent yearly), leading to a significant decline in its relative productivity.33 Meanwhile, services reached one-half of GDP, employing two out of everyfiveworkers by 1975. Labour released by agriculture reached 2 million in 1961-70 (Leal et ai, 1975), which to a large extent was absorbed by the 'urban' sector (industry and services), although emigration to Western Europe also represented a decisive outlet.34 However, a significant percentage of the labour force still remained in agriculture, as a comparatively low output per worker in European terms suggests, and as relative labour productivity indicates (Table 12.5).35 Given the disadvantage in output per hectare derived from poorer soil, a lower endowment of land per worker is behind the Spanish agricultural productivity gap (O'Brien and Prados de la Escosura, 1992; Simpson, 1995). Outward orientation of Spanish industrialization remained limited over 1959-75. By 1972, two-thirds of manufacturing output was still produced byfirmswith fewer than five workers, so size remained a major shortcoming for industry's reaping economies of scale and, thus, having access to foreign markets. Manufacturing performance was impressive, growing at over 10 per cent annually, with an increasing role for producer goods industries (Carreras, 1992). However, it depended mostly on home demand (87.6 per cent over 1962-72), with exports accounting for only 22 per cent of the increase, and a negative contribution of import substitution (Donges, 1976: 158, 168). The increase in manufactured exports was due largely to competitiveness (50 per cent) (Donges, 1976:206). Spain exhibited revealed comparative advantage mostly in labour and natural resource-intensive goods, but product-cycle goods were increasingly competitive.36 The Spanish experience tends to suggest, nevertheless, that industries that had followed ISI strategies in the 1940s and 1950s gradually managed to export after 1959 (Donges, 1976). In the 1960s, labour market rigidity represented a real obstacle for an outward shift of labour demand that could not match its supply. In fact, the low level of unemployment (1.7 per cent over 1960-75) did not increase, due to a steady migratory flow towards Western Europe. Migrant remittances contributed to balance Spain's current account. Underemployment remained present due to strict

372

Leandro Prados de la Escosura and Jorge C. Sanz 16 000

0.25

0.20-

1 0.15Labour force,, '/

0.10 -

8 0.05 - • Employment

10 000

0.00

1955

1960

1965

1970

1975

1980

1985

1990

Sources: Ministerio de Economia y Hacienda (MOISSES model).

Figure 12.6 Employment, labour force and the rate of unemployment: Spain, 1955-93

legislation that inhibited layoffs of redundant workers, together with low female participation in the labour force. The resulting pattern of development in the 1960s was, thus, largely dependent on capital accumulation and efficiency gains. Capital deepening was substantial, and fixed capital stock per head grew at 5.7 per cent annually (that is, more than doubling its size), while non-residential capital and machinery and equipment grew at 7.2 and 8.9 per cent per capita, respectively (Hofman, 1993b). Suarez (1992)findsthat, in the period 1965-75, most of real GDP growth is accounted for by total factor productivity gains (58.8 per cent) and capital accumulation (34.7 per cent), while increased labour input accounts for only 6.5 per cent (Table 12.2). In turn, macroeconomic performance played a decisive role in achieving a positive deviation from OECD average growth, most of which was accounted for by the differential money supply and real exports growth (Table 12.4).37 However, inflationary pressure (7.8 per cent annually in 1960-75), together with occasional current account disequilibria,38 constituted a threat that forced the economic authorities to impose episodic stabilization measures.39 In summary, orthodox fiscal policy, near equilibrium in the external sector, and expanding output, coexisting with unreformed factor and product markets and exchange controls, are the main features of the Spanish economy during 1959-75. Shocks and stagflation: the transition from dictatorship to democracy, 1975-85 The oil shocks (1973,1979) coincided in Spain with the end of Franco's regime and the transition to a democratic society. Structural inefficiencies were inherited from

Growth and macroeconomic performance in Spain, 1939-93

373

the Franco era (1939-75), and the post-1959 liberalization had been progressively curtailed by the pressure of interest groups, resulting in a mixture of market and dirigiste economy, whose negative effects would emerge with the supply shocks of the 1970s.40 Thus, the late 1970s opened an unstable political phase in which economic performance was dominated by disinvestment, inflation and job destruction. The oil crisis was aggravated by the fact that Spain was a heavily energy-dependent country,41 whose productive structure was biased towards heavy industry with weak demand. Furthermore, the situation was worsened by the fact that Spain's authorities perceived the oil shortage of 1973 as a temporary shock. The deterioration of the terms of trade, resulting from rising energy import prices, was not followed by a reduction in real wages. In fact, between 1973 and 1976, wages (nominal and real) boomed. Political unrest, initiated in the early 1970s and reaching a peak after Franco's death, led the government to implement compensating policies, such as keeping low energy prices by direct price intervention and nominal wage indexation, thus enhancing the impact of the oil shock and fuelling the current deficit and inflation, which rose as high as 24.5 per cent in 1977. Only after the first democratic elections (June 1977) were adjustment measures introduced (Garcia Delgado, 1990). The Moncloa Agreements represented a set of structural reforms and economic policy measures supported by the consensus of the main political parties and ratified by Parliament. A non-orthodox mix of incomes policies, plus accommodating fiscal and tight monetary policies, were its main features (Spitaller and Galy, 1992). Among those worth mentioning are the fiscal reform, in which progressive wealth and income taxes were included. An active monetary policy aimed at reducing inflation expectations followed.42 A new exchange rate wasfixedfor the peseta (20 per cent lower) in an attempt to improve the external disequilibrium, from which derived short-run positive effects on the current account.43 Trade liberalization resumed in 1977, but the 1979 oil shock, the unstable political climate and the negotiations with the EEC slowed it down (de la Dehesaer ai, 1991). At the same time, income policy agreements attempted to moderate increases in nominal wages.44 However, when the new, democratically elected authorities took steps to adjust to relative price changes resulting from the oil shocks, the lack of flexibility of input markets to reallocate resources acted as a brake. Until the early 1980s,financialmarkets remained regulated and segmented, and exchange controls on capital outflows remained in place, while the still effective Francoist legislation impeded layoffs andflexibilityof contracts in the labour market. Thus, if the set of measures included in the Pactos de la Moncloa are evaluated against economic performance over 1977-81, a favourable balance appears for (a still high) inflation, the external balance and firms' profitability (after wage moderation), while it was not so favourable for the labour market and GDP growth.45 The arrival of the Socialist Party to government in 1982 extended and deepened the reforms initiated with the Moncloa Agreements (1977). In particular, the reform of the industrial sectors most affected by the crisis (steel, textiles and shipbuilding) and the opening of the economy became the top priorities of the new government.46 Financial markets experienced a major deregulation, as interest rates and capital movements were freed. After the Socialist electoral landslide in 1982, a devaluation of the peseta took place, with short-term positive effects on the current account (1984-6), while monetary policy became more restrictive to check the rise in prices.

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Leandro Prados de la Escosura and Jorge C. Sanz

In turn, the growth of public expenditure and the increases of fiscal pressure represented the main features offiscalpolicy under all the Socialist cabinets (both up to 1986 and afterwards). The growth of public expenditure from 25 per cent of GDP in 1975 to 36 per cent in 1985 was due to the increase in current transfers and public investment, and to the service of a public debt (which rose from 13 to 45 per cent of GDP in the 'transition decade') associated with the introduction of the welfare state, and the costs of industrial reconversion and regional devolution (Gonzalez-Paramo, 1992). Such a major expansion in expenditure, without an offsetting increase in fiscal revenues, resulted in a sustained public deficit. In short, during thefirstthree years of Socialist government, the reduction in the rate of inflation continued (from an average of 16 per cent in 1978-82 down to 10.8 per cent in 1983-5), and external equilibrium was temporarily achieved, while substantial increases took place in unemployment (from 11.6 per cent of the labour force in 1978-82 to 20 per cent in 1983-5) and in the public deficit (from 3.3 to 5.7 per cent of GDP). When the entire transitional period from Franco's death to Spain's EEC membership is considered, some major features emerge. The 1973 and 1979 oil shocks resulted in a deceleration of economic activity that lasted up to the mid-1980s and implied comparative retardation (Table 12.3 and 12.4). In fact, real GDP grew at an annual average rate of only 1.7 per cent between 1975 and 1985 (Table 12.2). Real investment stagnated, while growth depended mainly on private consumption. Job destruction (at —1.6 per cent annually) becomes noticeable when the labour force increase over 1975-85 (0.6 million) is confronted with the 2 million fall in employment. Agriculture had the larger share of unemployed, 1 million workers, against 0.8 and 0.4 million in industry and construction. In turn, capital deepening continued, though at a substantially slower rate than in the years 1960-75. Thus, the stock of physical capital per head grew at 3.3 per cent annually (4.2 per cent for non-residential capital) (Hofman, 1993b). A look at the growth accounting exercise in Table 12.2 confirms a negative contribution of labour to growth (— 0.9 per cent yearly) that could not be offset by that of capital (0.7 per cent). Thus, between 1975 and 1985, employment destruction represented a severe brake on growth, while capital accumulation and, mostly, TFP gains explain it all. However, empirical evidence (Table 12.3 and 12.4) tends to suggest that capital deepening was not carried forward sufficiently, and TFP alone was not enough to close the gap with advanced countries over the 'transition years'. Macroeconomic factors did not contribute to catching up with OECD growth between 1975 and 1985 (Table 12.4). Average inflation reached 15.4 per cent, doubling its rate for 1960-75, while a substantialfiscaldisequilibrium, derived from the action of automatic stabilizers, raised the budget deficit up to an average 3.6 per cent of GDP. Besides, the slow reaction of the Spanish authorities to OPEC shocks contributed to fuel inflation, reduce competitiveness and provoke a rise in the current account deficit (up to an average of —1.1 per cent of GDP in 1976-85).47 When compared to the OECD average, Spanish exports were more labour than capital intensive, and more intensive in physical capital and natural resources than in human capital, while they were mainly composed of goods with weak demand (Martin, 1992). In brief, a still highly protected economy,48 dominated by small firms relying on obsolete techniques, prevented Spanish industry from achieving

Growth and macroeconomic performance in Spain, 1939-93

375

economies of scale and having access to innovation and latest-vintage technology.49 Moreover, economic growth during the 'democratic transition' (1976-85) was severely constrained by overregulated markets. In the labour market, restrictive industrial rules introduced under Franco, which aimed at offsetting the prohibition of independent trade unions by banning layoffs, constituted a major shortcoming for employment creation (Bentolila and Blanchard, 1990). Among Spanish firms most of them small in size, labour intensive and sheltered from competition bankruptcies increased dramatically, while the rate of unemployment rose, with an average rate of 12.8 per cent over the period 1976-85. In fact, the non-accelerating inflation rate of unemployment (NAIRU) jumped from 3.4 per cent in the late 1970s to 18.4 per cent in the early 1980s, to remain at a high level ever since (Dolado and Malo de Molina, 1985).50 When aggregate demand contracted during the crisis years, demand for labour fell and, given institutional constraints, quantity, and not price (wage), adjustments took place, resulting in high unemployment. Sectorial wages in Spain depended on the consumption aggregate wage, and not on sectorial productivity or the unemployment rate. Therefore, unemployed workers could not exert a downward pressure on wages, and unemployment has become a persistent phenomenon (Andres and Garcia, 1992). 7

Recovery of the late 1980s and its legacy: the integration of Spain into the EEC

Spain's admission into the European Community coincided with an expansionary phase of the international economy, and both contributed to a fast economic recovery in Spain. From 1986 to 1990, real GDP grew at an average rate of 4.4 per cent, the outcome of cumulative efforts to fight basic disequilibria associated with integration into the EEC, and of a closer link to the international markets. Positive short-run expectations opened the door to foreign capital and induced a burst of investment that was helped by the increase in profit margins and political stability.51 In fact, since a large technological gap existed between Spain and Western European industrial countries, direct foreign investment brought with it a technological transfer (Vinals, 1992). The positive effects on the labour market were immediate, and the unemployment rate fell from 21.9 per cent in 1985 to 16.3 per cent in 1990.52 In all, employment increased by 3 per cent annually, which represented more than 1.7 million new jobs between 1985 and 1990 (as much as from 1957 to 1974), and job destruction persisted only in agriculture (0.5 million).53 Suarez's (1992) growth accounting exercise reflects this improvement, showing that, from 1986 to 1990, job creation accounted for 38 per cent of real GDP growth, while capital, growing at over 5 per cent annually, contributed 32 per cent (Table 12.2). When placed within the OECD context, Spain overperformed in the late 1980s, with a major contribution from macroeconomics. The control of inflation and the management of money supply, together with a reduced budget deficit, accounted for most of it (Table 12.4). However, although the public deficit experienced a substantial reduction between 1985 (7 per cent of GDP) and 1990 (4 per cent), it persisted over these fiscal expansionary years.54 Nevertheless, other economic disequilibria worsened. After the peseta joined the European Exchange Rate Mechanism (ERM), the competitiveness of Spanish

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products declined (as is reflected in the negative contribution of exports growth in Table 12.4). The loss of competitiveness due to an appreciated exchange rate reached up to 30 per cent from the mid-1980s to 1993 (Camarero and Tamarit, 1994). Despite inflation falling to 6.5 per cent over 1985-90, the price differential between Spain and its main trading partners (EEC countries) widened. It has frequently been argued that Spain's differential inflation reflected the lack of competition in non-tradable goods markets.55 The implication of Spain's affiliation to the ERM coexisting with an increasing price differential was an appreciation of the real exchange rate of the peseta.56 However, part of the appreciation of the peseta was due to real factors, such as a productivity increase translated into higher wages, which means that not all the exchange rate appreciation implied a net loss in competitiveness.5 7 In turn, the current account deficit reached — 2 per cent of GDP in the period 1986-90.58 Currently, Spain's integration into the EEC has had a larger impact on imports than on exports. Over 1986-90, while the integration effect accounted for 53 per cent of the increase in Spain's manufacturing imports from the European Community, it contributed to only 28 per cent of the increase in Spanish manufactured exports to the EEC (Martin, 1992).59 However, the external deficit was largely due to the private capital inflow (mostly direct investment) that was required to renew and expand the productive capital stock. In fact, the currently account deficit was more than offset by long-term capital inflows due to its high returns over 1986-91.60 Successful restrictive monetary policy conflicted, however, with exchange rate management. When domestic interest rates rose, the inflow of foreign capital increased (reinforced by the liberalization of capital markets), leading to an increase in the amount of money in circulation.61 The intervention of the Bank of Spain in the foreign exchange markets, with immediate sterilization measures to reduce domestic credit, raised domestic interest rates even more.62 Fiscal policy, in turn, was clearly expansionary, and its pro-cyclical behaviour pushed the public deficit up from 1990. An international recession has taken place in the early 1990s. In fact, sluggish economic activity in most of the OECD countries has shown particularly severe features in Spain. The strain in foreign exchange markets, and changes in the ERM resulting from the 1992-3 'monetary storm', led to three successive devaluations in Spain (up to 20 per cent altogether), which improved competitiveness. The authorities decided, however, to keep the peseta in the ERM, trying to avoid the loss of credibility that might have followed had the government decided to apply a discretionary economic policy.63 Slackening GDP growth (at an average of 0.7 per cent), a substantial public and external deficit ( — 5.6 and —3.3 per cent of GDP, respectively), 5.5 per cent inflation, and job destruction (0.7 million and an unemployment rate reaching 19 per cent of the labour force) are the main features of the early 1990s. High unemployment (over twice the OECD average) represents today a unique feature of Spain's economy within the European Union. In fact, Spain's labour market suggests a case of hysteresis, since transitory shocks, such as changes in relative factor prices in the 1970s, have had permanent unemployment effects. Lack

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of market flexibility due to low labour mobility and high wage indexation are considered to be the main obstacles to reducing unemployment in today's Spain (Andres and Garcia, 1992).64 The indexation of nominal wages implies that anticipated demand shocks do not have any impact on employment. However, wage indexation amplifies the unfavourable impact of supply shocks on employment. In addition, the high costs of layoffs have impeded labourflexibilityand created a weak relationship between wages and the value of marginal labour productivity. Unemployed workers cannot exert enough downward pressure on wages, and as a result, unemployment becomes a persistent phenomenon. It has been argued that not only legal and institutional restrictions affected the lowflexibilityof wages, but other factors, such as firms' recruiting methods, also account for it. Thus, given large differences in labour qualifications, together with the existence of adverse selection and moral hazard,firmsmay offer wages over the market average in an attempt to recruit the best qualified workers, provoking a medium-term push on the average wage, and eventually increasing unemployment. Finally, severe restrictions on regional and sectorial labour mobility are posed by unemployment benefits that reduce incentives to migrate, and by housing market rigidities that make geographical mobility difficult. Recent approaches to the labour market depart from a disequilibrium perspective (Sneessens and Dreze, 1986; Bean and Dreze, 1990), assuming that the labour market is rationed by the installed capacity of thefirm,which effectively restricts the number of workers that can actually be hired in the short run.65 In addition, a firm may be ready to hire more workers at the given real wage, but a restriction on the size of the labour force prevents thefirmfrom doing so. Finally, even when the firm has enough installed capacity and there is enough labour available, there may not be enough demand to absorb it. In the case of Spain, Ballabriga et al. (1991) estimated the distinctive contribution of the different regimes (potential employment, demand-determined employment and labour supply) to explain the observed variation in employment between different periods during 1969-88. Two additional variables were included, labour utilization (whose increase contributes negatively to employment), and a residual term, structural mismatch, which accounts for market rigidities and information costs. The main results for the Spanish case are that, during recessions, restrictions on installed capacity and demand, plus structural mismatch, accounted for unemployment. Moreover, the utilization of labour tended to fall, offsetting the decline in employment.66 This fact seems to imply job hoarding, a feature of labour markets under high adjustment costs (Sargent, 1978). In recent years (1989-91), the economic recession contracted investment levels as a result of firms' pessimistic demand expectations, while labour costs increased relative to capital, reducing the amount of employment required per unit of productive capacity, and the demand restriction operated again (Andres and Garcia, 1992). From Spain's macroeconomic performance and policies in the late 1980s and early 1990s, some lessons can be drawn. The strategy of the Spanish authorities after joining the EMU was to gain credibility through a competitive deflation (Camarero and Tamarit, 1994). To do so, an overvalued real exchange rate was established for the peseta that allowed the purchase of raw materials and intermediate goods at

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relatively low prices, aimed at favouring structural change. In turn, economic agents were forced to exercise self-discipline in order to avoid further losses in competitiveness within an open economy. This strategy worked successfully for the tradable goods sector, but not for the one producing non-tradable goods, which fed the inflation differential with the EEC countries. Moderation of wages and financial costs did not take place because of the high interest rates resulting from monetary and exchange rate policies and the public deficit. Thus, the attempt to mitigate the social costs of restructuring the economy, by combining restrictive monetary and incomes policies with fiscal expansion, faces strict limits as high interest rates and their associated effects (appreciation of the real exchange rate and budget and external deficits) cannot be maintained for a long time without putting the country's competitiveness in jeopardy. In turn, market rigidities, which persisted in the post-Franco era and were reinforced in the labour market to keep social unrest at minimum levels, constitute a major inefficiency in Spain, with unemployment at the highest level in Europe.67 In fact, a competitive deflation strategy, trying to improve competitiveness through wage moderation, cannot succeed given Spain's high unemployment, as is shown by the failure of rising unemployment in the early 1990s to have a downward impact on wages.68 8

Concluding remarks

As Spain eventually succeeded in the transition from a highly regulated economy under an interventionist, authoritarian political regime, to an industrial democracy, some lessons from recent Spanish economic history may be of interest for today's developing ex-Communist countries. 1. The autarkic period (1939-59) resulted in high costs in terms of growth. These costs are not restricted to the 1940s, but include the 1950s, a decade of fast international growth and catching up, in which Spain remained relatively isolated and paid a heavy penalty in the form of growth that was unstable and below potential. International isolation, together with resource allocation aside from the market, are responsible, it is widely accepted today, for delayed postwar reconstruction and catching up. 2. Whether deeper and more rapid reforms in the 1960s increased the already impressive rate of growth and catching up is still a debated issue. It can be reasonably argued that faster growth (Table 12.1) might not have been feasible, but instead a more balanced development path, closer to that followed in Western Europe, would have taken place with lower efficiency and social costs.69 In fact, the Spanish experience of the 1960s and the early 1970s seems to question the extent to which factors other than capital accumulation and access to innovation and technology played a major role in Spain's economic growth, once the main constraints of autarky were eliminated. In other words, the allocative inefficiencies resulting from government overregulation and direct intervention in the late 1960s (particularly after the planes de desarrollo were implemented) do not seem to have put a significant brake on growth, as the institutionally oriented historiography has claimed.70 Nevertheless, cumulative inefficiencies during the Franco era constrained further adjustment to international competition in future years.

Growth and macroeconomic performance in Spain, 1939-93 379 3. Liberalization in post-1959 Spain was gradual, and several stages can be distinguished, linked to international agreements which posed no serious threat to Franco's dictatorship. In fact, both after autarky (post-1959) and during the transition to democracy (post-1977), financial stabilization was radical, but structural reform was gradual. These features make the Spanish case of special relevance for countries on their way to industrial democracy and aiming to open up, while maintaining social and political stability. However, the fact that liberalization took place over a very long period of time makes the Spanish experience of limited use for countries in which the transition to a market economy occurs within a democratic context, and where, consequently, a strong social pressure exists to proceed as fast as possible. 4. Once Franco's dictatorship was over and the return to democracy took place, a restrictive monetary policy and high exchange rate were necessary but not sufficient conditions for resuming growth and structural change in Spain under a different set of institutions. A restrictive fiscal policy and moderate labour costs, together with supply-side policies to improve firms' productivity and increase the flexibility of economic sectors, such as microeconomic measures to increase the productivity and competitiveness of the non-tradables sector, are also prerequisites for sustained growth and catching up.71

NOTES This paper is produced as part of a CEPR research programme on 'Comparative Experience of Economic Growth in Postwar Europe', supported by a grant from the Commission of the European Communities under its SPES Programme (no. SPESCT910072). Research for this paper has been funded by the Direction General de Planificacion, Ministerio de Economia y Hacienda. The authors are grateful to Nick Crafts and Gianni Toniolo for their comments on an earlier draft, and to James Simpson for his careful reading of the paper and useful remarks. We acknowledge the access to Pedro Fraile Balbin's work in progress on the political economy of Franco's regime, and to Francisco Comin's and Pablo Martin Acena's unpublished surveys of twentieth century Spain's economic history. The usual disclaimer applies. 1 Less intense than suggested by earlier GDP estimates (Prados de la Escosura, 1995). 2 Pre-Civil War highest GDP level (1935) was reached by 1951. 3 Annual growth rates are computed through exponential fitting. If, instead, the average rate of variation is chosen, the result for the 1940s improves (1.0 per cent, with a standard deviation of 4.4), while it remains unchanged for the 1950s (3.7 per cent, st. dev. 3.4). 4 The 6.3 per cent rate of growth for 1960-73 (Table 12.1) results from a new linkage of national accounts data (Prados de la Escosura, 1994). Official figures cast a lower rate, 5.5 per cent annually. 5 Employment grew at 0.82 per cent annually and labour force at 0.87 per cent between 1955 and 1974. 6 Non-residential capital grew even faster, doubling its ratio to output between 1950 and 1990 (Hofman, 1993b). 7 Thus, machinery and equipment doubled its share, reaching 0.44 of non-residential capital in 1973, although it contracted to 0.39 by 1989. 8 In particular, when machinery and equipment is considered, and Spain compared to the USA, France or Japan.

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9 De Long and Summers (1991) predict a growth rate of 3.1 per cent for GDP per worker in Spain between 1960 and 1985, while the actual growth was 3.7 per cent. 10 An alternative estimate of Spain's sources of growth, using an ad hoc framework, has been carried out by Hofman (1993a) for 1950-89, with similar results. The periodization by Suarez (1992) makes his estimates more adequate for our purposes. 11 Minor amendments have been introduced in Suarez (1992) TFP growth figures to allow inputs' contribution to growth and TFP to add up to the GDP growth rate. 12 It was a persistent phenomenon even though Spain performed well above the average up to 1973, and below it thereafter. 13 They rely on previous research by Andres et al. (1993). We acknowledge their permission to use the unpublished results. 14 However, supply-side policies are not directly accounted for in this exercise and should, therefore, be included in the residual. 15 For instance, in 1950, the average years of schooling in Spain per 1000 US dollars (1985 prices PPP) of non-residential capital were one-third of Japan's (Barro and Lee, 1993; Hofman, 1993b; Maddison, 1993). This hypothesis is explored in Prados de la Escosura (1994). 16 The Primo de Rivera's coup d'etat in 1923 opened a dictatorial era that ended in 1930. 17 As Fraile (1993) reminds us, dictatorships are constrained by specific circumstances, incentives and preferences, within which they maximize their utility, conditioning their economic performance. 18 FAO was joined in 1950 when financial links were established with the USA, leading to an economic agreement between the USA and Spain in 1953. Later, in 1955, Spain was admitted as a member of the UN. 19 Catalan (1993) provides a preliminary attempt to derive a series of the real exchange rate for the 1940s and 1950s that confirms the peseta's tendency to be overvalued. 20 From 1940 to 1947 the exchange rate remained unchanged. In 1948, a multiple exchange rate system for activities related to exports, imports, tourism and capital movements was adopted, lasting until 1959 (Donges, 1971; Gonzalez, 1979). A weighted average exchange rate is provided by Serrano Sanz (1992) for 1949-58, using the shares of imports and exports under each exchange rate as weights. 21 It allowed exporters to keep the foreign exchange they obtained from their sales abroad, as a means of payment for future imports. The introduction of a system of export subsidies aimed at improving the competitiveness of Spanish goods also failed in such a context. 22 This hypothesis is tested in Taylor (1994) and Lee (1994). 23 In fact, commodity imports reached an average of 11.7 per cent of GDP for the period 1947-59. In the early 1940s they remained around 5 per cent. 24 A foreign exchange crisis took place in 1959 as foreign reserves fell to $8 million from $58 million the year before, while Spain's committed payments represented $60 million. 25 Machinery and equipment per head more than doubled in the 1950s, growing at 8.2 per cent annually. 26 This procedure, called pignoracion, was frequently used in the last century, and constituted an indirect mechanism for financing the public deficit that would be used as collateral against credit from the Bank of Spam. In fact, at the end of

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27 28 29 30

31 32 33 34

35

36

37 38 39 40 41 42

1958, the issue of automatically pledgable securities ceased (de la Dehesa et a/., 1991). Specific limits were established to rediscount financial assets in the Bank of Spain, and the rate of rediscount was increased to make these specific loans more expensive. There were four different trade regimes (state, bilateral, globalized and liberalized), depending on the degree of control and on the restrictions imposed over the different varieties of imports (de la Dehesa et al.9 1991). Still 20 per cent of imports were ruled by bilateral trade agreements and government agencies. By weighting sectorial rates of protection with the sector's share in output, an ex-post (weighted average) effective rate of protection was derived for manufacturing by Donges (1976: 72, 76) for 1962 and 1968. Manufacturing (excluding food) was nominally protected by 31.3 per cent, and by 68.4 per cent effectively in 1962, while for 1968, in turn, it fell to 23.9 and 31.2, in nominal and effective terms, respectively. Durable consumer goods received the highest nominal and effective protection, whereas machinery and equipment had the lowest. A Stabilization Fund was also created with resources provided by the IMF, the OEEC and the private US banking system, to face disequilibria in the current account without affecting the rate of exchange (Donges, 1976: 59). Kendrick (1990) estimates a 4.2 per cent growth rate for TFP in the period 1960-73. From 0.56 to 0.41 between 1960 and 1975, taking 1 as the average labour productivity in Spain's economy. Spanish emigration to Western Europe (excluding seasonal) was 0.7 million in the same period (1961-70), according to Spanish official sources, but it was over 1.3 million if receiving countries' sources are consulted. For the entire period 1960-75, official estimates recorded afigureof 1.1 million permanent (non-seasonal) migrants to Europe. In 1975, Spanish final agricultural output per worker represented, in purchasing power parity terms, 29.9 per cent of the UK's, 44.5 per cent of France's, and 16.1 per cent of the USA's (Prasada Rao, 1993), despite the significant catching up experienced over the period 1960-75 (O'Brien and Prados de la Escosura, 1992). Such as leather and wooden goods, footwear, clothing, furniture, pottery and glass, minerals and metal manufactures, on the one hand, and chemical fertilizers, plastic, rubber and paper goods, and transport equipment, on the other (Donges, 1980). According to Andres et al. (1994), only Italian macroeconomic performance has a comparable explanatory power of differential growth. However, for the period 1960-75, the current account deficit only represented on average -0.6 per cent of GDP. In turn, the commodity trade balance and the trade balance (including services) represented — 6.8 and — 5.5 per cent of GDP. Adjustments were introduced in 1967,1970-1 and 1975 (stop-and-go policy) (de la Dehesa et ai, 1991). An idea of misallocation of resources in the post-1959 years is provided by Donges' (1976:225) estimates of the high opportunity cost of domestic resources in Spanish industry. Up to 75 per cent of its energy consumption was imported (de la Dehesa et al, 1991: 158). As opposed to the traditional passive monetary policy followed since the Franco years, which adjusted to the public sector need for resources and led to high rates of inflation.

382 Leandro Prados de la Escosura and Jorge C. Sanz 43 In 1978 and 1979, the negative trade balance fell sharply and the deficit on current account disappeared. 44 Pay increases were defined as a function of expected inflation, instead of last year's inflation. This measure, despite being a great step forward to break the traditional wage bargaining mechanism, would become a big obstacle to fighting inflation in the 1980s. In fact, nominal labour costs grew steadily at a higher rate than inflation. 45 A brief sketch of the delayed Spanish reaction to the oil shocks could be as follows. When the relative price of energy and raw materials rose,firmsreacted by reallocating their inputs so as to increase their marginal productivity. The fall in the demand for energy and raw materials reduced labour marginal productivity, andfirmshad to compensate through a reduction in their number of employees at a given real wage. The contraction of the demand for energy, raw materials and labour also reduced capital marginal productivity, leading firms to reduce their volume of investment. As a consequence, the change in relative prices of energy and raw materials provoked a contraction in aggregate supply, which reduced real output growth and raised the rate of inflation. Workers suffered an important fall in real wages as a result of increases in prices, and reacted by demanding higher nominal wages. As a consequence of higher input costs (raw materials, energy and labour) and the fall in internal demand (as unemployment increased), profitability declined and firms reacted by reducing investment and employment demand once again. Somefirmstried to avoid the economic crisis with new credits (thanks to the negative real interest rates, due to moderate nominal interest rates coexisting with high rates of inflation). Eventually, the measures of monetary restriction and the new attitude of lenders in a context of high inflation provoked an increase in real interest rates which produced a financial crisis in many firms. 46 Which was reinforced by the authorities' decision to keep Spain in the NATO military structure after joining (1981) and to accelerate economic integration into the European Community, achieved in 1986, which was widely viewed in Spain as the only means to reach political stability and to secure democracy (de la Dehesa et a/., 1991). 47 Meanwhile, the commodity trade deficit and the (total) trade deficit represented an average —5.4 and —4.1 per cent of GDP, respectively. 48 The average effective protection in 1980 was 33.7 per cent (Bajo and Torres, 1990). 49 In fact, by 1985, 80 per cent of firms still had fewer than ten workers, and R & D represented 1.1 per cent of manufacturing value added, against 4.6 per cent in the EEC (Martin, 1992). 50 De la Dehesa et al. (1991) provide alternative NAIRU estimates for 1974^9,6.6 per cent, and 1980-4,11.3 per cent. Crafts (1993), in turn, suggests that NAIRU reached 9.7 per cent in 1969-79, and 15 per cent in 1980-8. 51 The yearly increase in real investment reached a peak of 15 per cent in 1988. 52 For the years 1986-90, the unemployment rate represented, however, an average of 19.1 per cent. 53 Employment grew faster than active population (1.1 million). Labour creation in 1985-90 represented 0.3, 0.4 and 1.5 million in industry, construction and services, respectively. 54 An average public deficit of 3.8 per cent of GDP for 1986-90. 55 In fact, given their lower productivity, because of a lower capital/labour ratio and similar wage levels, non-tradables (and services, in particular) reached higher prices.

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56 Spanish relative prices rose both because of structural change and internal imbalances, i.e. the impact of non-tradables on tradable goods, the small size and backward technologies of firms, and labour market rigidities. 57 Factors that favoured an appreciation of the peseta were the inflow of capital and the terms of trade gain derived from a fall in oil prices, while the reduction of tariff barriers with entry into the EC and changes in consumer preferences towards foreign goods tended to cancel it out. 58 Over — 5 per cent of GDP for the trade balance. 59 Martin (1992:156) found that in the years 1986-90 final demand contributed 35 per cent and competitiveness 12 per cent to the increase in Spain's imports of manufactured goods from the EEC. In the case of Spanish manufactured exports to the EEC, Common Market demand provided 72 per cent, while competitiveness made a negative contribution. The overall increase in manufactured exports was only 38 per cent of that for manufactured imports. 60 Long-term capital inflows represented 2.8 per cent of GDP over 1986-91, and direct investment, 1.4 per cent. Meanwhile, the current account deficit reached —1.5 per cent and the trade deficit, —5.2 per cent. 61 Plus an overvaluation of the peseta and negative consequences on the current account. 62 In 1987 the targets for the monetary aggregate were revised, and some years later certain less orthodox measures were implemented. For example, in 1989 the Bank of Spain made explicit recommendations to commercial banks to impose credit rationing, and from 1987 to 1989 the control of exchange became a frequent policy. 63 The decision to stick to the ERM, in contrast to the cases of Italy and the UK, might also be related to the negative experience of the 1890s, when Spain gave up the gold convertibility of the peseta (Martin Acena, 1993). The poorer performance of Spain, as compared to these two other countries, deserves a thorough investigation (cf. Camarero and Tamarit, 1994). 64 This paragraph draws heavily on Andres and Garcia (1992). 65 Thus, potential employment is the number of workers that corresponds to the full utilization of the installed productivity capacity. 66 From the quantitative exercise it emerges that, in the late Franco years (1969-70 to 1971-4), the levels of installed capacity (0.6 per cent), demand (0.3 per cent) and labour availability (1.3 per cent) accounted for all observed employment growth (2.0 per cent), although structural mismatch ( — 0.4 per cent) and a high labour utilization ( — 0.6 per cent) reduced the explained employment growth (1.2 per cent). After the first oil shock and during the 'transition' years (1971-4 to 1975-82) there were negative effects on employment derived from restrictions in the installed capacity (— 2.1 per cent), in demand ( — 4.8 per cent) and in structural mismatch (—1.9 per cent), while positive effects were due to the fall in labour utilization (1.9) and supply (0.1), which together account for all the observed employment destruction ( — 7.7 per cent). A similar picture is obtained for the post-1979 oil shock (1975-82 to 1983-6), in which the negative contribution of capacity utilization ( — 5.6 per cent), demand ( — 5.9 per cent) and structural mismatch ( — 3.3 per cent) increased, hardly offset by the decline in labour utilization (0.6 per cent) and supply (0.1 per cent), amounting to all the observed decline in employment (—12.9 per cent). Finally, over the 1980s (1983-6 to 1987-8) positive contributions to observed employment growth (3.8 per cent) are derived from recovery of the levels of installed capacity (1.5 per cent), demand (2.5 per cent) and supply (0.2

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67

68 69 70

71

per cent), while the rise in labour utilization played a negative part ( — 0.9 per cent). There is an ongoing debate about the reliability and feasibility of unemployment figures for Spain, as the informal sector represents a non-negligible share of total economic activity. Adjusting for employment in the informal sector would probably cast a lower unemployment rate that, nevertheless, would have increased significantly since 1976. In fact, Spain's unit labour costs have increased to those in the EEC. The comparison of industrial performance in Spain and Italy seems to reinforce the argument (cf. Carreras, 1987, 1992). As Blanchard (1993: 232) recently put it, 'when one looks at postwar growth rates, the basic impression is that all countries had impressively high growth, no matter what strategy was being pursued'. If the post-1959 Spanish fast growth is viewed as a delayed postwar recovery, that contention would apply to Spain. In particular, the reform of the services sector (transportation, health, education), which is linked to the reform of public administration.

REFERENCES Anderson, C.W. (1970) The Political Economy of Modern Spain: Policy Making in an Authoritarian Regime, Madison, WI: University of Wisconsin Press. Andres, J. and J. Garcia (1992) Trincipales rasgos del mercado de trabajo espanol ante 1992', in J. Vinals (ed.), La economia espanola ante el Mercado Unico europeo: Las claves del proceso de integration, Madrid: Alianza. Andres, J., J.E. Bosca and R. Domenech (1994) 'Main patterns of economic growth in OECD countries', Direccion General de Planificacion Working Paper D-94001, Ministerio de Economia y Hacienda, Madrid. Andres, J., R. Domenech and C. Molinas (1993) 'Growth, convergence and macroeconomic performance in OECD countries: a closer look', Direccion General de Planificacion Working Paper D-93003, Ministerio de Economia y Hacienda, Madrid. Bajo, O. and A. Torres (1990) 'Estructura y caracteristicas de la protection en Espana', Information Comercial Espanola, no. 687, pp. 13-123. Ballabriga, F.C., C. Molinas, M. Sebastian and A. Zabalza (1991) 'Las restricciones de demanda y de capital en la economia espanola: 1964-1988', in C. Molinas, M. Sebastian and A. Zabalza (eds.), La economia espanola: Una perspectiva macroeconomica, Madrid: A. Bosch/IEF. Barciela, C. (1986) 'Introduction a "Los costes del franquismo en el sector agrario"', in R. Garrabou, C. Barciela and J.I. Jimenez Blanco (eds.), Historia agraria de la Espana contempordnea, vol. Ill, Barcelona: Critica. Barro, RJ. and J.W. Lee (1993) 'International comparisons of educational attainment', NBER Working Paper No. 4349. Baumol, W.J. (1986) 'Productivity growth, convergence and welfare: what the long-run data show', American Economic Review, 76 (5), pp. 1072-85. Bean, C. and J. Dreze (1990) 'European unemployment problem: lessons from a multicountry study', introduction to C. Bean and J. Dreze (eds.), Europe's Unemployment Problem, Boston, MA: MIT Press. Bentolila, S. and J. Blanchard (1990) 'Spanish unemployment', Economic Policy, 10, pp. 234-81. Blanchard, O. (1993) 'Panel discussion: lessons for Eastern Europe today', in R. Dornbusch, W. Nolling and R. Layard (eds.), Postwar Economic Reconstruction

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and Lessons for the East Today, Cambridge, MA: MIT Press. Camarero, M. and C. Tamarit (1994) 'La peseta en el SME: de la fortaleza a la crisis', Information Comercial Espanola, no. 728, pp. 145-59. Carreras, A. (1987) 'La industrial atraso y modernization', in J. Nadal, A. Carreras and C. Sudria (eds.), La economia espanola en el siglo XX: Una perspectiva historica, Barcelona: Ariel. (1992) 'La production industrial en el muy largo plazo: una comparacion entre Italia y Espana de 1861 a 1980', in L. Prados de la Escosura and V. Zamagni (eds.), El desarrollo economico en la Europa del sur: Espana e Italia en perspectiva historica, Madrid: Alianza. Catalan, J. (1992) 'Reconstruction, politica economica y desarrollo industrial: tres economias del sur de Europa, 1944-1953', in L. Prados de la Escosura and V. Zamagni (eds.), El desarrollo economico en la Europa del sur: Espana e Italia en perspectiva historica, Madrid: Alianza. (1993) 'Economia e industria: la ruptura de la posguerra en perspectiva comparada', Revista de Historia Industrial, no. 4, pp. 111-43. Chamorro, S., R. Commendador, J.J. Dolado, R. Repullo and J. Rodriguez (1975) 'Las balanzas de pagos de Espana del periodo de la autarquia', Information Comercial Espanola, no. 502, pp. 161-87. Comin, F. (1987) 'La economia espanola en el periodo de entreguerras (1919-1935)', in J. Nadal, A. Carreras and C. Sudria (eds.), La economia espanola en el siglo XX: Una perspectiva historica, Barcelona: Ariel. (1992) 'Una reconstruction economica diferente en la Espana de la postguerra', Estudis d'Historia Economica, no. 2, pp. 63-78. (1993) 'Estado y crecimiento economico en Espana: lecciones de la historia', Papeles de Economia Espanola, no. 57, pp. 32-56. (1994) 'Las etapas de la economia espanola (1923-1993)', unpublished manuscript. Crafts, N.F.R. (1993) 'Was the Thatcher experiment worth it? British economic growth in a European context', in A. Szirmai, B. van Ark and D. Pilat (eds.), Explaining Economic Growth: Essays in Honour of Angus Maddison, Amsterdam: North-Holland. Dehesa, G. de la, J.J. Ruiz and A. Torres (1991) 'Spain', in D. Papageorgiou, M. Michaely and A.M. Choski (eds.), Liberalizing Foreign Trade: The Experience of New Zealand, Spain and Turkey, Cambridge, MA: Blackwell. De Long, J.B. and B. Eichengreen (1993) 'The Marshall Plan: history's most successful structural adjustment program', in R. Dornbusch, W. Nolling and R. Layard, (eds.), Postwar Economic Reconstruction and Lessonsfor the East Today, Cambridge, MA: MIT Press. De Long, B. and L. Summers (1991) 'Equipment investment and economic growth', Quarterly Journal of Economics, 106 (2), pp. 445-502. Dolado, J.J. and J.L. Malo de Molina (1985) 'Desempleo y rigidez del mercado de trabajo en Espana', Boletin Economico del Banco de Espana, September, pp. 26-36. Donges, J.B. (1971) 'From an autarchic towards a cautiously outward-looking industrialization policy: the case of Spain', Weltwirtschaftliches Archiv, 107 (1), pp. 33-75. (1976) La industrialization en Espana: Politicas, logros, perspectivas, Barcelona: Oikos Tau. (1980) 'The Spanish industry in face of its integration into the European community', Economia Internazionale, 33 (4), pp. 399-415. Dowrick, S. and D.-T. Nguyen (1989) 'OECD comparative economic growth 1950-85: catch-up and convergence', American Economic Review, 79 (5), pp. 101O-30.

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Dumke, R. (1990) 'Reassessing the Wirtschaftswunder: reconstruction and postwar growth in West Germany in an international context', Oxford Bulletin of Economics and Statistics, 52 (2), pp. 451-91. Fraile, P. Balbin (1991) Industrializacion y grupos de presion: Le economia politica de la proteccion en Espana 1900-1950, Madrid: Alianza. (1993) 'Regulatory capture in peripheral Europe: the Spanish steel industry, 1941-1981 - an institutional analysis', unpublished manuscript, Universidad Carlos III. Fuentes Quintana, E. (1984) 'El Plan de Estabilizacion economica de 1959, veinticinco anos despues', lnformacion Comercial Espanola, nos. 612-13, pp. 25-40. (1989) Tres decenios de la economia espanola en perspectiva', in J.L. Garcia Delgado (ed.), Espana, Economia, Madrid: Espasa Calpe. Gandoy, R. (1987) 'Production y productividad en la industria espanola 1964-1981', Economia Industrial, no. 256, pp. 33-46. Garcia Delgado, J.L. (ed.) (1990) Economia espanola de la transicion y la democracia, Madrid: CIS. Garcia Santos, N. and P. Martin Acefia (1990) 'El comportamiento del gasto publico en Espana durante la Segunda Republica, 1931-1935', Revista de historia Economica, 8 (2), pp. 397-415. Gonzalez, M.J. (1979) La Economia politica del franquismo 1940-1970: Dirigismo, mercado y planificacion, Madrid: Tecnos. (1989/90) 'La autarquia economica bajo el regimen del General Franco: una vision desde la teoria de los derechos de propiedad', lnformacion Comercial Espanola, 676-7, pp. 19-31. Gonzalez-Paramo, J.M. (1992) 'El papel del sector publico espanol en el proceso de integracion economica en Europa', in J. Vinals (ed.), La economia espanola ante el Mercado Unico europeo: Las claves del proceso de integracion, Madrid: Alianza. Hernandez Andreu, J. (1980) Depresion economica en Espana 1925-1934: Crisis mundial antes de le Guerra Civil, Madrid: Instituto de Estudios Fiscales. (1986) Espana y la crisis de 1929, Madrid: Espasa Calpe. Hofman, A. (1993a) 'Long run growth in Spain and smaller Latin American countries: a comparative perspective', Proceedings of the SPES/EHES Conference on Long-run Economic Growth in the European Periphery, Coruna. (1993b) 'The capital stock of Spain in the 20th century', Proceedings of the SPES/EHES Conference on Long-run Economic Growth in the European Periphery, Coruna. Kendrick, J.W. (1990) 'International comparisons of productivity trends and levels', Discussion Paper No. 90-02, George Washington University. Leal, J.L., J. Leguina, J.M. Naredo and L. Tarrafeta (1975) La agricultura en el desarrollo capitalista espanol (1940-1970), Madrid: Siglo XXI. Lee, J.W. (1994) 'Capital goods imports and long-run growth', NBER Working Paper No. 4725. Lopez Garcia S. (1991) 'La organization de la investigation cientifica y tecnica tras la Guerra Civil: contrates y similitudes con los logros de las primeras decadas del siglo XX', Proceedings of Encuentro de Historia Economica, UIMP, Valencia. Maddison, A. (1993) 'Stime standardizzate dello stock di capitale: un confronto fra sei paesi', Innovazione e Materie Prime, no. 1, pp. 20-47. Malefakis, E. (1987) 'La economia espanola y la guerra civil', in J. Nadal, A. Carreras and C. Sudria (eds.), La economia espanola en el siglo XX: Una perspectiva historica, Barcelona: Ariel. Martin, C. (1992) 'El comercio industrial espanol ante el mercado unico europeo', in J. Vinals (ed.), La economia espanola ante el Mercado Unico europeo: Las claves

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del proceso de integration, Madrid: Alianza.

Martin Acena, P. (1993) 'Spain during the classical gold standard years, 1880-1914', in M.D. Bordo and F. Capie (eds.), Monetary Regimes in Transition, Cambridge: Cambridge University Press. (1994) 'La historiografia economica espanola en el siglo XX', in M. Palacios (ed.), Las ciencias sociales en la historiografia de lengua espanola, Bogota: Siglo XXL

Martin Acena, P. and F. Comin (1984) 'La politica monetaria y fiscal durante la Dictadura y la Segunda Republica', Papeles de Economia Espanola, no. 20, pp. 236-61. (1991) INI: 50 ahos de industrialization en Espana, Madrid: Espase Calpe.

Myro, R. (1983) 'La evolution de la productividad global de la economia espanola en el periodo 1965-1981', Information Comercial Espanola, no. 594, pp. 115-27. O'Brien, P.K. and L. Prados de la Escosura (1992) 'Agricultural productivity and European industrialization, 1890-1980', Economic History Review, 45 (4), pp. 514-36. Palafox, J. (1986) 'La politica presupuestaria de la Dictadura de Primo de Rivera: 6 una reconsideration necesaria?', Revista de Historia Economica, 4 (2), pp. 389-410. (1991) Atraso y democracia: La Segunda Republica y la economia espanola,

1892-1936, Barcelona: Critica. Prados de la Escosura, L. (1994) 'Growth and structural change in Spain, 19th-20th centuries', unpublished paper, Universidad Carlos III. (1995) Spain's Gross Domestic Product, 1850-1993: Quantitative Conjectures,

Universidad Carlos III Working Paper No. 95/05. (forthcoming) From Empire to Nation: Growth and Retardation in Spain, 1780-1930,

Cambridge: Cambridge University Press. Prasada Rao, D.S. (1993) Intercountry Comparisons of Agricultural Output and

Productivity, FAO Economic and Social Development Paper 112, Rome. San Juan, C. (1987) Eficiencia y rentabilidad de la agricultura espanola, Ministerio de

Agricultura, Madrid. Sargent, T.J. (1978) 'Estimation of dynamic labour demand schedules under rational expectations', Journal of Political Economy, 86 (6), pp. 463-99. Serrano Sanz, J.M. (1992) 'La apertura exterior de la economia espanola en perspectiva (1901-1980)', in J.L. Garcia Delgado (ed.), Economia espanola, cultura y sociedad: Homehnaje a Juan Velarde Fuertes, vol. I, Madrid: Eudema.

Simpson, J. (1995) 'Spanish agriculture: the long siesta, 1765-1965', unpublished manuscript, Universidad Carlos III. Sneessens, H.R. and J. Dreze (1986) 'A discussion of Belgian unemployment, combining traditional concepts and disequilibrium economies', Economica, 53, no. 210(S), pp. S89-S119. Soto, A. (1989) El trabajo industrial en la Espana contempordnea

(1874-1936),

Barcelona: Anthropos. Spitaller, E. and M. Galy (1992) 'Spain: landmarks in economic development, 1939-1992', IMF Working Paper 92/78. Suarez, F.J. (1992) 'Economias de escala, poder de mercado y externalidades: medicion de las fuentes del crecimiento espanol', Investigaciones Economicas, 2nd series, 16(3), pp. 411-41. Taylor, A.M. (1994) Tres fases del crecimiento economico argentino', Revista de Historia Economia, 12(3), pp. 649-83.

Vinals, J. (1992) 'La economia espanola ante el Mercado Unico: las claves del proceso de integration en la Comunidad Europea', in J. Vinals (ed.), La economia espanola ante el Mercado Unico europeo: Las claves del proceso de

integration, Alianza: Madrid.

13 Irish economic growth, 1945-88 CORMAC 6 GRADA AND KEVIN O'ROURKE

1

Introduction

Economic growth has made a welcome return to the headlines in the economics profession. Technical advances have made it possible to model the growth process rigorously in the presence of externalities and increasing returns, and this has spawned a vast literature formalizing many of the intuitions about growth previously held by applied economists and economic historians. Whether or not there are diminishing returns to capital, it seems clear that there are diminishing returns to theory, in this field at least. Theory urgently needs to be supplemented with empirical work, be it multicountry regressions or case studies, if thefieldis to retain its present vigour. We believe that Irish economic history offers many potential lessons for students of economic growth. While Dowrick and Nguyen (1989), Mankiw et al. (1992) and Freeman (1989) incorporate Ireland1 in their work, Ireland is excluded from consideration in well-known studies such as those by Calmfors and Drifrlll (1988), Crafts (1992) and Barro and Sala-i-Martin (1991). The last-mentioned (p. 151) go so far as to exclude Northern Ireland from their study on the grounds that it is 4a substantial outlier for the United Kingdom'! This seems to us mistaken: many of the theoretical issues explored by growth economists have resonances in the Irish experience. In this century, Ireland has swung from extreme protectionism to extreme openness. Its development strategy has at times favoured the exploitation of its comparative advantage in agriculture, at other times has been based on import substitution, and most recently has relied on the capital inflows and technology transfer associated with (heavily subsidized) foreign multinationals. It is a country that is peripheral in relation to Europe as a whole, but which has long had intimate links with the UK, one of Europe's largest economies. Not only commodities but labour and capital have been extremely mobile between Ireland and the rest of the world. Above all, there is a widespread perception that independent Ireland 'blew it', not least in Ireland. Two influential books recently published, Joseph Lee's Ireland 1912-1985: Politics and Society and The Economic Development of Ireland in the 388

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Twentieth Century by Kieran Kennedy, Thomas Giblin and Deirdre McHugh, have made the point forcefully. Using Louis Cullen's estimate of Irish national income per capita in 1911, they have argued that, while Ireland was a respectably wealthy country on the eve of World War I, its subsequent growth experience was disastrous, with the result that it slipped dramatically down the European income league. Kennedy et al. make their point largely with reference to growth rates in the UK. Over the period 1926-85, GNP grew at the same rate, 2.1 per cent p.a., in both countries, while per-capita product grew at 1.8 per cent p.a. in Ireland, and 1.7 per cent p.a. in the UK. They then point out that this performance is unsatisfactory, for two reasons. First, per-capita incomes in Ireland were lower than in the UK over this period, so Ireland should have been catching up rather than merely keeping pace with the UK. Second, British growth rates were low by European standards, and so keeping pace with the UK ensured long-run decline with respect to the Continent (Kennedy et al, 1988: table 6.1, pp. 118-21). Lee is less concerned with the UK, and more concerned with Europe. 'Ireland recorded the slowest growth of per-capita income between 1910 and 1970 of any European country except the United Kingdom . . . Ireland slid from being a reasonably representative western European economy, in terms of income per head, at the time of independence, to a position far below the western European average in 1970/ Moreover, 'Income per capita is itself an indulgent criterion by which to assess Irish achievement. Precisely because of the unique Irish population performance, a wide gap opened between developments at the individual and the national levels . . . No other European country, east or west, north or south, for which remotely reliable evidence exists, has recorded so slow a rate of growth of national income in the twentieth century' (Lee, 1989: 514-15). To summarize, recent Irish authors have tended to go beyond simple Irish-British comparisons, and made the following points: Ireland kept pace with the UK; given that the UK was the sick man of Europe, this implied that Ireland did not keep pace with Europe; Ireland should have grown more rapidly than the UK, given that it was poorer. This chapter addresses Ireland's growth experience between the 1940s and the present. Its comparative statistical appraisal focuses on the years since 1950, the period for which both the Penn Table Mark 5 and the OECD provide data.2 It does so in the context of growth theory new and old, and in the spirit of the survey of recent literature on productivity growth by Crafts (1992). How bad was Ireland's relative economic performance, and what can explain it? While the chapter may not provide definite answers, we hope to convince our audience that the questions are worth asking and that Ireland is a country worth studying. 2

Irish growth and the economic convergence debate

In the debate about the empirical relevance of the new growth literature, much prominence has been given to the question of convergence. Do countries with initially lower levels of GDP per capita grow more quickly, as the Solow model suggests; or can divergence rather than convergence occur over time? Standard models suggest that convergence can occur in many ways. First, there is the

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closed-economy Solow intuition: as capital accumulates and capital-labour ratios rise, the marginal product of capital falls. This on its own implies convergence (although, of course, if countries differ in various ways, they may converge to different steady states). In addition, there is a host of open economy forces which should strengthen this process, irrespective of differences between countries. We suspect that these open economy forces may in practice be more important. Poor, low-wage countries will attract capital and technology inflows, which boost labour productivity and living standards; and they will experience emigration, which improves the lot of those who stay at home. Furthermore, commodity trade may lead to factor prices converging internationally, and probably did in the late nineteenth century (O'Rourke and Williamson, 1992).3 On the other hand, if emigration involves a loss of human capital, or of the best workers within a given skill bracket, this can lead to capital outflows and divergence.4 In the absence of instantaneous technological diffusion, higher levels of technology in rich countries may also imply capital flows from poor to rich countries (Barro and Sala-i-Martin, 1991). Moreover, the original Solow intuition does not apply in the absence of diminishing returns, and the new growth theorists have argued forcefully that constant or increasing returns may be the rule rather than the exception. Empirical investigations have generally found that catch-up is a feature of economic growth, at least among OECD economies (Baumol et ai, 1989; Dowrick and Nguyen, 1989). The most influential studies of convergence may have been Barro and Sala-i-Martin's papers documenting convergence among US states and European regions, showing convergence to be a robust feature of these economies, occurring at the annual rate of about 2 percent (Barro and Sala-i-Martin,1991). However, while some less developed countries have grown rapidly in recent years, whether the entire globe forms a single convergence club is a controversial matter (Mankiw et a/., 1992; Durlauf and Johnson, 1992). This may mirror Williamson's early study of regional convergence within countries, which identifies a pattern of increasing regional inequality early in the growth process, and increasing equality later on (Williamson, 1965). Ireland is an OECD member, and has been an EC member since 1973. It is one of the most open economies in the world, with a very high trade-to-GDP ratio, policies designed to attract direct foreign investment, and strong links with international labour markets. By rights, then, it should have participated in the OECD convergence experience. Has it? First, a word is in order about what measure of economic growth is most appropriate for the issues we want to address. Economists might legitimately be interested in either productivity growth or the growth in living standards. In the former case, GDP per employed worker is the most reasonable measure to look at. In the latter case, GNP per capita is what matters. When the data are available, we examine trends in these two variables; however, for the most part, data availability dictates that we examine GDP per capita. As we will see, the distinction becomes potentially important in the post-1973 period. Previous studies which have examined Ireland's postwar economic performance have beenflawedin a number of respects. First, while they mention the experience of other peripheral European economies, they typically rely solely on average growth

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Table 13.1. Economic growth in Ireland, the UK and Europe, 1950-88

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Note: H-S, Heston and Summers; M, Maddison.

rates in Ireland and other countries, which does not give sufficient weight to the recent literature on convergence.5 Second, the choice of incomefiguresmatters; as is well known, difficulties arise in making national income estimates comparable across countries and time. The Heston-Summers and Maddison/OECD data sets represent the state of the art in this regard, and we now summarize the picture given by the two data sets. Unfortunately, it matters which data set you use. Table 13.1 gives evidence from the Penn Table Mark 5, as well as from Maddison's most recent data set. Average annual growth rates in GDP and GDP per capita are given for Ireland, the UK and the rest of Western Europe.6 GDP per capita is what is most relevant to the convergence debate, and on this criterion, Ireland's performance has been poor, especially according to Heston and Summers. Over the period 1950-88, Ireland's annual growth rate was only two-thirds of the Western European average, and a fraction less than the equally anaemic British rate. The period 1960-73 was a relatively good one for Ireland, when it easily outperformed the British economy, but even then Irish growth rates were somewhat lower than their European counterparts. The other two subperiods were disastrous, with Irish growth rates less than half as high as on the Continent, and substantially lower than in the UK. Note in particular the very low growth rate after 1973. While the oil shocks reduced growth worldwide, the relative Irish performance during this period was (according to the Heston-Summersfigures)even worse than during the 1950s. On the face of it, this challenges the conventional wisdom that EC membership has helped Ireland catch up with the rest of Europe during the past twenty years (although Ireland might, of course, have done a lot worse had it not been an EC member during this period). The Maddison data give a much more optimistic story, with Ireland doing better than the UK over the period as a whole (although it still does less well than Western Europe). The big difference between the two data sets lies in the post-1973 period: Maddison has Ireland outperforming Western Europe during this time. The reason for this can be easily seen in Figure 13.1, which plots the Irish GDP/capita indices

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1955

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Figure 13.1 GDP per capita indices: Ireland, 1950-88 (Maddison and Heston-Summers data sets)

from the two data sets. The two indices tell broadly similar stories until 1978, after which time the Maddison estimates continue growing according to trend, whereas the Heston-Summers index stagnates. We will have more to say about this discrepancy in what follows. The figures on GDP growth rates tell a broadly similar story, the only difference being that over the period 1950-88 as a whole, GDP grew slightly more rapidly in Ireland than in the UK, even according to Heston and Summers. Again, however, the Irish growth performance was well below that in Europe throughout the whole of the period, for both data sets. Only the Irish tendency to use the UK as a yardstick for performance has disguised Ireland's relative failure during this period. Moreover, these tables giving average growth rates conceal important information which makes Ireland's relative performance look much worse. In 1950, according to Heston-Summers data, Irish GDP per capita was 48 per cent lower than in the UK, and 15 per cent lower than in Western Europe. It is the case that convergence has been a feature of the OECD economies: Ireland should therefore have grown more rapidly than Western Europe as a whole. That it did not makes Ireland an important outlier. This outlier status appears most clearly when one examines graphs plotting GDP per capita growth rates against initial GDP per capita levels. Figure 13.2 does this for 1950-88,1950-60,1960-73 and 1973-88, using both the Heston-Summers and Maddison data. Several things emerge at once from these graphs. First, the familiar OECD convergence story emerges clearly, the strictures of Milton Friedman notwithstanding.7 The only subperiod in which a clearly visible negative correlation between growth and initial income is absent is 1973-88 (although it is weak during the 1950s). This could be due to a number of factors. The oil shocks and associated policy responses made this a turbulent time, of course; it could be that the short-run effects of different macroeconomic policies swamped any longer-run forces during this period. Or it could be that the forces which normally lead to convergence are absent during downturns, as was certainly the case during the interwar period

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(Williamson, 1994). This could be because downturns in economic activity lead to protection and other autarkic policies, or there could be deeper reasons connected with this growth process. Williamson has found strong international wage convergence before 1914 and after 1945, but no convergence between the wars. Perhaps international stability on the macroeconomic, exchange rate and/or trade fronts is necessary for convergence to take place. Second, Ireland is the clearest outlier over the whole period, having a much lower growth rate than its initial income would suggest. This is true with both data sets. During the 1950s and the post-1973 period, Ireland is joined by Spain, Portugal and Greece; the four countries seem to constitute a mini-convergence club, lying on a line to the left of the rest of Europe. During the 1960s they do a lot better, fitting into the general European convergence pattern to a greater extent; but even during this period, Ireland is an underperformer (especially according to the Maddison numbers). Third, the data set you use matters. We saw in Table 13.1 above that it matters a lot for average growth rates. It also matters for telling qualitative convergence stories about Ireland; but only for the post-1973 period. Ireland seems below (or to the left) of the convergence line with both data sets for the period 1973-88, but is far less clearly an underperformer if you use the Maddison data. The difference in Irish growth rates using the two data sets, which we saw in Table 13.1, and which is worryingly large, is sufficient to reverse one's conclusion about Ireland's post-1973 performance based on GDP/capita performance. However, the pessimist case can be resurrected for the post-1973 period, even on the basis of Maddison's numbers, if one considers GNP rather than GDP per capita. GNP is more relevant than GDP per capita for living standards: Heston and Summers give GNP as a multiple of GDP for a smaller sample of countries, after 1979. Applying these correction factors to the optimistic Maddison GDP numbers, we get the data portrayed in Figure 13.3: Ireland is once again a dramatic

Irish economic growth, 1945-88

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underperformer during this period. This is due to Ireland's excessive borrowing during the post-1973 period, which led to the GNP/GDP ratio shrinking from 96.4 per cent in 1979 to 88.1 per cent in 1988. Fourth, the meaninglessness of comparing Irish with British growth is apparent from these graphs. The standard story has been that Ireland kept up with the UK, but that the British economic performance was one of the worst in Europe. It appears that UK growth was more or less what would have been expected given its initial level of GDP per capita. Ireland should have been growing faster than the UK, but was not; it is Ireland which appears to be the sick man of Europe, not the UK (see also Castles, 1991: 21-2). Fifth, one result of Ireland's relatively slow growth was that between 1950 and 1973 it was overtaken by Spain (according to Maddison), or Spain, Italy and Austria (according to Heston and Summers). When viewed in the context of general European convergence, Ireland's performance thus appears even more disappointing than previous Irish authors have suggested. To summarize the evidence on Ireland's relative performance presented thus far: Ireland was a clear underachiever throughout the post-1950 period, no matter which data are used. There is one exception to this general finding: Maddison's GDP numbers show a satisfactory Irish performance (from the standpoint of the convergence literature) after 1973. However, even for the post-1973 period, Ireland is clearly a bad underachiever from the standpoint of GNP/capita growth, no matter whose data are used. From the perspective of the convergence literature, Ireland emerges as a spectacular outlier. What can explain all this? A first question which one might ask is: how did Irish productivity growth, as measured by GDP per employed worker, behave over the period? If Ireland was not an outlier by this standard, then its failure by the criterion of GDP per capita must be due to a relative deterioration in either Irish employment or Irish labour force participation. Figure 13.4 gives what information we have on GDP per worker. As may be seen by comparing with Figure 13.2, adjusting for labour force participation does indeed move Ireland closer to the 'convergence line'. Yet Ireland still remains somewhat of an outlier in most periods, the exceptions again being the post-1973 period according to the Maddison data, and the 1960s according to Heston and Summers. Figure 13.5 presents the data for GDP per employed worker, for EC countries only, and for the post-1964 period.8 Again, the qualitative picture is similar, although once more the adjustment appears to make Ireland look better (according to the Maddison data, Ireland is now hardly an outlier for the entire period 1964-88). Unemployment and higher dependency rates thus help partly to account for Ireland's poor growth in GDP per capita in the postwar period. On the other hand, productivity growth was not as fast as it should have been either, and some of the unemployment might plausibly be attributed to this (Kennedy, 1993). Moreover, higher employment might have implied lower average labour productivity: if so, better employment performance would have been possible only at the expense of slower productivity growth. In sum, there was a productivity failure as well as a more general standard of living failure over the period as a whole, and after 1973 as well if you believe the Heston-Summers data. Moreover, even if it were the case that Irish productivity growth, as measured by

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0.03-

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4000 6000 8000 1000012000 140001600018000 20000 (d) 1950-60, Maddison data )0-73

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(c) 1950-60, Heston-Summers data GR SP

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0.08-

6000

P A

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0.06-

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0.05-

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B

FL

0.04-

TT IRL

I

0.026000

10000

P

GR

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IRL 10000

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14000 18000 22000 GDP/worker, 1960 (1990 $)

CH 26000

(f) 1960-73, Maddison data

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0.025

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ca

(e) 1960-73, Heston-Summers data

0.015

FR NW

15000 20000 25000 GDP/worker, 1973 (1985 $)

(g) 1973-88, Heston-Summers data

30000

1 |

0.030 0.025

IRL

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IT

0.020 0.015 0.010

SPJKAB|R DK

sw^

p

0.005

NL

^

0 10000 15000 20000 25000 30000 35 000 40000 GDP/worker, 1973 (1990 $) (h) 1973-88, Maddison data

Figure 13.4 GDP per worker, initial level and growth: Europe, 1950-88

Irish economic growth, 1945-88

397

S8 0.0403

0.035-

|

0.030

2 0.035 5 0.030F BRD B UK

•a 0.025-

I 0.020-

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i 0.015 4000 6000 8000 1000012 00014 00016 00018 00020 000 GDP/employed worker, 1964 (1985 $)

12000 16000 20000 24000 GDP/employed worker, 1964 (1990 $)

P 0.08-1 i

* 0.07-

* 0.07-

1 0.06

1 0.06-

I 0.05-

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NLL

|

& 0.030.02-1

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(b) 1964-88, Maddison data

(a) 1964-88, Heston-Summers data P 0.08-

|

BRD UK

•a 0.025-

0.04& 0.03-

1

1

.

1

1

1

1

r

<

0.02-1

40006000 8000 10000 12 000 14 000 16 00018 000 20 000 GDP/employed worker, 1964 (1985 $)

8000

(c) 1964-73, Heston-Summers data

12000 16000 20000 24000 GDP/employed worker, 1964 (1990 $) (d) 1964-73, Maddison data

§8 0.035-

§8 0.035-

g 0.030-

S 0.030-

1 0.025-

I 0.025-

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IT

I 0.020

I 0.020BRD F 1 0.015-

I 0.015

S> 0.010-

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j 0.005

8000

12 000 16000 20000 24 000 GDP/employed worker, 1973 (1985 $) (e) 1973-88, Heston-Summers data

28 000

0.005 10000

15000 20000 25000 30000 Initial GDP/capita, 1973 (1990 $)

35000

(0 1973-88, Maddison data

Figure 13.5 GDP per employed worker, initial level and growth: Europe, 1964-88

GDP per employed worker, had been satisfactory since 1950, the conclusions which one would be justified in drawing from this would be unclear. The Irish dependency rate is not just a function of birth rates, death rates and attitudes towards female labour force participation. It is significantly affected by emigration, which is in turn produced by the same problem as leads to unemployment: a failure by the economy to create sufficient employment. Some commentators have argued that Irish productivity growth has been satisfactory, and that slowly growing living standards are thus due to Catholic mentalities reducing the proportion of the total population employed: the implicit inference is that no great economic failure is involved. We would argue that sluggish employment generation represents a serious failure of economic policy; the inference which we would draw from Figures 13.4 and 13.5 is that not only Irish productivity growth, but the performance of Irish labour market institutions, has been unsatisfactory ever since the mid-1960s.

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Cormac 6 Grada and Kevin O'Rourke

A second immediate question arises: how can there be such a large discrepancy post-1978 between the two data sets examined here? After all, they both make use of national accounts data, and the relative price information contained in the UN International Comparison Program. We confess to being puzzled by the discrepancy, and here content ourselves with listing potential causes for it: • The Maddison data pjecented here use 1990 prices, while the Heston-Summers data use 1985 prices; but the same discrepancy emerged when earlier OECD data using 1985 prices were used. • Revisions to the Irish national accounts which were used by one study may have been neglected by the other. • Transfer pricing by Irish multinationals means that the value of output given in the Irish national accounts may differ significantly from the value of output using world prices. Similarly, Irish agricultural output is sold at CAP prices, which are far above world prices. Both trends have become more important since 1978. These two sectors together account for a large share of total Irish output. If the two studies differed in the degree of aggregation used, so that one study failed to pick up these discrepancies between national and world prices in important sectors, that could explain the difference in the two studies.9 Finally, comparing the Maddison data with the Heston-Summers data for other European countries may be of some help in resolving the issue. Table 13.2 gives the percentage by which the Maddison data for GDP per capita (expressed in 1985 dollars) exceed the Heston-Summers data for 1950, 1973 and 1988/9.10 As can be seen, in the richer European countries the Maddison figures are generally around 10 per cent higher than the Heston-Summers data. In the poorer countries - for which, suggestively, agriculture is relatively more imporatnt - the gap is bigger still. The discrepancies between the two data sets tend to be relatively steady over time, except in the cases of Belgium, Norway and (especially) Ireland. In conclusion, it seems clear that some effort should be put into understanding the differences between these two widely used data sets. In the meantime, while these numbers can be relied on to tell reliable stories about broad international patterns, researchers should be wary of telling stories about individual countries. Nevertheless, on the basis of the evidence presented above, we feel that a negative assessment of Irish economic growth since 1950 is supported. 3

Irish economic history, 1945-92

We now offer a brief narrative outline of economic trends since 1945 in that part of Ireland known officially as Saorstat Eireann or the Irish Free State until 1948, and as the Republic of Ireland since then (see also 6 Grada, 1994a). The period since political independence in 1922 had been one of economic experimentation. The economic stance of the Cumann na nGaedheal party, which ruled between 1922 and 1932, had been deliberately cautious. It preached, and indeed practised, comparative advantage and fiscal retrenchment. This meant giving a wide berth to populist nationalist credos and relying on an improved performance from the dominant agricultural sector as the 'engine of growth' (Daniel, 1976). Agriculture then employed half the labour force, and agricultural policy aimed at emulating Danish

Irish economic growth, 1945-88

399

Table 13.2. Maddison and Heston-Swnmers GDP per capita (% by which Maddisonfiguresexceed Heston-Summers)

Austria Belgium Denmark Finland France FRG Italy Netherlands Norway Sweden UK Greece Ireland Portugal Spain

1950

1973

1988/9

11.7 1.8 13.7 9.5 11.6 5.1 10.3 15.0 6.1 12.4 12.0 15.9 0.04 34.7 24.2

94 4.5 10.5 8.5 7.0 6.7 10.9 10.5 7.2 13.1 10.9 17.9 -4.7 31.5 18.3

105 10.7 12.5 11.8 12.6 8.3 9.6 9.5 1.5 12.4 11.4 22.6 24.7 27.9 26.5

success by capturing the high-quality end of the British market for meat, eggs and dairy products. This policy, always associated with Agriculture Minister Patrick Hogan, had yielded few dividends by 1932; perhaps it was given insufficient time to assert itself (O'Brien, 1936). Another feature of Cumann na nGaedheal policy was fiscal and monetary prudence. Both nationalist ideology (which had long maintained that Ireland was overtaxed within the United Kingdom) and the emphasis placed on minimizing the input costs faced by farmers supported low taxation in the 1920s. Ministers also resisted the demands, which were becoming more vocal in the late 1920s, for widespread tariff protection. That the Irish economy, so closely linked to the UK's, grew sluggishly during the 1920s should come as no surprise. Emigration, long blamed on British maladministration, continued at a high rate, and living standards barely rose. The onset of the Great Depression in 1929-30 dented the appeal of Cumann na nGaedheal's liberal orthodoxies. They failed to maintain popular support, and were replaced by Eamon de Valera's Fianna Fail party in 1932. Now ideology and contingency would combine to transform a virtually free-trading economy into one bent on state supports and import substitution. Faced with the challenges of high unemployment and declining markets abroad for agricultural produce, Fianna Fail's alternative was to build an indigenous industrial sector through protection, and to reorient agriculture towards a more labour-intensive product mix. In a context of world depression, low farm prices and a political imperative to reduce unemployment, this strategy had its logic; in the short run, it produced a significant increase in employment in the sheltered industrial sector. The new manufacturing industries, small scale and low productivity, had already captured the home market by the late 1930s. However, neutrality during World War II forced a degree of self-sufficiency on the South's economy that exceeded the demands of even the most ardent economic

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Cormac 0 Grada and Kevin O'Rourke

nationalist. Imports as a share of national income fell from 26 per cent in 1938 to 11 percent in 1944, and imports of capital equipment and raw materials fell almost in proportion. Thus although the economy had been spared military destruction, near-autarky led to a running down of the capital stock through wear and tear. Gross domestic capital formation fell to a paltry 3.7 percent of national income in 1944-5, and output per worker in the manufacturing sector fell. Agriculture was less affected, and its share of national income rose from 28 per cent in 1938 to 37 per cent in 1944-5. Yet World War II was far from being a bonanza for Irish farmers: prices on the British market were strictly controlled, and an inadequate supply of fertilizers, feedstuffs and machinery depressed crop and milk yields. The result was a badly undercapitalized agricultural sector. In 1945, Ireland remained one of the poorest countries in Western Europe. Ireland experienced a postwar recovery, like the rest of Europe. This was largely predicated on trade: merchandise trade (imports plus exports) as a share of national income rose from 28 percent in 1945 to 64 percent in 1950. The resulting trade pattern could not be sustained for long, however; merchandise imports and exports had been roughly equal during the war years, but in 1946-50 the value of imports was double that of exports. A consumer boom produced a fourfold rise in the value of imported manufactured goods between 1945 and 1950. The multiparty coalition which ruled Ireland in 1948-51 after sixteen years of Fianna Fail government believed that the 'inadequacy of capital investment, particularly in agriculture' was the root cause of continued emigration. This emphasis on the leading role of the farm sector marked a return to the beliefs of the 1920s, although the new government failed to dismantle the tariff regime established in the 1930s. One result was a rise in the Department of Agriculture's share of government spending from 2 per cent in 1943-5 to 16 per cent in 1950-2. Overall, the economy's investment rate recovered, reaching 14 per cent of income in 1948-50; though (as critics would soon point out) perhaps too high a proportion was in 'social' investment, such as housing, hospitals and schools. Fianna Fail's radicalism of the 1930s had not extended into the monetary or budgetary sphere. Monetary experimentation was rejected out of hand, and Ireland's currency readily exchanged into sterling at par throughout. Though the sterling link was not without its tensions, particularly when sterling devalued, it probably boosted investor confidence and ensured the acceptance of the Irish pound. Thus the coalition government regarded the 1948 devaluation of sterling as 'most unwelcome', but nevertheless resigned itself to following the fate of sterling. The Irish banking sector, dominated by a cartel of joint-stock banks, may have lacked dynamism, but it proved very stable. The banks vehemently opposed the creation of an Irish central bank, and the Free State survived without one until 1943, when the Central Bank of Ireland was set up. Ireland stands out for being one of the few economies free of banking panics or failures during the 1930s. The budgetary stance of all administrations in the 1920s and the 1930s had been rather conservative, and even Fianna Fail paid no heed to Keynes's call in 1933 for deficit spending on urban renewal and other worthwhile projects (Keynes, 1933). At the end of the 1930s, Ireland's national debt was still relatively small by contemporary European standards. The decision to partition government spending plans into current and capital spending in 1949 was seen as the first sign of an Irish conversion

Irish economic growth, 1945-88

401

to Keynesian thinking; in the memorable quip of one economist, 'Keynes had come to Kinnegad' (Lynch, 1969: 187). During the postwar recovery phase,fiscalpolicy was quite lax. However, stop-go policies in which an adverse balance of payments signalled drastic fiscal action were to follow, and produced severe and largely unnecessaryfiscalcontractions in 1952 and 1957 (Kennedy and Dowling, 1975: chs. 13-14). Much was expected in Ireland of the Anglo-Irish trade agreement of 1948, which again opened up the British market to Irish livestock exports. The hoped-for growth (stipulated in an appendix to the agreement) was not realized, since the British system of deficiency payments depressed food prices. The terms of trade proved quite unfavourable to Ireland in the early and mid-1950s. The 1950s turned out to be a dismal decade for the Irish economy. GDP grew more slowly than in any other economy in the OEEC, and net emigration reached levels not equalled since the 1880s. Poor economic performance prompted a fundamental reappraisal of the policy package pursued since the 1930s. The reappraisal was articulated in a famous White Paper, Economic Development, and in the Programme for Economic Expansion (later called the First Programme), both published in 1958. These documents were quite vague about both policy instruments and targets, yet they presaged a new consensus on the need for a more outward-looking economic policy, including trade liberalization and reliance on direct foreign investment. The First Programme was Ireland's first tentative exercise in indicative planning; it outlined the strengths and weaknesses of the economy, emphasized the importance of farm investment, and held out hopes for slow economic growth. Its targets were modest in scope, and vague as to the mechanisms for achieving them. An annual growth rate of 2 per cent over afive-yearperiod was anticipated. In its emphasis on agriculture as the engine of growth, the First Programme was strictly traditional (Lee, 1989: 350-1); more important, it was explicit in its commitment to trade liberalization and the reorientation of industry towards foreign markets. The economy soon picked up; historians have generally tended to give the First Programme the credit, and the sharp rise in investor confidence in the late 1950s suggests that the Programme produced a 'euphoria effect'. However, another view posits that the economy, which was emerging from recession in any case, would have performed just as well in the absence of the Programme. The First Programme was succeeded by the Second (1964-70) and Third Programmes (1969-72). These were far more detailed than the first, and contained detailed sectoral projections. In neither case was even the overall aggregate growth rate target of 4 per cent per annum met, and both were abandoned before the 'due date'. The Second Programme, formally abandoned in 1967, was laid to rest because of the widening disparity between the projections for employment growth and reality. The plans were alsoflawedmethodologically (Norton, 1975; Bradley, 1990). Economic planning went out of favour for a few years, although it briefly returned with a vengeance in 1977 when a new Fianna Fail administration created the Department of Economic Planning and Development, and launched National Development 1978-1980. That plan's ambitious projections - including targets of 25 000 new jobs a year and an annual GNP growth rate of 7 per cent - proved to be wildly unrealistic. There followed The Way Forward (1982) and Building on Reality

402

Cormac 0 Grada and Kevin O'Rourke

(1984), but both of these emphasized budgetary constraints rather than overall growth targets. These documents, better characterized as stabilization programmes rather than exercises in French-style indicative planning, marked the end of Ireland's experiment with economic planning. That experiment is a reminder that setting and meeting detailed medium-term growth targets for a small open economy is a difficult, if not downright pointless exercise. By the late 1980s, planning's only legacy was the Programme for Economic and Social Progress, a joint commitment by

the social partners and government to income and social welfare targets. Much more important for the economy's improved performance than the commitment to planning was the renewed commitment to trade liberalization. This brought membership of the Anglo-Irish Free Trade Area (1966) and the European Community (1973). The stage was set in the early 1960s by the 'corporatist' Committee on Industrial Organization, created by the government in 1961 to study the likely impact of trade liberalization on native industry. The Committee's studies of the whole range of Irish manufacturing - twenty-six reports put together at some speed by representatives of the trade unions, government and business - painted a bleak picture of an industrial sector beset by shoddy design, poor marketing and short production runs. Detailed recommendations by the Committee were followed by the introduction of a grants scheme to helpfirmsseeking to adapt to free trade, and the strengthening of export-promoting state agencies such as An Bord Bainne (The Milk Board) and Coras Trachtala (The Export Board). These measures helped to prepare the way politically. The rather leisurely pace of tariff reduction envisaged under the Anglo-Irish Free Trade Agreement speeded up with EC membership, with Ireland undertaking to remove all tariffs against EC member countries by 1978. The static gains from trade liberalization were presumably small, although there may well have been important dynamic gains (see section 6 below). The Irish economy performed better between the late 1950s and the mid-1970s than at any other time since independence. GDP growth averaged about 4 per cent, and emigration had been brought to a virtual halt by the end of the period. The growth was predicated partly on direct investment by multinational firms, and partly on running down the external assets of the banking system. Ireland's initial main policy response to the oil crisis of 1972-3 was a succession of large budget deficits. The public sector borrowing requirement (PSBR) rose from 8.6 per cent of GNP in 1972-3 to 12.9 per cent in 1976^7 (Leddin and Walsh, 1992:122). At the time, this rise was rationalized in Keynesian terms. But budget deficits continued to accumulate in the following few years, shielding the Irish consumer for a time from the effects of the oil crisis, but raising the PSBR and the national debt to clearly unsustainable levels. The huge rise in public spending - the PSBR reached 17.3 percent of GDP in 1980 and 20.3 per cent in 1981 - failed to generate much productive investment: indeed, despite gross investment rates of 30 per cent of GDP in 1978-81, the economy grew at an average rate of only 2.5 percent in thefirsthalf of the 1980s. Economists were quick to criticize thefiscalexpansion of those years; indeed, the tone of some critics had turned apocalyptic by the early 1980s. Politicians were slower to learn than economic commentators, and as a result most of the 1980s were wasted undoing the damage of earlier fiscal recklessness. However the 'delusion' that Ireland could sustain living standards by borrowing in the wake of the second

Irish economic growth, 1945 88

403

oil price hikes had dissipated by 1983. The rhetoric of Budget Day speeches reflected lessons dearly learned. In 1978 the Budget sought 'to give an impetus to economic activity' that would increase the annual growth rate in GDP to an unprecedented 7 percent, as envisaged by National Development 1978-1980. The combination of tax cuts and public spending would, it was hoped, grease the wheels of the private sector. But while the Budget speech of 1981 derided 'loose comment about so-called disorder in the public finances', by 1983 there was a clear recognition that the cost of servicing the debt had 'preempted resources for the future'. 'Populist quick fixes' were ruled out in the 1993 Budget, and the PSBR has now been reduced to below 3 percent. The pervasive gloom of the mid-1980s, reminiscent of the 1950s, has given way to mild confidence about the future. Irish economic growth since 1987 has been among the fastest in the OECD. The Irish decision in December 1978 to participate in the European Monetary System (EMS) was a landmark in recent Irish economic history, since it brought to an end the monetary union between Ireland and Great Britain that had lasted since 1826. The aim of EMS membership was a monetary discipline which would win Ireland investor credibility, low inflation and low interest rates. At first, the inconsistent stance of Irishfiscalpolicy and repeated realignments of the value of the Irish pound (or punt) within the system's Exchange Rate Mechanism sapped investor confidence, and Irish interest rates remained high. The currency realignments ceased in 1986, and by the early 1990s the Irish yield curve was downward sloping and the gap between Irish and German interest rates minimal. By the early 1990s it could be said that the goals of price stability and low interest rates had been reached. This brought a reduction in the cost of servicing the national debt and in the fiscal burden facing the economy. The victory was costly, however, in terms of output and employment forgone, and some economists now argue that the exchange rate regime pursued by Ireland under the EMS was unduly deflationary (Dornbusch, 1989; Leddin and Walsh, 1992: 390-3). The aim of EMS membership had been to 'free' the punt from the shackles of a weak sterling. With a pwnr-Deutschmark exchange rate of £1 = 2.65DM, which has been maintained since mid-1986, the goal seemed to have been met by the early 1990s. The crisis caused by sterling's departure from the Exchange Rate Mechanism in September 1992 had therefore not been widely anticipated. Moreover, most commentators initially believed that Ireland would resist the pressure to devalue in order to maintain the credibility that had been so dearly won. The costly battle to 'save' the punt against the speculators lasted four months. In January 1993 the Irish currency was devalued by 8 per cent within the Exchange Rate Mechanism. With the virtual demise of the EMS in mid-1993, the Irish currency has become 'one of the smallest independent currencies in the world' (Walsh, 1993b). The search is now on for that golden rule-of-thumb which would yield a punt capable of reducing Ireland's savage unemployment rate without endangering exchange rate stability. The Irish combination of fiscal retrenchment, tough exchange rate policy and economic recovery in the 1980s has attracted the attention of outside experts, evoking the admiration of some and confounding others (Dornbusch, 1989; Giavazzi and Pagano, 1991). Giavazzi and Pagano have proposed the Irish recovery as a classic example of 'expansionary fiscal contraction', a claim denied by Barry (Barry, 1991; also Barry and Bradley, 1991). An alternative interpretation of recent

404

Cormac 0 Grada and Kevin O'Rourke

Irish macroeconomic history has buoyant world market conditions and capital inflows outweighing the deflationary effects of fiscal contraction (Leddin and Walsh, 1992: ch. 13; Barry, 1991). 4

Investment

The traditional Solow growth model places much emphasis on investment, even though steady-state growth is not affected by it. The new growth theory has placed even more emphasis on capital accumulation; indeed, it is largely motivated by the fact that traditional Solow-based growth accounting puts too small a weight on capital's contribution to economic growth (see, for example, Crafts, 1992: 391-3). While the Solow model suggested that an increase in savings rates could increase income levels but not growth rates, the new growth literature attributes both level and growth effects to investment. De Long and Summers have gone further and attributed major explanatory power to investment in equipment as a determinant in growth (De Long and Summers, 1991). The literature has tended to find a significant positive relationship between investment shares and growth, when growth is regressed on a list of explanatory variables including investment (Barro, 1991; De L ong and Summers, 1991; Mankiw et aL, 1992; Dowrick and Nguyen, 1989; Crafts, 1992). Moreover, investment is itself an endogenous variable related to, among other things, initial income levels. Traditional growth models would suggest that in poorer countries returns to capital, and hence investment shares, should be higher than in rich countries. Barro (1991) found this to be so, once initial levels of human capital had been controlled for. Theory and aggregate experience thus suggest that Ireland should have had very high investment shares during our period; if it did not, this might help explain its failure to converge. Irish policy-makers were traditionally concerned about a lack of investment in the Irish economy. The 1958 White Paper (1958: 35) highlighted 'the insufficiency of our current savings as a basis for national capital formation on the scale which would be necessary to enable us even to follow at some distance the rising standards in the rest of Europe'. Were these fears justified? Table 13.3, using EC data, gives investment shares for Ireland, the UK and twelve present EC members since 1960. Irish investment rates were consistently above UK levels, but only exceeded average EC levels after 1970. A similar picture emerges when the Penn Table data are used. Figure 13.6, based on that source, gives annual investment shares for Ireland, the UK and the rest of Europe from 1950. Irish investment rates were continually above UK rates, but only exceeded European rates during the 1970s and early 1980s. Investment was modest in Ireland during most of the 1950s, but increased rapidly in the following decade. The 1960s also saw a drop in marginal capital-output ratio; this was partly due to the utilization of infrastructure created in the early and mid-1950s (Kennedy and Dowling, 1975: ch. 11). The gross investment rate exceeded 30 per cent several times during the 1970s, but declined sharply thereafter. Conventional crowding-out stories seem implausible in a small open economy, and the high rates of the 1970s, a time when public expenditure was rising rapidly, suggest that it was not an issue for Ireland (Honohan, 1992a). The general climate of uncertainty and macroeconomic instability associated with the Irish debt crisis, and the severe downturn of the 1980s

Irish economic growth, 1945-88

405

Table 13.3. Gross investment, 1961-90 (as a % of GDP) Ireland

UK

E C 12

1960-9 1970-9

19^5 25.0

lil 19.2

218 22.8

1980-90

21.6

17.5

20.1

Source: European Economy, table 20. 35-| 309

I

• Ireland + UK * Other Europe

25

15-

10 -tf

1950

1955

1960

1965

1970

1975

1980

1985

Year

Figure 13.6 Investment shares: Ireland, UK and the rest of Europe, 1950-88

(largely caused by the earlier accumulation of debt) are much more plausible reasons for the decline. In the event, Irish investment rates only fell below European rates in 1987. In summary, the Irish underinvested if the yardstick used is European investment rates, and if one bears in mind the implication of the standard convergence story that poorer countries should invest more. Underinvestment might thus explain slow Irish growth prior to 1973, as well as the spurt in growth after 1973 which the Maddison data suggest. However, if Heston and Summers are right, the dismal Irish performance from 1973 onwards which they document cannot easily be explained by appealing to Irish underinvestment. But perhaps aggregate investment shares are not what is relevant: maybe the quality of Irish investment was poor and its composition wrong? De Long and Summers (1991) make a strong statistical case for the proposition that it is investment in capital goods that is crucial for growth; were equipment goods prices too high in Ireland, and was the share of GDP devoted to equipment investment too low? Figure 13.7, which uses the data provided by De Long and Summers, suggests that their insight cannot explain slow Irish growth. The normalized equipment price in Ireland was lower than that in most European countries* and the Irish equipment share was relatively high. Perhaps a more disaggregated approach is needed. Table 13.4 summarizes trends

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Table 13.4. Investment by use: Ireland, 1953-90 (%)

1953-9 1960-9 1970-9 1980-90

Dwellings Roads

Other buildings

Transport Agricultural Other equipment machinery machinery

17.1 15.9 22.9 22.4

37.0 33.5 26.8 24.2

14.1 14.4 12.4 14.0

5.6 4.3 2.1 3.7

5.5 4.8 4.5 2.5

20.6 27.1 31.3 33.2

Source: Derived from National Income and Expenditure.

0.13 0.12 0.11 0.10 0.09

FL

A BRD

08

°0.07

FR

IRL

DK

GR

NL

vl

B NW

0.06 0.05 SP

0.04 0.03 -0.5

-0.3

-0.1 0.1 Equipment price (normalized)

0.3

Figure 13.7 Equipment share and price: Europe, 1960-85 in the share of gross investment by use. The share of agricultural machinery in total investment has dropped steadily since the 1950s, while that of 'other machinery' has risen steadily, from one-fifth of the total in the 1950s to over one-third today. But the consistently high proportion spent on transport equipment is the most noteworthy feature of Table 13.4. Was this 'unproductive' investment, or was communications a relatively important industry in Ireland for geographical or other reasons? The output of the Irish transport and communications sector - about 6 per cent of GDP, proportionately no greater in Ireland than in other European countries in the period under review - casts doubt on the last explanation. Surely a more plausible explanation for the high share of transport is the loss-making capital grants to concerns such as the national air, rail and sea carriers. Dividing the output of the transport sector by the sum invested in it in a selection of European economies indicates that the return on investment in transport equipment was lower in Ireland than in any of the other European economies examined (Table 13.5). It is also sometimes alleged that too much Irish capital formation has been in the form of public sector investment. The argument is that the public sector feels less pressure and incentive to allocate funds to the most profitable uses. Defining public

Irish economic growth, 1945-88 407 Table 13.5. Returns on investment in transport equipment, selected years

Ireland

Italy

UK

Norway

Year

Ratio

1970 1979 1986 1964 1980 1986 1964 1980 1986 1964 1980 1987

1.7 1.9 2.4 3.3 2.7 2.9 4.1 3.4 4.2 2.2 3.6 4.8

Year 1964 1980 1987 Netherlands 1969 1980 1987 1964 . Belgium 1980 1987 1964 Sweden 1980 1987 Germany

Ratio 3.0 3.2 3.1 3.5 3.7 3.3 3.5 3.5 4.6 2.7 3.3 3.2

capital formation as public capital expenditure minus redemption of securities and payments to the rest of the world (usually a small item), the public share in total gross fixed capital formation in Ireland has indeed been high, usually ranging between 30 and 40 percent between the 1950s and the 1980s, and falling below 20 percent only in 1990 and 1991. n Eurostat provides a comparative perspective: it suggests that the public share in gross fixed capital formation was not particularly high in Ireland in 1970, but that by 1986 it was the highest in the EC. Capital grants to enterprises have typically accounted for only 10-15 percent of Irish public investment; capital formation by government and local agencies accounted for a half. Loans and share capital accounted for 37 percent in 1960-2, and 17 percent in 1988-90. On the face of it, there is scope for waste here, even if Barro finds evidence 'consistent with the hypothesis that the typical country comes close to the quantity of public investment that maximizes the growth rate' (Barro, 1990: 124). However, the share of the public sector in Ireland was twice that of the average (16.4 per cent) in Barro's 76-country sample (Barro, 1991: App. 1, p. 438). In summary, there would seem to be several reasons why Irish investment ratios, low as they were for much of our period, would overstate the investment performance of the Irish economy during this period. This highlights some of the problems with cross-country regressions of the sort that we will be looking at later in the paper: by using explanatory variables that are of necessity crude, they may on occasion hide more than they reveal.

5

Human capital and emigration

Human capital has been much emphasized in recent theoretical and empirical work on economic growth. In theoretical work, it is an important feature of the endogenous growth literature. In applied work, it has largely served as a way of refining the original Solow model, and making that model more consistent with the facts. Mankiw et al. (1992) stress that incorporating human capital boosts capital's share in income to an extent that capital accumulation can explain quite large

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differences in income per capita. More relevantly for our purposes, Barro and others have found that convergence does hold in a conditional sense: controlling for human capital, poorer countries do grow faster. The failure of LDCs to converge as a group on the rich countries is largely due to their poor human capital endowment (Barro, 1991). This finding will come as no surprise to economic historians, who were reminded by Richard Easterlin of the importance of education in facilitating the spread of new technology over a decade ago (Easterlin, 1981). Conditional convergence in the sense described above has become a widely accepted stylized fact. It thus seems natural to ask: is Ireland's failure to converge on the rest of Europe attributable to a poor record of human capital accumulation? Surprisingly, Ireland does quite well in international comparisons of educational expenditure and output. Irish expenditure on education has been both high and rising (from 3.1 percent of GNP in 1962 to 6.4 percent in 1989). This is reflected in Ireland's relatively high rate of school attendance in the recent study by Mankiw et al (1992), where Ireland ranks seventh out of 121 countries. Thus Ireland not only failed to grow faster than richer economies during this period; it also underperformed relative to its rate of investment in education. Walsh's recent econometric study of an OECD subset of the Mankiw et al data-set study confirms Ireland's poor record in 1960-85, 'in the sense that the level of GDP per adult reached in 1985 was lower than would have been expected on the basis of its initial level in 1960, the rate of growth of the labour force and the rates of human and physical capital formation'.12 Decline in the quality of education is unlikely: analyses of the contribution of education (measured by years of schooling) to earnings in 1972 and 1987 imply no decline in the interim, and the marginal returns to higher education are at least as high in Ireland as in other countries offering comparable data.13 Nor is the frequently alleged bias against technical and science-oriented subjects in the Irish education system supported by the facts (Sheehan, 1992). Perhaps emigration, by removing human capital, had something to do with the poor Irish performance? Ireland was after all an outlier as regards emigration, as Table 13.6 makes clear. If emigrants are better educated than the population at large, emigration will reduce the growth of income per capita in the sending country (Berry and Soligo, 1969; Dolado et al 1993). However, the selection bias in emigration from Ireland before 1960 was, if anything, towards unskilled workers, and therefore arguably reduced unemployment and upgraded the structure of the remaining labour force (6 Grada and Walsh, 1992). The net outflow declined during the 1960s, turning negative in the 1970s. When it resumed in the 1980s, the highly educated were disproportionately represented among the emigrants. But this is a problem for policy in the 1990s, and hardly explains the poor record hitherto. Emigration could have hurt the Irish economy in another way, however. Williamson (1993) examined the convergence in industrial wages across countries, and found that Ireland was in no sense an outlier according to this criterion after 1950: indeed, Ireland lies precisely on the estimated 'convergence line'. This finding is obviously at sharp variance with what the GDP or GNP statistics tell us. If industrial workers were doing as well as could have been expected, but the country as a whole was not, then some other group in society must have suffered. Was it capitalists? This seems unlikely, since capital is freely mobile between Ireland and the rest of the world. Farmers? This also seems unlikely, at least for the post-1973

Irish economic growth, 1945-88 409 Table 13.6. Net migration in Western Europe, 1950-87 (in thousands) 1950-73 Belgium France Germany Italy Netherlands Norway Sweden Switzerland UK

Ireland Total

287

3 360 7070 2139 47 0 336 755

^605 -534 15133

1974-87 -8 365

1042 544 -18 77 167 6 15 -68

2310

Note: The totals refer to the sums of absolute values. period of EC bonanzas. Williamson's finding may perhaps be reconciled with our own, if the industrial wages used in his analysis are not competitive market wages, but wages earned by privileged 'insiders' holding desirable jobs and protected by strong unions. 'Outsiders' in casual employment and on the dole queues would then be the ones who have lagged behind. The fact that Irish labour markets are well integrated with world markets might mean that insiders, who have the option of emigrating when suitable jobs come up abroad, demand and receive internationally satisfactory wages. Outsiders have the option of receiving substandard domestic wages, going on the dole, or emigrating. The recent experience of East Germany suggests a possible parallel here. Emigration may not by itself have raised East German wages (since labour is clearly not scarce there); but German integration may nevertheless have led to trade unions pushing up insider wages, leading to mass unemployment. We believe that a careful study of labour market institutions, and the ways in which these interact with world labour markets, has to be a priority for Irish researchers in the near future. In summary, then, while human capital accumulation has provided a useful way of reconciling aggregate evidence with the Solow model, and 'explaining' the lack of convergence at the global level, it does not, at first sight at least, explain Ireland's poor postwar economic performance. The role of emigration, however, deserves further study. 6

Trade policies

While the market imperfections at the heart of both new trade theory and new growth theory can potentially damage the case for free trade, the empirical case for free trade has on balance been strengthened by these developments. A well-known survey by Baldwin (1984:586) found that the estimated gains from trade liberalization in the context of standard competitive CGE models were very small: for example,

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Whalley and Wigle (1982) found that the gains to a 50 per cent multilateral tariff cut amounted to a mere one-third of 1 per cent of world GDP. Increasing returns have in practice boosted the static effects of trade liberalization: Harris and Cox (1984) found that a free trade agreement with the USA could boost Canadian welfare by almost 9 per cent of GNP. The dynamic effects of trade policy remain more elusive, at both a theoretical and an empirical level. It is true that if trade leads a country to specialize in less technologically progressive goods, this may imply dynamic losses that outweigh the static gains from trade (Young, 1991); and indeed, it is sometimes claimed that this is precisely what happened when Ireland specialized in linen rather than cotton in the nineteenth century. In a similar vein, it has occasionally been argued that only industry is capable of sustaining general productivity growth, and that economies such as Ireland, whose comparative advantage dictates that they should specialize in agriculture, will benefit from protection. On the other hand, if there are increasing returns to research, and trade leads all countries to put their research eggs in one basket, rather than spreading resources across sectors, then trade can boost growth everywhere (Davis, 1992). Trade in both goods and ideas will do the trick; the theory, by appealing to economies of scale in the production of new ideas, is reminiscent of Smith's dictum that the division of labour depends on the extent of the market (Rivera-Batiz and Romer, 1991). What the new theory adds to traditional, static trade theory is the possibility that trade will increase growth rates as well as income levels.14 More important for the debate than the theory, maybe, has been the plethora of empirical studies confirming that trade and growth go hand in hand. This work has taken the form of country studies, studying the effects of import substitution policies in several developing countries, as well as cross-country statistical studies.15 Ireland too has a failed import substitution experiment behind it; trade policy would certainly seem to offer a promising explanation for Irish retardation, at least during the 1950s. During the 1920s, Ireland continued to be largely free trading. After 1932, however, the De Valera government sought to create an import-substituting industrial sector. In an attempt to prevent tariff hopping by foreign companies, the government tried to restrict direct investments by foreign firms in the economy. Protection resulted in a very rapid increase in industrial employment and output in 1932-7, but that rise was not sustained and productivity remained low. Ireland remained protectionist until the late 1950s, much later than other European countries. It then progressively opened itself to the outside world, with tariff reductions, a free trade agreement with the UK in 1965, and eventually EC membership in 1973. The policy of protection brought in by De Valera in the early 1930s was not unique, and may have been a sensible response to the circumstances of the time (Neary and 6 Grada. 1991; O'Rourke, 1991). However, Ireland was slow to jump on the GATT bandwagon, only significantly liberalizing towards the mid-1960s with the Anglo-Irish Free Trade Agreement (AIFTA). It thus seems reasonable to enquire whether Ireland's failure to ride the postwar boom was due to its mistaken adherence to trade policies that had outlived their usefulness. The ratio of customs receipts to merchandise imports is a fallible,first-cutmeans

Irish economic growth, 1945-88 411 Table 13.7. A measure of two-way trade, North and South, 1926-91

South North

1926

1938

1951

1970

1980

1991

-42

-47 -11

-68 -8

-43

-31 n.a.

^23 n.a.

+3

+2

of tracking protection. That ratio rose from 12 percent in 1929 to 24 percent in 1939. In 1960 it was still 20 per cent, but by 1970 it had fall to 13 per cent, and by 1990 to 0.9 per cent. The fall in the effective rate of protection was greater still (McAleese, 1971).16 The ratio of merchandise trade (imports plus exports) to GDP rose in tandem from about 25 percent in 1945 to 55 percent in the 1950s, to 69 percent in 1960-73, and 106 per cent in 1974-89. A small but indeterminate part of the rise was due to transfer pricing, since tax relief on profits derived from exports prompted multinational corporations to declare low prices for imported raw materials and high prices for exports. The result was inflated value added, an artificially high return on capital, and exaggerated export and output levels. The rate of growth over the long haul is probably not much affected, however. How did protection affect the Irish economy? It certainly made it a lot more inward looking. A useful comparison here is with Northern Ireland, which as part of the UK was compelled to maintain free trade with Britain throughout our period. The trade ratio suggested by Kennedy et al. (1988: 234, 239) (defined here as (X — M)l (X + M ) for manufactured goods) effectively captures the contrast. The home market orientation of the new southern industrial sector caused the ratio to drop, while the more recent rise in the ratio captures the transition to a more outward-looking industrial sector. For the North, however, the two-way trade in manufactures was broadly in balance throughout (Table 13.7). The resulting industrial structure- a large number of widely dispersed small firms and a low degree of horizontal integration - reflected both the powers of local pressure groups and the small size of the local market. The following extract from Mary Daly's recent book on the 1930s will give a flavour of the distortions involved (Daly, 1992: 108; see also 6 Grada, 1994b: ch. 15): J.H. Woodington was refused permission to build a tannery adjacent to his Drogheda shoe plant or in an adjoining town. He was informed that the minister preferred a town that did not have an industry and was dispatched to Mountmellick following local representations, despite the lack of a suitable site. When he turned his attentions to Portlaoise because of an offer of local capital, officials proposed Tralee, 'where all the capital necessary would be available'. Few other sizeable towns in Ireland are as far from Dogheda as Tralee! Such a structure was unlikely to support the innovation necessary for sustained economic growth. It was also bound to deprive Irish industry of precisely the sorts of external economy of scale (skilled local labour forces, for example) that have been used to justify industrial protection. Why then did Ireland take so long to liberalize? Although the protectionist policies pursued by successive administrations since the early 1930s always had their critics, evidence of the damage caused was elusive

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before the 1950s. As mentioned, the tariffs imposed in the early 1930s had initially produced a sharp rise in industrial employment. Admittedly, it did not take capital long to absorb the sheltered home market, and industrial employment had already peaked before 1939. However, the message that import substitution could not have produced sustained economic growth was blurred by the enforced autarky of 1939-45, and the postwar recovery produced the illusion that protectionism was doing no harm. 1946-51 was the first five-year period since the Famine to experience population growth. Industrial employment rose considerably, industrial profits rose, and the rate of economic growth was respectable by European standards (Hall, 1951: 4-5; Lynch, 1969: 189). It was only when the rest of Europe left the Irish economy standing in the 1950s that the bankruptcy of the old policies became clear to policy-makers. Policy-makers and most opinion-makers in the early 1950s took protection for granted. The Commission on Emigration (1956:161) defended tariffs by noting that without them 'it would be difficult to conceive of industry on any wide scale maintaining itself or developing further', and insisted that future commitments to international agreements should not compromise 'our freedom to develop our industries as we think fit'. To those economists who continued to support free trade, in the mid-1950s it was still 'an unlikely Utopia' (Lynch, 1969). Even Whitaker's landmark Economic Development (1958), the government report which paved the way for the new economic policies of the 1960s, was circumspect about the issue. Noting that 'the coming of free trade in Europe in one form or another must be faced in due course', its main emphasis was on the need to allow in foreign capital rather than on abolishing tariffs (Whitaker, 1958:190; see also Whitaker, 1956). Indeed, the new Industrial Development Authority, established to attract direct foreign investment, sanctioned some tariff increases in its early years (Whitaker, 1958: 13), and neither the Central Bank nor the Department of Finance proposed freer trade as a panacea in the early 1950s. Policy-makers emphasized instead the need for state mobilization of investment funds and demand management. It took time for the argument for freer trade to sink in. Free trade appears to have helped boost Irish growth, as a glance at Figure 13.2(c)-(0 will suggest. The distance between Ireland and the 'convergence lines' implied by experiences of a large number of European economies narrowed after 1960. On the other hand, Ireland continued to underperform. Perhaps this was because free trade did not mean an end to government distortions. For example, it was surely no accident that the new tax incentives and grants introduced to attract foreign investment in export-oriented industries were geared to complement, rather than substitute for, existing inward-looking Irish-owned industries (Lee, 1989: 352). To this extent the Irish campaign to attract foreign investment was constrained from the start by the protectionist legacy. The shift to 'free trade' in Ireland was matched by a big increase in non-tariff distortions in the form of a huge rise in aids to industry. In 1983-6, 3 percent of GNP was being spent on promoting industrial development, equalling about one-eighth of industrial value added (Leddin and Walsh, 1992:482). Bond and Giesinger (1985:96) state that 'Investors receiving the maximum cash grant are being protected, in effect, with the equivalent of a 24% tariff on top of an average 27% tariff afforded by the EC's common external tariff' Such government distortions, falling under the general rubric of 'industrial

Irish economic growth, 1945-88

413

policy', may simply substitute for outright protection; if so, they may lead to a similar misallocation of capital. More importantly, by creating an impression that bail-outs might be available for underperformers, they might reduce innovation, an effect stressed by Michael Porter (1990). Furthermore, direct government subsidies to industry might be even more 'capturable' by interest groups than across-the-board protection; rent seeking might be as much or more of a problem, with all that this can imply for growth. It is to rent seeking, and other political economy factors, that we now turn. 7

Rent seeking and interest groups: the political economy of growth

The rent-seeking approach associated with Mancur Olson (1982) seems to offer a good framework for interpreting Ireland's relatively poor economic performance since 1945. Olson predicts, in the absence of disturbing causes, powerful tendencies for sectional interest groups to become entrenched in an economy. These groups will tend to cause institutional sclerosis and economic stagnation. According to Olson, societies fortunate enough to have been spared military invasion or serious political unrest for a long time, such as the United Kingdom, pay a price in that their very stability gives such interest groups ample scope to plan collective actions which restrict competition and retard growth. Only an external shock such as defeat in war or economic and political integration can destroy the influence of such groups. Aspects of the Irish record invite a reappraisal of this last hypothesis. First, the political convulsions of the nineteenth century may, contrary to Olson, have encouraged rather than hindered rent-seeking behaviour. The Land War, which pitted the peasantry against the land-owning classes, was eventually won by the former, after a series of rent strikes, some violence and much upheaval. Courts were instituted to set rents, and later the landlords were forced to sell their land at favourable prices, with the taxpayer helping to smooth the transaction. Barbara Solow, for one, has argued that this was disastrous for Irish agriculture: Incentives to adjust the economy in the face of new international conditions were to some extent paralyzed. There is no need to take too seriously landlord contentions that everybody rushed to court and neglected his farming, but if tenants could increase income more by litigation than by changing agricultural techniques, they would certainly do so. If valuers were swayed by appearances, a premium was even put on worse farming, and consequent dilapidation... with the tenants of Ireland crowding into court, no one was thinking about agricultural education, credit and marketing programs, improved cropping, selective breeding, and, in general, ways of assisting tenants to adjust to changed economic conditions. (Solow, 1971: 165-6) Could it be that experiences such as this had a long-run impact on the culture, leading entrepreneurial talent to focus on 'the grant' or some other government concession, rather than competing on world markets? A second point to make is that Ireland did undergo a violent revolution and civil war during the period 1919-23. Why then was rent seeking a problem in the new Ireland? Olson himself (1989) has questioned whether independence 'destroyed the organizational structure of Ireland'. Most historians would agree: the Irish

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revolution left property, the legal and banking systems, industrial relations and the civil service largely intact. The new regime sought to build up its reputation through institutional continuity wherever possible, so in the sense of Olson the revolution may not have been thoroughgoing enough. The protectionist coalition formed in the 1930s, which would soon command cross-party support and survive into the 1950s, would seem to fit Olson's model quite well. Urban workers, small farmers and manufacturing interests benefited from De Valera's policy of protection, sweetened with the 'farmers' dole', and together formed a powerful alliance (O'Rourke, 1991). Indeed, Olson (1989) pointed to free trade and EC membership as a means of ridding Ireland of the anti-growth coalitions that had become entrenched since the 1930s. If the maintenance of protection was due to a powerful Olsonian coalition, one might have expected to seefierceresistance to the liberalization that did eventually occur. Yet when the inability of the strategy of import substitution to sustain growth and employment became clear in the 1950s, the resistance offered by Olson-type lobbies was surprisingly weak. This supports the interpretation of the delayed liberalization put forward in the previous section: policy-makers had simply been slow to learn that protection was mistaken. In support of the Olson model, however, it could be argued that the scheme of adaptation grants to threatened firms instituted in 1962 and continued until 1967 was part of the price paid for the support or acquiescence of business and trade unions. The grants provided subsidies to firms which modernized their plant and equipment. The scheme followed the reports of the corporatist Committee on Industrial Organization, which revealed an indigenous industrial sector unlikely to cope with free trade (Kennedy et ai, 1988: 68). Initially intended as a temporary measure, the scheme took on a life of its own. Given the poor prospects and poor record of the majority of firms involved, these transfers must have yielded a very poor return. A recent paper by Patrick Honohan (1992b) has listed several of the more blatant examples of rent-seeking behaviour in Ireland. Semi-state companies, granted a monopoly position in the Irish market, have channelled rents into cost increases rather than profits for the Exchequer. A small state-owned enterprise making a worthless petrol additive was supported by making the additive compulsory in all petrol refined in Ireland. During the recent currency crisis, hand-outs were granted only to thosefirmswhich had been careless enough to leave themselves exposed to fluctuations in the Irish pound/sterling exchange rate. Honohan might also have mentioned the fact that allflightsbetween Ireland and the USA were for years forced to stop at Shannon Airport, as a result of some extremely effective lobbying by local interests. One institutional feature of Irish life that has often been blamed for some of the rent seeking that occurs in the country is the multi-seat constituency, which pits party member against party member, and places a premium on 'constituency service'. It also makes for more marginal seats, giving greater weight to regional issues than would be the case under either a 'national list' or a single-seat constituency system. For example, the Shannon stopover was supported even by the laissez-faire Progressive Democrats, presumably because two of its deputies represent the Limerick area.

Irish economic growth, 1945-88

415

Institutions and politics can matter in other ways. Did Ireland's pay bargaining structure retard output and productivity growth? The Olson model would seem to have a definite bearing here. Olson (1982) argues that interest groups such as trade unions and producers' groups inflict most damage when they are big enough to cause widespread disruption, but small enough for the social cost of their actions to remain an externality to themselves. In this view, either very weak or all-powerful lobbies may be preferable to something in-between. Thus it is often argued that corporatism works, both in pay bargaining and strategic policy decision making, because it takes account of macroeconomic constraints and minimizes the risk of inter-union disputes. Most analysts consider the cost in reduced wage dispersion worth paying. In Ireland, the experience of the Committee on Industrial Organization, which united management, unions and public service in analysing the shortcomings of protected industries in the early 1960s, and in proposing rationalization schemes, seems a good case in point. But more recent Irish experience in the pay bargaining sphere provides less cause for cheer. In an economy with high unemployment such as Ireland, the argument in favour of centralized agreements is that they should produce lower wage increases than plant-by-plant collective bargaining. However, a recent assessment of the Irish experience with centralized bargaining concludes that the outcome 'in terms of pay increases was higher than a decentralized wage bargaining situation' (Durkan, 1992: 349).17 Before the 1960s, old-fashioned collective bargaining was the norm in Ireland. The first attempt at a centralized agreement, the National Wage Recommendation of 1964-6, led to trade union suspicion of incomes policy, and decentralized bargaining followed until 1969. A serious industrial dispute prompted the re-emergence of centralized bargaining in 1969, but the rationale was good industrial relations, not full employment or inflation. Subsequent pay agreements stipulated a national norm, but also allowed for local bargaining to obtain further increases. This combination of centralized and decentralized bargaining arguably produced the worst of both worlds. The 'National Understanding for Economic and Social Development' of 1978 seemed to mark a watershed, in that it explicitly recognized the connection between pay and employment levels. However, the ensuing wage increases belied that view. The breakdown of the Second National Understanding in 1982 marked the end of centralized bargaining until 1987, with employers refusing to have any further truck with it. A sharp decline in wage inflation ensued, and there was industrial peace. Centralized bargaining resumed in 1987, according to Durkan 'once again accelerating] the pace of wage inflation'(Durkan 1992: 362). His assessment of the Irish experience with wage bargaining is cast in a very Olsonian mould: 'it is no surprise that once lobby groups get together the result is suboptimal. The result of bargaining will suit lobby groups, but how does it suit those excluded from the negotiation?' (Durkan, 1991; cited in Durkan, 1992: 363). Where does this fit in with the broader European experience with corporatism? Ireland does not feature in Calmfors and DriffiU's recent comparative study of the bargaining structure and economic performance in eighteen OECD countries (Calmfors and Driffill, 1988). Ireland's industrial relations make it an 'intermediate economy' in their framework, and adding it to their sample corroborates their case for a hump-shaped relation between the degree of centralization and economic

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Cormac 0 Grada and Kevin O'Rourke

Table 13.8. Calmfors-Driffill indicators of economic performance Unemployment Employment Okun index rate L A Centralized 4.0 economies B Intermediate 6.1 economies Ireland 11.0 B' (including Ireland) 6.9 C Decentralized 5.8 economies

Alternative performance index

C

L

2.3

72.5

2.7 13.0

6.1

6.2

3.6

4.8 5.0 4.9

60.9 54.6 59.9

- 3 . 2 14.5 — 5 9 23.7 - 3 . 7 16.0

8.7 9.8 8.9

7.7 20.9 9.9

6.5 10.5 7.1

2.9

65.8

-1.1

15.2

7.7

5.8

3.1

C

L

C

L

C

L = levels (1974-85 average). C = changes (1974-85 average less 1963-73 average). Note: The Okun index is the unemployment rate plus inflation; the alternative index is the unemployment rate plus the current account deficit as a percentage of GDP. Sources: Calmfors and Driffill (1988: 20); European Economy, no. 50. performance. In Table 13.8, rows A, B and C reproduce Calmfors and DriffilFs results for centralized, intermediate and decentralized economies; row B' shows the effect of including Ireland in the intermediate category. However, quite apart from the possible influence of other factors, the difficulty with measuring the degree of centralization precludes an attempt at measuring the importance of this effect. A related study by Freeman (1989:76) shows Ireland in the uncomfortable position of having moderate wage dispersion coupled with the lowest employment rate in a 19-country sample. Analysis of protection and industrial relations thus yields modest support for the Olson model. However, this model is notoriously difficult to test satisfactorily. Magee et a\. (1989: ch. 8) invoke the ratio of lawyers (a measure of unproductive lobbying activity in an economy) to physicians (representing productive white-collar workers) as an index of rent seeking, and find that per capita income in countries with more lawyers per doctor has grown more slowly in the period 1960-80. High-tariff countries also have more lawyers. Ireland is one of thirty-four countries to feature in their analysis. However, cross-country variations in the structure of these professions vitiate the exercise: in Ireland, for example, the legal profession has always restricted entry, while in the United States, the legal profession is relatively open but the American Medical Association operates a monopoly (compare Walsh, 1993a).

8

Some simple cross-section evidence

Finally, for further comparative focus, we subjected an 18-economy data set, based largely on Heston-Summers Mark 5, to statistical analysis. The strategy wasfirstto

Irish economic growth, 1945-88

417

gauge Ireland's status in the European 'convergence club' detected in section 2, by regressing growth in per capita GDP on initial GDP and an Irish dummy variable. We then added further explanatory variables, in an attempt to reduce the size of the (negative) coefficient on the Irish dummy. These variables were: the investment share of GDP (INV, taken from the Penn Table); a scale variable, as in Helliwell (1992); the share of GDP accounted for by agriculture (AG); secondary school enrolment rates (SEC, taken from the UNESCO Survey of Education (vol. 3) and the UNESCO World Education Report (1991)); a trade variable, TRADE, defined as the sum of merchandise imports and exports, and reflecting the well-known fact that trade is more important to small countries than to large; a proxy for corporatism (CORPOR), defined rather crudely by a dummy variable (since theory suggests that both highly centralized and highly decentralized systems of industrial relations work well, economies in those categories are given a value of one, and the rest (including Ireland after 1960) a value of zero); and a dummy variable, PERIPH, which equals one if the economy is geographically peripheral, in the sense of comprising part of Western Europe's external border, and which equals zero otherwise. The results for the period 1973-88 must unfortunately be treated with caution, due to the uncertainty over the Irish GDP data mentioned in section 2, and the steadily evolving GDP/GNP gap over the period. Tables 13.9-13.12 present the results of the analysis. We estimated variants of the following: GROWTH = a0 + ^(SCALE) + + a3|>(INV/GDP) - ln(n + g + 5)~] + a4[ln(SCHOOL) - ln(n + g + <5)] + a5CORPOR + a6TRADE + a7PERIPH + a8AG + a9IRL + e where n is the rate of population growth. We follow Mankiw et a\. in assuming that the sum of 3 (the rate of depreciation) and g (the rate of change in the level of technology) equals 0.05. Regressions of this form were first estimated for each period separately (Tables 13.9-13.11). Throughout the 'convergence' effect is reflected in the negative coefficient of GDP, although comparing periods suggests that the convergence that took place in 1950-73 was less evident in 1973-88. Ireland's poor showing is captured by the negative coefficient on IRL, usually greater than 1 percent. However, the drop in the coefficient on IRL from about 2 per cent during the 1950s to somewhat over 1 per cent in later periods is worth noting. This drop supports the notion that the shift to more outward-looking policies from the late 1950s led to improved Irish economic performance. The investment rate (INV) performs well throughout, and in the expected direction, although it does not always help explain away the coefficient on IRL: if anything, Ireland invested too much. Several of the variables suggested by theory help explain the variation in growth rates, although they fail to make a big dent in the size of IRL. More interesting is the outcome in Table 13.12, where the data are pooled, and coefficients estimated following the heteroskedastic correction suggested by Kmenta (1973: 508—17).18 Again, convergence is confirmed, with Ireland as an outlier. Again the investment rate (INV) works as predicted. Several other variables - SCALE, PERIPH, SEC, CORP, AG - work as predicted. Taken together, they

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Cormac 0 Grada and Kevin O'Rourke

Table 13.9. Cross-section analysis, 1950-60

CONST GDP

(1)

(2)

(3)

(4)

(5)

14.86 (3.10) -1.39 (2.36)

15.79 (3.41) -1.49 (-2.62) -1.91 (-1.54)

8.92 (1.23) -1.76 (-2.93) -2.04 (-1.67) 1.52 (1.23)

8.45 d-37) -2.90 (-4.58) -2.04 (-1.69) 2.00 (1.55) -1.19 (-1.93) 0.81 (2.24)

5.08 (0-74) -2.33 (-3.79) -1.84 (-1.65) 2.85 (2.18)

IRL INV

PERIPH SCALE TRADE R2 (adj.)

0.274

0.211

0.298

0.568

2.22 (2.01) 0.423

Table 13. 10. Cross-section analysis,1960-73

CONST GDP

(1)

(2)

(3)

(4)

29.83 (8.13) -3.04 (-8.14)

30.98 (8.55) -3.17 (-7.41) -1.20 (-1.47)

32.07 (3.52) -3.17 (-7.15) -1.22 (-1.42) -0.17 (-0.13)

0.739

0.757

0.740

30.66 (3.12) -3.22 (-6.90) -1.13 (-1.27) 0.11 (0.07) 0.10 (0.48) 0.725

IRL INV

SCALE R2 (adj.)

reduce the coefficient on IRL by about half. Most powerful in this sense is AG, the contribution of agriculture to GDP. This variable reduces IRL by about one-third. CORP also reduces the value of IRL, although not too much should be read into this. Of these variables SCALE, PERIPH and AG may be deemed exogenous at least in the short run, while CORP, INV and SEC are influenced by policy. The fault for Ireland's poor performance since 1950 thus seems to be partly 'in ourselves', partly 'in our stars'. It is unclear how to interpret the strong influence of AG on the size of the Irish dummy variable. First, it could be that agriculture is a slow-growing sector without any of the beneficial externalities emphasized by the new growth theorists; Ireland may have had a comparative advantage in the 'wrong' good, as in Young (1991). In order to evaluate this claim, one would need to compute total factor productivity growth in both agriculture and industry for a large number of economies. Second, it

Irish economic growth, 1945-88 419 Table 13.11. Cross-section analysis, 1973-88

CONST GDP

(1)

(2)

(3)

(4)

3.80 (0.58) -0.22 (-0.30)

6.51 (0.97) -0.51 (-0.69) -1.27 (-1.31)

-1.48 (-0.15) -0.76 (-0.99) -1.37 (-1.42) 1.66 (1.18)

-0.06

-0.01

-7.26 (-0.80) 0.43 (0.46) -1.51 (-1.72) 0.80 (0.59) 1.04 (1.98) 0.186

IRL INV PERIPH R2 (adj.)

0.014

may be that agricultural economies are governed by politicians who mistakenly believe that sustainable growth can only be based on industrialization; and that thus such economies are more likely to suffer from distortionary policies. Third, it is of course also true that Europe as a region does not have a comparative advantage in agriculture. European agricultural regions would therefore have declined faster than they actually have done, had government interventions not delayed the process. The growth implications of institutions such as the CAP are themselves ambiguous, even for agricultural economies, as the cosseting of particular sectors may reduce their long-run dynamism.

9

Conclusion

Patriotic Irishmen, worried about their country's lowly economic status, have long looked to history and to the achievements of neighbouring economies for inspiration. In the 1840s, Young Irelander Thomas Davis pointed to the Prussian system of technical education and the Norwegian system of succession; in the 1900s agrarian reformer Horace Plunkett urged his countrymen to make Ireland 'another Denmark', and economic nationalist Arthur Griffith saw a lesson in the 'resurrection of Hungary'. Though their diagnoses differed radically, all three believed that the performance of the Irish economy was far from optimal. Most subsequent assessments concur. Our own comparative perspective on the record since the late 1940s only confirms the gloomy assessments of earlier studies, such as those of Lee and of Kennedy et al. The outcome will hardly come as a surprise for the 1950s, conventionally deemed a 'lost decade' in Irish economic history. Yet when assessed in the context of a European pattern of 'convergence', even the 1960s, usually considered a 'golden age' for Irish economic growth, emerge in a rather unfavourable light. Why, then, has Ireland's record been so poor? In this preliminary survey we have reviewed some of the reasons given by other researchers and added a few of our own. In sections 4 to 7 we focused on certain possible causes in isolation, while in section 8 we adopted an explicitly comparative perspective. Our canvass suggested that factors such as the small size of the economy, the importance of agriculture,

420

Cormac 0 Grada and Kevin O'Rourke

Table 13.12. Cross-section analysis, 1950-88

GDP

20.10 (8.71) -1.98 (-7.45)

IRL

(4)

(3)

(2)

(1) CONST

21.16 (9.17) -2.09 (-7.88) -1.65 (-2.39)

INV

(5)

9.98 (3.07) -2.22 (-10.17) -1.72 (-2.71) 2.02 (4.45)

8.76 (2.63) -2.34 (-9.32) -1.50 (-2.31) 2.42 (4.30)

0.705

-0.41 (-1.44) 0.699

SCALE PERIPH R2 (Buse)

CONST GDP IRL INV AG

0.552

0.516 (7)

(8)

(9)

(10)

17.41 (7.86) -3.79 (-10.62) -0.95 (-1.77) 3.21 (8.82) -11.22 (-4.71)

18.12 (6.81) -3.80 (-10.34) -0.93 (-1.74) 3.14 (8.05) -12.08 (-5.21)

18.73 (7.41) -3.87 (-11.30) -0.88 (-1.70) 3.87 (11.30) -11.56 (-5.26) 0.49 (1.47)

17.09 (7.39) -3.82 (-10.70) -0.90 (-1.70) 3.13 (8.27) -10.82 (-4.50) 0.39 (1.21) 0.07 (1.31)

17.91 (7.88) -3.89 (-10.90) -0.87 (-0.52) 3.09 (8.01) -11.35 (-4.96) -0.42 (1.31)

0.07 (1.40)

TRADE 2

R (adj.)

CONST GDP IRL INV AG SEC

R2 (adj.)

0.819

0.861 (11) 19.12 (7.47) -3.97 (-10.51) -0.67 (-1.12) 3.02 (7.24) -12.65 (-5.09) 0.36 (1.08)

SCALE CORP

0.819

(6)

SEC SCALE

11.04 (4.13) -2.54 (-13.40) -1.70 (-2.70) 2.27 (6.16) 0.15 (2.71)

0.31 (1.33) 0.848

(12) 18.35 (6.36) -4.00 (-9.79) -0.68 (-1.09) 3.16 (7.01) -11.95 (-4.40) 0.36 (0.99) 0.05 (0.83) 0.34 (1.38) 0.824

0.850

0.853

0.10 (0.87) 0.858

Irish economic growth, 1945-88

421

low-quality investment decisions, and rent seeking in industrial relations, all played a role, although we doubt whether taken together they account for all of the gap between Ireland's actual and 'expected' performance. On the other hand, low rates of investment in human and physical capital do not seem to have been responsible, at least from the 1960s onwards. Finally, this survey, in common with most of the convergence literature, is aspatial. Could Ireland's proximity to the UK, a slow grower in absolute terms (although not an underperformer in the convergence sense) have led to slow Irish growth rates? Adding a spatial dimension to the empirical growth literature may prove a fruitful research programme for the future. It would be wrong to end on a wholly gloomy note, so let us add three caveats. First, the official Irish data underlying our figures and our tables probably underestimate Irish GDP in at least two ways: • The allowance for the output of the owner-occupied housing sector (larger in Ireland than in most or all of the other economies considered above) is deemed to be relatively conservative.19 • The size of the household economy is much larger in Ireland and the rate of female labour force participation much lower than in most European countries, so that GDP is a more conservative estimate of true output in Ireland than in other countries (Fahey, 1992; NESC, 1991). Any such downward bias in the measurement of GDP exaggerates our expectations of Irish economic growth in the convergence stakes. Second, relative economic performance is not everything: recent surveys of European public opinion confirm the common impression that the average Irishman and Irishwoman are happier and less angst-ridden than their British and most of their Continental neighbours.20 Finally, the Irish economy has been among the fastest growing in Europe since 1988, the end-date of our comparative analysis. A continuation of that pattern for another few years would force us to modify, if not reverse, our sombre verdict on the post-1973 period. NOTES Earlier versions of this chapter were presented at the CEPR workshop on European postwar growth in Lund (May 1993); at the European Historical Economics Association seminar on economic growth in the European periphery at the Pazo de Marinan, Galicia (July 1993); and at seminars at University College Cork and the University of Copenhagen. We thank Frank Barry, John Bradley, Nick Crafts, Kevin Denny, Rolf Dumke, Joe Durkan, Cathal Guiomard, John Kennan, Kieran Kennedy, Patrick Honohan, Moore MacDowell, Angus Maddison, Rodney Thorn, Gianni Toniolo, Brendan Walsh and Jeffrey Williamson for their comments and help. We are grateful to David Lee for excellent research assistance, and to the UCD Department of Economics Research Fund for financial support. 1 Unless otherwise specified, 'Ireland' is used to refer to the 26 counties, rather than the island as whole. 2 Summers and Heston (1991); data kindly supplied by Angus Maddison. 3 See also O'Rourke et al. (1993), O'Rourke et al. (1994), Boyer et al (1994) and Williamson (1994), for further discussion of late nineteenth-century convergence.

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Cormac 6 Grada and Kevin O'Rourke

4 O'Rourke (1992) contains a theoretical discussion; Mokyr and 6 Grada (1982) investigate some of the empirical issues involved. 5 Kennedy (1992) is an important exception. 6 Taken to be the following countries: Austria, Belgium, Denmark, Finland, France, West Germany, Greece, Iceland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden and Switzerland. The Maddison data set we have access to does not have data for Greece, Iceland and Luxembourg. 7 Friedman (1992); see also Quah (1993). These authors argue that a declining coefficient of variation over time represents true economic convergence; finding that initially poor countries grow more rapidly does not necessarily imply such convergence. The point is made by analogy with Galton's fallacy: the fact that the sons of tall fathers tend to be smaller than their fathers ('beta-convergence') does not necessarily imply that the size distribution of the population collapses over time ('sigma-convergence'). Sala-i-Martin (1993) shows that beta-convergence is a necessary but not sufficient condition for sigma-convergence. The size distribution argument would seem to hold because, over time, different families rise to the top of the height league in a random fashion. We wonder whether this is the right metaphor for understanding economic league tables, in which countries retain their places in the league table for very long periods indeed. More tellingly, maybe, sigma-convergence was a feature of post-1950 Europe (but not of the post-1973 period), as the following table shows: GDP per capita: coefficient of variation Year

Maddison data

Heston-Summers data

1950 1960 1973 1988

039 034 026 022

043 037 027 027

8 Comparable data only being available for this subset of countries. 9 We are grateful to Cathal Guiomard for this suggestion. 10 The Maddison data refer to 1989, and the Heston-Summers data to 1988. 11 These data are given in the national accounts. 12 See Walsh (1933a: 30-3). Walsh notes, however, that his results only lend weak statistical support to this conclusion, unless GNP rather than GDP is used. 13 Of course, if education differentials reflect the power of 'insiders', rather than the relative productivity of the well educated, this conclusion does not hold. 14 Even the standard Solow model implies much longer 'medium-run' gains from trade than a static model; the addition of scale economies or other 'new growth theory' elements is, however, necessary to boost growth permanently. See Baldwin (1989), which represents a pioneering attempt to estimate these growth effects. 15 See, for example, the World Development Report (1987). A problem to date in empirical studies has been the lack of a theoretically valid index of protection; Anderson and Neary (1994) provide a promising candidate. 16 See n. 15. We hope to compute an Anderson-Neary trade protection index for Ireland at some future stage. 17 See also Hardiman (1993); Leddin and Walsh (1992: 264-7). 18 This was done because standard diagnostic tests suggested strong heteroskedasticity in the pooled data set.

Irish economic growth, 1945-88

423

19 The allowance for actual and imputed rent - currently about £400 per household per year - seems very low. One could argue for a much higher figure - say £1,000 per annum - and that would add about 2 percent to Irish G D P per head. Compare Kennedy and Dowling (1975: 325-6). 20 See Eurobarometer, no. 33 (June 1990).

REFERENCES Anderson, J.E. and J.P. Neary (1994) 'Measuring the restrictiveness of trade policy', World Bank Economic Review, 8 (2), pp. 151-69. Baldwin, R. (1984) Trade policies in developed countries', in R. Jones and P. Kenen (eds.), Handbook of International Economics, Vol. 1: International Trade, Amsterdam: North-Holland. (1989) T h e growth effects of 1992', Economic Policy, 9, pp. 248-81. Barro, R. (1990) 'Government in a simple model of endogenous growth', Journal of Political Economy, 98 (2), pp. 103-25. (1991) 'Economic growth in a cross section of countries', Quarterly Journal of Economics, 106 (2), pp. 407-43. Barro, R and X. Sala-i-Martin (1991) 'Convergence across states and regions', Brookings Papers on Economic Activity, no. 1, pp. 107-82. Barry, F. (1991) T h e Irish recovery, 1987-90: an economic miracle?', Irish Banking Review, Winter, pp. 23-40. Barry, F. and J. Bradley (1991)'On the causes of Ireland's unemployment', Economic and Social Review, 22, pp. 253-86. Baumol, W.J., S.A.B. Blackman and E.N. Wolff (1989) Productivity and American Leadership, Cambridge, MA: MIT Press. Berry, R.A. and R. Soligo (1969) 'Welfare aspects of international migration', Journal of Political Economy, 77 (3), pp. 778-94. Bond, E.W. and S.E. Guisinger (1985) 'Investment incentives as tariff subsidies: a comprehensive measure of protection', Review of Economics and Statistics, 67 (1), pp. 91-7. Boyer, G.R., T J . Hatton and K. O'Rourke (1994) 'Emigration and economic growth in Ireland, 1850-1914', in T.J. Hatton and J.G. Williamson (eds.), International Migration and World Development, London: Routledge. Bradley, J. (1990) T h e legacy of Economic Development: The Irish economy 1960-1987', in John F. McCarthy (ed.), Planning Ireland's Future: The Legacy of T.K. Whitaker, Dublin: Glendale Press. Calmfors, L. and J. Driffill (1988) 'Bargaining structure, corporatism and macroeconomic performance', Economic Policy, 6, pp. 14-61. Castles, F.G. (1991) 'Democratic politics, war and catch-up: Olson's thesis and long-term economic growth in the English-speaking nations of advanced capitalism', Journal of Theoretical Politics, 3 (1), pp. 5-25. Commission on Emigration and Other Population Problems (1956) Report, Dublin: Stationery Office. Crafts, N.F.R. (1992) 'Productivity growth reconsidered', Economic Policy, 15, pp. 389^26. Daly, M.E. (1992) Industrial Development and Irish National Identity, 1922-1939, Syracuse, NY: Syracuse University Press. Daniel, T.K. (1976) 'Griffith on his noble head: the determinants of Cumann na nGaedheal economic policy 1922-32', 1ESH, 3, pp. 55-65. Davis, D. (1992) 'Essays in the Theory of International Trade and Economic

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Growth', Ph.D. dissertation, Columbia University. De Long, B. and L. Summers (1991)'Equipment investment and growth', Quarterly Journal of Economics, 106 (2), pp. 445-502. Dolado, J., A. Goria and A. Ichino (1993) 'Human capital and migration', mimeo. Dornbusch, R. (1989) 'Credibility, debt and unemployment: Ireland's failed stabilization', Economic Policy, 8, pp. 173-209. Dowrick, S. and D. Nguyen (1989) 'OECD comparative economic growth 1950-1985: catch-up and convergence', American Economic Review, 79 (4), pp. 1010-30. Durkan, J. (1991) 'Economic policy in the 1990s: the post fiscal adjustment era', mimeo. (1992) 'Social consensus and incomes policy', Economic and Social Review, 23 (3), pp. 347-63. Durlauf, S.N. and P,A. Johnson (1992) 'Local versus global convergence across national economies', NBER Working Paper No. 3996. Easterlin, R. (1981) 'Why isn't the whole world developed?', Journal of Economic History, 41 (1), pp. 1-19. Fahey, Tony (1992) 'Housework, the household economy and economic development in Ireland since the 1920s', Irish Journal of Sociology, 2, pp. 42-69. Freeman, R.B. (1989) 'Labour market institutions and economic performance', Economic Policy, 6, pp. 64-80. Friedman, M. (1992) 'Do old fallacies ever die?', Journal of Economic Literature, 30 (4), pp. 2129-32. Giavazzi, F. and M. Pagano (1991) 'Can severe fiscal contractions be expansionary? Tales of two small European economies', The NBER Macroeconomics Annual, Cambridge, MA: MIT Press. Hall, F.G. (1951) Inquiry into Irish Commercial Profits, Dublin: Dublin Chamber of Commerce and The Federated Union of Employers. Hardiman, Niamh (1993) 'Wage agreements', in J. Goldthorpe and C. Whelan (eds.), Industrial Society, London: Oxford University Press. Harris, R. and D. Cox (1984) Trade, Industrial Policy, and Canadian Manufacturing, Toronto: Ontario Economic Council. Helliwell, John F. (1992) 'International growth linkages: evidence from Asia and the OECD', NBER Working Paper No. 4245. Honohan, P. (1992a) Inter sectoral Financial Flows in Ireland, Dublin: ESRI. (1992b) 'Rent-seeking in Ireland', mimeo. Johns, C. (1993) 'Last in the class?', Studies, 82 (325), pp. 9-23. Kennedy, K.A. (1992) 'Real convergence, the European Community and Ireland', Presidential Address to the Statistical and Social Inquiry Society of Ireland, May. (1993) Facing the Unemployment Crisis in Ireland, Cork: Cork University Press. Kennedy, K.A. and B.R. Dowling (1975) Economic Growth in Ireland: The Experience since 1947, Dublin: Gill and Macmillan. Kennedy, K.A., T. Giblin and D. McHugh (1988) The Economic Development in Ireland in the Twentieth Century, London: Routledge. Keynes, J.M. (1933)'National self-sufficiency', Studies, 22, pp. 177-93. Kmenta, J. (1973) Elements of Econometrics, New York: Macmillan. Leddin, AJ. and B.M. Walsh (1992) The Macroeconomy of Ireland, 2nd edition, Dublin: Gill and Macmillan. Lee, J.J. (1989) Ireland 1912-1985: Politics and Society, Cambridge: Cambridge University Press. Lynch, P. (1969) 'The Irish economy since the war, 1946-51', in K.B. Nowland and T.D. Williams (eds.), Ireland in the War Years and After, 1939-51, Dublin: Gill and Macmillan.

Irish economic growth, 1945-88 425 Magee, S.P., W.A. Brock and L. Young (1989) Black Hole Tariffs and Endogenous Policy Theory: Political Economy in General Equilibrium, Cambridge: Cambridge University Press. Mankiw, N.G., D. Romer and D.N. Weil (1992) 'A contribution to the empirics of economic growth', Quarterly Journal of Economics, 107 (2), pp. 407-37. McAleese, D.F. (1971) Effective Tariffs and the Structure of Industrial Protection in Ireland, Dublin: ESRL Mokyr, J. and C. 6 Grada (1982) 'Emigration and poverty in prefamine Ireland', Explorations in Economic History, 19 (4), pp. 360-84. National Economic and Social Council (NESC)(1991) Women's Participation in the Irish Labour Market, Report no. 91, Dublin. Neary, J.P. and C. 6 Grada (1991) 'Protection, economic war and structural change: the 1930s in Ireland', Irish Historical Studies, 27 (107), pp. 250-66. Norton, D.A.G. (1975) Problems in Economic Planning and Policy Formation in Ireland 1958-1974, Broadsheet Series No. 12, Dublin: Economic Research Institute. O'Brien, G. (1936) 'Patrick Hogan', Studies, 25, pp. 353-68. 6 Grada, C. (1994a) 'Introduction', in C. 6 Grada (ed.), The Economic Development of Ireland since 1870, Cheltenham: Edward Elgar. (1994b) Ireland: A New Economic History 1780-1939, Oxford: Oxford University Press. 6 Grada, C. and B.M. Walsh (1992) 'Irish emigration: patterns, causes, and effects', UCD Centre for Economic Research. Olson, M. (1982) The Rise and Decline of Nations: Economic Growth, Stagflation and Social Rigidities, New Haven, CT: Yale University Press. (1989) 'The rise and decline of nations: where does Ireland fit in?', 19th Geary Lecture (ESRI, Dublin), mimeo. O'Rourke, K. (1991) 'Burn everything British but their coal: the Anglo-Irish economic war of the 1930s', Journal of Economic History, 51 (2), pp. 357-66. (1992) 'Why Ireland emigrated: a positive theory of factorflows',Oxford Economic Papers, 44 (2), pp. 322-40. O'Rourke, K., A.M. Taylor and J.G. Williamson (1993) 'Land, labor and the wage-rental ratio: factor price convergence in the late nineteenth century', NBER Working Papers Series on Historical Factors in Long Run Growth, No. 46. O'Rourke, K., J.G. Williamson and T. Hatton (1994) 'Mass migration, commodity market integration, and real wage convergence: the late nineteenth century Atlantic economy', forthcoming in T.J. Hatton and J.G. Williamson (eds.), International Migration and World Development, London: Routledge. Porter, M. (1990) The Competitive Advantage of Nations, New York: Free Press. Quah, D. (1993) 'Galton's Fallacy and tests of the convergence hypothesis', Scandinavian Journal of Economics, 95 (4), pp. 427-43. Rivera-Batiz, F. and P. Romer (1991) 'Economic integration and endogenous growth', Quarterly Journal of Economics, 106 (2), pp. 531-55. Sala-i-Martin, X. (1993) 'The wealth of regions: evidence and theories of regional growth and convergence', mimeo. Sheehan, J. (1992) 'Education, training and the Culliton Report', UCD Centre for Economic Research Policy Paper PP92/5. Solow, B. (1971) The Land Question and the Irish Economy, 1870-1903, Cambridge MA: Harvard University Press. Summers, R. and A. Heston (1991) 'The Penn World Table (Mark 5): an expanded set of international comparisons, 1950-1988', Quarterly Journal of Economics, 106 (2), pp. 327-68.

426 Cormac O Grada and Kevin O'Rourke Walsh, B.M. (1933a) The contribution of human capital to post-war economic growth in Ireland', CEPR Discussion Paper No. 819. (1993b) 'Irish exchange rate policy in the aftermath of the currency crisis', Irish Banking Review. Whalley J. and R. Wigle (1982) Trice and quantity rigidities in adjustment to trade policy changes: alternative formulation and initial calculations', mimeo. (cited in Baldwin (1984)). Whitaker, T.K. (1956) 'Capital formation, saving and economic progress', Administration, 4 (2), pp. 13-40. (1958) Economic Development, Dublin: Stationery Office. Williamson, J.G. (1965) 'Regional inequality and the process of national development: a description of the patterns', Economic Development and Cultural Change, 13 (4), pp. 3-84. (1993) 'Economic convergence: placing post-famine Ireland in comparative perspective', mimeo. (1994) 'The evolution of global labor markets in the First and Second World since 1830: background evidence and hypotheses', Explorations in Economic History (forthcoming). Young, A. (1991) 'Learning by doing and the dynamic effects of international trade', Quarterly Journal of Economics, 106 (2), pp. 369-405.

14 Italy NICOLA ROSSI AND GIANNI TONIOLO Except for being rotten, it is a success. The Economist, 3 April 1993.

1

Introduction

Future historians are likely to take the crumbling of the Berlin wall in 1989 as the date when the 'postwar' era ended in Europe. In Italy, however, 'postwar' history came to a clear end on 5 April 1992. At the general elections held on that day, a relatively modest if surprising shift of the electorate away from the traditional parties opened the way to a 'quiet revolution', which was still unfolding at the time that this book went to print. Its outcome is by no means sure except for one thing: Italian politics will never be the same again. And since, as we shall see, institutions and politics played not a minor role in shaping the economy, we may now safely look at the half-century that followed the fall of Fascism as a well-defined phase in the economic history of the country: the postwar years are definitely ripe for historical analysis. Italy's performance relative to the world's more advanced large economies is summarized in Table 14.1. As the catching-up approach predicts, Italy is outperformed by a latecomer', Japan. The prediction, however, is not clearly fulfilled in the case of such 'early comers' as Canada, Germany and France, all of which have growth rates that are not significantly different from Italy's over the whole fifty-year period. Over the postwar period (1950-89), Italy outperforms Canada and France, whereas the growth differential with Germany remains negligible. Table 14.1 undoubtedly summarizes a success story, relative both to that of other countries and to Italy's own economic record in the previous three centuries. At the same time, it is not an unqualified success, even when looked at from a purely aggregate quantitative point of view. It might be argued that, given Italy's relative backwardness around 1950, a higher long-term growth rate could have been expected, such as to allow a full catch-up with Germany. Two questions, therefore, are addressed in this chapter: (1) what were the sources of Italian growth over the last fifty years, and (2) could Italy have grown faster?

427

428

Nicola Rossi and Gianni Toniolo

Table 14.1. Levels and growth rates of real per-capita GDP: G7 countries, 1938-89 (% per annum) Annual average: growth rates Level Level 1938-89 1950-89 1950-73 1973-89 1989 1938 (USA = 100) (USA = 100) USA 100.0 United Kingdom 87.9 Canada 68.3 Germany 67.3 France 62.6 45.9 Italy Japan 35.0

2.3 2.0 3.0 2.6 2.7 3.2 5.2

1.9 2.3 2.7 3.7 3.1 4.0 5.2

2.2 2.5 2.9 4.9 4.0 5.0 8.0

1.6 1.8 2.5 2.1 1.8 2.6 3.1

100.0 74.2 96.0 76.4 75.8 70.7 96.0

Note: Italian data in this table are not strictly comparable to those used elsewhere in the paper (from Rossi et. al., 1993). Source: Maddison (1991). Table 14.2. Main economic indicators: Italy, 1951-90 (%) 1951-63 1964-73 1974-90 1950-90 Gross domestic product Imports of goods and services Private consumption Public consumption Equipment investment Construction investment Exports of goods and services Employment PSBR (% of GDP) Trade account (% of GDP) Current account (% of GDP)

5.8 13.1 5.8 4.1 10.4 11.0 12.4 1.1 2.3 -3.1 -1.4

5.0 10.7 5.6 4.0 8.1 1.6 10.3 0.3 4.7 -2.1 -0.1

2.7 4.2 3.3 2.6 2.6 0.0 4.9 0.8 10.3 -2.4 -1.6

4.3 8.1 4.6 3.4 5.8 3.9 8.6 0.8 6.2 -2.4 -1.0

Sources: Central Bureau of Statistics (1STAT) and Bank of Italy.

2

The aggregate performance: an overview

The main economic indicators for the period under review are summarized in Table 14.2. At this level of aggregation, the growth pattern is likely to look rather familiar to observers from other European countries. It may perhaps be noted that 1963 the year with the lowest unemployment rate - is a convenient breaking point for the 'high growth years'. Whereas during 1964-73 G D P and private consumption continued to grow rapidly, a considerable slowdown is shown by investments, with those in construction coming almost to a standstill. At the same time, the rate of growth of employment was less than a quarter that of 1951-^53 and the public sector borrowing requirement doubled. After 1973, the imbalance between the growth rates of consumption and investment continues and government deficit spending

Italy

429

Table 14.3. Value added per labour unit: Italy, 1951-89 (annual average rates of growth, %)

Agriculture Industry Services Public administration Overall

1951-63

1964-73

1974-89

1951-89

5.3 5.6 3.7 0.1 4.7

5.1 5.4 4.4

3.7 3.0 0.6

4.6 4.4 2.5

-0.2

-0.1

-0.1

4.9

1.9

3.5

Note: Labour units are defined as full-time-equivalent workers; growth estimates are, therefore, close, if not identical, to value added per hours worked. Source: Rosse et ai, 1993.

doubles again. Job creation improves, mounting unemployment being mainly explained by rising participation rates. As for growth in value added per labour unit (Table 14.3), the following features are worth noting: • The very high growth rate in agriculture, accompanied as it was by a major employment shift away from the sector. • The collapse of 'gross labour productivity' in the service sector after 1973. • The prima-facie lack of any improvement in the efficiency of the public administration throughout the period. The latter points will be taken up in the second part of the paper, as a part of our explanation of the causes of the not entirely satisfactory performance of the Italian economy. In discussing the main economic trends, mention must be made of the 'Southern question', that major structural feature of the Italian economy, to a large extent still poorly understood in its deeper causes. In order to do so, Table 14.4 shows the evolution of gross labour productivity levels in the South relative to the Centre-North. Judging by this admittedly rough indicator, it appears that the Southern regions were unable to catch up with the rest of the country, despite their initial (1951) relative backwardness. In a nutshell, the 'Southern question' can be summarized by saying that, in spite of its very respectable rate of growth - which allowed real output per person employed in 1989 to be 3.6 times higher than in 1951 - the South did not even begin to close its (gross) productivity gap with the richer Centre-North. The gap actually widened during the so-called miracle years (1951-63), while the recovery that characterized the following decade subsequently faded away: the differential in product per labour unit between the two areas at the end of the period under review was larger than in 1951. The poorly performing sectors of the Southern economy are agriculture and industry, while in both services and public administration, gross productivity grows faster than in the rest of the country. In 1951,48 per cent of Southern workers were employed in agriculture, as against 32 per cent in the Centre-North; the gross productivity gap, however, was in favour of the South. The relative decline of

430 Nicola Rossi and Gianni Toniolo Table 14.4. Regional value added per labour unit: Italy, 1951-89 (Southern Italy as % of Centre-North)

Agriculture Industry Services Public administration Total

1951 108.7 87.0 79.7 97.7 82.1

1963 92.6 77.7 86.8 97.8 79.5

1974 80.0 86.2 92.4 105.9 81.9

1989 73.6 80.8 83.5 105.7 78.1

Note: Value added at constant prices per standard work unit. Source: Central Bureau of Statistics (1STAT). product per worker in Southern agriculture reflects the increasing inability of the other sectors fully to absorb the agricultural surplus labour (underemployment) created by the introduction of new techniques. As a broad generalization, Table 14.4 may be read as follows. The widening (gross) productivity gap between North and South during the early postwar years (1951-63) is likely to be related to the better potential for exploiting economies of scale (internal and external to thefirm)prevailing in the most developed part of the country. The experience of other countries shows that an increasing 'dualism' may be first expected in the early stages of sustained growth, to be succeeded by a tendency for regional economies to converge (e.g. Williamson, 1965). In fact, the decade following 1964 saw the beginning of a productivity catch-up by the South. Such a process, however, came to a halt (and eventually suffered a reversal) during the latter part of the period covered by our analysis. 3

Total factor productivity, market structure, scale economies and capacity utilization

Standard total factor productivity analyses rest on assumptions that are not easily verified in actual long-run growth processes. Those relating to perfect competition and full flexibility of factor inputs are particularly difficult to accept. We have, therefore, used a general theoretical framework - developed by Morrison (1988, 1992a, 1992b) among others - which enables us to relax the binding assumptions of the traditional measures. Such a framework (detailed in Rossi and Toniolo, 1993), provides the conceptual basis for the empirical computations, drawing from an ad hoc database, on which we base our analysis of the performance of the Italian economy. To illustrate the point, let the representative firm's technology be described by a production function (y — y(x,t)) or, equivalently, by a cost function (c = c(w,y,i) where y is output, c is total cost, x is a vector of / inputs with corresponding price vector w, and r is a variable (usually a time counter) summarizing the state of technology.* In this simplified setting, total factor productivity growth is traditionally represented by total output (cost) growth net of the contributions of factor inputs (factor prices and output): that is, by the output elasticity with respect to the technology indicator (d\ny/dt = eyt) or by the cost elasticity with respect to the same

Italy 431 variable (d\nc/dt = ect), respectively. Following Solow (1958), it can be shown that these residuals isolate increasing efficiency in production (technical change) if perfect competition prevails in the output market and if short-run as well as long-run fixities (increasing returns to scale) are ruled out. Under these condition, non-parametric estimation of productivity growth is usually accomplished by focusing alternatively on the revenue (primal) or cost (dual) component of the profit definition. In the primal measure, potential growth in output (for given inputs) when technology changes is given by

where syi is the share of the ith input in terms of the value of total output (w Alternatively, and equivalently, the dual measure focuses on the potential cost reduction induced by technology changes (for given output and factor prices), ect = (c/c) - (y/y) - J>ci(*iM)

(2)

where sci is the share of the ith input in terms of the value of total costs However, once the above assumptions are relaxed, their impact on the productivity residual must be explicitly recognized. Returns arising from market power (imperfect competition), from varying utilization of inputs (short-run fixities), as well as from technological characteristics (scale economies) have to be accounted for, and the traditional productivity growth measures amended correspondingly. Therefore, let the reference model be given by a profit-maximizing factor demand model under unrestricted returns to scale and quasi-fixed inputs. Imperfect competition is assumed to prevail in the output market. In this context, the functional characterization of the technology of a representative firm in short-run equilibrium is given by the restricted profit function or also by the restricted cost function. The latter (cv — cv(w9y9k,t), otherwise known as the variable cost function, defines the minimum cost thefirmincurs for a given volume of output (y), for a given vector of variable factor prices (the / x 1 vector w), a given state of technology (t) and a given level of quasi-fixed factors (indicated by the M x 1 vector k). The restricted cost function allows us to distinguish neatly between variable factors of production (utilized in amounts corresponding to minimum variable costs) and quasi-fixed ones (utilized in amounts that do not necessarily correspond to minimum costs, but are typically characterized by some sort of partial adjustment). Morrison (1992a) has shown that, in order to recognize sub-equilibrium and scale economies, dual (cost-based) measures of productivity growth should be adapted as follows:2

[(

) ^

(3)

where (1 - £e c k , = 1 — £(dlncr(w,r,/c,^O/dln/c./)) *s a n index of factor utilization rate j

j

and ecy denotes the long-run elasticity of costs with respect to output and is an obvious indicator of scale economies. The two indexes adjust the traditional dual

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measure for short-run fixities and non-constant returns, respectively. The corresponding primal measure of productivity growth is given by

ey, = -ecl + ec,{l - 1(1 + epy)/Ul - ^

JecJJ}

(4)

where one plus the inverse demand elasticity facing thefirmepy is a natural index of market power.3 Equations (3) and (4) summarize the implications of sub-equilibrium models for productivity growth measurement. In order to isolate exogenous technical change, they account for the impact on the cost structure of (1) capacity utilization, (2) returns to scale and (3) market power. The 'economic' index of factor utilization (1 — JX*,) represents the outcome of j

explicit economic optimization processes. For a given 'potential' output level, it expresses the economy's ability to adjust to sudden changes in aggregate demand. For a given aggregate demand, however, it shows the economy's optimizing reaction to changes in input prices,fixedfactor quantities, non-constant returns to scale and adjustment cost. This 'economic' index of capacity utilization provides information on both cyclical and trend factors affecting the economy. In this respect, the importance of allowing for capacity utilization in the assessment of long-term productivity growth should not be overlooked: economic historians have long recognized that undercapitalization and overcapitalization are far from being purely cyclical phenomena. The persistent changes in relative factor prices in the 1970s and 1980s provide a clearcut example. Far more difficult to pinpoint is the content of the indicator of scale economies: that is, of the long-run elasticity of costs with respect to output, ecy. At the aggregate level, returns to scale may be associated with a large number of factors other than internal firm scale economies.4 The possibility arises, for example, if one firm's economic activity or accumulation of knowledge conveys external benefits to other firms. Similarly, externalities linked to market thickness or infrastructure expenditure may induce scale economies. Unfortunately, the indicator generated by the above theoretical framework captures the direct effect of scale on costs, but does not provide any information on the nature of that effect. From the economic historian's point of view this is more unfortunate, since different determinants of scale economies at the aggregate level may well lead to substantially different views of the growth process in specific countries. Therefore, the information contained in the scale economies indicator needs to be supplemented by additional qualitative evidence on factors which could be responsible for aggregate non-convexities.5 The excess of price over marginal cost provides a straightforward indicator of market power. In principle, mark-up levels respond to demand and supply changes facing the firm. Indeed, considerable efforts have been devoted in recent years to assessing the behaviour of the mark-up over the business cycle. In what follows, however, the pattern of aggregate mark-up behaviour will only be allowed to react to a limited set of demand-side variables. The three indicators just mentioned combine into a fourth index measuring economic profitability:

py/c, = ^ 1 - Ee c ^6 c y - 1 j/(l - €py)

(5)

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Table 14.5. The sources of growth: Italy, 1938-90 (revenue side, % per annum)

Output Labour inputs Energy inputs Non-energy imports Private capital Public capital Productivity residual €

t

1938-90

1950-90

1950-73

1974-90

4.0 0.4 6.3 7.0 3.8 2.7

5.3 0.9 7.9 8.5 4.6 3.1

6.89 1.1 14.1 10.3 5.3 3.4

3.2 0.7 -0.2 5.9 3.6 2.6

1.8 0.2

2.7 0.4

4.0 1.1

0.9 -0.7

Note: Average annual compound growth rates. Equation (5) indicates the way profitability relates to market power and shows that mark-ups may actually be consistent with zero profits because profits generated by market power may turn out to be counteracted by the effects of short-run and long-run fixities. For example, if the economy is undercapitalized, profits may well be higher than under full long-run optimization. Similarly, if returns to scale are permitted, the profitability arising from market power may be further reduced. If reliable proxies were available for the indexes measuring the deviations from Solow's assumptions, then computing adjusted productivity growth measures would be immediate. Unfortunately, this is not the case for most if not all historical data sets. It is therefore necessary to specify parametrically the representation of the firm's technology, and to revert to econometric methods to obtain coherent estimates of the relevant magnitudes. The specification and estimation of the relevant econometric model as well as the underlying statistical information are briefly described in the appendix.6 The model assumes three variable inputs (labour, energy and non-energy imports) and two quasi-fixed factors (private and public capital), and its parameters have been estimated over the sample 1892-1990 (allowing for the shorter time span for which labour input information is available: that is, 1907-39). The model appears to perform remarkably well. In particular, it is worth noting that, thanks to the highly flexible specification of the technology, no structural break (in a statistical sense) shows up in the period under examination. Nevertheless, the estimated coefficients turn out to imply substantial variations in key magnitudes, such as own- and cross-price elasticities. Tables 14.5 and 14.6 provide a full decomposition of output and cost growth over the period 1938-90.7 Over the period 1950-90, output growth rate exceeds 5 per cent per annum, despite a limited contribution of labour inputs. The overall contribution of factor inputs reaches about 2.5 percentage points per annum. As a result, total factor productivity (TFP) growth, as reflected in the traditional measure of the Solow residual (measured as potential output growth for given factor inputs: that is, by the primal measure eyt) amounts to almost 3 per cent per annum. Increases in the efficiency of production over time would therefore apparently account for more than 50 per cent of total output growth. Evidence of a multifactor productivity

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Table 14.6. The sources of growth: Italy, 1938-90 (cost side, % per annum)

Total cost Output price Labour price Energy price Non-energy imports price Private capital user cost Productivity residuals

1938-90

1950-90

1950-73

1974-90

19.5 14.0 18.6 12.1 12.5 15.5

13.4 7.4 12.1 5.0 5.8 8.7

11.0 3.6 9.8 -1.7 2.5 3.7

17.1 13.0 15.4 15.3 10.6 16.1

-3.0 -2.3 -0.9

-3.0 -1.9 -0.5

-4.4 -3.3 -1.4

-1.0 0.0 0.9

Note: Average annual compound growth rates. 1.41.21.00.8 0.6 0.4 Dual TFP unadjusted Dual TFP adjusted for short-run fixities Dual TFP adjusted for short- and long-run fixities

0.2 0

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

Figure 14.1 TFP levels: Italy, 1938-90 (1985 = 1) slowdown shows up in the early 1970s. Between 1974 and 1990, despite a stable contribution of labour inputs, output growth reaches 3 per cent, while TFP growth falls to less than 1 per cent.8 On the cost side, the evolution of output and factor prices conveys a similar story. Throughout the period, average costs grow at a rate of about 8 per cent per annum, in spite of much larger increases in labour costs (more than 12 per cent per annum over the period 1950-90). As a result, the dual TFP measure (as given by potential cost reduction for given factor input prices, ect) averages about 3 per cent over the whole period. However, it reaches only 1 per cent in the post-1974 period. As it turns out, though, much of this pattern simply reflects returns to scale and adjustment costs (short-run fixities). Once adjusted for the latter, the dual TFP growth measure (€ct) is severely reduced, with the period 1974-90 showing no 'true productivity' gains. Moreover, when the adjustment takes into account both

Italy 435 short-run and long-run fixities (ec,), total multifactor productivity growth is nothing but a tiny fraction of output growth.9 Over the period 1950-90, out of 5 percentage points of average output growth, only one-tenth may be imputed to the 'adjusted' Solow residual: that is, to exogenous shifts of the production frontier. One-third (that is, 1.5 percentage points on average) may be attributed, instead, to the scale economies emerging at the aggregate level. The adjustment of the multifactor productivity residual also provides information on the nature of the productivity slowdown which apparently concerns only the exogenously shifting component of technology. In the late 1960s, fully adjusted productivity levels reach a maximum in 1968 and taper off (Figure 14.1), with the corresponding residual turning from usual negative average values to positive ones. As a result, during the period 1974-90, cost decreases (productivity increases), instead of originating from technical change, can be attributed entirely to the combination of scale economies and short-run adjustment costs.10 Interestingly, the timing implied by unadjusted figures turns out to be highly misleading. Unadjusted productivity levels reach a maximum in 1974. They subsequently stagnate for almost a decade to show remarkable increases after 1982. Quite clearly, unadjusted figures end up by magnifying the role of thefirstoil shock, while fully adjusted figures point to the 1960s as the roots of the malaise. The productivity trends just mentioned originate from structural characteristics of the Italian economy prevailing throughout the period 1950-90, which may be summarized as follows: • During the whole half-century, revenues never fell short of covering costs of production, including appropriate returns to capital (Figure 14.2). Over the period 1950-90, the product price exceeded average costs by 20 per cent on average, thereby giving rise to economic profits. Profit margins reached a high during the war and then rapidly fell to a local minimum in the early 1950s. The following upward trends ended in the early 1980s, when rising real interest rates led to a further unprecedented fall. • The profitability slowdown of the early 1950s can partly be explained by declining market power deriving from profit-maximizing behaviour under monopolistic competition. However, the representative firm's market power, as given by the ratio between output price and marginal costs, (1/(1 4- epy) (Figure 14.3), while changing considerably over time, remained of sizeable magnitude during the whole period under investigation, averaging about I.6.11 • On the cost side, the post-1945 Italian economy appears to have been characterized by substantial long-run returns to scale. The inverse long-run cost elasticity with respect to output (Figure 14.4) averaged 1.3 in the period 1950-90.12 • Finally, in the late 1950s, the Italian economy turns from undercapitalization to excess capacity, the market price of capital substantially exceeding its shadow price on the margin. Since the capacity utilization index, 1 — £e ckj (Figure 14.5), j

reveals whether or not the economy operates at the desired level of capital stock, the capital level observed throughout the 1960s, the 1970s and most of the 1980s turns out to exceed the desired (optimum) level, despite decreasing social-overhead capital formation.13

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2.12.01.9 1.81.71.61.51.41.3 1.21.1 1.0 H 0.9

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1970

1975

1980

1985

1990

Figure 14.2 Profitability: Italy, 1938-90 1.80 n 1.75-

1.70

1.65

1.60-

1.55-

1.50 1940

1945

1950

1955

1960

1965

Figure 14.3 Market power: Italy, 1938-90

Italy 1.7 1.61.5 1.41.31.21.1 1.0 0.9 0.8

1940 1945 1950 1955 1960 1965 1970 1975 1980 1985

1990

Figure 14.4 Scale economies: Italy, 1938-90 1.41 1.3 1.21.11.00.90.80.7

1940 1945 1950 1955 1960 1965 1970 Figure 14.5 Capacity utilization: Italy, 1938-90

1975 1980 1985 1990

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438 Nicola Rossi and Gianni Toniolo 4

The legacy of Fascism and the war

Three features of the economy during the 1930s had a long-run impact on the postwar economy. The first relates to a particularly strong 'autarkic' reaction to the difficulties of the 1930s. Not only were trade restrictions such as quotas and bilateral agreements applied to a large extent, but exchange controls became increasingly binding from 1934 onwards. Moreover, the Fascist government set out to introduce a large number of administrative controls over almost every aspect of economic life. The second point to be recalled here concerns the counter-cyclical hiring policy in the public sector, introduced by Fascism during the Great Depression (Piva and Toniolo, 1988) as part of its successful consensusseeking drive aimed particularly at the lower-middle classes. The third event of far-reaching importance was the huge lending of last resort undertaken in 1931-3 in order to avoid the liquidation of the two largest (German-type) banks in the country and thefinancialpanic that was likely to follow. As a result, a state-controlled agency, Istituto per la Ricostruzione Industriale (IRI) was created to own and manage a large number of manufacturing and utility companies previously owned by the banks (Toniolo, 1993). Against this background, it is possible to single out those legacies of the 1930s that are likely to have affected Italy's potential for growth after 1945: • A technology gap developed in most manufacturing industries relative to most advanced countries in the West, as witnessed, for instance, by an inquiry into the engineering sector carried out by a Stanford team in the early 1950s; in this respect, the fact that only a small part of industrial equipment was destroyed during the war turned out to be a mixed blessing. • A large body of legislation was in existence in 1945, granting the government power for a rather minute regulation of the economy. • Public administration came to be thought of and organized as a way to create consensus through patronage rather than primarily as an instrument of cost-effective allocation of public resources. • The size of public ownership in manufacturing and utility companies was by far the largest in the western world; the credit sector was almost entirely under direct or indirect government control. Last but not least, postwar Italy inherited from the past the large gap in production and income that characterized the South relative to the rest of the country. According to one estimate, in 1938 'the total per capita income in Southern Italy was only just over half (55 per cent) that of Northern Italy' (Molinari, 1949:31). One must recall, however, that the origin of this peculiarity of the Italian economy dated back several decades before both the Great Depression and Fascism.14 The effects of the Second World War on the productive potential of Italy have not been the subject of a study as careful and detailed as the importance of the issue would suggest. In general, however, it is safe to say that 'the bulk of Italian industry survived the war largely intact' (De Cecco and Giavazzi, 1992). Social overhead capital, particularly roads, railways and bridges in the Centre-North, was more penalized than industrial equipment; its repair, however, required mostly pick and shovel work, then an abundant factor in Italy, and could easily be carried out.

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Therefore, in the aggregate, the war did not result in major physical long-term bottlenecks for growth. 5

Setting the stage: reconstruction and stabilization

At the end of hostilities, Italy's GDP was roughly back to the 1915 level,15 down 39 per cent relative to 1939, the best prewar year (Rossi et al, 1992). Recovery was slightly more rapid than in the case of Germany and Japan. Italy's GDP regained its prewar level sometime between 1949 and 1950; the other two defeated Axis powers, between 1951 and 1952 (Maddison, 1991). Real growth was particularly rapid in 1946 (25 per cent) and in 1947 (14.5 per cent). It slowed down in the following two years due both to the monetary squeeze undertaken to stop inflation and also to diminishing advantages deriving from 'closing the gap' by exploiting aggregate economies of scale. That the latter 'explain' most of the growth realized soon after the war is hardly surprising in the light of the effect of the war on Italy's productive potential. Since industrial equipment was largely intact, its productivity was bound to increase rapidly as repair work on roads, bridges, etc. proceeded, unifying the domestic market and re-establishing communication with the rest of the world (harbours and the like). Between 1945 and 1949 a number of decisions affecting long-term growth were made. In particular, foreign policy was firmly anchored in the western camp, and domestic policy was shaped around the priority given to the isolation of the Communist Party. Both choices had wide-ranging economic implications. After two years of coalition governments, which included both Christian Democrats and Communists, the latter were excluded from the De Gasperi cabinet which took office in May 1947. In the general election held in the following April, the Christian Democratic Party secured almost 50 per cent of the votes and the possibility to rule the country with the support of the small parties of the centre for the following fifteen years. The final decision about long-term foreign policy commitments followed: in March 1949, Parliament authorized the government to sign the North Atlantic Treaty. On the institutional side, it is worth noting that a new constitution was approved in 1947 by a large majority which included the Communist Party. As a reaction to twenty years of Fascism, the Constitutional Assembly strived to make sure that dictatorships or even authoritarian governments could never rule Italy again. Careful attention was therefore devoted to building a well-designed system of checks and balances between the various state powers and individual institutions, while at the same time disregarding the need for efficient government. It is easy to see the long-run economic implications of such an understandable ideological bias of the constitution's fathers. The main economic decisions made at the time appear to be strictly connected with the political ones. A bold pro-market, pro-trade liberalization decision was made as far as international economic relations were concerned. This was, to be sure, a revolutionary departure from a time-honoured protectionist stance dating back to the 1870s and 1880s. In March 1947, Italy applied for membership of the IMF, thus entering into an early commitment to fixed exchange rates and currency convertibility. The Marshall Plan, the OECD and the European Payment Union

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followed (on the latter, see Carli, 1993). Quotas and other non-tariff barriers to trade were abandoned. Import duties were lowered. In 1953, Italy joined CECA (European Coal and Steel Community). Monetary policy, after the 1947 price and exchange rate stabilization, was so consistent with the choice of an open economy that it gained sharp criticism from Paul Hoffman, the author of the official Country Study report on Marshall aid presented to the US Congress in February 1949 (ISE, 1948). The Italian authorities were accused of being obsessed with inflation and foreign currency reserves at the expense of growth in domestic demand. Domestic economic policy decisions were nowhere near as clear cut as those on the international front. If'democratic planning' advocated by the left and by some sectors of the Christian Democratic Party was ruled out, both the overall policy stance and day-by-day decision making were often inconsistent with the needs of a developing market economy. As mentioned above, postwar Italy had inherited from Fascism a highly regulated private sector, an inefficient public administration and large state stakes in manufacturing, utilities and banking. Both the left and, on different grounds, relevant segments of the business community argued that the administrative tools for state intervention in the economy should be left in place, to be used by democratic governments in the pursuit of their own goals, be they income distribution or protection of individual enterprises. A small if vociferous patrol of free-traders argued the opposite, but their political weight was negligible. Rather than being privatized, state enterprises came to be seen as a tool for economic development. Their number increased. Government subsidies to the South were made permanent with the establishment, in 1950, of the Cassa del Mezzogiorno. Public administration continued to be assigned the role of provider of income to the lower-middle classes: the number of civil servants rose from 16.7 per thousand inhabitants in 1937 to 23.2 in 1952 (Ragionieri, 1976). At the same time, nothing was done to pass anti-trust legislation, to create a stock exchange security commission or, more generally, to define clearly the rules of the economic game. The credit sector remained almost entirely under public control (either by the state or by local authorities, as in the case of savings banks). As Guido Carli (1993:3) put it, Italy's policy making was, like Faust, torn between two conflicting souls: the first made for a long-term commitment to trade liberalization and fostering of competition in the international markets; the second could not get away from state intervention and protection of vested interests on the domestic front. To be sure, this state of affairs was partly unavoidable and partly beneficial, at least in the medium term. Privatization of IRI companies was out of the question unless banks were allowed to step in, thereby recreating the unstable financial environment that had characterized the heyday of the 'German-type bank'. The latter had ended in such a disaster that the option was rightly seen as most undesirable. An active policy for the South was advocated from virtually every quarter of the political spectrum: besides being acceptable in principle on ethical grounds, it was made necessary to prevent creeping social unrest from becoming open. As for the public administration, the overall stability of the country made it necessary to avoid crushing the lower-middle classes. The fact remains, however, that vested interests were created which in due time were able to establish themselves at the very heart of political parties and trade unions. The same can be said about the reluctance of the main political parties to enhance competition in non-tradable

Italy 441 sectors: on the contrary, national and local governments alike imposed minute regulations on small shopkeepers, craftsmen and owner-occupiers in agriculture, which tended to shelter them from open confrontation in the marketplace. 6

An 'economic miracle'?

The years 1950-63 have often been described as those of the 'economic miracle'. To be sure, this period saw the single most outstanding performance of the Italian economy for a comparable period of time. GDP rose at the very respectable annual rate of 5.9 per cent. Productivity, as measured by our 'adjusted' residual, increased on average by 3.7 per cent per annum when the effect of scale economies is taken into account (ecr), the highest in the subperiods considered in this chapter. It is noteworthy, however, that 'pure' (exogenous) productivity growth was also exceptionally large: more than three times higher than the average for the whole postwar period (1950-90). Efficiency was thus increased both by 'endogenous' factors, mainly a swift reallocation of resources, and by 'exogenous' ones such as imported (unincorporated) technology. That this episode of remarkable growth was termed a miracle can be understood in the light of previous history and of the rapid transformation which Italy underwent in a very short time span. There was, however, nothing to it that economic historians may not try to explain using the tools of their trade. On the supply side, a number of reasons are given for Italy's outstanding economic performance during the 1950s and the early 1960s: • Due to the technology gap accumulated during the 1930s and the war, large productivity gains could be obtained from borrowed technology, particularly given the country's endowment in well-qualified engineers16 and the existence of a fairly disciplined and educated labour force. • Given the low marginal productivity of agricultural labour, the reallocation of manpower to manufacturing resulted in rapid increases in aggregate productivity per worker. • An elastic (Lewis-type) labour supply contributed to a virtuous circle whereby wages increased less than labour productivity, allowing profits, and thereby investments, to expand more rapidly than output (Kindleberger, 1967). • The rapid growth in social overhead capital augmented private sector productivity. • The newly found international and domestic stability (Boltho, 1982) unbound those Promethean 'animal spirits' of which Northern Italy suddenly discovered itself to be particularly well endowed. Favourable conditions prevailed on the demand side as well: • By the first half of the 1950s, Italy's per capita income reached a level characterized by a high (income) elasticity of demand for consumer goods: a large domestic market therefore existed for goods the production of which enjoyed particularly large returns to scale at the prevailing technology. • Aggregate domestic demand was sustained by public works; the construction sector boomed due to both private and public demand of subsidized homes with the so-called Piano Fanfani (Ciocca et al., 1975).

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• World-wide, demand for goods in which Italy enjoyed a comparative advantage increased rapidly (Lamfalussy, 1963), feeding into production scale and increasing returns. Finally, both the Bretton Woods setting and domestic fiscal and monetary policy were partly responsible for creating a productivity-enhancing environment: the 1950s and most of the 1960s were characterized by a stable foreign exchange at a slightly undervalued rate, by low and predictable inflation, and by the most moderate public sector borrowing requirement in the country's history (Ganugi and Toniolo, 1992). A policy of artificially low interest rates was enforced throughout the period, thanks to government direction of the banking system and to the existing controls on international capital movements. During 1958-63, 'almost Japanese' growth rates were attained: GDP grew on average by 6.3 per cent between 1958 and 1963, and by 7.6 per cent in 1961 alone. In less thanfifteenyears, labour markets turned from structural unemployment to full employment. In fact, one of the peculiarities of the experience of 1950-63 relative to long-term trends was the very rapid rate of growth of labour inputs (1.34 per cent per annum, as against 0.67 for 1950-90). At the same time, labour participation rates fell (from 66 to 51 per cent between 1958 and 1983) mostly as a (partly statistical) result of labour force migration from country to town. In 1963 the unemployment rate reached its lowest historical level: 2.6 per cent. More generally, changes in the structure of the economy and of society at large, which in the advanced countries of the West took several decades to be completed, were compacted into less than twenty years, during which Italy was abruptly turned from an agrarian economy (and society) into an industrial one. Given the rapidity of the aggregate transformation, it may come as no surprise that some areas and sectors did not keep pace with the overall advance. The most notable and well-known problem in this respect is that of the regional diffusion of industrialization, which moved from the North-West to the North-Eastern and Central areas, while, as shown in Table 14.3, the Southern provinces even saw a widening in their productivity gap with the North. But it was not only the South that lagged behind: a large part of the intendence did not keep up; in particular, the modernization of public administration was further delayed. 7

The roots of the malaise, 1963-73

From the point of view of aggregate performance analysis, the years 1963-73 did not mark a sharp break with the previous period. The slowdown in output and productivity was anything but dramatic, since both remained way above the secular trend. The annual growth rate in GDP was more than respectable, 4.8 per cent; that in cost-based productivity was about 3 per cent. The decline was more pronounced in 'pure' (exogenous) productivity than in that deriving from scale economies (endogenous). When seen in the light of Italy's economic history since the political unification of 1861, full employment was the truly revolutionary result of the 'miracle' years. It had a number of implications both in the short and, what matters more, in the long run. In the medium term, labour shortages in some areas and trades simply fed into

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wages and output prices. In 1963-4, a severe monetary squeeze was put in place to cool down inflation and reduce the balance of payments deficit. Unemployment rose to 3.8 per cent in 1965, but a further decline in labour participation rates kept labour markets fairly tight throughout the 1960s. A capital flight of extraordinary magnitude accounted for an important part of the external account deterioration. Italian capitalists, unprepared as they were to face full employment, were slow to adjust to its most immediate political and industrial relations consequences. Trade unions gained wider consensus and stronger bargaining positions with approaching full employment, but they were not culturally and ideologically equipped to use their newly acquired power to foster growth rather than to push for drastic immediate changes in income distribution. The year 1962 saw the second highest number of strike hours in postwar history (up 411 per cent on the previous decade's average). More generally, the equilibria at the centre of the political spectrum, which had guaranteed stability since 1948, gave increasing signs of weariness starting in the late 1950s. In 1962, the first centre-left government was formed; as a price for its participation in the government, the Socialist Party asked for, and was granted, the nationalization of the electricity industry. Both facts were relatively harmless in themselves, except that they were taken by some as a sign that postwar stability was over: many of those who had either legal or illegal ways of taking some of their assets abroad did not hesitate in doing so. In 1964 a half-hearted attempt at preparing a coup by segments of the armed forces (Lanaro, 1992: 325) paved the way for a swift retreat of the reformist army. Despite a decade of centre-left governments committed to 'reforms', setting the rules of the economic game once more proved impossible. In the second part of the 1960s, the economy reacted in a textbook fashion to full employment and the attendant rise in wages: for the first and only time in Italy's modern economic history, labour inputs actually fell, while private investment, after a slump in 1964-5, grew at an annual rate of 8 per cent for the rest of the decade. To counteract the effects on employment of the substitution of labour for capital by the private sector, the government stepped up its own investment, this again being an obvious textbook reaction. On the whole, it may be that agents overreacted to full employment - a largely unanticipated situation - but the expected signs of their reactions were correct. In spite of this, the seeds of a number of future problems were sown during this period. The economic problems of the following decades had largely non-economic causes. Most of them can ultimately be traced back to a less than satisfactory adjustment of Italian society to the economic reality created by largely unanticipated rapid growth. Institutions, politics, public administration, unions of employers and employees, and ideologies remained to some extent those of an underdeveloped economy. This seems to us to be a crucial characteristic of Italian history during the second half of the 1960s and the 1970s. Later on, during the 1980s, it can be plausibly argued that it was the 'political order' alone which lagged behind the 'economic and social order' (Pombeni, 1993). The reasons for society at large not entirely keeping pace with a growing economy are far from being fully investigated. A few tentative explanations may, however, be advanced. Two of them bear directly on the way postwar growth proceeded:

444 Nicola Rossi and Gianni Toniolo • High returns could be drawn simply by shifting resources from one sector to the next: that is, by widening rather than deepening the capital stock. The economy itself was not, therefore, fully stimulating a transformation in social organization, in education or in ideology. • The 'dualistic' character of growth meant that a large portion of the country lagged culturally and socially behind whatever changes were induced by economic development. This was the part of the country where most of the public administration and a fair share of national political leaders came from. Apart from these, one can list a number of non-economic reasons why the whole of society and politics lagged behind. One of them has been already mentioned: the reaction of Fascism had built into the heart of most institutions a system of checks and balances which privileged control - and veto powers - over efficient government. The success of policy making came to depend - or was thought to depend - on the existence of a wide consensus from society at large. This meant that the more far-sighted politicians, and members of the ruling class, found it more difficult than elsewhere to carry out 'modernization' policies (i.e. in public administration) without having to compromise with conservative political and social visions. It is also argued that the Cold War and the existence of a strong Communist Party made true political competition impossible, the Christian Democrats being condemned to govern, the Communists to eternal opposition. While this is certainly true, the worst effects of such a situation on Italian society were mainly felt after the second half of the 1970s; during the earlier years, the economy suffered from the fact that, in a society where ideologies seemed to matter more than elsewhere, both the Catholics and the Marxists were singularly inept at leading the necessary cultural change. Finally, one should mention vested interest. When in order to achieve 'modernization' it is necessary to compromise with the most conservative parts of the society, when market, efficiency and similar concepts are, at best, regarded as dirty words, traditional interests (some of them legitimate and even progressive in an agrarian society) are compacted and strengthened; they are given positive support in becoming vested. It is then easy to see that, given the initial conditions and the character of the Italian 'miracle', the uneven growth of the economy on the one hand and of society and politics on the other can be seen, at least in part, as being endogenous to the process of economic growth itself. In this respect, the events of 1969-71, which help to explain the subsequent slowdown in the economic efficiency of the system, have their deep roots in the stubborn resistance of Italian politics and society to adapt to the ultimate result of previous growth. It has been argued that 'the crisis of the "model" of economic development that had led to the "economic miracle" becomes manifest in 1963 and irreversible in 1969' (Sassoon, 1986). In as much as the 'model' was based on a high elasticity of supply of labour, this is a safe conclusion. It is during the 'hot autumn' of 1969 that the effects of full employment on the Italian economy and society become unmistakably clear. During that year, 302 million hours of strike were recorded, up by 438 per cent on 1968.17 Strikes coincided with a more general upheaval in which the student movement played a non-negligible role (Gigliob*ianco and Salvati, 1980; Sassoon, 1986; Ginsborg, 1989; Lanaro, 1992). As far as workers were concerned, the

Italy

445

'hot autumn' was neither only about wages nor only about working conditions: it was primarily about a larger say in politics and in society, starting from 'control in the use of manpower'. As far as productivity growth is concerned, these developments meant a considerable decrease in the flexibility of the economy. This was unfortunate: exogenous shocks of unprecedented magnitude would soon require exactly the opposite course to be taken. The results of 1969-70 on labour markets can be summarized as follows: • Changes in labour organization became much more difficult to introduce, since they had to be negotiated at shop-floor level. • Rigidity was introduced in the wage system by making individual negotiations almost impossible. • Tight hiring and, particularly, firing regulations were introduced, and overtime was either abolished or severely constrained. • A Workers' Charter was approved by Parliament in 1970, which strengthened the bargaining power of workers and made a number of anti-trade union practices illegal. Moreover, it was during this period that a set of generous social policies were initiated which, in the long run, had an undesirable influence both on the efficiency and efficacy of public expenditure, and on its size. The changes introduced in the social security system set a time bomb into the state budget, with the introduction of generous state-financed pension schemes for private and public employees, and of special plans for self-employed workers, together with the increasing use of disability pensions for welfare purposes. All this was 4in connection with the switch in 1968 from a contributions-based system to an earnings-based system and the far-reaching reform of INPS pensions in 1969, in particular the introduction, and subsequent improvement, of methods of indexing pension benefits to prices and real earnings' (Franco and Morcaldo, 1990: 107). In general, it was from the early 1970s onwards that the expansion of public expenditure became increasingly dependent on vested interest pressures on decisionmakers, who responded as if no budget constraint applied (Giarda, 1988). The use of public expenditure as a tool for easing social conflicts was magnified, and efficient resource allocation was neglected (Brosio and Marchese, 1986). In the long run, however, as our productivityfindingsconfirm, the growing inefficiency of the public sector and public expenditure resulted in low-quality services and perverse distribution effects, in turn affecting social consensus itself (Musu, 1992). 8

Productivity slowdown, 1973-92

8.1

An overall appraisal

Between 1973 and 1989, Italy's GDP growth remained above the G7 average; it was in fact the second highest in the group (Table 14.1). According to our measures (Rossi et al.y 1993), which differ slightly from Maddison's and thus from those in Table 14.1, GDP average annual growth was 3.2 per cent in 1973-80,0.6 per cent in 1980-3, and 2.7 per cent in 1983-90. Capital input growth did not differ significantly from that in the 'high growth decades', while labour inputs increased at about the secular rate. Import growth declined sharply from the previous periods. Both

446

Nicola Rossi and Gianni Toniolo

Solow's and our adjusted residuals nose dive from the late 1960s for about fifteen years, showing a moderate recovery thereafter. Over the whole period 1974-90, Solow (cost-based) residual averages a growth rate of about 1 per cent per annum, whereas our adjusted 'exogenous' (pure) dual residual takes a positive value, indicating a net negative contribution to aggregate performance from 'exogenous' inefficiencies. Most of these we attribute to inadequate institutions and rent seeking in the protected service sector, both private and public (given the safe assumption that the growth rate of both incorporated and unincorporated technical progress remained positive). In order to understand the peculiar characteristics of Italy's productivity slowdown, one must consider (1) inefficiencies in the service sector and (2) the inadequate provision of social overhead capital. The share of the service sector in GDP was 31.9 per cent in 1951 and 51.1 percent in 1990 (43.0 and 65.3 respectively if public administration is included). Barca and Visco (1992) have provided convincing evidence that productivity growth in this largely non-traded sector was low, relative to most other European countries, particularly in those services - such as telecommunications - that are typical of the most advanced phases in capitalist development. Aggregate productivity was affected in two main ways: (1) by a sheer composition effect (i.e. an increasingly large share of GDP originated from a sector characterized by productivity growth lower than the EEC average); and (2) by the fact that, at the time of a major shift from making to buying in the supply of services to manufacturing, such services were characterized by low quality and high prices, due to lack of exposure to foreign competition. In fact, the market power of our representativefirmpicked up again in the mid-1960s after declining for over two decades. Another reason behind Italy's productivity slowdown is to be found in the inadequate supply of social overhead capital. Our estimates show that, at the on-going set of relative prices, agents consistently desired a higher level of public capital as a complement to private capital. This pattern of output and productivity growth is consistent with an interpretation of Italy's economic and political history that runs as follows. As mentioned earlier, the Italian economy was made less rather than more flexible in the years immediately preceding the first oil shock. During the same period, social and political instability increased. Trade unions took a more radical stance in order to cover their 'left flanks' and to compete with each other. In 1968 the 'organic' centreleft governments gave way to a succession of weaker centrist and centre-left coalitions (Sassoon, 1986), not authoritative enough as crisis cabinets. Inflation and low-cost government borrowing could for a while contain social discontent. The same can be said of the agreement signed in 1975 between employers and trade unions, with the highest political blessing, for a new and stronger form of wage indexation. After the second oil shock, the commitment to exchange rate stability provided an anchor for industrial restructuring and curbing inflation. When an antiinflationary policy stance was finally adopted, this resulted (1980-3) in slower growth than in most industrial countries.18 The subsequent recovery and relatively high growth (1984-9) derived in part from (largely state-aided) industrial restructuring and improved labour relations. The political parties in the ruling coalitions,

Italy

447

however, remained relatively weak and in competition with each other: therefore, they resorted to deficit spending in competing for popular consensus. For a while the fiscal stimulus thus fed into the economy resulted in relatively high growth rates. In the longer run, however, it precipitated the economy into the weak and edgy position of the early 1990s, which fed instability in the process of political transition. 8.2

Inflation, unemployment and industrial restructuring, 1973-82

The social and institutional developments of the late 1960s and early 1970s had made the Italian economy more vulnerable to exogenous shock. After the Yom Kippur crisis of 1973, fragile governments under heavy social pressure resorted to inflation and devaluation, as lesser evils then unemployment. In 1975, GDP actually fell for thefirsttime since the Great Depression and war, but average GDP growth for 1974-9 was far from negligible (3.3 per cent per annum), while both unemployment and inflation rose considerably.19 Investment, both private and public, was stimulated by low (at times negative, ex post) real interest rates. In spite of these soft policies, the country was hit by a wave of terrorism, both left and right wing, the answer to which was an experiment with 'national unity' governments (1976-9). While such governments proved again unable to cut inflation and the public sector borrowing requirement, they were capable of taking a far-sighted decision. Joining the EMS in 1978 was, in fact, a bold step. It looks even bolder considering the timing: social and political tension was at its peak. The issue was hotly debated. Thefinaldecision was made by the government amidst the opposition of powerful interest groups and against the advice of some of the most qualified members of the economic profession. The move had one political and two economic objectives: on the one hand, it seemed important to signal both at home and abroad a renewed interest in the politics of European unification; on the other hand, exchange rate stability was seen as a precondition both for a crack-down on inflation and for the creation of an environment that would stimulate industrial restructuring and productivity growth. The second oil shock made anti-inflationary policies less effective; at the same time, industrial restructuring became more urgent. Monetary policy succeeded in getting price increases back to single-digit growth only in 1984-5. The reorganization of a number of large and medium-sized enterprises was helped by the government in at least two ways: by providing generously for early retirement and special unemployment benefits (cassa integrazione), and by giving its political support to agreements aimed at changing the system of industrial relations and wage setting (including wage indexation) inherited from the 1970s. The reaction of Italian industrialists to falling industrial productivity, low profits and high corporate debt was, on aggregate, only half successful. While the large private companies were able to shed excess labour, to start new investment programmes, to redress thefinancialstructure and, therefore, to prepare themselves to harvest some benefits from the upturn of world production and demand, important problems remained unsolved which were to have a negative impact on productivity over the following years. Three stand out as being of paramount importance:

448 Nicola Rossi and Gianni Toniolo • Since 'restructuring' took place with the decisive help of the government, the long-standing unhealthy relationship between big business and politics was strengthened rather than severed. • While there was some restructuring of public enterprise as well, it did not go far enough. • Little attention was paid to such elements affecting productivity as R & D, vocational training, the school system and, in general, efficiency in the service sector, both private and public. In these circumstances, it is not surprising that the productivity upturn we observe from the mid-1980s onwards is extremely moderate. 8.3

Growth, deficit spending and increasing inequality, 1983-92

Italy too had its 'splendid eighties'. From 1984, the growth rate of GDP increased, reaching 4.1 per cent in 1987; private consumption grew at an even higher rate. Inflation fell from a two-digit figure to an average of about 6 per cent. On the political front, the Craxi cabinet, in office from August 1983 to April 1987, seemed to provide both stability and effective government: such qualities were magnified and almost unanimously praised by the media. In spite of all the glitter of extravagant consumption, newly found price stability (of a kind) and the much publicized sorpasso of the UK in GDP per capita, both the Craxi government and those that followed during the decade (led by the Christian Democrats) did little to tackle the causes of low productivity growth. According to a British historian, The 1980s look in many respects similar to the years before 1968; then too the economy was developing, material bases for reforms existed but the centre-left politicians missed that opportunity' (Ginsborg, 1989: 568). Another historian observed: 'Italians returned to the opulence of the early 1960s, without having redressed the fundamental anomalies in the economic fabric' (Lanaro, 1992: 450). The growth in domestic welfare was itself severely flawed by adverse changes in income distribution (Figure 14.6). From the late 1960s, the egalitarian bias of Italian society translated into unprecedented welfare expenditures and absolute (as opposed to proportional) wage indexation. As a result, notwithstanding the evolution of the labour market, economic inequality, as measured by the Atkinson index,20 remained relatively stable until the early 1980s. Similarly, poverty (head count) rates oscillated around 5 per cent until 1982.21 During the 1980s, however, both the poverty and the Atkinson inequality indices deteriorated relative to the previous decade. At the same time, unemployment remained stubbornly around 9 per cent from 1982 to the end of the decade: the highest level in postwar history. The inability or unwillingness of the governments of the 1980s to put their own house in order by reducing the government borrowing requirement is the best synthetic indicator of substantial impotence in dealing with the structural problems of the economy. The ratio of outstanding state debt to GDP rose from 51 per cent in 1982 to 102 per cent in 1990. According to our estimates, productivity growth remained extremely low due to 'exogenous inefficiencies', which we tend to attribute to public administration, to the low quality/high price of services, notably 'network

Italy 25 i

449

Poverty index (head count) Atkinson's inequality index

20-

15-

10-

5-

0

I

1973

1975

1977

,I

1979

1981

1983

1985

1987

1989

1991

Source: Rossi (1993).

Figure 14.6 Inequality and poverty: Italy, 1973-91

services', and to poor R & D. Attempts were made to increase efficiency in labour and capital markets; they were only partially successful in making them more competitive. As mentioned above, integration into the European economy widened the gap between those sectors, such as manufacturing, that were fully exposed to international competition and those that enjoyed natural protection (i.e. construction and most services). Overall, the market power of the 'representative firm' remained exceedingly high by international standards. Lack of competition explains a stubbornly high inflation rate compared to Italy's main competitors (Barca and Visco, 1992). Finally, mention should be made of social overhead capital formation. An inefficient public administration, high construction costs due to poor competition and kickbacks (the two being obviously related) and budget deficits account for public capital remaining below its desired (optimum) level throughout the decade. As private and public capital are complementary, here is an additional reason for growth remaining below its potential level. 9

Concluding remarks

As postwar history draws to an end, this long episode in Italian 'modern economic growth' looks like an undeniable success, in spite of its flaws and structural weaknesses. The significance of Italy's postwar achievement is evident in the face of the past performance of the Italian economy itself and of international comparisons. The question, however, remains: could Italy have grown faster? While no comprehensive answer can be offered given the complexity of the counterfactual involved, our results confirm an opinion widely held by economists and observers at large that the inefficiency of the public sector, lack of competition in sheltered industries, and corruption account for at least part of the productivity slowdown

450

Nicola Rossi and Gianni Toniolo

which is observed after the mid-1960s. An exercise in productivity growth conducted on the UK economy using the model employed in this paper yields the following tentative result: given a service sector as efficient as the British one and the UK's level of corruption, Italy's growth in the 1970s and 1980s would have been on average one yearly percentage point higher than it actually was.

Appendix The empirical implementation of the theoretical model referred to in section 3 requires specification of the unknown restricted cost function (cv = cv(w,y,kfy The description of short-run firm behaviour is based on aflexiblefunctional form known as Generalized Leontief (GL) due to Diewert, modified where necessary to account for the existence of fixed factors. Assuming three variable inputs (labour, energy imports and other imports, denoted by the subscripts /, e and m, respectively) and two fixed factors (private capital, /c, and social overhead capital, z) we let: /

c>,y,/c,z,r) = y[a 0

i

+ Ivv/V + yyyy + yty(ty)0-5)-] 4- yO5\ I f t w ^ 5 + E i

Li

+ yykiky)05)!^05

i

+ Ivv^jzr)0-5 + y y2 (z> 5 )]

i

J

i

where a, /?, e and y are parameters to be estimated and where the scalar t is, in fact, a vector, accounting for: (1) a linear trend, (2) a cyclical indicator (number of bankruptcies), (3) the change in private capital stock, and (4) the change in social overhead capital. The latter two variables obviously take care of adjustment costs. The corresponding system of restricted factor demands is given by: xjy = dcJLwXyJVdWi = X«oK.w/-5

+

pitt05

+ ynt + yyyy + yty(ty)0-5 +yytk0-5 + ykk(k/y)

+ PiWy)0-5 + 7zl(zt/y)0-5 + yyzz0-5 + yjz/y)

+ y,2(fc0-5z°-5)/y

(A2)

while price determination is as follows:

p = [1/(1 + n0 + / / ^ K + I l a ^ w / - 5 + X/W 05 »

j

l.5yly(ty)0-5)

] i

(A3)

i

The simultaneous system of equations (A2) has been estimated with maximum likelihood estimation methods over the sample period 1894-1990.22 Table Al

Italy Table A l . Parameter

<*lm

<*em

k Pmt,

h,

fc Am,

K K

Pek Pmk Ax

A,

Pmz

451

estimates

0.156 -0.311 -0.139 0.128 0.377 0.028 -0.008 -0.254 -0.034 -0.030 0.008 0.001 0.001 -0.552 -0.862 -1.224 0.003 0.004 0.001 1.090 0.205 0.170 -1.676 -0.096 -0.119 5.448 0.587 0.454

(0.069) (0.462) (0.128) (0.143) (0.064) (0.008) (0.004) (0.040) (0.013) (0.013) (0.001) (0.001) (0.001) (0.946) (0.625) (0.621) (0.003) (0.001) (0.001) (0.412) (0.305) (0.297) (0.487) (0.320) (0.330) (1.167) (0.629) (0.656)

yt, yt2t2 y,3,3 yuu yyti yyt2 y,,3 yyu ytit2 yhti ytiU y,2,3 yt2U y,3,4 yyk ytik y,2fc yt3k yuk 7 yz yt z yt2Z yf3X yf4Z yfcfc yzz y kz m0

-0.001 (0.000) mx

0.531 (0.903) 0.000 (0.001) 0.002 (0.001) -0.002(0.006) 0.099 (0.004) -0.002(0.001) -0.000(0.000) -0.002(0.001) 0.096 (0.049) -0.073(0.063) 0.057 (0.094) 0.001 (0.001) -0.006(0.004) 0.002 (0.006) 0.759 (0.300) -0.007(0.028) 0.001 (0.001) 0.003 (0.001) 0.001 (0.002) -0.002(0.001) 0.026 (0.050) -0.003(0.002) 0.005 (0.002) -0.005 (0.004) 0.429 (0.232) 0.907 (0.976) -1.329(0.943) -0.326(0.109) -0.072(0.054)

Note: In parentheses, asymptotic standard errors corrected for heteroskedasticity. Bold characters indicate original parameter values multiplied by 1000. reports parameter estimates and their asymptotic standard errors. It is worth noting that our database (Rossi et al, 1992) extends the available official sources recently reviewed in Rey (1991) in a number of respects. In particular, a special effort was made to acquire a consistent estimate of energy and labour inputs and input prices. NOTES We would like to thank Oreda Orsingher and Andrea Sorgato for excellent research assistance. Financial support from the Italian National Research Council (Grant No. 91.04064.CT10) is gratefully acknowledged. 1 Technological improvements in the design of investment goods (embodied technical changes) are not explicitly accounted for in what follows, and will therefore be compressed in the total factor productivity residual. For a recent discussion on the impact of quality changes on investment goods and hence on productivity, see Hulten (1992).

452 Nicola Rossi and Gianni Toniolo 2 Notice that dual measures, being cost based, are not influenced by demand-side adjustment such as the market power adjustment. 3 Clearly, if all inputs are variable, Gckj = O(V,). Furthermore, if returns to scale are absent and perfect competition prevails in the output market, ecy = (1 + epy) = 1, and equations (3) and (4) end up reproducing the traditional primal and dual measures. 4 Increasing returns are often related to endogenous growth. However, they are neither necessary nor sufficient to generate endogenous growth. On the endogenously growing literature on endogenous growth, see Sala-i-Martin (1990a, 1990b). 5 Quantitative evidence on the time-series properties of scale economies and related productivity indicators could also prove quite important. In particular, scale-induced growth and the productivity residual may be expected to show rather different time-series properties. 6 Estimates and their economic implications are further discussed in Rossi and Toniolo (1993). 7 It should be noticed that output is unconventionally defined as the sum of gross domestic product at factor cost and total imports ('extended' value added), hence the origin of discrepancies with data in section 2. 8 On the determinants of the multifactor productivity slowdown, see the review paper by Englander and Mittelstadt (1988). 9 More generally, adjusted productivity residuals provide strong evidence of smaller productivity growth than generally thought. 10 The negative trend in 'fully adjusted' TFP levels reaches a minimum in 1982 when fully adjusted aggregate productivity levels parallel the 1955 records. From 1982 'fully adjusted' productivity levels stagnate. 11 In the present simplified setting, the index is nothing more than the ratio of output price to marginal cost and, as such, it is uniquely determined by the price elasticity of demand. However, it can be shown that, in a more general framework, the index would also incorporate a measure of oligopoly such as the Hirschman-Herfindahl index of the firms concentration. i 12 In the war years (1939-45), marginal cost falls short of average total cost. From the late 1940s, however, following the remarkable revival of liberalism in international transactions, sizeable scale economies prevail. While the connections between the evolution of scale economies and the policy stance of the late 1940s and early 1950s is still entirely to be explored, the above timing is nonetheless remarkable. 13 The latter may be shown to be a complement to rather than a substitute for private investment: by producing a sizeable reduction in the representative firm's variable costs, it therefore provided additional incentives to private fixed capital accumulation. 14 The literature on the subject is as large as the relevance of the problem to Italian history, politics and economics deserves. For a brilliant overview, in Italian, see Bevilacqua(1993). 15 GDP per capita, however, was back to the level of 1908-9; the wartime (1939-^5) decrease totalled 41 per cent. 16 The number of university graduates in engineering, declining during the Great Depression, had picked up again in the late 1930s. Throughout the 1940s, Italian universities produced more than twice as many graduates in engineering as in 1939. 17 In 1969 the number of strike hours per worker in industry was the highest in postwar history, although it remained considerably below the record level of 1919-20.

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18 In 1980-3, GDP growth was only 0.8 per cent per annum. 19 Unemployment rose from 4.0 per cent in 1973 to 5.4 per cent in 1978, according to Istat revised measures, and from 6.2 to 7.8 according to Maddison (1991). Consumer price inflation averaged 15 per cent per annum. 20 The Atkinson index of inequality incorporates an explicit redistribution preference that basically measures how much total income society is prepared to lose in order to carry out a given redistribution of income. Figures reported in Figure 14.6 assume, for comparability, a degree of inequality aversion equal to unity. It should be underlined that Figure 14.6 presents inequality indices of the distribution of household consumption (and not income). 21 Poverty is defined as less than 50 per cent of average equivalent consumption. 22 Actually, the estimation method takes into account the fact that the labour input ratio is only observed over the subsample 1907-39.

REFERENCES Barca, F. and I. Visco (1992) 'L'economia italiana nella prospettiva europea: terziario protetto e dinamica dei redditi nominali', Temi di discussione delta Banca d'Italia, no. 175. Bevilacqua, P. (1993) Breve storia dell'Italia meridionale dall'Ottocento a oggi, Rome: Donzelli. Boltho, A. (1982) 'Growth', in A. Boltho (ed.), The European Economy: Growth and Crisis, Oxford: Oxford University Press. Brosio, G. and C. Marchese (1986) // potere di spendere: Economia e storia della spesa pubblica daWunificazione a oggi, Bologna: II Mulino. Carli, G. (1993) Cinquant'anni di vita italiana, Bari: Laterza. Ciocca, P.L., R. Filosa and G.M. Rey (1975) 'Integration and development of the Italian economy', Banca Nazionale del Lavoro Quarterly Review, September, pp. 284-320. De Cecco, M. and F. Giavazzi (1992) 'Inflation and stabilization in Italy', mimeo. Englander, A.S. and A. Mittelstadt (1988) 'Total factor productivity: macroeconomic and structural aspects of the slowdown', OECD Economic Studies, 10, pp. 7-56. Franco, D. and G. Morcaldo (1990) 'The Italian pension system: development and effects on income distribution and poverty', Labour, 4, pp. 105-24 and 133-59. Ganugi, P. and G. Toniolo (1992) 'II debito pubblico italiano in prospettiva secolare (1876-1947)', in Ente Einaudi, // disavanzo pubblico in Italia: natura strutturale e politiche di rientro, vol. II, Bologna: II Mulino. Giarda, P. (1988) 'Una interpretazione della crescita della spesa pubblica in Italia', Rivista Bancaria, nos. 11-12, pp. 11-22. Gigliobianco, A. and M. Salvati (1980) // maggio francese e I'autunno caldo italiano: la risposta di due borghesie, Bologna: II Mulino. Ginsborg, P. (1989) Storia d'Italia dal dopoguerra ad oggi, Turin: Einaudi. Hulten, C.R. (1992) 'Growth accounting when technical change is embodied in capital', American Economic Review, 82, pp. 964-80. ISE (1948) Country Study dell'ECA sull'Italia, Milan. Kindleberger, C.P. (1967) Europe's Postwar Growth, Cambridge: Harvard University Press. Lamfalussy, A. (1963) The United Kingdom and the Six, London: Macmillan. Lanaro, S. (1992) Storia dell'Italia repubblicana, Venice: Marsilio. Maddison, A. (1991) Dynamic Forces in Capitalist Development: A Long-Run Comparative View, Oxford: Oxford University Press.

454 Nicola Rossi and Gianni Toniolo Molinari, A. (1949) 'Unemployment statistics in Italy (with special reference to Southern Italy)', Banca Nazionale delLavoro Quarterly Review, January-March, pp.76-88. Morrison, C.J. (1988) 'Quasi-fixed inputs in US and Japanese manufacturing: a generalized Leontief restricted cost function approach', Review of Economics and Statistics, 70, pp. 275-87. (1992a) 'Unraveling the productivity growth slowdown in the US, Canada and Japan: the effects of subequilibrium, scale economies and markups', Review of Economics and Statistics, 74, pp. 381-93. (1992b) 'State infrastructure and productive performance', NBER Working Paper No. 3981. Musu, I. (1992) 'II riequilibrio della finanza pubblica in Italia: ragioni e natura di una strategia strutturale', in Ente Einaudi, // disavanzo pubblico in Italia: natura strutturale e politiche di rientro, vol. I, Bologna: II Mulino. Piva, F. and G. Toniolo (1988) 'Unemployment in the 1930s: the case of Italy', in B. Eichengreen and T. Hatton (eds.), Interwar Unemployment in International Perspective, Dordrocht, Boston and London: Kluwer. Pombeni, P. (1993) Autoritd sociale e potere politico neWItalia contemporanea, Venice: Marsilio. Ragionieri, E. (1976) 'La storia politica e sociale', in Storia d'Italia, vol. IV (3), Turin: Einaudi. Rey, G.M. (ed.) (1991) / conti economici delVItalia, Rome: Laterza. Rossi, N. (ed.) (1993) La crescita ineguale, 1981-1991: Rapporto CNEL sulla distribuzione e la redistribuzione del reddito in Italia, Bologna: II Mulino. Rossi, N. and G. Toniolo (1993) 'Un secolo di sviluppo economico italiano: permanenze e discontinuity', Rivista di Storia Economica, 10, pp. 145-75. Rossi, N., A. Sorgato and G. Toniolo (1993) 'I conti economici italiani: una ricostruzione statistica, 1890-1990', Rivista di Storia Economica, 10, pp. 1-47 (English translation: 'Italian historical statistics, 1890-1990', Nota di lavoro no. 92-18, Dept of Economics, University of Venice, 1992). Sala-i-Martin, X. (1990a) 'Lecture notes on endogenous growth: F, NBER Working Paper No. 3563. (1990b) 'Lecture notes on endogenous growth: IF, NBER Working Paper No. 3564. Sassoon, D. (1986) Contemporary Italy: Politics, Economy and Society since 1945, London and New York: Longman. Solow, R. (1958) 'Technical change and the aggregate production function', Review of Economics and Statistics, 39, pp. 312-20. Toniolo, G. (1993) 'Italian banking, 1919-36', in C. Feinstein (ed.), European Banking Between the Wars, Oxford: Oxford University Press. Williamson, J.G. (1965) 'Regional inequality and the process of national development', Economic Development and Cultural Change, 13, pp. 3-84.

15 West German growth and institutions, 1945-90 WENDY CARLIN

1

Introduction

Popular perceptions of West German economic growth are polarized: either it is the miracle economy of the postwar era, the 'strong-man' of Europe, or it is a sclerotic economy, typifying Europe's inflexibility in labour and capital markets relative to the United States. One way of reconciling these apparently contradictory views is to depict West Germany as 'the fading miracle', as Giersch et al. (1992) have done. From this perspective, the miracle has long since gone and memories have lingered far behind the reality. But in Michel Albert's recent popular account of postwar capitalism (1993), Germany's reputation for dynamism and adaptability remains untarnished. One aim of this chapter is to put these contrasting interpretations into a longer-term and explicitly comparative perspective. Throughout, Germany's performance will be compared with that of the other three large European economies, the UK, France and Italy. It is useful to begin by looking at attempts to identify a common OECD pattern of growth over the long run, and then at the extent to which West Germany fits this pattern. As a starting point, two such studies are used to provide a benchmark for the assessment of German growth. First is an endogenous growth model based on Scott (1989) and estimated by van de Klundert and van Shaik (1993; henceforth, KS) for a group of eight OECD economies from 1870, extended to sixteen for the postwar period. The second study is that of Dowrick and Nguyen (1989; henceforth, DN) which is a Solow-type model with exogenous technical progress, augmented with catch-up estimated for a group of twenty-four OECD countries for the postwar period. In KS's analysis, a strikingly simple growth equation is estimated, where the growth of GDP is explained by the investment share, the growth of labour input measured by man-hours and catch-up. Catch-up is found to be significant for 1950-60 and 1960-73. Investment appeared to be less effective in generating growth only in Australia in their primary sample and in Scandinavia in the larger sample. The disappearance of the catch-up effect accounts for the bulk of the slowdown after 1973 in the KS equation. Thus neither weaker investment nor lower 455

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Table 15.1. The proximate causes of growth: Germany, 1870-1989 (GDP, % per annum, labour input measured by hours) Period

1870-90 1880-1913 1913-29 1929-38 1950-60 1960-73 1973-89

Actual growth

2.38 3.18 1.20 3.78 7.97 4.37 2.05

Explained by

Unexplained

Investment share

Growth rate Catch-up of employee-hours

1.55 1.91 1.61 1.32 2.20 2.39 1.98

0.41 1.08 -0.14 1.14 0.85 -0.67 -0.49

2.68 2.51

0.03 -0.20 -0.65 0.93 1.84 -0.24 0.18

Source: van de Klundert and van Shaik (1993: table 5). effectiveness of investment can account for the post-1973 slowdown in the OECD. They interpret this as signifying that the major economies have experienced a 'return to normal' after the exceptional period of the postwar years. By contrast, Dowrick and Nguyen find that TFP catch-up persists in the post-1973 period and that lower investment is largely responsible for the growth slowdown. Turning to Germany, it is the only country in the KS sample for which there is a large positive residual for the 1950s (see Table 15.1). Their equation suggests that more than half of German growth in the 1950s is not accounted for by investment and labour force growth. In addition to the common feature of 'catch-up', it is necessary to introduce German-specific factors in order to understand this period. Dowrick and Nguyen come to a very similar conclusion: Germany's per capita growth of GDP was 2 percentage points above the sample average for 1950-60 once account was taken of catch-up and cyclical bias, capital and employment deepening. In terms of the polarized characterization of German performance referred to earlier, both cross-country studies are agnostic about growth after 1973. In KS, after the high positive residual for 1950-60, Germany has a small negative residual for the rest of the Golden Age (1960-73) and a small positive one for the post-1973 years. In DN, unexplained growth virtually disappears for 1960-73 and is 0.64 percentage points above the OECD average for the third period. Compared with the other three large European economies, DN find that Germany's performance is well above that of the other three for the 1950s, below France and Italy for 1960-73, and above all three for the post-1973 period. To sum up, the broad picture about German postwar growth which emerges is that the 1950s were quite exceptional both in terms of German historical experience from 1870 and in comparison with other countries. From 1960 to 1973, the contribution of capital and catch-up are very similar to their values for the 1950s (in KS), but growth is markedly lower. Labour input declines and the high positive residual turns negative. This suggests a period of capital deepening as the economy adapts to labour shortage. The two studies differ in their interpretation of the relative role of investment and catch-up in accounting for the generalized post-1973

West German growth and institutions, 1945-90 457 Table 15.2. Convergence of value added per hour in manufacturing and the total economy: Germany 1950-90 (US'A =100)

Total economy Manufacturing

1950

1960

1973

1979

1990

27^6 38.9

410 61.6

59X) 79.7

69^6 95.8

752 85.9

Source: van Ark and Pilat (1993: table 5, p. 27). Table 15.3. Growth accounting for manufacturing: Germany, France, Italy and UK, 1950-88 (% per annum) Germany 1950-61 Output 10.1 8.3 Capital 3.3 Labour TFP 5.3 1961-73 Output 5.1 Capital 6.6 Labour 0.0 3.6 TFP 1973-88 [79-88] Output 1.2 Capital 1.7 Labour -1.3 TFP 2.0

France

Italy

UK

5.5 3.2 0.7 4.1

8.3 5.6 2.2 5.2

2.8 3.4 0.8 1.4

7.3 5.2 0.8 5.3

6.9 5.3 0.7 5.2

3.3 3.8 -0.5 3.0

[0.8] 1.3 [1.3] 2.5 [-1.0]-1.7 [1.4] 2.1

[0.2] 2.7 [1.7] 2.1 [-2.1]-1.0 [1.6] 3.0

[2.4] -0.2 [1.3] 1.5 [-1.8]-2.8 [3.5] 2.1

[0.1] [0.9] [-3.9] [3.5]

Source: Data set from Bhaskar and Glyn (1992). Note that labour input is employees, and weight on capital input is the net profit share.

slowdown, but concur in finding that German performance was just above average, whether the reference group is the OECD or Germany's large European competitors.1 From the perspective of convergence, it is striking that Germany has continued to narrow the total economy productivity gap with the USA over the entire postwar period. However, the aggregate data hide a sharp divergence between the relative dynamism of the manufacturing and non-manufacturing sectors from 1979 (see Table 15.2). The impression from the labour productivity comparisons is confirmed in a cross-country regression analysis of sectoral TFP growth in OECD countries, in which Rowthorn finds that Germany has a positive residual for the three non-manufacturing sectors and a negative one for manufacturing (1992). Yet manufacturing industry traditionally has been viewed as the engine of growth in Germany. It is a technologically progressive sector in the terminology of Baumol et al. (1989). Table 15.3 presents the growth accounts for manufacturing for Germany and the three other large European economies. Germany's TFP performance in manufacturing is well below that of France and Italy in the 1960-73 period, and

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300 -i 250*•

USA

N

200150Germany = 100 10050H

.—

""

UK

Japan 0 1950

1955

1960

1965

1970

1975

1980

1985

Source: van Ark (1993: table IV.4, p. 190).

Figure 15.1 Manufacturing productivity levels, 1950-89 (value added per hour worked; Germany = 100) even falls below that of the UK from 1973. Comparisons which begin from 1979 eliminate the UK's particularly poor performance in the 1970s and present an impression of an even greater weakness of German manufacturing. The hourly labour productivity level data presented in Figure 15.1 paint a similar picture. However, judgements of the decline of German manufacturing prowess should be postponed until a closer examination is made of the character of productivity improvements in the 1980s. The data in Table 15.3 highlight the feebleness of output growth in manufacturing in both France and the UK, along with the extreme weakness of investment in the UK. The German data present a mixed picture: more limited labour shedding than in the other countries and average capital stock growth. Germany's competitiveness as measured by its performance in export markets has not weakened in the post-1973 period, as would have been expected on the basis of the productivity data. This suggests that an analysis of the relationship between growth performance and other indicators of performance in manufacturing is called for. How can economic institutions and policy be introduced into the analysis? For the OECD as a whole, the existence of catch-up in the 1950s and the 1960s and its disappearance thereafter (or particularly low investment in the DN explanation) must be explained. Since this is a common phenomenon, common factors should be sought. This suggests that cross-country institutional differences and variations in policy are largely irrelevant. Yet in 1945 it was quite unclear if Germany would become a member of the 'convergence club'. Decisions taken by the Occupation governments between 1945 and 1948 played a central role in establishing membership. German 'supergrowth' in the 1950s appears to be a genuine outlier and calls for an examination of the 'reconstruction' effect (Dumke, 1990). Dumke finds that inclusion of the level of postwar productivity relative to prewar in the growth equation is significant and accounts for the German residual for the 1950s. Why

West German growth and institutions, 1945-90

459

should a war-induced output drop create the conditions for especially rapid growth: that is, not simply explaining rapid recovery to prewar levels, but fast growth persisting beyond the recovery phase? One hypothesis is that rapid investment was promoted by a disproportion between the stocks of human and physical capital. The idea is that a high level of human relative to physical capital entails a high return to investment, promoting growth. The human capital available to West Germany increased sharply from the end of the war until 1961 through the inflow of German expellees and refugees. The inflow continued until the building of the Berlin Wall in 1961. If the boost to growth from the human to physical capital disproportion occurs solely through market incentives, then once again, the role for institutions and policy shrinks. The second hypothesis accounting for a reconstruction growth effect is that the war destroyed growth-inhibiting redistributive coalitions (Olson, 1982). The Olson hypothesis prompts a comparison between the weak growth that followed the First World War in Germany and the exceptionally rapid growth after 1945. Superficially, it seems plausible that there was a growth-inhibiting distributional conflict after the First World War but not after the Second. Why was the outcome so different? Is there any evidence of a role for the Occupation, the division of Germany and international commitments in the creation of institutional structures compatible with rapid growth? Although large, successful managerial companies had been established in Germany even before the First World War in steel, chemicals and engineering, international and domestic institutional arrangements prevented Germany from taking full advantage of the growth opportunities offered until the 1950s. For the years from 1961 to 1973, German growth performance is in line with the average. This performance is notable, however, for the extent of capital deepening. Unemployment was extremely low and foreign workers were recruited to mitigate the labour shortage. Why did the adjustment to labour shortage take the form of immigration rather than wage increases? Was the human capital endowment of these workers sufficient to offset the productivity growth dampening effects of immigration (in a full employment economy)? Compared with other European economies, migration to Germany was unusually high in this period. Looking for German participation in common domestic factors which played a role in bringing the Golden Age to a close, one can highlight the common European experience in the 1960s of adjustment to slower labour force growth in the context of very tight labour markets (Flanagan et al., 1982; Armstrong et ai, 1991). The most dramatic manifestation of the problem of managing a smooth transition to slower growth throughout Europe was the rash of strikes and wage explosions from 1968 to 1971. Adjustment in Germany was postponed through the policy of recruiting foreign workers. The unions favoured the foreign worker policy and also contributed to the wage moderation of the 1960s by exercising bargaining restraint. However, the heightened distributional conflict associated with labour shortage eventually emerged with the outbreak of wild-cat strikes in 1969. The period of slow growth from 1973 raises many puzzles. Country studies focus on idiosyncratic country failings, often apparently ignoring the common character of the slowdown. It appears that institutional differences in labour markets in combination with differences in macroeconomic policy have been responsible for the wide variation in employment and unemployment performance across countries suffering the same slowdown in growth (e.g. Glyn and Rowthorn, 1988; Calmfors,

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1993). There is also some suggestion that changes in the personal distribution of income have differed in a systematic way across countries with different institutional structures in the post-1973 period: inequality has increased less in countries with encompassing institutions (Green et al., 1992). This lends support to the hypothesis that, while growth is little affected by country-specific institutions (as found, for example, by Crafts, 1992), the distribution of the burden of slower growth across the population in terms of unemployment and income differentials may be more affected. Germany is often attributed with a distinctive institutional structure. Is there any evidence of an interaction between German institutions and the growth slowdown? This question necessitates an attempt at identifying features of a West German economic model. We will look at the relationship between the industrial relations system, vocational training, and the ownership and governance structure of enterprises, including the role of employee representation. Germany is characterized by a dense network of unions, works councils, employers and other business associations, which is embedded within a legal framework that promotes the continuity of economic structures and relationships. Examples from labour and corporate law of legally defined forms of continuity are employment protection and the status of supervisory boards, and their role in mitigating the need for hostile takeovers as a method of enhancing management efficiency. It has been suggested that, in a set of core industries in Germany, this structure has proved responsive to the demands of increased competition in the product market. For other industries, the model fails to generate rapid adaptation because of a stalemate between the stakeholders as to the appropriate strategy. An effective form of government intervention to promote adjustment has not been developed. The structure of the chapter is as follows. We begin in section 2 with the interwar period, focusing on reasons why growth was so feeble in the Weimar Republic. In section 3, we look at the period of reconstruction from 1945 to 1961. The aim is to provide an explanation for the very rapid growth in the 1950s - relative both to Germany's historical experience and to that of other OECD economies. Section 4 examines the second phase of Golden Age growth, focusing on capital deepening and the recruitment of foreign labour. Looking for factors signalling the close of the Golden Age, Germany's experience of industrial relations disharmony, wage explosions and sharp growth in the share of state expenditure in GDP, in common with its European neighbours, is analysed. Section 5 turns to the slow growth of the 1970s and 1980s, and the debate about West Germany's relative performance. The issue of the relationship between economic institutions and growth is taken up in section 6, with an attempt to set out the main features of the West German economic model. The chapter concludes by drawing some tentative lessons from the growth experience of West Germany for the prospects for growth in the reunified Germany. 2

The growth weakness of the Weimar Republic

Military defeat in each of the world wars was followed in Germany by periods of great economic instability and inflationary pressure: only after the Second World War was the instability followed by rapid growth. Comparison of the two postwar reconstruction episodes is clearest if the starting date is the year following each

West German growth and institutions, 1945-90

461

currency reform: 1924 is compared with 1949. The weakness of the Weimar reconstruction as compared with that of the Federal Republic was reflected across all dimensions. German reconstruction after World War I was also weak in comparison with the rest of the industrialized world: world industrial production (dominated by the USA) was over 40 per cent above prewar by 1928-9, as compared with 14 per cent in Germany (Borchardt, 1990: 130). Of particular note is the comparison between investment in the two periods. The post-1948 gross investment share was historically high (25 per cent in 1949) and rising through the 1950s, while the investment share in Weimar was historically low and remained around the 18 per cent level from 1924 to 1929 (Mendershausen, 1954: table IX, p. 49). Many accounts of low growth in the Weimar period focus on the explanation of low investment. Knut Borchardt has stimulated an intense debate with his argument that the central reason for weak investment was a profit squeeze, which he links to the role of collective bargaining and the welfare state in the Weimar Republic.2 He argues that a major factor contributing to the profit squeeze was the ability of the trade unions to secure wage increases above those warranted by the growth of productivity. The unions were able to do this, according to Borchardt, because of their enhanced bargaining power, arising from the Weimar compact between unions and employers in 1918, which both restored wartime compulsory arbitration by the state and introduced a system of unemployment insurance and benefits (Borchardt, 1990). Borchardt's thesis must be qualified in several respects. First, trade union strength in the Weimar period should not be exaggerated: organizational strength was weakened both by the inflation and by the split in the labour movement. Second, even in industries where profits could be protected through mark-up pricing, investment was weak. Factors extending well beyond the new setting for industrial relations appear to have played a role. After a decade of war and inflation, the German economy enWged in 1924 in a weak competitive position. As Kato points out, investment during the inflation was often irrational, taking the form of 'diversification into sectors having few close inter-sectoral ties with existing operations and ... made without much concern for productivity' (1988: 11). Given the concessions to labour under Weimar, the productivity gap vis-a-vis Germany's competitors could only be made good through rapid productivity growth. Although there was much discussion at the time about rationalization, the necessary investment and organizational changes did not take place on a broad front (James, 1986; Kato, 1988). Questions of industrial organization and industrial structure as well as industrial relations appear fundamental to the low investment of the Weimar years. A key question in the interwar impasse in Germany is to explain why heavy industry, with its aim of a return to the pre-1913 order where the state played a minimal role in the economy and employees were subordinate, remained dominant and was not supplanted by the industries of the 'second industrial revolution', where supporters of 'the American model' were prevalent. The Americanization of the German economy occurred only after the Second World War - where 'Americanization' refers to the generalized use of'modern' techniques of production and management, combined with the recognition by business of mass consumption as part of a legitimate new form of capitalist economic organization (see Maier (1987) and

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Berghahn (1986) for arguments along these lines). (The German form of Americanization has a number of characteristic features - often with roots in early German industrialization - and is discussed further in section 6.) One explanation for the investment failure is that there was an alternative strategy available to heavy industry that was less risky than industry-wide rationalization - the operation of price-fixing cartels. At the end of the nineteenth century, anti-trust legislation in the United States was paralleled in Germany by a law making cartels legally binding. The availability of pricefixingas a strategy had the effect of delaying and distorting the process of industrial restructuring associated with the new manufacturing technologies, and left industry with a persistent problem of excess capacity. James describes the limited form of rationalization and the weakness of productivity growth in the post-stabilization years (James, 1986: 146-54). The major difference between large German and US enterprises in this period was that 'industrial leaders in the United States continued to compete functionally and strategically for market share, while in Germany they often preferred to negotiate with one another to maintain market share at home and in some cases abroad' (Chandler, 1990:12). Chandler (1990) points out that it was only in those companies where investments had been made well before the First World War, which were sufficient to exploit the cost advantage of scale and scope, that recovery took place in the mid-1920s. Chemicals (IG Farben) and electrical machinery (Siemens and AEG) achieved successful rationalization. Investment in mechanical engineering was hampered by the dampening effect on profitability of the high prices of inputs due to pricefixingin heavy industry, and by the high cost and limited availability of credit to the small and medium-sized firms which dominated this sector (Kato, 1988: 15-16). Kato in particular stresses the impact of the weakness of the banks following the hyperinflation on finance for investment in some key sectors. Thus a patchy pattern of investment and rationalization was the outcome of the fact that few industries had both the incentive to invest (no cartel option) and the means to do so (access to finance). In addition to the constraints of industrial organization, the structure of German industry in the 1920s hampered the transition to a form of growth based on mass consumption. Although German entrepreneurs, like American ones, had undertaken the investments necessary to create industries successful on a world level, the German enterprises were concentrated in producer and capital goods, whereas the US firms produced consumer goods as well. Even German producers in electrical equipment, like Siemens, appear to have had no vision of creating a mass market for the output of consumer goods. James tells of Siemens' idea in 1932 of promoting the radio as a replacement for the piano in the home: 'He designed an elegant black box with folding doors as a luxury radio: it barely sold' (1986:152). In the isolated cases where investments were made in consumer goods in the 1920s, such as the US foreign direct investment in the automobile industry, seeking a mass market was not attractive: German roads were poor and earlier heavy investment had produced a highly efficient, cheap railway network (James, 1986: 153). The employers were successful in having the legislation on the eight-hour day revoked (in 1923), but were unable to prevent the establishment of collective bargaining. By 1928, nearly 30 per cent of workers were covered by either regional or Reich-wide wage agreements (James, 1986: 210). Nor were they able to prevent

West German growth and institutions, 1945-90

463

the reintroduction of the wartime compulsory arbitration system. 4[T]he organisations of employers and workers found it very difficult to reach autonomous agreements in the slow-growth Weimar economy, and as a consequence called the state in more and more frequently' (James, 1986:211). It was state intervention in wage setting and the 'political wage' rather than trade union strength per se which lay behind the strategy of the industrialists to support deflationary policies in the late 1920s and into the Great Depression, as a means of reversing the Weimar system of industrial relations (Weisbrod, 1990: 62). Borchardt is right to identify weak investment in the 1920s as symptomatic of a 'sick' economy, and to suggest that this sickness could not be cured by counter-cyclical medicine.3 However, there appear to have been broad structural problems in the domestic (and international) economy which prevented successful transition to a modern capitalist economy.

3

Reconstruction, 1945-61

3.1

Marshall aid, the currency reform and the preconditions for rapid growth

The announcement of the Marshall Plan in 1947 marked the turning point in US attitudes to German recovery, and began to lower the uncertainty about the political and economic future of the country. Economic reconstruction of the Western zones of Germany was to be fostered. The existing distribution of private property rights would be confirmed and a market economy restored. The Marshall Plan cleared the way for the USA to assume the dominant role vis-a-vis the British, and plans for nationalizing the heavy industries of the Ruhr were shelved. US influence was important later in strengthening the hand of the German policy-makers who were in support of a liberal trade policy and opposed to the revival of the prewar cartels. But West Germany could not enjoy the benefits of membership of the catch-up club until market incentives were restored. This highlights the importance of the currency and economic reforms of mid-1948. Between the cessation of hostilities in 1945 and the economic and currency reform of mid-1948, West German economic recovery was constrained by both physical and institutional factors. Destruction of the industrial capital stock and of the labour force was not responsible for the low level of output. Behind the appearance of chaos and destruction was an industrial capital stock considerably larger and of more recent vintage than before the war. The balance between wartime investment and destruction had favoured the German economy relative to those of the other major Western European countries. The industrial capital stock was only slightly higher in 1948 than in 1939, with a more favourable age structure, and was technically more advanced, in spite of disinvestment and dismantling after 1945 (Krengel, 1958). Parallel with the underlying strength of capital equipment was a labour force swollen by immediate postwar immigration. The loss of prime-age males in the war was offset by immigration combined with a higher level of wartime training, leaving the labour force equal in quality and quantity to that before the war. The physical impediments to recovery were bottlenecks in the flow of raw materials and fuel, due to the almost complete paralysis of the transport system and the mismatch between labour and jobs due to the loss of housing stock.

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Table 15.4. The balance between productivity and product wages in industry: Germany, 1948-52 (1938 = 100) Year

Real wages

Product wages

Productivity (output/ employment)

Real input costs

1948 1949 1950 1951 1952

75 85 101 105 112

64 74 84 80 85

59 69 82 91 95

98 107 124 129 113

Source: Carlin (1989, table 2.2, p. 56). Data from Bank deutscher Lander, Monthly Reports and Annual Reports; UNECE (1949, 1953, 1954). The institutional impediment to growth was the absence of either a coherent set of market incentives or an effective planning system for resource allocation. Economic transactions reverted to a complicated form of barter plus a narrow black market. Well over half of the economic activity in the first two years after the war took place outside official channels. There was no functional money due to the rapid expansion of the money supply during the war, the maintenance of fixed prices and the low level of output. Firms were rationed in the labour market as labour supply was reduced owing to the low availability of consumer goods. Extensive absenteeism lowered the output of firms, reinforcing the rationing of goods to consumers. The result was a state of repressed inflation, in which both the supply of output and the supply of labour were reduced below what they would have been had there been functional money and flexible prices and wages. Payment in kind was the essence of the relationship between employer and employees and between producers. The objective of businesses under these conditions was to accumulate stocks, ensure the survival of the firm and maintain goodwill in the hope that conditions would improve (Carlin, 1989). The preconditions for a successful currency and economic reform in mid-1948 were not only the strength of the productive base of the West German economy and the clearing of bottlenecks, but also the business confidence engendered by the inclusion of the Western zones in the Marshall Plan. The currency reform, designed by the USA, entailed harsh redistributive effects in favour of those owning real assets and away from holders of financial assets. Enterprise and government debts were basically written off - as was their counterpart in personal sector savings. This eliminated the monetary overhang. Employers were left with physical assets, but with very limited liquidity. The technical design of the reform contributed to its immediate success in forcing producers to release their accumulated stocks of goods so as to remain liquid. The new currency broke the repressed inflation equilibrium, with the supply of goods and labour rising fast. Alongside the currency reform, the German economic authorities, under the leadership of Ludwig Erhard and against the advice of most Anglo-American advisers, introduced a sweeping liberalization programme. The bulk of price controls were lifted, as well as the major quantitative controls over the

West German growth and institutions, 1945-90

465

allocation of resources. The incentive to work was raised by the availability of consumer goods and even further by the government's decision to make overtime earnings tax-free. For the reforms to mark a change of regime promoting long-term decision making, it was essential not only for the release of hoarded stocks, but also for current production to be profitable. This is confirmed by the data in Table 15.4 (given that the profit share in 1938 was very high (Maier, 1987)). Highly profitable current production fostered favourable expectations about future profitability and promoted investment on a broad front. Investment was also encouraged by the very high depreciation allowances and other tax concessions for investment introduced soon after the currency reform by the German authorities (Wallich, 1955). An examination of the investment series clearly shows the break between the quality of recovery at mid-1948 (Carlin, 1989: table 2.1, p. 54). The evidence of De Long and Summers (1992) about the robustness of investment in machinery and equipment in their growth equation suggests that the structure of tax allowances in Germany at this time was particularly growth promoting. Macroeconomic stability was threatened towards the end of 1948. Prices rose sharply, and weakening confidence in the new currency was reflected in the reappearance of hoarding and barter. The German authorities were advised to reintroduce price controls and the selective allocation of raw materials. They refused: the Bank deutscher Lander tightened credit conditions. This choice of policy was probably important for growth because it interrupted the attempts of German business to rebuild their traditional price-fixing arrangements (section 2). The government signalled its unwillingness to maintain aggregate demand at home at a level sufficient to ensure full utilization of capacity:firmswere forced to enter or re-enter export markets. Wallich commented: 'German businessmen, having so long been cut off from the outside world, would not willingly seek new markets abroad if selling was made easy for them at home' (1955:83). Their task was made easier when the Korean War boom generated rapidly growing demand for investment goods, in which Germany, unique in Europe, had spare capacity. The Germans had to re-enter international markets in the early 1950s, but they were not starting from scratch: 80 per cent of exported branded articles in 1952/3 were sold using trademarks valid world-wide before the war (Kramer, 1991: 184). Many authors have argued that the radical cheapening of transport and communications following the Second World War greatly increased the awareness of investment opportunities and facilitated diffusion of technology, management techniques and consumption patterns (Abramovitz, 1989; Scott, 1989; Nelson and Wright, 1992). Trade liberalization interacted with improved communications to facilitate the spread of best-practice techniques, as well as raising growth through specialization and economies of scale. West Germany was particularly favoured by virtue of its pattern of specialization in investment goods. 3.2

Wartime disruption and competing explanations for German 'supergrowth'

By 1951, prewar levels of GDP (1938) and of industrial productivity (1936) had been attained in West Germany (Maddison, 1991; Wallich, 1955). While the end of a

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phase of recovery can be dated at about 1951, the cross-country growth equations suggest that Germany benefited from a growth bonus (on top of catch-up) until 1960. As noted in the introduction, Dumke has proposed a reconstruction growth bonus specifically related to war-induced effects. He tests the model by assuming that the 'best measure of material loss due to the war is provided by the comparison of prewar and postwar levels of output' (1990: 476). This measure turns out to be significant and both complementary to and competitive with the catch-up term in a cross-country regression for OECD countries in the postwar period. Both effects are significant, but the inclusion of catch-up reduces the size of the reconstruction effect. Dumke puts forward two hypotheses as to the mechanisms through which wartime disruption promotes growth. The first links Janossy's thesis, of the growth-enhancing effects of a disproportion between the stock of human and physical capital, to the recent theories of growth (Lucas, 1988; Barro, 1989) which assume constant returns to a broad measure of capital that includes human capital. A high ratio of human to physical capital raises the marginal product of capital, inducing high investment. The second hypothesis linking wartime disruption to growth is an Olsonian one, stressing the effect of war in breaking up coalitions of vested interests. There are two caveats to the first market-driven interpretation of German supergrowth. First, the disproportion between human and physical capital should be considered carefully. As Krengel and Abelshauser have documented, the industrial capital stock was higher in 1948 than before the war, while the labour force was about the same size. Loss of capacity was concentrated in housing and the basic industries of coal, iron and steel, electricity and water, as well as transport. Yet it was in precisely these sectors that market forces could not induce higher investment. Because of the maintenance of price controls in these sectors and continuing uncertainty about ownership, private returns to investment were very low. Both the Marshall Plan (indirectly through the use of Counterpart Funds) and, later, organized business in West Germany played a key role in rebuilding capacity in these sectors. Marshall aid Counterpart Funds financed over 40 per cent of investment in coal in 1949-50,20 per cent in electricity in 1949-51, and 15 per cent in iron and steel in 1950-1. The business associations organized a levy on light industry and services. This investment aid levy picked up the burden of providing finance for the basic industries from the Counterpart Funds - financing almost 20 per cent of investment in coal, iron and steel, and power between 1952 and 1956 (Carlin, 1989: 63, 64). Second, it is questionable whether the role of surplus labour in maintaining the profitability of investment can be considered a purely war-related effect. Surely there is also a Cold War effect: a transfer from East to West, as Abelshauser insists (1983: 96-8). Reserves of underemployed labour have long been identified as a source of exceptional growth in the Golden Age (Kindleberger, 1967). The one-off boost to growth from the reallocation of labour to more productive uses appears particularly relevant for West Germany in the years up to 1961. West Germany, like a number of other continental European economies, benefited from a pool of labour in agriculture which could be drawn into industry without putting upward pressure on wages. In addition, there was a steady inflow of well-trained and mobile German immigrants from East Germany and elsewhere in Europe.

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A total of 3.6 million refugees from East Germany entered West Germany between 1950 and 1962 (adding to the 2.5 million who entered between 1946 and 1950). On average this labour pool was well trained and highly mobile. Abelshauser argues that the inflow of trained labour permitted West Germany to devote a smaller proportion of GDP to training and education in the 1950s than was the case in the Weimar Republic, without negative consequences for growth (1925: 2.8 per cent; 1951:2.4 per cent; 1962:2.7 per cent; 1968:3.0 per cent (Abelshauser, 1983:97)). Econometric evidence from cross-section data in the most recent period (O'Mahony, 1992b) suggests that the German productivity advantage over the UK depends on higher capital per head, of more recent vintage; higher R & D expenditure; and higher human capital per worker, as measured by the higher proportion of skilled labour in the German economy. In the reconstruction period, rapid capital accumulation produced a very 'young' industrial capital stock (40 per cent of machinery and equipment was less than five years old by 1957 (Krengel, 1958: 52-3)). The import of human capital through the inflow of skilled workers almost certainly boosted productivity and, through the mechanisms highlighted by the new growth theory, may well have contributed to rapid growth. It seems possible that the average human capital of these immigrants was higher than that of the host population, creating the possibility of the strong endogenous growth effects suggested by Dolado et al. (1993). Surplus labour contributed to the weakening of the economic strength of the trade unions relative to that of employers in the immediate postwar period. The unions were accorded a diminished role in economic policy making from 1947, in parallel with the rehabilitation of business. The shift in the balance of power towards business was symbolized by the loss of union financial resources in the currency reform, and was confirmed in the stabilization episode of 1949, in which rationalization and labour shedding took place. The growing cohesion of the business associations was further marked by the passing of the Works Constitution Act in 1952, which weakened the position of the unions at plant level. The economic weakness of labour reflected high unemployment and the economic insecurity of employees. The pool of unemployment in this period included highly skilled and motivated refugees, who can be thought of as good substitutes for the existing labour force and hence as a genuine excess supply of labour, dampening union wage bargaining power. Trade union membership density fell from a peak of 36 per cent in 1951 to 32 per cent in 1955. It is union economic weakness in this period more than a conversion to 'the politics of productivity' (Maier, 1987) which accounts for wage moderation (Carlin, 1992). Wage claims were made to look even more moderate ex post by the unexpectedly rapid growth of productivity (Giersch et al, 1991: 76-8). An Olsonian view of German supergrowth would focus on the effect of the war in destroying growth-inhibiting distributional coalitions, and thus opening up a period of growth unfettered by the activities of interest groups. Subsequent growth would then depend on the extent to which new interest groups were encompassing, and on the effect of a period of political stability in generating renewed institutional sclerosis. However, in political parties, business associations and unions there is a clear continuity between the personnel and organizations of the Bonn and Weimar republics (Unger and van Waarden, 1993; Paque, 1993). Especially in the British occupation zone, which included the Ruhr industrial area, the unions were seen as a

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Table 15.5. Sources of growth of non-agricultural employment: Germany, 1955-73 Growth of nonagricultural employment

Of which from (000s):

% p.a. 000s

GDR > Abroad Unemployment Agricultural Residual

1955-61 2.6 1961-9 0.3 1969-73 0.5

543 106 199

144 9 0

71 107 265

96 0 -24

122 136 110

110 -146 -152

Sources: OECD, Labour Force Statistics, Statistisches Jahrbuch, 1962, 1975; SVR, Jahresgutachten. core institution of the new Germany. Organizationally, the unions were stronger than they were during the Weimar period: their economic weakness in wage bargaining in the 1950s was due to the conditions in the labour market discussed above. There is some evidence of the emergence of more encompassing unions in the postwar period. In particular, the shift from craft-based to industrial unions already under way in the Weimar period was completed. The more striking change in industrial relations - but one, as emphasized by Paque (1993), which is not central to Olson's interpretation - was the removal of compulsory state arbitration in wage setting.

4

Golden Age growth, 1961-73

4.1

Labour shortage and growth

In 1961, labour supply conditions in Germany changed sharply with the building of the Berlin Wall, which ended the inflow of labour from the East. Between 1950 and 1961, the labour force grew by 1.5 per cent per annum; from 1961 until 1973, it grew by only 0.4 per cent per annum. Even more striking is the slowdown in non-agricultural employment growth from 2.5 per cent (1955-61) to 0.4 per cent after 1961. Table 15.5 shows the sources of growth of non-agricultural employment between 1955 and 1973. In spite of the recruitment of foreign workers, who comprised one in ten employees by 1973, the labour market remained extremely tight. Inter-industry wage differentials were compressed (Gerfin, 1977). However, as argued elsewhere (Carlin, 1992), the tightening of the labour market did not result in the full utilization by the unions of their increased bargaining power. First, there was a parallel increase in the level of organization and cohesion of the employers' associations. Second, the unions chose to exercise bargaining restraint. In the early 1960s, the attempt by the engineering union IG Metall to make use of tension in the labour market by supporting decentralized wage negotiations was defeated by the concerted action of the employers. Subsequently, although the underlying balance of factor availability was operating to shift the factor distribution of income in labour's favour, the union refrained from pushing their advantage - apparently

West German growth and institutions, 1945-90 469 Table 15.6. Educational and vocational qualifications of German and foreign employees, 1984 (%) Nationality German Foreign

Vocational education

School education

Completed Without

Lower secondary school

University

72.6 30.0

87.8 79.1

5.1 3.2

22.3 53.6

Source: Franz (1993: table 4, p. 8). recognizing the benefits for their membership of protecting competitiveness and investment. Further evidence for this interpretation comes from the fact that the unions supported the recruitment of foreign workers, just as in the 1950s they had supported trade liberalization. Maier's reference to the 'politics of productivity' is a better description of the 1960s than the 1950s. Growth slowed down because of the fall in the growth of the labour supply and the exhaustion of the pool of labour. Did the recruitment of foreign workers affect the growth rate? This subject has been hotly debated in Germany (see, for example, Giersch et al, 1992). Until 1969, the jobs filled by foreign workers were concentrated in a few branches of manufacturing and construction. A limited number of large firms provided most of the employment (Gerfin, 1977: 138). These were unskilled workers and, unlike the early immigration from East Germany, were not close substitutes for German workers. Table 15.6 compares the qualifications of foreign and German employees in 1984. There is no doubt that the use of foreign workers affected the development of German industry. It probably prolonged the period for which wage restraint was exercised, by providing Germans with mobility out of unskilled and semi-skilled employment into more attractive jobs. Unlike the first wave of postwar migration, the human capital of the foreign workers was lower than that of the host workforce. In Dolado et al.'s (1993) augmented Solow model (with full employment), such migration is productivity growth dampening. Franz (1993) uses a rationing model to stimulate the effects of lower migration in this period. He finds heightened macroeconomic tension in the form of higher price and wage inflation from 1969 to 1973, as compared to the baseline of the actual level of immigration. Lower migration would presumably therefore have hastened the rate of scrapping and the speed of exit from labour-intensive industries. We have much less basis for confidence that an offsetting shift of resources into other industries would have occurred. Given the weakening of investment in the early 1970s, in response to the already severe profit squeeze (see section 4.3), it is difficult to believe that higher investment would have been stimulated by a sharper rise in unit labour costs associated with lower levels of immigration.

4.2

Demand buoyancy

In accounting for the existence of catch-up in the Golden Age, or for the need to introduce dummy variables for the 1950s and 1960s, exponents of the growth

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equation approach, just like the growth accountants, find they must introduce ad hoc factors. It seems that growth benefited from other sources in the Golden Age (apart from factor accumulation, the reallocation of labour stimulated by the gains from trade liberalization, and access to world markets and reconstruction after the war). Alternatively, even if the residual in growth accounting is reduced by using a larger weight for the contribution of capital, the high level of investment remains to be explained. Common to a number of accounts is the buoyancy of aggregate demand (e.g. Scott, 1989; Maddison, 1991). But there is a serious problem of causality involved here because it can be argued that governments were able to maintain buoyant domestic demand in the 1950s and 1960s because of favourable supply-side conditions: that is, demand simply accommodated the rapid growth of potential. On the other hand, Keynesians argue that government commitment to maintaining demand fostered favourable expectations about growth which raised investment and, in turn, the growth of potential (e.g. Boltho, 1982; Allsopp, 1985). For Germany, the issue of the role of demand is less muddied by the simultaneity problem, since until 1968 the government steadfastly refused to undertake a commitment to maintain domestic demand. In the Golden Age, Germany benefited from demand buoyancy as an external effect of the strong growth of its markets, especially in Europe. Modernization of the French and Italian economies called for new capital equipment and this was supplied by Germany. The formation of the European Community contributed to the creation of favourable expectations especially in Italy, as the threat of increased competition acted to boost investment. When demand slackened at home, high capacity utilization in German industry was maintained because of export growth. This was assisted by very long periods of fixed exchange rates combined with restrained wage behaviour, during which German competitiveness was maintained (until 1969). Detailed analysis of German export behaviour in the 1950s and 1960s confirms that, once markets had been re-entered, Germany benefited from the strong growth of its markets (commodity and area composition) rather than from the growth of market share (Maizels, 1963; Batchelor et ai, 1980). 4.3

The end of the Golden Age: the significance of the 1966-7 recession and its aftermath

In the growth equation approach, the slowdown after 1973 is accounted for either by the disappearance of'catch-up' or by the fall in investment share. Less attention in that tradition has been devoted to explaining either of these two phenomena. Elsewhere (e.g. Armstrong et ai, 1991; Marglin and Schor, 1990; Flanagan et al.9 1982) efforts have been made to document the deterioration of the environment for growth from the late 1960s. There appears to have been a common experience in the OECD countries of a build-up of distributional conflict over wages, conditions of work (new technology, organization of production) and the level of financing of government expenditure. Olson would emphasize the length of the period of political stability, while others would emphasize the disappearance of labour supply flexibility as the underlying determinant of the rise of distributional tension. Accounting for the timing of the wage explosions is not easy (see Soskice, 1978).

West German growth and institutions, 1945-90

471

rl2 -10 30-

-8 2 20-

1

10-

Capital stock growth x -2

0 1951 53 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 Sources'. Carlin (1987), updated using VGR Fachserie 18 Reihen S15, S17.

Figure 15.2 Profitability and capital accumulation in manufacturing: Germany, 1951-90

Either way, it was reflected in increased inflationary pressure and declining profitability before 1973. Although growth rates did not decline until after 1973, these developments at the end of the 1960s can be interpreted as weakening the environment both for catch-up and for investment. The issue in relation to Germany is the extent to which its industrial relations system was able to insulate it from the common tensions apparent at the close of the Golden Age. The limits to union moderation were met in the aftermath of the 1966-7 recession, the first occasion on which GDP had fallen since the currency reform. This recession is significant for understanding German growth at the close of the Golden Age and in the years that followed. A most striking aspect of the recession was the extent to which private sector employment was cut in respect to the fall in demand. Before 1967, downswings were associated with slightly falling productivity growth due to labour hoarding. But in 1966, the sharper than usual slowdown in output growth produced a/a// in the level of employment; in 1967, employment fell by much more than output. The recession produced significant changes in work practices and technology to increase productivity - it was referred to by the Council of Economic Experts as a Reinigungskrise, a cleansing crisis (1969/70, Z78). New systems for job evaluation and performance appraisal to enable a general intensification of work were introduced (Miiller-Jentsch, 1981:48). The Bundesbank reported that the recession had the effect of improving the allocation of labour between industries and revealed cases of over- and misinvestment (Annual Report, 1966: 10). The combination of these sharp improvements in productivity with the wage restraint brought about by a voluntary incomes policy, produced a rebound of

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profitability in the boom that followed. The SPD was in government for the first time and had established a tripartite forum ('Concerted Action') for the coordination of wage and price setting with the requirements of aggregate demand. The union leadership agreed to cooperate in wage moderation as part of a package deal which included increased government expenditure and, of greater long-term significance, employment security in situations of rationalization. The downward trend of profitability since 1955 was reversed over the 1965-9 cycle, with the net profit rate in manufacturing in 1969 above that of 1965. It fostered an investment boom in 1969-70, the intensity of which has not been repeated. Figure 15.2 shows the paths of manufacturing profitability and capital accumulation. The strength of the upswing produced a rare loss of discipline by both unions and employers' associations. Wild-cat strikes in the engineering industry in 1969 were fostered not only by the surge of profits and the very tight labour market, but also by plant-level resentment at changes in work organization introduced during the recession. They were rapidly settled by employers offering substantial enterprise and plant wage increases above the negotiated levels. The result was a shift in union strategy: in the light of the threat to their authority from their membership, they were no longer able or willing to deliver the level of bargaining restraint which had characterized the 1960s. As well as exercising less restraint, the unions experienced an increase in their bargaining power over the final cycle of the Golden Age. Membership density increased and they were able to extract important changes in industrial relations legislation from the government. At the same time, the exchange rate underwent a very sharp appreciation, producing an annual deterioration in German relative unit labour costs of 8.1 per cent per annum. High nominal wage increases and weakening labour productivity growth were common to Germany and its trading partners in these years, so that excluding the appreciation of the exchange rate, relative unit labour costs would have declined by 1.7 per cent per annum. The remarkable aspect of the impact of exchange rate appreciation is that German firms exercised extraordinary restraint in their pricing behaviour in export markets, raising prices by only just above the rate of increase of world export prices. This meant, on the one hand, a very sharp squeeze on profits in tradables (Figure 15.2) and, on the other, that Germany's share of world exports of manufactures continued to rise from 1969 to 1973 (Carlin, 1987: 347). The change in union behaviour meant that the gains to real wages associated with the appreciation were not eroded by moderate claims in subsequent wage rounds. It is impossible to identify clearly the implications for growth of these developments because of the occurrence of the first OPEC shock in 1973. Businesses appeared to be taking the long view in seeking to maintain their market share by holding down export prices in the face of the revaluation of the Deutschmark. On the other hand, the erosion of profitability must have been at least partly responsible for the failure of investment to grow following the trough of 1971 (unlike any previous cycle) (see Figure 15.2). The early 1970s saw the exercise by the unions of increased bargaining strength, registered by an upward shift in the expected real wage which unions sought to negotiate (at given unemployment). However, well before the OPEC shock, the Bundesbank made it clear that the reflection of heightened distributional tension in higher inflation would not be tolerated. There was a return to the

West German growth and institutions, 1945-90

473

traditional assignment of inflation control to monetary policy, with thefloatingof the Deutschmark in the spring of 1973 and the adoption by the Bundesbank of a tight non-accommodating monetary policy.

5

Slow growth, 1973^90

Slow growth was common across the OECD in this period, yet the econometric estimates reported in section 1 suggest that West German performance was not below average: residuals for Germany for this period are small and positive. As noted above, however, the situation with respect to manufacturing industry is rather different, especially if the focus is on the period from 1979 rather than from 1973 (Tables 15.2 and 15.3). It has been shown that there is little correlation across countries between the slowdown in growth after 1973 and the rise in unemployment (Glyn and Rowthorn, 1988). It is not surprising, therefore, that whereas cross-section studies of unemployment have found support for the idea that both highly decentralized labour markets and ones where there is high coordination in wage-setting institutions lower equilibrium unemployment, efforts tofinda systematic relationship between such structures and growth have been unsuccessful (Crafts, 1992). One interpretation of this result is that different institutional structures have affected the distribution of the common burden of the slowdown. Most obvious are different patterns of unemployment (Calmfors and Drifrill, 1988; Soskice, 1990), but changes in household income distribution from 1973 have also differed across groups of countries with different institutions (Green et al, 1992). The available evidence suggests that income inequality declined in OECD countries during the Golden Age. In the years of slow growth since 1973, the general trend towards equality has been halted everywhere. However, while inequality has increased markedly in the UK and USA, it has remained stable in the Nordic countries, Austria and Japan (and also in Canada) (Green et ai, 1992). Inequality fell between 1950 and 1973 - with the rise from 1960 to 1973 failing to offset the earlier decline (Sawyer, 1976). A recent study of real disposable income per consumption unit (i.e. adjusted for household composition) shows that the income of households of salary earners, pensioners and the unemployed relative to those of wage earners remained virtually unchanged between 1980 and 1990 (Bedau et al., 1993: table 5.7, p. 103). The only major change has been the rise in income of self-employed households (outside agriculture) from 2.4 times that of a wage-earning household in 1980 to three times in 1990. In terms of levels, in the late 1970s, Germany had a more equal distribution of income than the UK and a lower poverty rate (Buhmann et al9 1988; O'Higgins and Jenkins, 1990). In section 5.1 we look at the deceleration of growth in the intershock period, focusing on the role of investment. Section 5.2 takes up the debate about the weakness of German growth in the 1980s: two divergent views can be found in the literature. On the one hand are those for whom Germany is the archetypal sclerotic European economy, where institutional rigidities have inhibited the structural changes imposed by developments in the world economy in the 1980s. A quite different view is that German economic institutions have facilitated adaptation.

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5.7

The weakness of investment

Capital stock growth slowed from 6.1 per cent per annum (business) in 1969-73 to 3.9 per cent per annum in 1973-9; for manufacturing the slowdown is even more dramatic - from 6.0 per cent per annum in 1969-73 to 2.2 per cent per annum for 1973-9 (see Figure 15.2). For Germany - in contrast to the other three large European economies - it is clear that the proximate cause of slow growth in the intershock period was the slowdown in the rate of growth of the capital stock. Total factor productivity growth did not slow down markedly until after 1979. From 1979 to 1985, growth slowed even further, but this additional deceleration cannot be accounted for fully by slower growth of the capital stock. In terms of growth accounting both for GDP and for manufacturing, TFP growth more than halved. Germany's TFP performance relative to other OECD countries right across manufacturing industry dipped sharply after 1979 (Wolff, 1992).4 Econometric evidence to support the role of declining profitability in the fall in investment in Germany is provided by Bhaskar and Glyn (1992). In an investment equation estimated for both manufacturing and non-agricultural business with the net profit share, output growth and a relative cost term, using data from 1951 to 1988, they find both the profit share and relative costs to be significant. (For manufacturing, output growth is also significant.) Using the estimated values of the coefficients, they find that for Germany over half of the fall in the investment rate {I/K) between 1960-8 and 1980-8 was accounted for by a lower profit share, under a third by higher relative cost of capital to labour and the remainder by lower output growth. Japan is the only other country of the G7 for which lower profitability accounted for at least half of the decline in investment. It is striking that German economic policy debates in the 1970s and 1980s were couched in terms of the problem of profitability. This theme is found repeatedly in the reports of the influential Council of Economic Experts and in the annual reports of the Bundesbank (Carlin; 1987; Giersch et ai, 1992). The belief by the authorities that profitability had to be restored to its level of the late 1960s for sustainable growth to ensue underpinned monetary policy from early 1973 with thefloatingof the exchange rate. Following the OPEC shock, the Bundesbank reiterated its determination to force domestic agents to reduce their claims in line with the (reduced) output available (Bundesbank, Annual Report, 1973:1). Their determination was tested the following year when public sector workers led the wage round, seeking high wage increases. Public sector and then private sector employers acceded to the wage demands presumably expecting monetary policy to be eased. The Bundesbank refused to budge, with the result that a severe deflation was imposed. This episode is highly significant for two reasons. First, it demonstrates that the Bundesbank was prepared to inflict cuts in output, employment and short-term profitability, which were necessary in its view to promote the recovery of long-term profitability and investment. (This echoes the behaviour of the Bank deutscher Lander in 1949.) And second, it established a Bundesbank policy rule under floating rates that higher inflation would produce monetary tightening and exchange rate appreciation. For the powerful engineering union IG Metall, it was therefore imperative that the initiative in future wage rounds be held by them rather than by

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475

Table 15.7. Apprentices as a share of employment in Germany, 1950S (%)

1950 1969 1980 1988

Whole economy

Manufacturing

4.7 4.9 6.3 6.1

8.4 5.7 7.5 7.3

Source: Broadberry (1993: table 4, p. 28). the public sector union. Wage increases would have to be held down sufficiently to ensure that the Bundesbank was not forced to tighten policy. This episode can be seen as partially but not entirely reversing the upward shift in union bargaining intensity which occurred in the early 1970s. While the sharp decline in manufacturing profit share was stemmed and, for business, the profit share had recovered to its 1973 level by 1979, a return to Golden Age values did not take place. Reference to the success of the 1949 stabilization highlights a key missing element in the second German attempt to use stabilization policy after 1973: the strong growth of exports. The export orientation forced on German business by the tight macroeconomic policy stance from 1949 focused the attention of business and unions on productivity and investment rather than on price fixing or aggressive wage setting. This was rewarded with the arrival of the positive external shock of the Korean War. By contrast, there was a slowdown in world trade in the 1970s. Moreover, specialization in capital goods in an era of dramatically slowing investment was likely to be a handicap compared with its advantages in the 1950s. Although Germany was able to hold its share in world export markets, it could do no better than this - unlike Japan. Unlike physical capital, there is no clear sign that the post-1973 period saw a fall-off in the rate of accumulation of human capital in Germany. A major component of the process of skills acquisition is the dual system of youth training, in which over two-thirds of young Germans complete an externally certificated apprenticeship where training is provided by the employer at the workplace and by the state at a vocational college. With its origins in the .nineteenth century and largely unchanged for sixty years, it 'appears to be characterised by a state of stable equilibrium with high demand for training places on the part of young people and high demand for trainees from industrial and commercial organisations of all sizes and in virtually all sectors of the economy'(Steedman, 1993:1279). Table 15.7 shows the stable share of apprentices in employment. There is indirect evidence of the continuing effectiveness of the system of human capital accumulation in Germany in the 1980s from the pattern of earnings differentials. Abraham and Houseman (1993) find some support for the hypothesis that the decline in earnings inequality in Germany through the 1980s (which contrasts with rising inequality in the USA), is due to the fact that the relative supply of more educated workers was at least maintained in Germany during the 1980s, in contrast to the USA where it slowed considerably. Seconu, they suggest that the broadly based training provided to German young people who are not 'collegeeducated' makes them better substitutes for both older and more educated workers,

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Table 15.8. Comparative levels of labour productivity per hour, manufacturing: Germany, USA and Japan, 1973-90 (US'A = 100) Machinery, equipment

Chemicals

Germany Japan G 1973 1979 1990

90.0 110.7 87.6

J

50.6 90.5 60.4 79.6 106.0 78.0 114.4 76.7 83.8

Total manufacturing

Textiles

Food

G

J

G

J

G

J

81.0 85.9 88.2

53.2 54.9 48.0

68.4 74.1 75.8

39.5 39.8 37.0

79.7 95.8 85.9

49.2 62.6 77.9

Source: van Ark and Pilat (1993: table 4, p. 17). thereby muting the effect of shifts in relative demand for labour on relative wages. Labour shedding in Germany has been organized to keep up the level of apprenticeships by making redundant the oldest workers - who go officially into unemployment en route to retirement.5 The industrial relations system has been crucial in preventing such senior 'insiders' from threatening the continuation of training rates in a period of low growth.

5.2

Productivity and competitiveness: the debate about German performance in the 1980s

A whole series of productivity indicators can be produced which show an unambiguous deterioration in Germany's performance in manufacturing relative to its major competitors (including the UK) in the post-1979 period (e.g. Wolff, 1992, using OECD data). The inferences drawn from Wolff's data are broadly supported by the more careful productivity calculations for Germany, Japan and the USA used by van Ark and Pilat (1993) and reported in Table 15.8. Turning from pure productivity measures to competitiveness, Germany's cost competitiveness deteriorated from 1979 to 1989 by 12 per cent, using the IMF's measure of relative normalized unit labour costs (RNULC) in manufacturing. Relatively weak measured productivity performance was not offset by sufficiently moderate wage settlements. However, it is noteworthy that Germany's competitiveness as measured by relative export unit values slightly improved over this period. (Japan is the only one of the other large OECD countries to show a similar pattern: RNULC increased by 24 per cent, while relative export unit values increased by only 14 per cent.) An obvious way of interpreting this pattern would be to say that German companies sought to maintain their market share in the face of rising relative costs by allowing their profit margins to be squeezed, as had occurred in the period from 1969 to 1973 described earlier. However, this is hard to reconcile with the strong recovery of manufacturing profitability in the second half of the 1980s, to a level close to that of 1979 (Figure 15.2).6 Given that there was no overall trend in profitability over the period, it might be argued that the market test of competitiveness is the ability of an economy to maintain its position in international markets - both for exports and in the domestic market. Table 15.9 suggests that Germany's share of world exrfort markets was little changed over the decade of the 1980s. Unlike Japan and unlike its earlier

West German growth and institutions, 1945-90 477 Table 15.9. German export competitiveness, 1979 and 1990 (1972 = 100) 1979

1990

Germany Germany's share of world export markets 101.7 due to change in market share 99.0 due to change in product or regional growth of world exports 102.7 Japan 102.3

100.7 95.5 105.3 118.7

Source: Calculated from DIW (1992: table III.E.2/2, p. 108). performance in the 1950s, Germany was unable to achieve a major increase in market share. Nevertheless, given the dismal performance on productivity and the weak levels of physical capital accumulation in German manufacturing in the 1980s, this result is striking. Unlike the other large European economies and the USA, Germany maintained through the 1980s an industrial structure in manufacturing which was highly correlated with the structure of world exports (OECD, 1989: table 4.8, p. 132). Table 15.10 provides more detail on German export and import performance in a number of key sectors in the 1980s. It shows that export market share has been maintained both in machinery and transport equipment and in chemicals. The contrast with the image presented by Table 15.8 is remarkable. Nevertheless, there are signs of the erosion of domestic market share in the rise in import shares. Signs of improvements in US or UK performance in international competition commensurate with their productivity improvements are not apparent in the data. There are two divergent views in the literature about German economic performance in the 1980s. The most familiar view, focusing on productivity and investment weakness, is presented very clearly in Giersch et al. (1992) and identifies mounting institutional rigidities which weakened the economy'^ ability to adapt to structural change. The alternative view focuses on the successful adaptation of German industry to increased competition in product markets. This approach, exemplified in the studies in Katzenstein (1989), is based on detailed 'qualitative' analysis of the behaviour of companies in adjusting to market pressures. It hints at possible problems with productivity-based indicators of performance and competitiveness, and suggests that an exclusive focus on productivity may exaggerate weaknesses in German industrial performance in the 1980s. These alternative interpretations of the supply side produce sharply different judgements about the role of macroeconomic policy in growth in the 1970s and 1980s. In the 'supply weakness' interpretation, an activist fiscal policy during the 1970s, and in particular Germany's leading role in the coordinated international expansion in 1978/9, worsened the conditions for growth. Once interventionist fiscal policy was abandoned and its operation brought into line with monetary policy in a medium-term stability orientation in the early 1980s, macroeconomic policy ceased to hamper growth (Hellwig and Neumann, 1985). Germany's persistent current account surplus in the 1980s is attributed to the lack of sufficient worthwhile investment opportunities at home to absorb rising business savings (e.g. Giersch et al, 1992: 245-50).

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Table 15.10. World market shares of Germany and its competitors, 1980 and 1990 (% share of country in world exports or imports; the rank of the country is show in brackets after X or M) Machinery and transport equipment (MTE)

1980

1990

Chemicals

1980

1990

X{2) Germany (value of X = $197bn) M(2) Japan X(l) M (10) USA X(3)

16.5

16.5

17

17

6.5 14.5 1.5 17 12 7 5.5 7.5 5.5

8.5 16.5 3 15 16.5 6.5 6 6 6.5

Germany *(1) (value of X = M(l) $51bn)

9

10

Automotive; products 1980 (subdiv. of MTE)

1990

Office machines and telecom equipment (subdiv. of MTE)

X(l) 21 Germany (value of X = $69bn) M(2) 6 Japan X(2) 20 M(10) 0.5 USA X(3) 12.5 M(l) 19.5 France X(5) 10 M(5) 5 UK 6 X(l) M(4) 5.5

21.5

Germany X(3) 10 (value of X = $21bn) Af (2) 9.5 Japan X(\) 21 M(9) 2.5 USA X(2) 20 M(l) 15 France 4.5 X(9) M(4) 6 UK 6.5 X(4) 6.5 M(3)

France UK

M(l) X(4) M(4) X(5) M(3)

9 20.5 2 10 23.5 8 6.5 4.5 7

Japan USA France UK

4.5 X(7) M(6) 4 X(2) 15 M(3) 6 9.5 X(3) M(2) 8 8.5 X(4) M(5) 5 1980

5.5 5 13 7.5 9.5 8 8 6 1990

7 9 22 3.5 17 20 4 5.5 6.5 7.5

Source: GATT, World Trade 1990-1991, tables IV. 43, 34, 39, 29.

From a perspective emphasizing the successful adaptation of German industry, the very restrictive monetary and fiscal policies pursued from the early 1980s were unnecessary, in the sense that they were not required to impose discipline on the unions. Germany, it is argued, could have operated at a higher level of activity, and by implication with higher growth (thus turning the relationship between the interest rate and the growth rate in favour of growth, and hence reducing the budgetary problem), without an unsustainable deterioration in macroeconomic stability. From this viewpoint, the persistent current account surplus reflects the failure to run the economy at maximum sustainable output (e.g. Soskice, 1990).7 Englander and Mittelstadt find that slow output growth has a depressing effect on TFP growth in the medium term (1988:47-8, table 20). To the extent that a more

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expansionary demand policy would have inflationary or budgetary consequences, the relationship between demand and TFP growth does not support the use of such a policy. Since the consequences may be distortionary and productivity decreasing (1988: 48), the relationship cannot be exploited by policy. This implicitly assumes that the economy is operating at minimum sustainable unemployment. To the extent that Germany was operating with greater than minimum sustainable unemployment, Englander and Mittelstadt's results suggest that failure to expand demand contributed to weak productivity performance.

5.2.1 The 'sclerosis' view Giersch has been a long-standing proponent of the 'sclerosis' view. He identifies several growth-inhibiting institutional structures which reduced growth in a situation in which profitability was under pressure from increased union aggressiveness and higher commodity prices. Giersch et al. (1992: 213) argue that there was a shift away from the institutionalized social peace characteristic of the 1960s due to a 'deep-seated sociological and economic transformation'. They point to a number of episodes in industrial relations to support this view: (1) the unions' decision to leave the 'Concerted Action' tripartite discussions in 1977 over the issue of codetermination; (2) the print dispute in 1978, which sought to slow down the introduction of new technology; and (3) the working hours campaign by the unions in support of a 35-hour week. However, the case for identifying a fundamental break in the industrial relations climate is far from clear. Giersch et al. themselves play down the importance of (1) and (2). Compromise over the working hours campaign produced increased flexibility in the utilization of fixed capital and labour. Moreover, this period saw a high level of cooperation between the engineering employers and unions over the restructuring of the apprenticeship qualifications to meet the demands of new technology and the need for the multiskilling of workers (Casey, 1990). Second, they argue that there was a new qualitative dimension to public subsidization and the heavy legal regulation of economic activity in the 1970s and 1980s: 'Naturally all the resources retained in structurally weak sectors were lacking in those branches - mostly high-tech industries and modern services - which could be expected to have a bright future in a world of free trade and free capital movements' (Giersch et al., 1992: 217). The third factor was the likely disincentive effect on work effort of the system of income and payroll taxation. The analysis of sclerosis leads to the policy recommendations of liberalization and a shift towards the institutional minimalism of traditional neoclassical theory. In line with the Giersch view, it has been suggested that the brighter outlook for German productivity growth from 1988 arises from the easing of labour market regulation in 1985 to facilitate the use of short-term contracts, and the impact of the single market programme in lowering barriers to entry in product markets and facilitating cross-border mergers and takeovers (O'Mahony, 1992a: 57). Doubt is cast on the significance of German labour legislation as a mechanism of sclerosis by thefindingsof Houseman and Abraham (1993) that the adjustment of total labour input in Germany in response to changes in demand is very similar to that in the USA and appears not to have changed following the weakening of

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Table 15.11. Comparisons of productivity measures in the biscuit industry: quality effects (UK = 100, data are for 1989 and 1990) West German productivity (employee-hour); census of production - unit-value ratio method

Productivity (employee-hour); sample of plants in biscuit manufacture in Germany

Manufacturing

Food, drink, Biscuits tobacco

Tons/ Quality-adjusted employee-hour value added/ employee-hour

120

107

80

75

140

Source: Mason et al (1993).

employment protection in 1985. They key difference is that in Germany adjustment occurs through hours of work rather than through layoffs. In the context of structural adjustment, the option of short-time work is not necessarily inefficient: long-term unemployment may be reduced by the avoidance of large-scale layoffs. Public subsidy of short-time working can allow a slower reduction in employment through increased reliance on attrition and on voluntary departure of the most mobile.

5.2.2 The 'successful adaptation view This view focuses on private sector driven adaptation to increasing competitive pressures in Germany's core industries: machinery, motor vehicles and chemicals. The argument centres on the strength of German adaptation in these industries, arising from the cooperation between unions, works councils and employers in the training system, the role of committed ownership, allowing long-term incremental innovation strategies, and the pressure that employment security places on companies to upgrade the skills of their employees and the quality of their output. Case studies illustrate the way in which German companies developed the strategy of what has been referred to as 'diversified quality production', in response to the opportunities provided by microelectronic technology and the pressure to evacuate price-competitive market segments: for example, motor vehicles (e.g. Streeck, 1989), mechanical engineering (e.g. Herrigel, 1989, on machine tools), chemicals (e.g. Allen, 1989) and financial institutions (e.g. Oberbeck and Baethge, 1989). From a completely different tradition, the series of matched plant studies carried out at the National Institute, although primarily aimed at uncovering the determinants of comparative productivity levels rather than long-term company strategies, frequently uncovered patterns of diversified quality production consistent with the findings of the industry case studies. Of note is that the National Institute studies included industries outside those regarded as comprising Germany's core, such as furniture, clothing and food processing. There is a major problem with quantifying the improvements in quality which are stressed in the case studies. However, a detailed study has recently been completed by Mason et al. (1993) of the biscuit industry in Germany, the UK, France and the Netherlands, where they attempt to quantify the extent to which productivity

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comparisons based on the National Institute/Groningen method of using unit-value ratios (as used in the calculations in Table 15.8 above) differ from quality-adjusted output per employee-hour. A relatively simple product which is traded internationally was chosen to facilitate the comparison. Table 15.11 summarizes the various productivity measures. This study highlights the discrepancy in levels which arises from quality differentials. German producers would have had to follow a strategy in the 1980s based on moving continually into higher-quality market segments, for this to impart a measurement error into the trend of productivity growth measured according to the unit-value method. There is one further interesting insight in the biscuit study. It found that the average age of machinery in all four countries was very similar and was uncorrelated with the inter-country quality-adjusted productivity differences. However, in Germany, a 'pro-active' engineering policy was identified, where engineering staff worked closely with production supervisors to develop and adapt machinery. Low-tech, low-cost modifications to equipment were characteristic of the processing operations. 'According to one German manager, it could take a competitor "up to ten years" of incremental improvements to achieve the desired throughput on capital equipment' (Mason et al, 1993: 28). This study may provide one tiny piece of evidence which can help to explain how Germany has maintained its share of product markets in the face of falling cost competitiveness and low measured physical capital accumulation. The human capital endowment of German workers is linked to the quality-adjusted productivity performance and to the product strategy chosen. The complementary skills of production workers, supervisors and engineers enabled low-cost/high-return improvements to equipment which were not available to plants elsewhere. The possibility therefore exists that measurement error is partly responsible for the competitiveness/productivity/investment paradox. Unfortunately, there has been no work done in Germany comparable to the effort made in the United States to construct quality-adjusted price indices. While is it therefore impossible to make any calculations as to the underestimation of output and capital growth due to the failure to adjust for quality changes, the results from the USA indicate that the bias may be substantial.8 Gordon (1990) found that for producers' durable equipment, the 'alternative' price index increased at a rate of 3 per cent per annum slower than the official series over the period 1947-83 (table 12.2, p. 536). Using the official price index, the ratio of equipment investment to GDP remained constant over the period, whereas using Gordon's alternative index, it trebled (table 12.5, p. 546). 5.2.3 An evaluation There are common threads in these two interpretations. An important point of agreement is the idea that direct government intervention in industry has been largely unsuccessful in this period. Neither in sunset (shipbuilding, steel) nor in sunrise (electronics, biotechnology) have attempts by the government to foster competitiveness met with success. By contrast, the government largely stayed clear of the three core sectors (and banking) (Katzenstein, 1989:19). Government support for biotechnology since the early 1970s appears to have revealed the inability of German scientific institutions to facilitate advancements in this field.

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The 'successful adaptation' view focuses on the incentives internal to the existing structures of labour and business. One simple hypothesis would be that weaker German productivity growth in manufacturing in the 1980s than in the UK and USA reflects the existence of different forms of productivity growth. In the core sectors in Germany, export market shares have been maintained through innovation and increases in quality, but average productivity growth for manufacturing has been pulled down by slow rationalization of ailing sectors - as compared with the UK. This does reflect the institutional structure in Germany - strong unions and ownership structures which militate against radical changes of strategy and can lead to blocking coalitions and inertia (e.g. Houseman, 1991; Mayer, 1993). Klodt (1990) and Giersch et al. (1992) provide evidence of the role of increased government subsidies and higher effective protection in slowing the decline of employment in the so-called Ricardo industries (mining, agriculture and shipbuilding). This suggests that the growth of the physical capital stock and of human capital may be the best guide to the balance between the different qualities of productivity growth. The insights from the case studies and the biscuit industry suggest that human capital may play a more important role than physical capital in the German strategy of the 1980s.

6

Is there a West German economic model and, if so, has it affected growth?

6.1

Growth and institutions

The new growth theory has opened the way for the influence of institutions on growth to be taken seriously (by neo-classical economists). Within the traditional Solow model, even if institutions (or policy) were thought to affect capital accumulation, a higher investment share could only raise growth temporarily and by a small amount. By contrast, the new growth theory emphasizes a much broader notion of capital accumulation - investment not only in physical capital, but also in human capital and intangible capital (innovation). Institutions which, for example, foster investment in human capital and therefore raise the stock, in turn stimulate further investment in the other complementary forms of capital, raising the growth rate. To illustrate the possible magnitude of such effects, consider the simple example provided by King and Levine (1993). They compare Solow's production function y — Ak° (where y is per-capita GDP, k is the per-capita stock of physical capital and A represents the omitted residual elements including human capital) with the new growth theory production function of the form y = A(K)a where K is the comprehensive capital aggregate and a is the associated share parameter (1993: 160-1, 164-5). In the Solow case, the estimated upper bound on a is about 0.5, while the work of Mankiw et al. (1992) finds a value for a of 0.8. This matters because a rise in the investment share of 10 per cent produces a higher annual growth rate of 0.33 per cent over a thirty-year period in the Solow model (with a = 0.5), but of 1.33 per cent per annum in the model in which a much more comprehensive view is taken of the notion of investment. Of course, even more dramatic results emerge if the value of a is put at one, as in the endogenous growth approach.

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483

The opening up of the debate about the role of institutions in growth by the new theoretical advances appears especially relevant to the analysis of West Germany. First, the discussion of the experience of the interwar period in section 2 suggested that institutions played a part in the growth failure of the Weimar Republic. Second, there is a long tradition in the attempts to explain weak British postwar growth of drawing contrasts with Germany and its allegedly superior institutions. Third, two major institutional developments have taken place in the UK and USA (and elsewhere) in the 1980s which have been absent in Germany, in spite of the presence of a conservative government from the early 1980s: the major weakening of trade unions and financial liberalization. In Germany, trade union strength has been largely untouched and the twin phenomena of financial liberalization (the expansion of consumer credit and the increasingly active market for corporate control) have not been observed. Has German failure to follow these institutional restructurings hampered its growth performance? The 'ordo-liberal' architects of West Germany's postwar economic constitution took the view that they were engaged in constructing a distinctive model. Their concept of a 'social market economy' originated from a diagnosis of the failings of the Weimar Republic in which weak governments had become increasingly open to the rent seeking of private sector interest groups (Giersch et al., 1992: 27). The implication was that a strong state with strictly limited competencies was required. By limiting the tasks of the state, the leverage of special interest groups would be minimized. One reflection of the objective of restricting the scope of state activities was to establish free collective bargaining in 1949, without compulsory arbitration by the state as in the Weimar period. In particular, the state would be anti-interventionist following rule-based macroeconomic policies, it would use anti-cartel legislation and free trade to combat rent seeking by interest groups, and it would deal with market failures by using 'market-conforming' instruments. But the state does not abstain from influencing interest groups: [T]he State in the Federal Republic acts in a variety of ways as a supporting, facilitating, encouraging force in the formation and preservation of broad, encompassing, internally heterogeneous interest organizations. Ironically, but hardly unintended, the interventionist policy of the German State on the organizational forms of social interests enables it in many cases to abstain from direct economic intervention since it provides interest groups with a capacity to find viable solutions between and for themselves. (Streeck, 1984b: 145) This 'model' of the social market economy stood in sharp contrast to the 'postwar settlement' in the UK. The UK's postwar settlement is often taken to include interventionist macroeconomic policy, associated with a commitment to full employment; the build-up of the welfare state; the use of 'non-market' techniques such as nationalization to deal with market failures; and government agreement with the trade unions to secure wage restraint, in exchange for the continuation of trade union 'privileges' on the shop floor regarding the organization of work. Alfred Chandler (1990) has identified a distinctive German form of industrial capitalism originating in the late nineteenth century, which he calls 'organized

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capitalism'. The challenge is to identify the circumstances under which organized capitalism detracted from or contributed to growth. One example of the interaction of policy measures with 'organized capitalism' to produce growth-dampening effects is the policy of official support for cartels. The use of foreign trade as a pro-competition instrument in West Germany in the 1950s was discussed above. Berghahn (1986) charts the 'Americanization' of German companies over the course of the 1950s and 1960s, in the sense of the demise of paternalism and cartel behaviour. American influence did not extend to corporate governance or to the wage bargaining system. Hallmarks of a West German model - at least as perceived in the literature on Anglo-German comparisons - relate to the following characteristic institutions: • Industrial relations: industrial unions, works councils at plant and company level, highly organized employers' associations and high employment security. • Vocational training: the dual training system (apprenticeships in companies combined with state-funded vocational schools) and national standards of certification regulated by chambers of commerce. • Finance and the ownership of industry: a close relationship between banks and industry, and a small proportion of companies subject to the classic split between management and a dispersed ownership. In all three cases, cooperative relationships between agents from different institutions which are not mediated through market transactions play a vital part in arguments identifying growth-enhancing institutions. It has been argued that differentiated business strategies across the advanced countries have emerged in the past decade as a consequence of developments in microelectronics and of the increased competition from the so-called Asian miracle economies. These economies have succeeded in a sustained process of switching their workforce from less to more sophisticated products (Uucas, 1993). 6.2

The core institutions of the German model: industrial relations, vocational training and the financial system

6.2.1 Industrial relations The economics literature on the relationship between industrial relations institutions and growth is not well developed. However, Lancaster's (1973) model of the dynamic inefficiency of capitalism provides insights into the implications for growth both of the conflict between labour and capital and of inter-union rivalry. Lancaster was concerned with the first issue. He set up the problem as a differential game in which capitalism was characterized as a dynamic conflict: 'Each group has control over one key variable - the workers over their consumption in each period, the capitalists over the rate of investment - but the outcome for both groups depends on the other group's decision variable as well as its own' (1973: 1096). The dynamic inefficiency arises because the workers' wage-setting decision (consumption in each period) is separated from the capitalists' investment decision. The model suggests that, under circumstances of incomplete information, wage decisions may depend on the confidence of the union that consumption forgone will

West German growth and institutions, 1945-90

485

actually be invested. 4[O]ne way of reassuring them on this point is by granting them institutionalized influence on the management of the enterprise' (Streeck, 1984b: 147). The access to information and rights of consultation of works councils and of the employee members of the enterprise supervisory board under the provisions of co-determination in West Germany can therefore be interpreted as a means of mitigating dynamic inefficiency. Pohjola (1984) has extended Lancaster's model to consider the effects of union rivalry on growth. In this case, the 'capitalists' are modelled by an investment machine which automatically invests output which is not consumed. The dynamic inefficiency now arises because independent wage setting by the rival unions will result in a shift to setting the highest level of wages earlier than would occur under a collective union decision. The reason for the lower than optimal growth is fundamentally the same as in Lancaster's model: the inability of one group to ensure that its decision to postpone consumption will actually be translated into investment. Centralizing the bargaining structure is an obvious way of eliminating the externality. But for Germany, the relevant question is how to explain coordinated wage setting in spite of the formal location of wage negotiations at industry level (Soskice, 1991). In brief, the method of wage setting in Germany has operated to coordinate private and public sector wage increases so as to protect international competitiveness; to regulate differentials between skill categories in the industry agreements; and to permit limited flexibility via the 'second round' of wage setting at local level. It has been suggested in a repeated game context that one influence on whether cooperative play is forthcoming from different unions is the level of inflation (Pohjola, 1992:69-70). In a low-inflation environment the costs of cheating are higher, since it is easier to distinguish exogenous price shocks from those associated with one union cheating on the wage agreement. This argument provides a link from the independence and statutory obligation of the Bundesbank to maintain low inflation to cooperative (growth-promoting) behaviour between unions. 6.2.2 Vocational training New growth theory (e.g. Romer, 1989; see also Scott, 1989) highlights the contribution which investment in human capital can make to growth. Problems of data availability have meant that empirical tests of the role of human capital in comparative growth have typically been limited to schooling variables. But the distinctive feature of human capital formation in the German economy, especially as compared to the UK and the USA, is the extensive vocational training system. Twelve years after leaving school, 80 per cent of Germans had received a training certificate or post-secondary education degree, and almost all of the remainder had received some formal post-secondary education or training (Buechtemann et al, 1993: 101). In a series of plant-level comparisons of industrial productivity between Germany and the UK carried out at the National Institute (Daly et al., 1985; Prais et al, 1989; Steedman and Wagner, 1987, 1989; Mason et al, 1993), Vocational training has emerged as a prime candidate in explaining persistent productivity differentials. In particular, it is the delivery by the system of broadly based intermediate skill levels which marks it out from the US and UK systems. Support for the results of the

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Table 15.12. The transition from school to work: comparison between Germany and the USA School-leavers in training and further education n years after leaving school (% of cohort) 1 year 4-5 years 12 years Germany USA

79.0 33.6

40.7 9.3

3.9 5.5

School-leavers unemployed n years after leaving school (% of cohort) 1 year 4-5 years 12 years Germany USA

3.9 9.7

1.9 11.9

3.0 4.6

Matching of skills acquired with skills required by the job five years after leaving school Germany % of school-leavers in jobs requiring the specific occupational qualification they were trained in 70 USA

% of school-leavers in jobs requiring: only brief on-thejob training

6 months on-thejob training

some post-school training

20

55

25

Memorandum items (ave. 1980-90) Youth unemployment (% total unemployed less than 25 years) Germany USA EC

24.6 39.3 41.8

Standardized unemployment rate (%) 5.8 7.0 9.5

Source: Buechtemann et al. (1993: tables 1, 3a, 4b-c, pp. 105-6); OECD, Historical Statistics 1960-1990, table 2.19. plant-level comparisons has been provided by the econometric estimates of O'Mahony (1992b). Using ad hoc growth accounting methods following Denison, van Ark and Pilat (1993) find that the German labour quality index for manufacturing is 96.5 per cent of the USA on the basis of educational qualifications, and rises only marginally to 98.5 per cent when an adjustment for vocational qualifications is made. In these calculations, the higher proportion of college-educated employees in US manufacturing outweighs the effect of German vocational training. More research is required on the contribution of different types of education and training to on-the-job learning and productivity, not only in manufacturing but also in the service sector. The panel data study of Buechtemann et al. (1993), which includes non-manufacturing as well as manufacturing jobs, compares German and US labour markets. It provides

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487

evidence, albeit indirect, on whether the Germany system 'provides for a better allocation and utilization of labour through producing more standardized, portable workforce skills and sending clearer signals about acquired skills and corresponding productivity potentials to employers' (1993: 103). Table 15.12 suggests a more efficient use of labour in the years following school in Germany. This is reflected at the aggregate level in Germany's relatively low youth unemployment. A majority of those undertaking training in Germany find employment in jobs requiring those qualifications. By contrast, three-quarters of US school-leavers in work five years after leaving school were in jobs requiring at most six months' on-the-job training. The provision of marketable skills to an unusually broad section of the workforce in Germany can be explained by the presence of a set of specific institutional arrangements (Soskice, 1992). For the German system to work, it must provide incentives for school-leavers to work hard at school in order to compete for apprenticeships; for apprentices to contribute to the cost of training through low training wages; and for firms to offer and partially fund training places, and to be willing to have their standards of training supervised. To create these incentives, institutional arrangements include the division of responsibilities between the state, business, unions and individuals. The state contributes to thefinancingof training through the provision of vocational schools in which apprentices spend one or two days per week. It also establishes national standards for vocational qualifications. Unions and employers' associations cooperate closely in defining the detailed content of apprenticeships and in setting low training wages. The monitoring of training standards within companies is the responsibility of the local chambers of industry and commerce. This system helps overcome the unwillingness of companies to allow government officials close access to the details of production and other business activities. The wage-setting system and monitoring by works councils prevents employers from poaching trained workers and, by eliminating the free-rider problem, creates incentives for firms to contribute to investment in training. The legal protection of the artisanal (Handwerk) sector plays a vital role in the supply of training places at the bottom end of the ability scale (Steedman, 1993). To secure a sufficient demand for apprenticeships by young people, there is a hierarchy of apprenticeships according to the quality of the internal labour market to which the training place provides access and the value of the training in the external labour market. 6.2.3 Finance and industry A literature has recently developed proposing that the financial sector can have a large effect on productivity-enhancing investment, which, via the new growth theory, can have a large effect on growth (Bencivenga and Smith, 1991; Roubini and Sala-i-Martin, 1991). King and Levine (1993) sketch an intuitively appealing route through which financial markets can affect investment. In the traditional view, financial intermediaries are passive processors of financial surpluses from the household sector to the enterprise sector. The 'new view of finance' sees financial intermediaries as active participants in the shaping of industry. An efficient financial system will permit the evaluation of ideas without allowing those ideas to be appropriated by competitors, and it will be able to evaluate investments including

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those in intangible capital goods and deal with the problem of the poor quality of collateral for such investments (King and Levine, 1993: 159). Thus countries with better-functioning financial systems will allocate savings to higher-productivity projects, which in turn will raise growth. The testing of such theories econometrically is in its infancy (see King and Levine (1993) and the comments on their paper by Gertler and Roubini). The variables used to measure the financial system seem too crude to help identify if there are differences between the relative efficacy of financial systems in the different advanced economies. However, with the notion of a set of linkages from the financial system to comprehensive capital formation to growth in mind, one can turn to the long-standing debate about the relative merits of the Germanfinancialsystem. Many industrialized economies are characterized by what can be described as 'insider'financialsystems (Corbett and Mayer, 1991; Franks and Mayer, 1992), in which external markets for corporate control are not relied upon to enforce efficient behaviour on the managers of firms through the threat of hostile takeover. In the German system (a classic 'insider' one), large companies have a supervisory board obliged to monitor the management board (Schneider-Lenne, 1992). Important shareholders (other companies and banks) and stakeholders (employees, other companies (suppliers and purchasers), and banks) are represented on the supervisory board. Moreover in Germany, a far smaller part of the business sector is characterized by the classic separation of ownership and control than is the case in the UK. The classic separation occurs in the joint stock public company. In Germany only about one-fifth of turnover in the economy is accounted for by public joint stock corporations (AGs). This contrasts with the UK, where at least 53 per cent of turnover is accounted for by public companies. Even in public companies, shareholdings are much more concentrated in Germany than in the USA or UK. In the 200 largest listed Germany companies, almost 90 per cent offirmshad at least one shareholding of at least 25 per cent. In the UK, by contrast, in more than four-fifths of the largest 200 listed companies, the largest shareholding was below 25 per cent. The striking feature of ownership of large companies in Germany is not ownership by the banks, but the extent of cross-ownership between non-financial companies (Franks and Mayer, 1992). Although the strong position of Andrew Shonfield (1965) that German banks plan industrial development cannot be sustained, it can be argued that the 'insider' financial system promotes investment in human, intangible and physical capital that is specific. to enterprises and their long-term relationships with related companies. Difficulties with realizing the value of such investments in the event of a change of ownership deter investments of these kinds in economies with outsider financial systems (Mayer, 1993; Kester, 1992; Porter, 1992). The advantages of such relationships lie in their ability to foster long-term investments which are relationship-specific - overcoming problems of opportunism which bedevil market transactions, especially in relation to investment in intangibles such as human capital and research and development, where the costs of writing complete contracts are prohibitive (Williamson, 1985). What role do the banks play in sustaining such relationships? The attempted Americanization of the German banking system following the Second World War was unsuccessful. The US occupation authorities did not succeed in their attempt to

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implement a 'Glass-Steagall' separation of commercial from investment banking. They managed to break up the three large banks on a regional basis, but only until 1958. Contrary to common perceptions, the German banking system is not highly concentrated. The 'big banks' in West Germany accounted for only 12 per cent of bank lending to non-bank enterprises and the self-employed in 1988. The state-owned savings banks and credit cooperatives accounted respectively for 35 per cent and 16 per cent of loans to enterprises in 1988 (Edwards and Fischer, 1993: tables 5.1,5.4). Both the large banks and the savings and cooperative sector banks play a part in corporate governance in Germany's 'insider system'. Although holding only a modest proportion of the entire market for loans, the big three banks maintain a far greater web of connections linking them to the governance of large German firms (through ownership of shares, control of voting rights, representation on supervisory boards and syndication of new share issues: see Edwards and Fischer, 1993: tables 5.4^5.8, 9.3). For small and medium-sized firms, relationships with banks are not cemented by cross-ownership or membership of supervisory boards. Rather the savings and cooperative banks - for which counterparts do not exist in the UK - appear to form long-term relationships with their clients which are not found between small and medium-sized enterprises (SMEs) and banks in the UK (Harm, 1991; Deakins and Philpott, 1993). One explanation for this is that the regulated 'local embeddedness' of the savings banks (whereby banks are limited to a region and hence often to the fate of a limited number of industries) means that they have an incentive to concentrate on long-term relationships with their local customers. Early in German industrialization, bank coordination of industry took place through direct channels of supervisory board membership and bank ownership stakes in industry. More recently and especially in the past decade, technological advance has reduced the feasibility and importance of direct monitoring. German banks reduce informational asymmetries not by having tremendous industrial expertise, as was the case before the First World War, but by their use of reputational monitoring. Indirect or reputational monitoring has replaced direct monitoring as banks make use of inside information on companies gathered by other related companies, other banks and employers' and industry associations (through their training, technological transfer and export marketing activities) (Soskice, 1993:26). Related companies have an incentive to tell the truth to the bank, since they have their relationship-specific investments at stake if the bank were not to know some 'bad news' about the company and fail to take corrective action.9 From this perspective, German 'long-termism' should be interpreted in terms of non-market relationships between companies and other companies, employees, bank(s) and institutions such as vocational colleges, industry associations and chambers of commerce. This interpretation provides a way of understanding the less than whole-hearted embrace by German business of financial and labour market deregulation in the 1980s. 7

West German growth - what does it tell us about the prospects for growth in East Germany?

In the midst of the euphoria of German reunification in 1990, allusions were made to the currency reform in 1948 and the Wirtschaftswunder of the 1950s. Such parallels

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proved potent politically. But in historical and economic terms, a parallel is scarcely discernible. As argued in section 3, in 1948 the currency reform clarified existing property rights and gave business the confidence to deepen the recovery process already under way by embarking on forward-looking decisions. Two more factors were identified as critical in turning the recovery into self-sustaining growth: production was highly profitable and the Korean War boom fostered favourable expectations of a rapidly growing demand for German output, especially capital goods. Large, well-established German companies picked up the threads of long-established markets. The situation facing the state-owned enterprises of the GDR in 1990 was very different. Reunification brought with it dramatic wage increases for East Germans, which rendered unprofitable the great majority of enterprises in the tradable goods sector (Akerlof et al, 1991). The organizational form of large enterprises was designed to fit an allocation system and an international division of labour unrelated to market incentives. Large-scale restructuring of enterprises was required, as well as finding new owners and new markets (Carlin and Mayer, 1992). East Germany is likely to defy the pessimistic 42 per cent convergence rule' (Barro and Sala-i-Martin, 1991), which would predict convergence of East to West German living standards in no less than seventy years. But this will be a result of mechanisms quite different from those underlying West German supergrowth in the 1950s. For East Germany, the extremely high investment share (if maintained) of 45 per cent of GDP (and 25 per cent of GDP for business equipment investment) is central (Dornbusch and Wolf, 1994; Burda and Funke, 1993). The key difference from the postwar period is that this investment is coming from outside the East German economy. The emphasis in sections 5 and 6 on West Germany's institutional structure and the way it has affected business strategies in the 1980s provides a note of caution to the optimism engendered by the scale of investment in East Germany. The emergence of microelectronic technology and fast-growing competition in sophisticated manufactured goods revealed differential adaptation patterns within the advanced economies. Germany's institutional rigidities of employment protection, highly structured wage setting and compulsory consultation by management with the workforce ruled out adaptation through cost-cutting strategies, and forced companies to move into high-value-added products and processes (Sorge and Streeck, 1988). By the same token, the West German institutional structure makes possible forms of innovation which are not available to economies which are unable to sustain long-term relationships between companies, their employees andfinancialinstitutions. The regions of East Germany are obliged to operate under the labour market and other forms of regulation transferred from West Germany, and will not have the option of being a low-wage economy (cf. the Czech Republic). If they are to develop an indigenous economic base and enterprises are not to remain as the 'extended work-benches' of West German companies, then the institutional structure must be created in which the long-term relationships that seem essential to West Germany's high-wage economy can be built up. For example, in the absence of local chambers of commerce which can provide the appropriate monitoring for apprenticeships, this task is being carried out by local governments - much to the distaste of West German companies operating there. There must also be a network of other related

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firms, a local infrastructure for the diffusion of innovations, and stability in banking and business association personnel that is sufficient to enable the development of 'collective knowledge of reputations' (Soskice, 1993). Without these features of a coordinated market economy, East Germany will have little chance of succeeding in the kinds of market that successful West Germanfirmsmoved into in the 1980s. The danger for East Germany is of having only the constraints entailed by German labour and corporate law, and few of the positive externalities associated with that system in the West.

NOTES For useful comments on earlier drafts I would like to thank Andrea Boltho, Nick Crafts, Barry Eichengreen, Andrew Glyn, Tony Nicholls, Karl-Heinz Paque, Albrecht Ritschl and Gianni Toniolo, as well as participants at the CEPR conference on postwar growth in Oxford in December 1993. For their help and advice I would also like to thank Werner Abelshauser, Bart van Ark, Steve Broadberry, Rolf Dumke, David Soskice, Frank Stille and Karin Wagner. 1 Note the contrast between the conclusion about relative German growth performance after 1973 using these comparative growth equations, and Giersch el a/.'s characterization using the raw GDP growth rates: 'as all could now see, West Germany gradually turned into a laggard in the international growth race, with the lowest real GDP growth of the six largest industrialized countries' (1992: 185). 2 A good collection of papers in English by the major participants in the debate is von Kruedener (1990). 3 For a fascinating analysis of contemporary proposals to boost profits and stimulate investment through the use of tax credits, see Kalecki (1932) and Rustow (1978). 4 Some doubt is cast on the decline in manufacturing TFP growth by the disaggregated analysis of Flaig and Steiner (1993). Examining TFP growth in 25 of the 31 two-digit branches of West German manufacturing industry over the period 1961-85, they find a trend neither in conventional TFP nor in their measure of TFP adjusted for capacity utilization and economies of scale, and no structural break during the period. 5 The increased duration of spells of unemployment in the 1980s in Germany is partly accounted for by this pattern (Schettkat, 1991:146-7, 181-2). 6 Given the productivity level data, it is also hard to reconcile the profitability data with the estimates for compensation per hour in manufacturing reported in Hooper and Larin (1989): they suggest that hourly compensation in Germany was 27 per cent above that in the USA in 1988 and 25 per cent above in 1979 (table 1, p. 341). 7 See Carlin and Soskice (1990) for a theoretical discussion of this open economy concept. 8 Pilat and van Ark (1993), however, do not believe that improved price indices would substantially alter their conclusions about comparative productivity levels. 9 This suggests that the conclusions of Edwards and Fischer's study (1993) should be interpreted with caution. They are unable to substantiate empirically the existence of two specific channels through which German banks enhance the performance of large German companies. Their work focuses on patterns of direct monitoring (to alleviate asymmetric information problems and to monitor

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managerial behaviour on behalf of the owners) in large public companies. They do not address the broader context of the financial system in Germany and the UK (including the small and medium enterprise sector), or the issue of indirect reputational monitoring.

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16 An exercise in futility: East German economic growth and decline, 1945-89 ALBRECHT O. RITSCHL

1

Introduction

Social experiments do exist. Divide a country in such a way as to create a rich mix of industries, of natural resources and of human capital in either part. Then isolate both halves from one another and expose them to entirely different sets of economic policies. After forty years of experimenting on various stages, just lift the barriers again and let markets decide on the final outcome. This, in short, is what shapes the economic history of East Germany. It sets the frame for the questions to be asked of East Germany's economic record. In what respect were the starting conditions for East Germany different from those of the West? When did East Germany experience prosperity, and what were the principal moving forces behind it? And are there obvious economic reasons for the final demise of Communism on German soil? Observers have often pointed to the general inefficiency and backwardness of Communism as the principal explanation. Though this is evidently true, it is also superficial. In history, backwardness itself has not necessarily been unstable; nor have phenomena like massive state intervention or the lack of political freedom. This chapter is intended not to give easy answers, but to attempt to set a framework for asking these questions in a more specific way. There are two reasons for this limitation. First, existing literature on East German economic growth is only scattered and still quite small. In what follows, it will be attempted to draw some of the literature together and to review the bits of available evidence. Second, methodological problems arise in dealing with the growth record of a Communist economy. Many of these will be disregarded in the following, and standard techniques will be used. However, existing figures often cannot be taken at face value, and data quality is discussed whenever possible. As revised macroeconomic data are still scarce, future research needs to be directed towards elaborating a more reliable database. The subsequent, still very tentative remarks are organized as follows. Section 2 gives a quick overview of macroeconomic performance. Section 3 turns to the experience of the 1930s and the starting conditions around 1950. Section 4 reviews 498

East German economic growth and decline, 1945-89

499

evidence on East German productivity performance around 1950, arguing for an emerging productivity gap vis-d-vis West Germany in that very period. Section 5 gives a brief review of the East German transition to Communism and idiosyncrasies of its planning system. Section 6 examines the record of the 1950s. In section 7, the Not-So-Golden Age of the 1960s is reviewed. Section 8 turns to what could be termed the Golden Seventies, a phase of continuously increasing living standards that has little reflection in Western European performance. Section 9 traces the gathering storm, or the advent of the economic conditions that contributed to the collapse of the old system in late 1989. Section 10 gives a brief retrospective of the economic aftermath of unification, trying to identify some of the motives that guided German economic policies during 1990, and section 11 concludes. 2

Macroeconomic performance: a brief overview

Assessing the growth and productivity record of East Germany depends heavily on the data employed. Official figures for East Germany put annual growth of output since 1950 at about 5.6 per cent. By comparison, the respective figure for West Germany is around 4.5 per cent. If East German official data were true, East Germany would have easily caught up with West German productivity and living standards, and the revolution of 1989 would probably not have occurred. The notion that East German output data were often fabricated was common to West German debates in the 1950s. This changed during the late 1960s when West Berlin's Deutsches Institut fur Wirtschaftsforschung(DIW) started reporting on the East German economy using official figures. In the 1970s, the view became dominant that both German economies grew at similar rates, although a productivity gap of roughly one-third was assumed to still exist (DIW, 1971). This observation was placed in the context of general disillusionment about the sources of West Germany's Wirtschaftswunder. Conventional wisdom had mostly seen postwar recovery in West Germany as a lucky combination of German work ethics, market-oriented policies and Marshall aid. In contrast, revisionist interpretations emphasized that West Germany's Wirtschaftswunder was just part of a common European trend (Janossy, 1966; Abelshauser, 1975, 1981). The evidence presented by Janossy seemed to indicate that a sort of economic miracle had occurred in Communist Eastern Europe as well. Even worse, Janossy had argued forcefully that postwar recovery would soon be over and that a general productivity slowdown would follow, irrespective of prevailing economic systems. His argument, which anticipates Abramovitz's (1979,1986) catching-up hypothesis, induced West German writers (Manz, 1968; Abelshauser, 1975; Borchardt, 1991) to de-emphasize the role of institutional change in explaining postwar growth.1 Evidence on East German economic growth is presented in Table 16.1. Table 16.1 rests on three different estimates of East German output and productivity performance. The first (column I), derived from GDP estimates by Merkel and Wahl (1991), appears to be the most useful one. The second, rather more optimistic estimate (column II) is based on official data of aggregate output. The reason for the discrepancy is that official output data for East Germany exclude the service sector, as published national accounts followed the MPS system which focuses on manufacturing and resource extraction. Merkel and Wahl (1991) have

500 Albrecht O. Ritschl Table 16.1. Growth ofper-capita output and productivity: East Germany and West Germany, 1950-89 East Germany

1950-60 GDP or national income per capita Labour productivity TFP growth 1960-73 GDP or national income per capita Labour productivity TFP growth 1973-9 GDP or national income per capita Labour productivity TFP growth 1979-89 GDP or national income per capita Labour productivity TFP growth

West Germany III (pessimistic)

I (plausible)

II (official)

5.8 4.4 4.0

10.8 9.4 9.0

3.5 2.8 2.9

7.1 5.7 4.4

3.8 3.5 2.4

4.7 4.4 3.3

2.9 2.6 1.8

3.9 4.1 2.3 (3.2)

3.9 3.0 1.9

4.8 3.9 2.7

2.7 1.8 1.0

2.5 2.6 0.9 (1.3)

2.7 2.2 1.2

4.1 3.9 2.6

0.5 -0.2 -0.5

1.6 1.3 (1.8) 0.6 (1.0)

Note: All data refer to annualized percentage growth rates. Sources: East Germany I Based on SNA-type GDP per capita and per person employed. Calculated from Merkel and Wahl (1991: table 7). II Based on MPS-type produced national income (excluding services) per capita and per person employed. Calculated from offical East German data in Statistisches Amt der DDR (1990: 14). Ill Based on SNA-type GDP at West German Deutschmark values. Calculated from Merkel and Wahl (1991, table 7). West Germany Calculated from Statistisches Bundesamt (1993a, tables 24.2, 22.2; 1993b, table 1). Bracketed figures are per person-hours worked, using spread between monthly and hourly wages (Sachverstandigenrat, 1991, table 77, rows 6 and 10) as proxy for labour time change. argued that, because of ideological emphasis on physical goods production, the service sector was systematically neglected and grew more slowly with regard to both size and productivity. Adding estimates of output in the services sector, they arrive at a GDP series which underlies column I. These data suggest that growth was much slower than indicated by the MPS-type figures underlying column II. Taking the average for the whole period 1950-89, this revision would put annual

East German economic growth and decline, 1945-89

501

growth at 3.77 per cent instead of the 5.62 per cent given by the official data. Accordingly, growth of labour productivity and TFP is remarkably lower, the latter dropping to less than 2 per cent per annum in the post-1973 period. The third estimate (column III), again based on estimates of Merkel and Wahl (1991), gives growth evaluated in West German Deutschmarks. The rationale for this is that, due to quality deterioration and disguised inflation, the external value of East German output declined steadily (see section 7 for more on this). The procedure of applying an overall imputed exchange rate to GDP is obviously questionable, as Deutschmark prices of East German non-traded goods are hard to determine. However, results are not entirely implausible. The Deutschmark deflator for East German domestic product applied by Merkel and Wahl drops by about 50 per cent during the postwar period. Annualizing, this would put the average inflationary bias in East German growth data at 1.78 per cent per annum, which appears to be a fairly reasonable estimate (see section 7). Data in column III would indicate that all was not well with East Germany's performance from the very beginning. According to them, TFP growth was already below 2 per cent during the 1960s, and in the 1980s it even became negative. In sum, column III appears to provide a lower bound for the range of plausible growth paths. Comparing with West German data, much depends on the standard adopted. Judging from official figures, East Germany outperformed the West during the whole period, with regard to both overall growth and productivity. This result has been refuted even by former members of East Germany's State Planning Commission (Kusch et al., 1991). Accounting for East Germany's stagnant service sector, as in column I, East Germany looks worse than West Germany during the 1950s and 1960s, but manages to catch up a bit thereafter. Accounting for East Germany's worsening terms of trade, this impression changes, and during the 1980s, productivity growth even becomes negative. We note in passing that from 1973 on, West German productivity performance is remarkably poor as well, even if the trend reduction in West German working hours is accounted for. Table 16.1 also reveals that, despite their vastly different economic policies, both parts of Germany underwent fairly similar patterns of growth and productivity slowdown, whatever the true growth figures for East Germany. During the 1950s, this was hardly anticipated. East Germany's economy wrestled with high rates of migration into West Germany, to the effect that in the period from 1949 to 1960 population decreased by more than 10 per cent. Table 16.2 reports on population and the labour force in East Germany. Table 16.2 shows that the effects of both emigration (prior to 1961) and population decline were more than offset by an increase in the labour force arising from a spectacular surge in female labour force participation. During the early 1970s, East Germany had an international record low of fertility, which has generally been attributed to East German labour policies. From the mid-1970s on, pro-natal programmes were launched, expanding the already elaborate network of free daycare and kindergarten facilities, but including also preferential allocation of housing to families with children. In a cohort analysis of East German fertility, Dinkel (1984) has argued that, although these policies -failed to offset fertility reduction completely, marked effects on reproductive behaviour resulted. From the last column in Table 16.2 it becomes apparent that, before the unification, virtually

502 Albrecht O. Ritschl Table 16.2. Population and the labour force: East Germany, 1950-89 Population Employment0 (000s) (000s)

1950 1960 1973 1979 1988 1989

7196 7686 7844 8184 8594 8547

18 360 17188 16951 16740 16675 16434

5

participation (%) Male

Female

82.1 85.3 80.7 77.7 77.8 78.4

44.1 61.9 77.5 78.0 81.0 82.3

Share of children in kindergarten0

20.5 46.1 76.7 92.3 94.0 (94.2) 95.1 (95.3)

a

Excluding employment in army, police and state security, etc. (c. 800 000) and vocational trainees (c. 300000). ft As percentage of labour force aged 15-65 (males) and 15-60 (females). c Definition of kindergarten age changed in 1985. Bracketed term for 1989 is calculated according to previous definition. Source: Zentralverwaltung fur Statistik (1975), Statistisches Amt der DDR (1990). Table 16.3. Human capital investment in East Germany, 1950-89 (% of age group 15-21 years) Enrolment in vocational training 1950 1960 1973 1979 1989

24.2 21.0 29.5 29.3 27.9

Size of

Graduates from Fachschulen

Hochschulen

15-21 (000s)

0.5 1.7 3.0 2.3 3.3

0.2 1.0 2.1 1.4 2.0

1592.7 1461.0 1570.6 1707.5 1211.6

Source: Statistisches Amt der DDR (1990). all children in East Germany attended nursery schools. East Germany thus invested a lot to increase the number of persons employed. Combining this evidence with TFP data from Table 16.1, it becomes apparent that, even during the 1950s, growth of domestic output in East Germany was largely on the extensive margin. Investment in human capital, which was generally at a high level, peaked in the mid-1970s and experienced a certain decline thereafter. This is mostly due to population decline. Therefore, data adjusted for cohort size exhibit a more even pattern (Table 16.3). During the 1950s and 1960s, all parts of the educational sector expanded rapidly. Since, before the erection of the Berlin Wall in 1961, high emigration rates prevailed among educated young people, this policy failed to translate into higher per-capita levels of human capital. Assuming that human capital formation is a factor of production, the erection of the Berlin Wall should, therefore, have helped to boost productivity. In the context of Table 16.1 above, this

East German economic growth and decline, 1945-89

503

Table 16.4. Estimates of comparative East German levels of productivity (West Germany = 100) High 1950s

Low

78 44

1960s

67-78

1970s

63-70

34 46 33 1980s

1991 1993

54 103 80 61 47 41 29 29 13-30 40-60

Source Melzer (1980) Merkel and Wahl (1991) DIW (1971), Wilkens (1976), Melzer (1980) Merkel and Wahl (1991) Wilkens (1976), DIW (1979), Melzer (1980) DIW (1987) Merkel and Wahl (1991) Collier (1985) CIA (1986) Summers and Heston (1988) Gorzig and Gornig (1991) DIW (1987) Gorzig (1992) Merkel and Wahl (1991) Beintema and van Ark (1993) i Sachverstandigenrat (1993)

would introduce upward bias into Solow-type TFP estimates for the period from 1960 on. However, as can be seen from Table 16.1, East Germany experienced a drop in TFP that was at least as large as in West Germany for the same period. During the decade between 1979 and 1989, the total number of 15-21-year-olds decreased by roughly 30 per cent. This is reflected in a similar drop in vocational training participation, which is the lowest category of secondary education. In contrast, graduation from professional Fachschulen colleges and from Hochschulen, or universities and other advanced schools, even increased during that period. In the aggregate, per-capita human capital appears to have increased throughout the decade, which would imply that human-capital-adjusted TFP growth was even lower than the Solovian calculations of Table 16.1 would suggest. Numerous attempts have been made to compare East Germany's productivity performance directly with West Germany. Calculations made during the 1970s put the comparative productivity performance of East Germany in a rather optimistic perspective, possibly reflecting wishful thinking under the influence of political detente. After the unification of 1990 and the subsequent slump of East German output, a series of downward revisions of productivity estimates set in. Data are presented in Table 16.4. Starting with a high of over 100 per cent in a CIA publication of 1986, estimates of comparative East German productivity performance range from over 70 per cent of West German levels in the early DIW studies (which also include Wilkens (1976) and Melzer (1980) to around 40 per cent in DIW's most recent release (Gorzig, 1992) and a record low of only 29 per cent in studies of Merkel and Wahl (1991) and Beintema and van Ark (1993). Whatever the true figure is, data appear to confirm the impression from Table 16.1 that the gap between West and East

504 Albrecht O. Ritschl

Germany was never closed and possibly even widened again during the 1980s. Downward revisions of East German output and productivity figures have also been made for the post-unification period, which confirms the more pessimistic views on East Germany's pre-unification performance. Comparisons at industry level recently released by the Sachverstandigenrat (1993: 82) show productivity to have been consistently below 30 per cent of comparative West German levels in 1991, with a recovery to around 40-60 per cent in 1993. 3

The legacy of the 1930s and the war: how bad a start?

To explain the economic backwardness of their country, Marxist-oriented East German writers (e.g. Neumann, 1980; Barthel, 1979; Roesler et a/., 1986) have often pointed to unfavourable initial conditions that gave the later GDR's economy a bad start. Three frequently mentioned reasons are disproportions of East Germany industry, wartime destruction of productive stock, and reparations to the Soviet Union and it satellites. As far as disproportions are concerned, lacking capacities in heavy industry are said to have hampered growth by creating bottlenecks that were difficult to overcome. According to this view, the predominance of light industry in East German manufacturing created disproportions that rendered a significant part of East Germany's capital stock almost useless. Western writers have commonly refuted this view, pointing to the possibilities of international trade and the principles of comparative advantage (see, for example, Stolper, 1960). In what follows, yet another perspective will be adopted. It shall be argued that, with regard to both natural resources and industry structure, the initial endowment of the GDR was in many respects almost optimal for the autarky policies intended. Possibly it was not so much lack of heavy industry but rather the ideological fixation on heavy industry that created disproportions in GDR output and possibly led to insufficient growth. East Germany had inherited a relatively rich mix of industries from Nazi Germany, ranging from innovative industries like Saxon machine tools, the Berlin electronics and communication industry, and the Dessau and Rostock-based aircraft, jet and rocket propulsion plants, to the large organic chemical industry complex around Leuna and Bitterfeld. Natural resources included Europe's largest supplies of brown coal and substantial deposits of copper and other non-ferrous metals. This composition of industry on GDR territory in 1945 was not just the outcome of a market process. Rather, it emerged from conscious decisions under Nazi economic planning - and in some cases from the war economy of World War I. Economic planners had sought to build up a new heavy industry base focused on chemical import substitution industries in central Germany. Being located at the geographical centre of the former German Empire between the cities of Leipzig and Hanover, it would be less exposed to enemy attacks than Germany's traditional industry centres of the Ruhr, and Saar and Upper Silesia, which were all close to Germany's borders. Also, being halfway between the coal basins of the Ruhr and Upper Silesia, it would have access to coal even when cut off from one of these suppliers. And in the worst case, it could still get energy and raw materials from the nearby brown coal fields.

East German economic growth and decline, 1945-89

505

Table 16.5. Output of GDR industry as a percentage share of total output of Postdam Germany, 1944 %

Brown coal Fertilizers Potash Electric power Steel Iron Industry total

66.9 63.0 58.9 34.8 7.9 1.6

28.7

Source: Matschke (1988: 61). Synthetic nitrogen production at Leuna had helped the armies of the Kaiser overcome their shortage of explosives in 1915-16. During World War II, synthetic rubber from Buna and synthetic fuel from a whole number of hydrogen fuel plants in the later GDR kept Hitler's army going and his air force in the air until Allied precision bombing starting in mid-1944 reduced capacities at too fast a rate to repair the damage (see Birkenfeld, 1961). As has become apparent again since the unification of 1990, many of these plants were of little or no use under the conditions of free trade. Indeed, industry had been fairly reluctant to invest in Hitler's autarky programme (see, for example, Hayes, 1987). However, the conditions created by Nazi economic planning were quite favourable for a programme of continued autarky. Table 16.5 highlights some characteristics of the industrial structure of East Germany in 1944. As becomes clear, the weakest part of the GDR economy was the lack of iron and steel capacity. This was due to the fact that, after the war, not all of central Germany's new industrial district came under Soviet control, the Nazi-built steel works and low-grade ore mines of Salzgitter and the nearby Volkswagen car plant of Wolfsburg being only a few miles behind the border in West Germany. Had these been included in the GDR as well, the whole Nazi import substitution industry complex with its built-in division of labour would have been preserved intact for the use of Communist autarky policies. Indeed, war damage was apparently far lower than initially expected. Early studies (Harmssen, 1951) seem to confirm the impression of heavy damage, estimating surviving capital stock after the war at 100 per cent of its 1936 value and the remaining capacity after subsequent dismantling by the Soviets at a mere 50 per cent of that value.2 Later studies, however, have arrived at much more moderate figures, pointing out that high investment during the war had far outweighed the losses due to war damage (see Kupky, 1957; Krengel, 1958). As Table 16.6 shows, recent estimates conclude that, by the end of the war, the capital stock of later East Germany was around 40 per cent higher than in 1936, which comes close to similar data for West Germany. However, what differs between both Germanies is the behaviour of capital stock during the subsequent years of dismantling until 1949. Considerable dismantling of

506

Albrecht O. Ritschl

Table 16.6. Capacity losses due to war damage and dismantling: East Germany and West Germany, 1936-50 (remaining capital stock in manufacturing, 1936 = 100)

East Germany Harmssen Melzer 1936 1944 1946 1948 1950

100 100 50

(a) 100 143 102 103 107

West Germany (b) 100 143 86 89 95

Zank

Krengel

100 138

100 136 116 113 122

80

Note: (a) Including, (b) excluding Soviet-owned SAG companies. Source: Melzer (1980); Zank (1987); Harmssen (1951); Krengel (1958). Germany's armament industry and its heavy industry base had been agreed upon at the 1945 Potsdam Conference on Germany (see, for example, Gimbel, 1976). However, disagreement over the details and the scope of the dismantling programme soon arose among the victorious powers. Difficulties in reaching a consensus were aggravated by the failure of the Germany economy in 1947 to settle on a stabilized growth path. As a result, dismantling programmes were curtailed in the Western zones of occupation from 1947 on, whereas they were continued in full gear in the Soviet zone, the later GDR.3 As a consequence, East German capacity declined more strongly than that of West Germany. By 1948, the year of currency reforms in both halves of Germany, capital stock is held to have decreased to markedly below its 1944 level. As investment rates were minimal in both parts of Germany during 1945-8, most of the capacity loss is due to large-scale dismantling by the Soviets. In West Germany, total dismantling during the whole period amounted to around 1.6bn (US)RM in 1944 prices, or 2.4 per cent of the existing capital stock of 1944, whereas the respective figures for East Germany are 6.4bn (US)RM, or 22 per cent of 1944 capital stock (Melzer, 1980).4 The effects of dismantling were partly magnified by the bottlenecks it created. Although much dismantling concerned armament and its related suppliers, bottleneck industries were affected as well. In the short run, therefore, the remaining production potential was constrained to less than what aggregate data would indicate. A well-known example is the railway system, whose capacity was reduced to almost 50 per cent. Therefore, additional investment (albeit of very high marginal productivity) was required to render existing stock productive again. However, studies of the West German transportation system (above all, Abelshauser, 1975) have argued that, even before the return to free markets in 1948, removal of bottlenecks from the West German railroad system proceeded at an amazing speed and had significant effects on aggregate productivity. Similar observations were made in East German key industries (see Karlsch (1993) for a detailed account of the effects of dismantling on East Germany). The long-term effects of dismantling on East German factor endowment were partly outweighed by labour migration. A massive influx of refugees and expellees

East German economic growth and decline, 1945-89 507 Table 16.7. Population in Postdam Germany, 1939-50 (million)

1939 1946 1950

Total 59.74 64.06 69.18

Western zones 42.99 46.56 50.79

Eastern zones 16.74 18.36 18.39

Sources: Statistisches Bundesamt (1952); Zentralverwaltung fur Statistik (1958). Table 16.8. Capital-labour ratios in German manufacturing, 1950

Capital (bn US DM) Employment (million) K/L (thousand DM)

West 62.46 4.80 12.73

East 28.38 2.24 12.68

Sources: Krengel (1958: 90); Melzer (1980: 36, 58). from the lost provinces of Pommerania, Silesia and East Prussia5 and of ethnic Germans from all over Eastern Europe increased the total population of Postdam Germany6 from 59.74 million in 1939 to 64.06 million in 19467 (see Table 16.7). In the Soviet zone of occupation, population had increased to 9.6 per cent. Thus the increase was slightly larger than in West Germany, where population growth was 8.3 per cent. Mostly this was due to the fact that by 1946 the Soviet zone still held a disproportionately large share of refugees. However, migration continued after 1946, affecting both halves of Postdam Germany quite asymmetrically. As many refugees from the East went on to West Germany: by 1950 the population of West Germany had increased by another 4.2 million people, while population on GDR territory stagnated.8 The overall effect of wartime destruction, dismantling and immigration on East German factor endowment must therefore be split into a pure level effect on the one hand and a structural effect on the capital-labour ratio on the other. Aggregate capital-labour ratios in East and West German manufacturing are given in Table 16.8. As can be seen from the table, there is no visible difference in capital-labour ratios in manufacturing between both parts of Germany. This suggests that the aggregate effects of dismantling on the East German economy must have been offset or even outweighed by migration, to the effect that in 1950, East Germany's per-capita endowment with productive stock was not significantly smaller than in West Germany. Hence, in order to argue that East Germany's starting conditions were significantly worse than in West Germany, one would have to resort not to capital stock, but to human capital embodied in the labour force. However, migration followed the westward route to individual freedom, which East Germany did not provide. Thus, lack of human capital cannot plausibly be considered part of the starting conditions facing East Germany's economy, as it was endogenous to the conditions created by Communist policy. Two things stand out from the discussions in this section. First, the East German capital-labour ratio was not vastly different from that of West Germany. Neither

508

Albrecht O. Ritschl

the losses of capacity nor the gains from immigration had resulted in obvious disproportions between capital and labour that could significantly explain the subsequent difference in macroeconomic performance. Hence, the effects of wartime destruction and subsequent dismantling on capital stock, which have been such a dominant theme in the literature on East Germany, are relevant only with regard to the short-term bottleneck problems they created. With regard to human capital itself, East Germany failed to take advantage of the postwar influx of expellees and refugees. However, this fact was not exogenous to East German policies. Second, with the exception of steel production, East German autarky policies benefited to a considerable extent from Nazi import substitution industries, which had their regional centre on the territory of the later GDR. It seems safe to say that the effects of this on East Germany's endowment far outweighed the adverse consequences of Soviet dismantling on industry structure. 4

The productivity gap in the making, 1945-50

Investigation into East Germany's productivity performance has two different aspects. On the one hand, the standard comparison of productivity with the USA as the international leader in productivity performance could be made. On the other, interest can be focused on a comparison with West Germany as a measure of what East Germany's performance under free market conditions would have been. In asking this question, one would need to have more information on the timing of East Germany's comparative productivity record. Given the results of the previous section, differences in initial factor endowments as a source of the discrepancy may be ruled out. As a consequence, two explanations remain. The first is technical obsolescence that emerged over time, assuming, for example, that technical progress is embodied in either the capital stock or human capital. The second alternative focuses on the inefficiency of a Communist economy in reaching a given production possibility frontier even in the short run. Then, a productivity slump would follow from the very transition to Communist planning itself, regardless of the technical degree of obsolescence of the capital stock. An easy way to isolate these factors from one another is to examine productivity performance in East German industry during the process of transition to Communism. Owing to low investment in both parts of Germany at the time, it can safely be assumed that technological differences played no role. Also, it is plausible to assume that a lack of qualified personnel, which became a problem in the late 1950s, was not yet a major overall difficulty during the first postwar years. To examine East Germany's productivity record in manufacturing, output data are needed. The officially published figures of industrial production for 1950 show an increase to 111 per cent of the industrial output of 1936. If this were accurate, the speed of recovery in East Germany would even have exceeded that of West Germany. For 1958, East German statistics show industrial output to have been at 276 index points of 1936, compared to 232 in West Germany (Stolper, 1960). This is obviously implausible. Contemporaneous observers already presumed that the East German figures gave nominal, not real output (see Griinig, 1950; Gleitze, 1956). Interestingly, this was actually admitted by the East German side (Schmidt, 1953).9 As Zank (1987) has

East German economic growth and decline, 1945-89

509

Table 16.9. Output in East German manufacturing, 1945-50 (1936 = 100) 1946 1947 1948 1949 1950 1952 1955 1958 Plausible Official Stolper (1960)

(I) 46 (II) 42.1 (III)

52 63 75 53.7 71.4 87.2

87 110.6 157 210 266 75.3 95.3 127.1148.8

Sources: (I) Barthel (1979). (II) Zentralverwaltung fur Statistik (1958). Table 16.10. East German manufacturing output per person employed, 1936 and 1950 1936

1950

Total in 000 RM at 1936 prices West

1950 (% of 1936)

4.636

4.544

98.0

4.055 4.055 4.055

3.110 3.954 2.771

76.7 97.5 68.3

East (I) Plausible (II) Official (III) Pessimistic

Relative to West Germany = 100 (I) Plausible (II) Official (III) Pessimistic

87.5 87.5 87.5

68.4 87.0 61.0

(% of 1936) 78.2 99.4 69.7

Sources: See text. argued, there is a structural break in official figures from 1948 on, switching from real output to nominal output. Official data would then describe output correctly up until 1947, but include price changes thereafter. Table 16.9 provides official output data along with more plausible archival data reported in Barthel (1979) and a rather pessimistic estimate by Stolper (I960). 10 In the light of the remaining discrepancies, it shall be attempted to give plausible upper and lower bounds for productivity in East German industry. For this, series I of Table 16.9 is used as a plausible output estimate, with Stolper's pessimistic estimate (series III of Table 16.9) as a lower bound. Both indices were spliced to 1936 value added. West German industry output indices are taken from Statistisches Bundesamt (1952), again spliced to output in 1936. Data for employment and hours worked for a comparable coverage of industry in both Germanies come from Melzer (1980). Results are summarized in Table 16.10, which compares output per person in East German industry in 1950 to West Germany. Inspection of the last column in Table 16.10 shows that in 1950, productivity in East German manufacturing was still at least around 25 per cent lower than in 1936, while at the same time, West German productivity had almost recovered to its 1936 level. Official East German figures, however, would suggest that the speed of recovery was almost identical.

Table 16.11. Company data on East German productivity, 1936-50 (1936 = 100)

Spinning mills Brown coal mines Cable production (KWO) Potash mining Bast fibres Cotton jersey textiles Machine tool builders Printing machines Locomotives and railway cars 1

1943.

1936

1938

1939

1940

1944

1945

1946

1947

1948

1949

1950

100 100 100 100 100 100

_ 100 -

100.7 100 -

— 100 -

104.0 103.5 90.6 88.3 99.5 74.3 83.5°

— 85.6 22.0 7.4 42.6

— 83.6 80.2 48.8 50.4 72.5 53.6 33.7 26.9

81.9 63.0 96.9 46.5 41.4 62.5 53.1 47.5 34.0

— 76.2 97.8 56.1 71.3 39.0

_ _ 126.6 64.5 79.6 45.5

— 143.9 64.9 88.6 -

East German economic growth and decline, 1945-89

511

Looking at productivity relative to West Germany, it can be seen that, in the aggregate of manufacturing, East German productivity was lower than in West Germany even before the war. By 1950, the GDR had apparently lost further ground, the distance increasing by some 20 per cent, or even more if the pessimistic estimate (III) based on Stolper (1960) is believed. Two things stand out from these results. First, by 1950 there existed a sizeable productivity gap that cannot be plausibly attributed to technical obsolescence in East German industry. Second, productivity differences existed even before the war: about 12 percentage points of the postwar productivity difference could be attributed to the prewar gap. It should be noted, however, that these data are not adjusted for composition effects, which might explain part of the bias. As a first step towards correction, the evidence reviewed so far can be supplemented with disaggregate data. East German calculations from archival material (Roesler et al.91986) provide output per person for a variety of industries on either afirmor an industry level. Though not statistically representative and not in all cases property deflated, these data appear to confirm the above results, suggesting that in many industries productivity in 1950 was still around 20 per cent lower than before the war. Results are summarized in Table 16.11. Data in the table, taken from Roesler et al. (1986), seem to bear out two things. First, a slight productivity decline appears to have occurred during World War II. Second, there is a very marked productivity slump after 1945. Apparently, it was overcome only gradually, and dispersion of productivity among the various industries increased rapidly. This latter observation is probably as interesting as the level effect itself, as it can be directly attributed to the idiosyncrasies of central planning in the various different branches of industry. Indeed, surveys made by planning boards and the Soviet economic administration during mid-1947 revealed planning imperfections,fixedprices and, above all, a dire lack of work discipline to be the major reasons why productivity was so unsatisfactory (Miihlfriedel and Wiessner, 1989:76). The evidence of this section thus indicates that East Germany's transition to Communism did indeed have an adverse hysteresis effect on productivity. 5

East Germany's transition to Communism: a brief review

In postwar East Germany, central planning did not have to be introduced by the Communists, as it already existed before. Economic planning during the war had been based, first on an elaborate system offixedprices, second on cost accounting regulations, and third on a system of circulating partly tradable ration coupons, from which a given producer would receive supplies in proportion to the output he passed on to his downstream customer. The assignment of these tickets was left to committees of industrialists, who bargained with the Central Planning Bureau over targeted output rates. However, the Soviet administration and later the GDR did not base their own planning system on the structures left by Nazi planning boards. Instead, these were dissolved entirely and central planning rebuilt from scratch. Only a few weeks after the surrender of Nazi Germany, the Soviets had created both a Soviet Military Administration (SMAD) and a body of German economic planning boards. Being interested both in appeasing the German working class and making resources available for economic reconstruction in the USSR, the Soviets initially managed to

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Albrecht O. Ritschl

revive industrial activity in their zone at a faster rate than did the Western Allies. Large parts of heavy industry were nationalized and put under provisional control of local and regional Treuhand agencies, the control of individual plants being given to often spontaneously formed workers' councils and initiatives. In Saxony, nationalization of industries according to a specified list was accepted by the population in a referendum of 30 June 1946, with a reported majority of 72.7 per cent in favour of the proposal. By the end of 1948, about 40 per cent of East Germany's industrial capacity is said to have been nationalized; most of it was subsequently reorganized in the form of Volkseigene Betriebe (VEB). To this was added another 20 per cent of industrial capacity put under direct Soviet control as Soviet joint stock companies (SAG), using the legal framework of Germany's joint stock company law of 1937. The decisive steps in Soviet policies towards nationalization and increased production were apparently taken in early 1947 (see Karlsch (1993) for a detailed account) as a reaction to inter-Allied struggle over the German reparation issue (on the latter, see Gimbel (1976)). In March 1947 the SMAD allowed East German industry officially to exceed the output limit laid down in the inter-Allied Level of Industry Plan of 1946 (see Gillingham, 1991) by three to four times (Miihlfriedel and Wiessner, 1989: 71 f.), whereas similar decisions in the Western zones were only taken half a year later (Berger and Ritschl, 1995). In June 1947, a German central planning board, Deutsche Wirtschaftskommission (DWK), was established by the Soviets and given additional power over the Lander, the state economic administrations that had been established in 1945. Its competences were rapidly increased and control over nationalized industry was brought into its final shape when the Soviets left the Berlin Control Commission in early 1948. Soon after, separate monetary reforms were implemented in the Western zones on the one hand and the Soviet zone on the other. The subsequent Soviet blockade of West Berlin marked the true beginning of Germany's division. It was followed by a Western embargo and, consequently, a breakdown of interzonal trade with West Germany, which apparently caused severe shortage of essential supplies to East German industry, and thus a reorientation towards increased autarky and also towards economic integration with Eastern Europe (Neumann, 1980). At the same time, the DWK implemented its first aggregate plan for the second half of 1948, followed by a biannual plan for 1949-50. After the GDR was founded formally, the DWK was converted into a number of ministries for industry. Central coordination was placed in the hands of a ministry for planning that was soon renamed Staatliche Plankommission (State Planning Commission), which existed up to 1990. The German planning boards created by the Soviets were apparently not free to choose their planning methods, bound first by socialist ideology in general and second by the planning practices of the SMAD. Nazi economic planning had typically worked backwards from final products to upstream supplies without overall frames, giving more political weight to downstream producers. In contrast, the SMAD imported the USSR-type rationing planning system that favoured primary suppliers over light industry. Also, the ideological approach to motivating workers and increasing productivity was imported from Russia. The East German publication of Barthel (1979: 138) is a typical, surprisingly recent praise of the efficiency of Stachanov-type pioneer worker methods.

East German economic growth and decline, 1945-89 Table 16.12. East German reparations to the USSR (bn

1945 1946 1947 1948 1949 1950 1951 1952 1953 Total

(1) 2.0 3.0 1.0 0.1 — _ 6.1

(2) 0.5 1.5 2.0 2.2 2.2 2.1 2.1 2.1 2.1 16.8

(3) 0.1 1.0 1.5 1.6 1.7 2.1 1.2 1.1 1.2 11.5

(4) — 0.5 0.6 0.5 0.5 0.5 0.4 0.3 0.3 3.5

(5) _ 0.1 0.4 0.6 0.8 1.1 1.6 1.4 1.3 7.3

513

(US)RMIM)

(6) 1.0 2.5 2.5 — 0.6 0.6 0.6 7.8

(7) — 0.1 0.1 0.1 0.1 0.2 0.2 0.2 0.1 1.1

Total 3.6 8.7 8.1 5.1 5.2 6.0 6.1 5.7 5.4 53.9

Note: Deviations in sums due to rounding. (1) Dismantling. (2) Cost of occupation. (3) Reparations out of current production. (4) Transferred profits of Soviet-owned SAGs. (5) Cost of uranium production of Wismut AG. (6) 1945: wild dismantling; 1946-7: seignorage from occupation money issue, etc.; 1951-3: profits from East German buybacks of SAG companies. (7) Subsidies to bilateral trade. Source: Karlsch (1993: 230). Table 16.13. Per-capita consumption in early postwar Germany (1936 = J00)

(a) Grunig (1950) East Germany West Germany East/West (b) Stolper (1960) East Germany West Germany East/West

6

1936

1947

1948

1949

100 100 100

36 52 69

39 58 67

44 75 59

88

51 92 48

1950

1951

75 99 67

90 106 75

The 1950s: an East German Wirtschaftswunderi

At first glance, East Germany's growth record during the 1950s looks favourable. As Table 16.1 bears out, average growth of per-capita GDP during the 1950s may have been around 5 per cent p.a. However, the data hide structural problems that plagued the East German economy and inhibited full reconstruction. Under the first five-year plan from 1951 on, preference was given to investment in primary products and capital goods industries at the expense of consumer-oriented light industry. To a considerable extent, this choice appears to have been dictated by Soviet demands for reparations out of current production, which focused on

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Albrecht O. Ritsch!

intermediate products and capital goods. Until very recently, the quantitative picture of reparations out of current production has been lacking, and the reparations burden has been subject to extended speculation. Early estimates (Bundesminister fiir innerdeutsche Beziehungen, 1985) arrive at a total of 34bn (US)DM for the period from 1945 to 1953, which would be roughly equivalent to East Germany's net national product (in MPS classification) of 1951. Later calculations have tended to produce far higher figures. Recent work by Karlsch (1993) tends to confirm the earlier estimates. Also, it shows that the burden of reparations took rather indirect forms, consisting of items like costs of occupation and uranium deliveries by the Soviet-owned Wismut AG. A breakdown is given in Table 16.12. The single largest item in Table 16.12 is occupation cost, which mainly covered the requirement of Soviet troops (around 450000) stationed in East Germany. Deducting this item from reparations, the total burden would be around 37bn(US)M. Less than 20 per cent of these took the form of dismantling, while the remainder is to be regarded as reparations out of current production in a wider sense. It is noteworthy that the bulk of these came in disguised form, with official reparations (column 3) taking only one-third of the share. As a consequence, living standards in East Germany were initially depressed at very low levels. Table 16.13 gives an overview of estimates of private consumption per capita around 1950. Data in the table exhibit a deterioration of East Germany's relative position in the late 1940s.This is partly a direct consequence of an upward jump in West German living standards after the currency reform of July 1948, which in West Germany was accompanied by large-scale abolition of central planning. Also, a certain catching up with West German standards becomes visible around 1950, as the last row indicates. However, the sources from which Table 16.13 is derived warn their readers against upward bias in East German data arising from quality deterioration and disguised price increases. Insufficient supply of consumer goods, an increase in labour norms (that is, a cut in real wages) and mounting unrest in the population in early 1953 led to a surge in emigration rates, and caused the political leadership to devise a 'New Plan' in mid-1953, cutting back its investment goals. Also, the party admitted policy mistakes and promised a certain reorientation towards the middle class. However, failure to give in on the labour norms issue provoked wild strikes among Berlin workers on the eve of 17 June that soon spread over the whole country. After this revolt, which was suppressed by Soviet occupation troops, the labour norms were soon restored. Perhaps more important, the revolt was also the reason for the Soviets to abandon further reparations (see Lentz (1979) and Buchheim (1990b) for a detailed discussion).11 Contrary to political promises at the time, the principal concentration of efforts on heavy industry at the expense of living standards remained largely unaffected by the events of 1953. This is also reflected in the composition of investment, shown in Table 16.14. As can be seen from the table, the share of investment in the primary goods sector, including mining and energy, shows a remarkable increase over prewar levels from 1951 on. As a long-run consequence, investment dragged in the other sectors, especially in light industry. In the short run, however, there was a major exception to this rule, indicated by a hump in the share of investment in

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515

Table 16.14. Composition of output (Y) and investment (I) by major sectors: East Germany, 1936-60 (%) 1936 Primary goods Metal processing Light industries Total

1950 I

1951 Y

1955

I

Y

59.9 18.3 22.8 100.0

31.2 53.2 30.0 62.2 25.8 27.3 24.2 26.9 43.0 19.5 45.8 10.9 100.0 100.0 100.0 100.0

I

Y

I

1960 Y

I

28.9 69.6 29.0 73.4 24.4 12.0 27.0 14.4 46.7 18.4 44.0 12.2 100.0 100.0 100.0 100.0

Y 27.9 31.9 40.2 100.0

Source: Calculated from data in Melzer (1980). Table 16.15. The efficiency of investment: East Germany, and West Germany, 1950-60 Marginal capital-output ratio in manufacturing 1950/1 1951/2 1952/3 1953/4 1954/5 1955/6 1956/7 1957/8 1958/9 1959/60

Average investmentoutput ratio (%)

East

West

East

0.48 0.82 1.16 1.35 1.64 3.73 2.84 1.61 1.28 2.36

0.57 1.40 1.45 0.89 0.85 1.57 2.58 3.86 1.45 0.99

6.38 7.46 8.87 10.19 9.86 10.65 12.93 12.80 14.27 16.72

Sources: Manufacturing data calculated from Melzer (1980); aggregate percentage investment-output ratio calculated from Merkel and Wahl (1991).

metal-processing industry around 1950. Apart from possible replacement of previously dismantled equipment, this appears to reflect a concentration of investment within the SAG sector that produced exclusively for Soviet reparation demands. What also stands out from Table 16.14, however, is a surprising failure of investment to boost output. 12 In fact the share of primary products in total output continued to fall throughout the decade, in spite of concentrated investment efforts. Certainly the desire to increase the degree of self-sufficiency from West Germany and reduce the disproportions in East Germany's initial capital endowment has been a major reason for the concentration of investment in heavy industry. However, the increase of capacities in bottleneck sectors should have had the effects of an initial big push, with more balanced growth thereafter. In contrast, data in Table 16.14 appear to indicate that there was substantial overinvestment with regard to primary products, which led to sharply decreasing returns (a good

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Albrecht O. Ritschl

discussion of these policies and their effects by a former East German planner is that ofObst(1973)). Comparing this to capital productivity in the aggregate is difficult because of the aforementioned data problems. Generally, the picture looks more favourable. Table 16.15 provides marginal capital-output ratios for manufacturing in both Germanies and an estimate of the aggregate investment-output ratio in the East German economy. For the first half of the decade, the table exhibits a relatively good performance by East Germany. Partly this arises from the inflationary bias in output figures, which was referred to above. During the recession of 1957/8, East Germany appears to have fared relatively better than West. Subsequently, however, West Germany recovered to high marginal efficiency levels, whereas East Germany did not. Another striking feature of Table 16.15 is the low share of investment in aggregate output at a time when investment-output ratios in West Germany were above 20 per cent. This phenomenon seems to have been largely neglected in the literature. The only source I could find (Baar, 1983) attributes the lack of investment during the 1950s, first to the relatively high capital endowment inherited from the war, and second to reparations during the first half of the decade. During the second half of the 1950s, planners became increasingly dissatisfied, as the envisaged growth of output in raw materials and heavy industry did not come about at the expected rates. The same was true for labour productivity. East German writers complain that, during the second half of the decade, wage growth consistently outstripped productivity growth, save for machine building (Miihlfriedel and Wiessner, 1989: 202). Apparently, remembrances of the revolt of 1953 were strong enough to prevent the party leadership from further attempts to bring labour norms and real wages into line. However, these developments also reflected the continuing emphasis of economic planning on heavy industry. At a time when West German mining was at the brink of the first of its subsequent crises and most investment was diverted into machine building and consumer-oriented industry, East German planners still hoped for a big push in heavy industry that would lay the base for catching up with West Germany. East German economists had a debate about the reasons for this emphasis on heavy industry (see Muhlfriedel and Wiessner, 1983; Roesler, 1983; Baar, 1983). Baar's paper includes a relatively open discussion of the dangers of concentrated investment efforts in a specific industry. As far as the use of officially correct language in these contributions permits interpretation by an outsider, Baar's warnings, which he put in the context of the 1950s, can be read as a critique in the vein of Table 16.15 above (Baar, 1983: 13ff.). Hopes for a big push were soon disappointed, and so the second five-year plan starting in 1956 was abandoned in 1958 and a new seven-year plan launched. However, this plan was again based on unrealistic extrapolations, as it envisaged an increase in average growth rates to over 9 per cent per annum. Moreover, as West German analysts pointed out (e.g. Gleitze, 1967a, 1967b), the seven-year plan took the planning goals, not actual output and capacity of 1958, as its starting base, thus being burdened with a deficit from the very beginning. In the very short term, however, the seven-year plan appears to have fared pretty well. All available output indicators show an increase in growth rates to over 10 per

East German economic growth and decline, 1945-89

517

cent around 1958. East German writers have attributed this to intensified Eastern European trade relations in the wake of political stabilization after the revolts in Hungary and Poland (Neumann, 1980; Roesler et al, 1986). Indeed, for the first time since the war, signs of relative prosperity seemed to appear. Food rationing was finally abandoned, and emigration rates to Western Germany dropped. It was during this period of relative optimism that East Germany's party leader, Walter Ulbricht, formulated his famous goal of catching up with and surpassing West German levels of consumption by 1961 (Christ and Neubauer, 1991). 7

2 fast 4 you: frustrated catching up, the Berlin Wall and attempted reform during the 1960s

The East German dream soon proved to be short-lived. Much of the seeming prosperity during the late 1950s had been accompanied by a certain decline of political pressure on the remainders of the private sector. All this evaporated in the wake of accelerated collectivization in agriculture. In a first wave during 1958, land under collective ownership had increased by over 40 per cent. In 1960 the area covered by agrarian cooperatives doubled again (Hartmann, 1971). These waves oide facto expropriation of private farmland are commonly interpreted as the primary reason why output of agrarian products fell and emigration into West Germany increased sharply (e.g. DIW, 1974; Weber, 1988). Soon it turned out that the planned goals of 1958 had been unrealistic. The years 1959 and 1960 experienced a sharp productivity slowdown. As a consequence, the seven-year plan was abandoned de facto in 1961. Communist planners made the most severe of all possible plan revisions: on the eve of 13 August 1961, the Berlin Wall was erected, closing the last remaining gap in the Iron Curtain. This documented most clearly that the idea of competing openly with Western consumerism had been given up altogether. The erection of the wall marks the beginning of a period of economic reform in East Germany. Being relieved from the pressure towards short-term success, authorities attempted to introduce elements of economic rationality into the planning system. In this wake, the so-called New Economic System (NES) was introduced in 1963. The idea of this reform was to exert planning through indirect methods, using credit, taxes and intervention prices as policy instruments - or economic levers, as socialist planning language termed it. This new concept, borrowed from proposals of the Soviet economist Evsey Liberman, centred around obtaining realistic shadow prices to reflect relative scarcities (see Roesler (1991) for a review). Thus, firms were given the right to retain considerable parts of their accounting profits and invest them according to their own priorities. Accordingly, the central industry ministries in Berlin were dissolved and planning authority transferred to the Vereinigungen Volkseigener Betriebe (VVB). These VVB, bearing some resemblance to cartels, had been created as early as 1948, but had gained little significance. Now they would plan their own activities, being only loosely coordinated by a central planning board in Berlin. To render this efficient, rational cost accounting methods and enforceable business contracts had to be reintroduced. The VVB thus started producing aggregate balance sheets for all the VEB they encompassed, attempting to steer investment and output within these conglomerates according to cost accounting methods.

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In order to make it possible for firms to calculate profits in a more rational way, the system of planning prices was reformed. The old price system had been largely inherited from the Nazis, with only minor corrections by the Soviet military administration during the late 1940s (see Stolper (1960) for an account of East German pricing methods in the 1950s). The main feature of the new price system was a revaluation of existing stock. Under the traditional depreciation procedures, real capital was typically undervalued. Given the lack of a market for stocks, these accounting values would be the only basis for calculating profit rates, signalling spuriously high profitability. Finding a suitable price vector proved difficult in practice, and the idea of steering investment by profits was probably never really carried out. Indeed, the blessings of the planning reform were mixed (see DIW (1974) for details; a rather more optimistic view is Roesler (1991)). On the one hand, output of consumer durables continued to increase, which reflected the party's preference for appeasing East Germany's population. On the other, authorities were apparently disappointed by aggregate growth, which according to official figures lingered around 4 per cent per annum. To this was added growing concern over the political consequences of the reform. In the initial atmosphere of economic liberalization, an opposition movement had blossomed both within and outside the party. Later commentators have seen this as an East German version of the reformist Communism that came to power in Czechoslovakia during the short-lived Prague spring (e.g. Weber, 1988). In East Germany, the first signs of political spring ended in late 1965. Critical voices in cultural and political life were suppressed again. Also, authorities determined that indirect planning was insufficient to produce the politically desired structures. The party thus introduced what was called the second phase of NES policy. Defacto, however, it was an attempt to superimpose central planning on the newly devised system of indirect regulations. The industry ministries were reintroduced, using annual plans andfive-yearperspective plans as their major planning devices. To improve capital productivity, it was attempted to concentrate investment effort on high-technology industries. Indeed, the shares of electrical and optical industry and of machine building in total investment increased markedly during the 1960s. However, these programmes failed to have permanent effects on the efficiency of investment (see Obst (1973) for a discussion). Table 16.16 shows estimates of marginal capital-output ratios during the 1960s on both the industry and the aggregate level. Data in the first column of Table 16.16 are for manufacturing; like their counterparts in Table 16.15, they may be slightly optimistic with regard to output growth. In the third column, official investment data at 1985 prices have been divided into the GDP data of Merkel and Wahl (1991) at 1985 East German prices. As can be seen, an overall increase in marginal capital-output ratios was accompanied by a large surge in the ratio of investment to output. Recovery from the critical years of 1960-2 partly exploited the gains from investment during those years. From 1966 on, however, marginal capital-output ratios increased again. The Merkel and Wahl series offers an interesting comparison, as it indicates that services were hit less by the recession of 1961/2, whereas during the late 1960s, GDP was apparently hit harder than the manufacturing sector. In sum, during the 1960s the economy began running into quickly decreasing returns to capital, which must have

East German economic growth and decline, 1945-89 519 Table 16.16. The efficiency of investment: East Germany, 1960-70 Marginal capital-output ratio

1960/1 1961/2 1962/3 1963/4 1964/5 1965/6 1966/7 1967/8 1968/9 1969/70

Manufacturing

Aggregate economy

3.66 3.63 7.41 4.43 3.53 3.17 2.94 3.11 2.53 3.20

11.1 5.7 5.8 6.3 4.6 5.9 4.6 5.9 6.8 6.2

Aggregate investmentoutput ratio

17.8 17.8 17.7 17.4 18.5 19.3 19.8 20.6 22.0 24.5

Sources: Data for manufacturing from Melzer (1980); aggregate output data from Merkel and Wahl (1991), GDP estimate underlying column I, Table 16.1; aggregate investment from Statistisches Amt der DDR (1990). been a hard lesson to learn for planning bureaucrats whose ideology was built around the labour theory of value. The fact that returns to investment had decreased did not, of course, go unnoticed. In 1965, East Germany's party leader Ulbricht addressed this very explicitly: 'Whereas during 1951 to 1955, aggregate investment of 32bn (US)M increased national income by 21bn M, 63bn M of investment during 1956 to 1960 brought about an increase in income of only 21 bn M. And during 1961 to 1964,66bn M of investment have produced only 10.7bn M of additional national income'(cited in Melzer, 1980). On top of this, new difficulties developed at the end of the decade. This is also reflected in the output of consumer durables. For several categories, production slowed down and aggregate growth fell short of the envisaged targets. Data for consumer durables are shown in Table 16.17. In the 1950s, output of consumer durables had started from very low levels. Data in Table 16.17 also reflect the massive effort of the consumer goods industry to grow into sizeable proportions around 1959, the starting year of the failed seven-year plan. During the late 1960s, however, output in major categories slowed down, and even fell around 1968. Observers have blamed this on the inconsistencies between the NES on the one hand and reintroduced central planning on the other (see, for example, Obst, 1973; Weber, 1988). A similar view was apparently adopted by the party itself, which abandoned the whole NES experiment in 1970.

8

The Golden Seventies: a belated Wirtschaftswundert

The year 1971, when Ulbricht was replaced by Honecker as party leader, is generally seen as the end of economic experimenting in East Germany (Weber, 1988; Christ

520 Albrecht O. Ritschl Table 16.17. Output of consumer durables by categories: East Germany, 1950-70 (000s)

1950 1955 1956 1957 1958 1959 1960 1961 1062 1963 1964 1965 1966 1967 1968 1969 1970

Cars

Refrigerators

Washing machines

7.1 22.2 28.1 35.6 38.4 52.7 64.1 69.6 72.2 84.3 93.1 102.9 106.5 111.5 114.6 120.9 126.6

0.7 17.3 23.9 24.9 53.4 86.6 138.6 166.1 191.6 245.1 323.9 561.6 359.6 403.0 377.0 366.0 380.3

0.7 18.4 24.8 34.9 44.0 107.7 132.5 160.1 196.1 255.5 276.8 364.8 474.7 400.4 292.9 274.9 254.5

Television sets 38.6 55.4 108.8 180.0 289.7 416.5 374.0 461.2 580.0 591.2 536.7 288.9 314.3 323.9 356.8 380.1

Source: Statistisches Amt der DDR (1990). and Neubauer, 1991). The Honecker administration recentralized the economy in several steps, forcing industry into huge Kombinate, or combines, which had a monopoly in their respective market. Also, the new leadership aimed to improve living standards and adopt a more active stance in welfare policies. Welfare support schemes and housing construction were scaled up considerably. Partly this was financed by an old-age security reform that promised attractive internal returns to those willing to increase their social security contributions (Hockerts, 1994a). In the short run, the additional revenue created in this way helped finance Honecker's ambitious welfare programmes. However, it is difficult to see how this scheme could have been supported after reaching maturity. Indeed, assuming liability for East Germany's social security system became one of the largest burdens of unification after 1989. In the short term, the new approach was apparently successful. National income and the output of consumer durables resumed growing at satisfying rates, at least as far as official figures are concerned. East Germany evaded the worldwide recession of 1973/4, producing what appeared to be a small economic miracle of it own. At the same time, East Germany gained international political recognition, and relations with West Germany were also normalized to a certain extent. During the ninth party congress of 1976, however, this strategy was modified (Hockerts, 1994b). Debates about setting priorities were suffocated under a new policy formula, which proclaimed the 'identity of economic and social policy'. To this day the motivation which guided party leaders is not quite clear. Apparently the idea had been to redirect emphasis towards productivity growth and increased

East German economic growth and decline, 1945-89

521

Table 16.18. Growth in the East German economy, 1970-80 (annualized growth rates, %) GDP

Investment

Housing construction

Output of Refrigerators TV sets Passenger cars

1970-5 4.23 1975-80 3.24

5.00 3.32

8.86 1.27

6.73 3.86

6.01 2.59

4.68 2.12

Sources: GDP from Merkel and Wahl (1991); all other data from Statistisches Amt der DDR (1990). investment. Only one week after the party congress, a whole bundle of costly welfare measures was presented in an apparent attempt to appease the disappointed population. Even the official figures show that by 1975 East Germany's small miracle of the early seventies was over. Returns to investment remained low and decreased further. Employing official data in 1985 prices as in Table 16.16 above, marginal capital-output ratios during both halves of the 1970s were 6.85 and 8.99, respectively. During the second half of the 1970s, growth rates also declined. Although official figures of aggregate performance look pretty good, output growth in sensitive branches of the consumer goods industry gives the impression of a marked slowdown from 1975 on. Table 16.18 provides a breakdown of official growth figures for the 1970s. The discrepancy between the aggregate and industry-specific figures that emerges during the second half of the 1970s pertains to the 1980s as well (see section 9 below). Again, this may be supplemented with data on investment-output ratios. In Table 16.19, marginal capital-output ratios at the aggregate level are compared to average investment-output ratios. The table shows that the marginal efficiency of investment decreased further during the decade, despite very high shares of investment in total output. This tendency was obviously stronger towards the end of the decade. Measured by the effect on output, East Germany thus invested a lot to accomplish very little. Nevertheless, Tables 16.17 and 16.18 indicate that, during the first half of the decade, East Germany fared relatively well. Later observers have pointed to a surge of foreign borrowing as a possible explanation. In fierce criticism of the Honecker period, former staff members of East Germany's State Planning Commission (Kusch et al., 1991) have argued for a link between East German capital imports during the 1970s and balance of payments problems during the 1980s. Comprehensive time-series data on East Germany's balance of payments appear to be unavailable even today (Steger, 1993). Working from the balance of trade, a certain pattern nevertheless emerges. Table 16.20 provides cumulative balance of trade figures by periods and areas. It indicates that, during the 1970s, foreign indebtedness built up at fast rates. Cumulative deficits with Western countries amount to 27bn (US) valuta marks. Assuming that all transactions within COMECON were made on a clearing basis and neglecting trade with LDCs, this provides for a back-of-the-envelope estimate of East Germany's foreign indebtedness

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Albrecht O. Ritschl

Table 16.19. The efficiency of investment: East Germany, 1970-80

1970/1 1971/2 1972/3 1973/4 1974/5 1975/6 1976/7 1977/8 1978/9 1979/80

Marginal capital-output ratio

Average investment-output ratio

O9 5.19 5.62 6.67 6.20 6.65 7.88 9.26 9.37 10.95

25.12 24.83 24.83 25.68 26.02 26.07 26.85 27.30 27.25 26.78

Source: All data computed from Merkel and Wahl (1991). Table 16.20. East Germany's cumulative trade balance in the 1970s (million 'valuta marks' at current prices)

1966-70 1971-5 1976-80

All countries

COMECON

Western hemisphere

+1383 -6989 -28813

+1668 +4928 -3841

-2180 -12868 -25207

Source: Statistisches Amt der DDR (1990). at the time. Internal documents on foreign reserves published in Suhr (1991) reveal that one 'valuta mark' was evaluated at US$0.5405. This would put East Germany's foreign debt around the end of the 1970s at roughly US$14.5bn, which in turn would imply interest obligations close to US$1 bn per year. These figures are possibly overstated, as East Germany had additional foreign exchange revenues from West German tourists visiting their families in the East, and from West German government transfers (see section 9 below). For 1982, Kusch et al. (1991) estimate the dollar worth of East Germany's foreign debt at 12.3bn. Whatever the true figure, the estimates give an impression of the burden that had accumulated during the Golden Seventies, waiting to be borne during the 1980s. 9

The road to bankruptcy, 1980-9

By 1983, East Germany was on the brink of default. 'We could not make our debt service any more. We lived from hand to mouth. Imports were cut down. I negotiated credits on deliveries in the Soviet Union and then sold the merchandise in the West. There was only one solution: The Federal Republic (i.e. West Germany) had to give a signal. Whether the whole thing was about one or two billions was entirely ridiculous. This could not solve the problem. The delicate question was: would the Federal Republic be willing to sustain the GDR?' This is how East Germany's former chief administrator of foreign exchange affairs, Alexander

East German economic growth and decline, 1945-89

523

Table 16.21. The efficiency of investment: East Germany, 1980-9

1980/1 1981/2 1982/3 1983/4 1984/5 1985/6 1986/7 1987/8 1988/9

Marginal capital-output ratio

Average investment-output ratio

11.22 12.77 10.61 6.06 5.69 8.24 7.91 10.91 19.26

26JL8 26.19 24.37 23.75 21.78 21.66 22.20 23.27 24.40

Source: Calculated from Merkel and Wahl (1991). Schalck-Golodkowski (Forbes Magazine, 1991), described the balance of payments crisis of 1983 in retrospect. The precise political terms of the deal made between both Germanies in the early 1980s are still unclear, as is the role of Schalck-Golodkowski himself, who fled into West Germany soon after the Berlin Wall had opened, presenting himself to West Germany's secret service (see Suhr (1991) for details). In essence, East Germany was bailed out of its foreign exchange impasse through a credit of 1 bn Deutschmarks. But other stabilizing forces were also at work. Under the COMECON pricing system of 1959, clearing prices had been set proportional to a five-year moving average of past world market prices. Temporarily this would relieve East Germany from the effects of oil price explosions, as Soviet output of crude oil was large enough to supply all of East Germany's needs. This dragging effect was possibly operative already in the 1970s, helping to explain why the aforementioned slowdown of growth occurred only in the second half of the decade. But it also afforded opportunities for East Germany around 1980, when Soviet COMECON oil prices were significantly lower than the world market level. East Germany specialized in dumping growing proportions of its entitlement to Soviet oil on the Western European market. In this way, it was possible for East Germany to stabilize its trade balance again and service its debt from external surpluses. Social costs of this policy were apparently high. To economize on its oil budget, East Germany launched an extensive autarky programme in the energy sector, drawing on its natural deposits of brown coal and uranium. The substitution of oil products by coal necessitated large investments whose marginal product was close to zero, if not negative. Kusch et al. (1991) estimate the direct cost of substituting oil with brown coal at 18bn marks. Aggregate output data for the 1980s must be interpreted with extra caution, as there appears to be evidence that frequent changes in classifications and reporting methods, and sometimes simple fabrication, were used to hide the mounting problems of East Germany's economy. But even from the noise data we have for that period, it becomes apparent that the marginal efficiency of investment was at extremely low levels (Table 16.21).

524 Albrecht O. Ritschl Table 16.22. World market and COMECON prices for crude oil, 1972-89 (US $ per barrel)

1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

World market price

COMECON import price

COMECON price as percentage of world market price

2.10 3.39 11.29 11.02 11.77 12.88 12.93 18.67 30.87 34.50 33.63 29.31 28.70 27.16 15.35 17.70 14.00 17.00 22.00

2.0 2.7 3.3 5.4 5.9 7.7 10.1 12.5 18.3 20.2 27.8 30.9 32.0 31.0 36.2 35.9 32.2 27.1

94 79 29 49 50 60 78 67 59 59 83 105 111 114 236 203 230 159

Source: Schroter (1994: table 2). These data indicate that, after a bad slump around 1982, there were signs of recovery during the mid-1980s.13 However, the tide turned again when the Soviets insisted that their oil export quotas within COMECON be fully exhausted and that payment be made in convertible exchange. In this way, the same effect that had been operative in the 1970s was working again, albeit in the reverse direction. Table 16.22 provides estimates of crude oil prices pertaining to East German imports. Table 16.22 compares world market prices for crude oil with East German import prices under trade agreements within COMECON. According to these data, prices of East German oil imports from the Soviet Union remained significantly below world market levels until 1983. To the extent that East Germany could substitute oil with domestic brown coal and its derivatives, obvious possibilities for arbitration were opened. It is noteworthy that this form of reswitching is very analogous to Nazi autarky policies in the 1930s. Indeed, the hydrogen plants that enabled East Germany to do this had been built under the conditions of foreign exchange shortage (and war preparation) in Nazi Germany. The closing of the price gap in the early 1980s apparently contributed to the aforementioned foreign exchange crisis of 1982 (Kusch et qi, 1991). Desperate attempts to economize further on the use of convertible exchange were frustrated by Soviet policies in 1985, when the Gorbachev administration started to insist on payment of further oil deliveries in foreign exchange. This way, the East Germans

East German economic growth and decline, 1945-89

525

Table 16.23. Growth in the East German economy, 1980-9 (annual growth rates) GDP

Investment

Housing construction

Output of Refrigerators TV sets

1980/1 1981/2 1982/3 1983/4 1984/5 1985/6 1986/7 1987/8 1988/9

2.39 1.95 2.29 3.73 3.96 2.77 3.03 2.29 1.28

2.44 -5.13 -0.30 -4.87 3.37 5.32 8.00 7.25 0.90

8.15 -17.52 17.27 -2.83 -1.14 0.37 -4.95 -3.05 -10.26

2.86 6.97 8.89 17.39 8.62 4.65 5.63 4.56 1.44

6.97 5.45 2.27 -4.15 4.49 6.54 1.59 7.05 0.06

Cars 1.96 1.50 2.94 7.28 4.14 3.59 -0.38 0.44 -0.49

Sources: GDP growth calculated from Merkel and Wahl (1991); all other data calculated from Statistisches Amt der DDR (1990). were forced to repay the de facto foreign exchange credit extended to them by the Soviets during the previous decade. To examine the growth record of the 1980s more closely, Table 16.23 continues Table 16.18, examining growth rates in the East German economy at different levels of aggregation. Data in the table are obviously paradoxical. In the first years of the decade, GDP growth combines with continuously falling investment. At the same time, more disaggregate indicators of output and investment growth display very high, mutually uncorrelated fluctuations (a phenomenon which, however, could already be observed for the 1960s: see Table 16.17). During the second half of the decade, aggregate data indicate high rates of investment growtlji, while disaggregate figures fail to exhibit a common pattern. The wild fluctuations exhibited by these data strongly contrast with the general image of a stagnant, if not declining economy that is usually given in the literature. It is generally accepted, however, that due to frequent and arbitrary changes in reporting bases and methods, East German output data for the 1980s are especially unreliable. The implausibly high volatility in sectoral growth rates shown in Table 16.23 would support this view. More reliable information is available from balance of payment data, for which there exist internal estimates. Available figures suggest that, during the second half of the 1980s at least, the terms of trade of East Germany's economy worsened steadily (Table 16.24). East German authorities estimated this by calculating an index of foreign exchange receipts per unit of domestic resource cost, called Devisenertragskennziffer, or indicator of foreign exchange profitability. This number measured receipts of 'valuta marks' per unit of effort in East German marks, where valuta marks were defined as an index of convertible currencies (discussed in Akerlof etal. (1991)). Akerlof et al. (1991) calculate their data from unpublished disaggregate figures at the Kombinate level, while thefiguresof Sinn and Sinn (1992) reflect the rates applied by East Germany's Statistical Office. The precise timing differs between the various

526

Albrecht O. Ritschl

Table 16.24. Valuta mark/mark exchange rate for East German exports (Devisenertragskennziffer), 19 70-89 1970

1980

1985

Stat. Amt der DDR (1990) Kusch et al. (1991) 0.536 Sinn and Sinn (1992) AkerMetal. (1991)

0.454 0.420

0.275 0.350 0.535

1986

0.280 0.292

1987

1988 1989

0.230 0.258

0.227 0.246 0.230 0.230 0.246 0.265

estimates. However, there is a marked decline during the second half of the decade. Although a deterioration of the dollar/Deutschmark exchange rate at the same time may have contributed to this, data leave little doubt that, after 1985, stabilizing the balance of payments put a strongly increasing burden on the East German economy. A full quantitative picture of East Germany's balance of payments is still lacking (a preliminary report on activities of a Bundesbank working group is Steger (1993)). Up to 1988, East German trade statistics were denominated in valuta marks, a weighted average of convertible foreign exchange, evaluated atfixedexchange rates (see Zentralverwaltung fur Statistik, 1989). In the last edition of East Germany's Statistical Yearbook (Statistisches Amt der DDR, 1990), balance of trade statistics from 1985 on switch from valuta marks to valuta equivalents (Valutagegenwert), or domestic East German marks. West Germany's Statistical Office, Statistisches Bundesamt (1992), has released a Deutschmark-based trade balance for East Germany, which also extends back to 1985. As these latter figures exclude West Germany, intra-German trade was added to arrive at a full account of East Germany's overall trade position. Data on East German trade are surveyed in Table 16.25. Figures in valuta marks (VM) exhibit a fairly stable trade surplus throughout the second half of the decade. In contrast, both the valuta equivalent (VE) and Deutschmark (DM) figures indicate that, during that time, East Germany's trade position deteriorated strongly. That East Germany's position worsened also becomes visible from the estimates of East German foreign debt in the last column of Table 16.25. This deterioration is even more pronounced when trade with Western industrialized countries and West Germany is singled out. Data shown in Table 16.26 reveal that, from 1986 on, East Germany accumulated considerable trade deficits vis-a-vis Western countries. During the period 1985-9, exports to Western countries other than West Germany dropped by more than 25 per cent, while imports from the same area continued to increase. At the same time, intra-German trade, which was bound by a clearing agreement, remained relatively stagnant. Although East Germany continuously ran deficits in intra-German trade, this did not contribute to its foreign indebtedness, as the unique situation at the border between both Germanies afforded extra foreign exchange revenues to the East German state. These were caused first by West German tourists visiting relatives in the East, and second by government transfers. For the period from 1975 to 1989, East Germany's cumulative foreign exchange surplus from transactions with West Germany on service and transfer account amounted to 25bn (US) Deutschmarks net of East German debt service to West German creditors (Bundesbank, 1990a).

East German economic growth and decline, 1945-89

527

Table 16.25. East Germany's trade balance and foreign debt, 1980-9

Trade balance (million)

VM 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

-5840 -1073 5353 8030 6901 6789 1040 3264 3015

VE

19941 1815 -2552 -6417 -3614

Foreign debt (million)

DM

4178.8 -266.6 -2004.5 -2121.5 -935.1 2168.4 -31157.6

US$ 12.3 12.0 11.3 13.3 15.7 16.8 18.5

Notes: VM = Valuta marks. VE = Valuta equivalents, domestic currency. DM = West German Deutschmarks. Sources: VMfigures,Zentralverwaltung fur Statistik (1989); VEfigures,Statistisches Amt der DDR (1990); DMfigures,Statistisches Bundesamt (1992); $figures,Kusch et al. (1991). During 1988 where a breakdown is available, netflowsof services and transfers from West to East Germany were 1967 million DM. This sum also marks the feasible combined deficit on trade account and debt service that East Germany could run, assuming that no other major source of foreign exchange revenue existed (see Bundesbank (1990a) for a similar argument). If the Deutschmark data in Table 16.26 can be taken at face value, this in turn implies that, in 1987 at the very latest, a new debt crisis was developing. This is confirmed by preliminary data on East Germany's balance of payments of 1989, computed under a Bundesbank project (Steger, 1993). According to these figures, East Germany's deficit on current account with regard to non-socialist countries was almost 16bn East German marks. Applying a conversion rate of 4.4 marks per West German Deutschmark (DM), this is equivalent to 36.bn DM. During the same year, net transfers and service incomes from West Germany totalled 1277 million DM, leaving East Germany with a current account deficit of 6855 million East German marks or 1558 million DM. In passing we note the tremendous deficits after the unification, which are mostly due to large real resource transfers from West Germany (see the bottom of Table 16.26). It is also interesting to observe that exports to Western countries other than West Germany have continued to fall since unification. Drawing the arguments of this section together, it seems safe to conclude that balance of payments troubles contributed strongly to the mounting difficulties of East Germany's economy in the 1980s. During the first half of the decade, the counterproductive effects of dumping Soviet oil on the world markets and drawing

528

Albrecht O. Ritschl

Table 16.26. East German trade with Western countries, 1980-9 (million VM, VE, DM) Official trade balance vis-a-vis all Western countries (1) (2) (3) VM VM VE

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

_ , , , , . , . Deutschmark balances vis-a-vis all Western countries West Germany (4) (5) (6) (7) (8) (9) Exports Imports Balance Exports Imports Balance

-5464 -5425 197 -1682 5219 2726 4690 3129 3846 2949 4212 1495 1349 250

19993 4760 -5433 -9482 -8398

9404 8273 6667 6307 6914 5105 4454

7126 2013 7534 128 8624 -2678 9115 -3254 9256 -3240 5660 -13607 3935 -37229

7636 6844 6645 6789 7205 8274 8985

7901 -265 7454 -611 7367 -721 7234 -446 8103 -898 21326 -13052 46733 -37748

Notes: (1) Export surplus ( + ) in valuta marks vis-d-vis all non-socialist countries. (2) Export surplus ( + ) in valuta marks vis-a-vis Western industrialized countries. (3) Export surplus ( + ) in valuta equivalents vis-d-vis Western industrialized countries. (4-6) Trade balance with Western industrialized countries. (7-9) Trade balance with West Germany. Sources: (1) Zentralverwaltung fur Statistik (1989). (2,3) Statistisches Amt der DDR (1990). (4-9) Statistisches Bundesamt (1992).

on domestic brown coal instead were still being felt. During the second half, the relative rise of COMECON oil prices dried up this source of foreign exchange revenue. Soviet insistence on convertible cash payment for intra-COMECON oil deliveries even developed into a significant drain on East Germany's position. Dire lack of foreign exchange made it impossible to continue boosting East German living standards artificially, which prevented the government from appeasing its population as it had in the 1970s. Finally, the increasing need for fresh money made East Germany susceptible to pressure from its creditors, especially from those in West Germany who had already bailed out their Communist partners from a previous balance of payments crisis in the early 1980s. 10

The aftermath of unification

When the Berlin Wall opened on the night of 9 November 1989 - a date which has many historical connotations for Germans14 - West Germany should have had no problem in preparing for unification. Everything had been arranged perfectly - at least theoretically so. West Germany's constitution of 1949 provided not just one,

East German economic growth and decline, 1945-89

529

but actually two ways for East Germany to join.15 Official West German doctrine continued to regard Berlin as the official capital. As a consequence, the Federal Government long refused to erect other than provisional buildings in West Germany's capital of Bonn, and parliament, the Bundestag, continued to reside in a former lecture hall. In the same spirit, Article 2 of the Bundesbank Act stated that its headquarters after unification would have to be moved to Berlin. All government measures were so designed as to provide for future reunification: the system of ZIP codes introduced in the early 1960s provided free slots for East Germany, and so did the systems of telephone area codes and car licence plates. To settle all practical questions, West Germany's Federal Government had operated a thinktank in the rank of a ministry whose main task was to prepare all kinds of reserve programmes for the day of unification. However, unification came one generation too late, to the effect that the old doctrines had fallen into oblivion. Indeed, policy consulting with regard to unification restarted from scratch, and new priorities were set. In the town of Bonn, a new House of Parliament was just nearing completion when the Wall came down. After the currency union, the Bundesbank Act was changed and all references to Berlin were eliminated. Instead of enlarging the old ZIP code system, a new one was created. Whether or not the Bundestag and central government should move from Bonn to Berlin was debated fiercely and continues to be a matter of speculation and suspicion. Nor did East Germany's economy follow the course which was anticipated at the time of unification. Expectations had been rising high, as it was held that, with the inclusion of East Germany into West Germany's institutional and monetary framework, a new Wirtschaftswunder was ahead. However, since early 1990, East Germany has experienced the worst peacetime slump since the Great Depression. This phenomenon has generated a large and fast-growing literature (standard references include Akerlof etai, 1991; Sinn and Sinn, 1991;Siebert, 1991a, 1991b; see Sinn and Sinn, 1992, for a review). Basically, three main hypotheses for the failure of East Germany's economy to pick up early can be discerned. The wage pressure view attributes the slump to an irresponsible wage bargain over East Germany between West German trade unions and employers' associations (Sinn and Sinn, 1992; Siebert, 1991b). According to this view, the West German wage bargaining system proved counterproductive when imported into East Germany, as both trade unions and employers came from West Germany and shared a common interest in not generating a low-cost competitor east of the Elbe river. The second interpretation argues from an endogenous growth point of view that convergence of East Germany's economy will take a very long time to occur (Barro and Sala-i-Martin, 1991). The third interpretation emphasizes the de facto appreciation of the East German mark through conversion at par by the currency reform of July 1990 (Siebert, 1991b). Available figures indeed indicate that wages were disproportionate. In 1992, East Germany's wage bill accounted for 91.4 per cent of national income, where the latter figure still includes depreciation (Statistisches Bundesamt, 1993a). At the same time, GDP per person employed was around 42 per cent of that of West Germany (equivalent to the West German level of 1959/60), whereas wages per person stood at 64.2 per cent.

530 Albrecht O. Ritschl

Evidence for the appreciation of East German currency can be inferred from the implicit exchange rates of Table 16.24 above. According to them, the unit export value of East German products quadrupled as East German marks were converted to Deutschmarks at par. The adverse impact effects of this on East German competitiveness are the main theme in Siebert (1991b).16 Additional explanations have been put forward, such as the break-up of East Germany's traditional markets in the East, the manifold uncertainties associated with property restitution, and the Treuhand policies of privatization (on the latter, see Christ and Neubauer, 1991; Suhr, 1991). An economic historian's contribution to an explanation of how all this could happen would have to focus on the interests and expectations that guided policy making in Germany during 1989/90. Early advisory reports (Sachverstandigenrat, 1990a; Wissenshaftlicher Beirat, 1989)17 were dominated not by concerns over recovery as such, but rather by fears of a huge wave of immigration from East Germany. According to these reports, clear and credible signs would have to be given to induce East Germany's population to stay. Among other things, this would have to include measures to stabilize living standards. Written only weeks after the Wall had opened, these reports anticipated that keeping East Germany independent would not help convince the East Germans that the abandonment of Communism was irreversible and that pro-market policies would be followed. Instead, the Wissenshaftlicher Beirat, or advisory council to the Ministry of Commerce, went so far as to recommend quick and unconditional unification as the only way to prevent further mass flight from the East. Others, including the Sachverstandigenrat, were more reluctant. Heavy criticism developed when in January 1990 the spokeswoman of the opposition party in West Germany's parliament, Matthaus-Maier, published a press article proposing quick adaptation to currency union and conversion at par. The DIW's president, Hoffmann (1990a), wrote a fervent reply warning of continuous mass unemployment in East Germany should these plans be realized. However, only a few weeks later the government jumped on the bandwagon and offered negotiations with East Germany about currency union. Consideration of credibility effects and fear of further immigration from East Germany seem to have played a dominant role in this decision (Christ and Neubauer, 1991; Schui, 1991). However, only two days after this announcement, the Sachverstandigenrat (1990b) published a worrisome letter to the Chancellor, pointing out that currency union as a way to halt mass emigration from East Germany was not very credible and would be counterproductive. Apparently, a divide between Germany's two major economic advisory boards opened over this issue. In a report to the Ministry of Commerce in March 1990, the Wissenshaftlicher Beirat (1990) re-emphasized the need for quick currency reform and also discussed in detail the problem of finding optimal conversion rates. The majority proposal recommended conversion of flows at par and of stocks at two marks to the Deutschmark, which comes very close to what was finally adopted in mid-1990. In this report, concern over living standards again dominated fears of spoiling East Germany's competitiveness. It was argued that, while conversion of flows at par was economically feasible, halving wage rates by convertingflowsat two marks

East German economic growth and decline, 1945-89

531

to the Deutschmark would be socially undesirable and raise emigration rates again. Fear of further emigration from East Germany is also reflected in Bundesbank (1990b). This source documents the details of currency reform in East Germany. It also hints at the conceptual differences between the Bundesbank's own plans and those of the Federal Government which were realized in the end.18 It is interesting to note the emphasis in this document on purchasing power arguments. To make a case against fears of inflation, it pointed out that, due to low East German prices of non-traded goods, purchasing power was about equal and conversion at par thus justified. The same point is also made in detail in Sinn (1992) and Sinn and Sinn (1992).19 Interestingly, in the German discussion the issue of competitiveness has commonly been dealt with in terms of aggregate productivity, not competitiveness in traded goods. For example, the aforementioned Bundesbank report estimates East German aggregate productivity at about 40 per cent of West German levels to conclude that, given the wage differentials which prevailed at the time, conversion at par was feasible. In an attempt to conceal the apparent infighting between the Bundesbank and the Federal Government, it is only implicit in this report that the Bundesbank would have desired conversion at a lower rate. Attempts at de-emphasizing the productivity problem are also apparent in the published versions of the reports of the Wissenshaftlicher Beirat (1990). The disturbing evidence was that the data on implicit mark/Deutschmark exchange rates (Table 16.24 above), which were known to decision-makers at the time, called for much lower conversion rates, suggesting 4:1 as the proper conversion rate. Sinn and Sinn (1992: ch. 3) elaborate on this in detail, pointing to low relative prices of non-traded goods as the explanation of why, during the Communist years, low exchange rates coexisted with purchasing power parity at par.20 Choice of the conversion rate for nominal contracts thus entailed two factors: the competitiveness of East German industry, and the propensity of East Germans to emigrate. Sinn (1992) has referred to this as the problem of two-sided competitiveness, arguing that the risk of mass emigration from East Germany would have been a danger to East German competitiveness as well. It is apparent that caution must be applied in interpreting the political decisionmaking process until all internal documents become available. However, it does not seem unreasonable to conclude tentatively that currency conversion at par and the promise of quick catching up with West German living standards were the result not of poor analysis, but rather of rational political decision making. Both West German policy-makers and an influential wing among their economic advisers preferred subsidizing East German living standards at the risk of macroeconomic difficulties, to the risks of mass migration that a more cost-oriented approach would have entailed. Winning the East German elections of March 1990 may also have played a role in this setting of priorities, as possibly did foreign policy considerations (see, for example, Hoffmann, 1990b). But certainly, the idea of exposing East German consumers to conversion rates oriented towards competitiveness was never seriously considered. One caveat remains to be discussed. Several observers, such as Sinn and Sinn (1992), have stressed that, whatever the optimal rate of currency conversion might have been, competitiveness was much more severely hurt by the huge rise of wages after monetary union. Thus the blame for the slump would be placed on the

532 Albrecht O. Ritschl

outcomes of collective wage bargaining and not on currency conversion itself. Apparently, this point is one about expectations. In its letter of 9 February 1990 to West Germany's Chancellor, two days after the announcement of currency union, the Sachverstandigenrat (1990b) expressed concern that currency union would create expectations of a fast catching up in living standards. West Germany, they argued, would implicitly commit itself to hugh public subsidies for East Germany, and these would be all the larger as introducing convertibility on the fast track would hamper the self-sustained recovery of the East German economy. Other critics joined in, warning that fast currency reform and purchasing-power-oriented conversion would create overly optimistic expectations (e.g. the head of the influential DIW institute of economic research, Hoffmann, 1990a). Indeed, before the first nationwide elections, the Kohl administration campaigned with the promise that East Germany's states would turn into 'flourishing landscapes' within a few years, and that the real cost of unification would be almost zero. Given these expectations, wage arbitration policies after monetary unification cannot plausibly be considered to have been exogenous to currency conversion. To put this more explicitly, the wage increases negotiated between trade unions and employers' associations were well in line with official policy statements that had declared quick adaptation to West German living standards the primary policy goal. How could wage arbitrators successfully advertise a low-cost approach to East German recovery to their constituencies, at a time when politics played down the cost of unification in the aggregate? To analyze whether there existed feasible alternatives to the policies actually pursued, a counterfactual would have to be considered in which politics had adopted a 'blood, sweat and tears' attitude towards generating expectations. Whether or not such a way of preparing the public for the burdens of reconstructing East Germany would have been superior to the consumer-oriented approach actually chosen could be a matter of future research. 11

Conclusion

This paper has tried to summarize evidence on East German postwar growth and to present a synopsis of the literature. To a large extent, the above discussions were dominated by issues of data quality and interpretation. At present, available data are still unsatisfactory, and methods of adjustment necessarily crude. Despite the existing measurement problems, however, some patterns do emerge. Although reparations burdens were heavy, the starting position of East Germany's economy was probably not as bad as is generally maintained. Re-examining output and productivity during the early postwar years, evidence obtained indicates that it was the transition to Communism itself which had a hysteresis effect on productivity. During the 1950s, migration to West Germany apparently hampered catching up with West Germany's pace of reconstruction. Data show that, after the erection of the Berlin Wall, East Germany missed the chance to boost productivity. Whereas during the 1970s, East Germany's record looks comparatively favourable, there is evidence of a marked productivity slowdown in the 1980s. This phenomenon combined with mounting balance of payments problems to lay the ground for the break-up of Communist power in East Germany prior to the unification of 1990.

East German economic growth and decline, 1945-89

533

Inspection of scattered evidence on East Germany's balance of payments and foreign debt data during the 1970s and 1980s suggests that a debt crisis built up during the early 1980s and, after an interplay of recovery, again towards the end of the decade. Increases in living standards during the 1970s thus came at the expense of wealth during the 1980s. We conclude that a severe economic crisis was mounting in East Germany even before unification. In the previous section, evidence on the policies of economic unification was reviewed briefly. The result is that the main motive for West German policy-makers at the time was to prevent mass emigration from East Germany, and that policy advisers well understood the macroeconomic risks of the strategies adopted. Thus the obvious conclusion is that the East German slump since 1990 is the result not of analytical or policy failures, but rather of conscious choice under uncertainty about the East Germans' willingness to emigrate. NOTES Helpful comments from Knut Borchardt, Christoph Buchheim, Nick Crafts, Barry Eichengreen, Hans-Giinter Hockerts, Rainer Karlsch, Dietmar Petzina, Harm Schroter, Christoph Schmidt, Oskar Schwarzer, Gianni Toniolo and seminar participants in Lund, Salzburg and Munich are gratefully acknowledged. 1 Recent contributions which reconsider the role of institutional change for West German growth include Giersch et al. (1992) and Berger and Ritschl (1993). Evidence in favour of Janossy's hypothesis is present in Dumke (1990). See Eichengreen and Uzan (1992) for a critique. 2 Output and capacity in 1936, for which detailed industry survey data are available, were generally accepted as a benchmark for Germany's peacetime capacity requirements during the negotiations on industrial dismantling (see, for example, Gimbel, 1976). 3 Buchheim (1990a: 80ff.)has pointed out that, in West Germany, the time profile of dismantling may have been quite different from the pattern implicit in the data in Table 16.5, as many dismantling programmes already agreed on in 1946 were not carried out until 1949. However, his estimate of total capital stock lost comes very close to Krengel's (1958). 4 Discrepancies between the various different series in Table 16.6 partly result from adjusting for Sowjet-Aktiengesellschaften (SAG), or Soviet joint stock companies. These had been formed by the Soviet Military Administration out of seized property in 1946 to ensure reparations from current production. Their value in 1944 prices has been estimated by Melzer (1980) at 3.3bn (US) RM. Beginning in 1950, these SAGs were successively handed back to the East German Central Planning Bureau. Melzer's own series, reproduced in Table 16.6 as Melzer (a), includes these capacities. We calculated a companion series excluding SAG stocks as Melzer (b), using his own data and methods. The estimates of Zank (1987) are slightly more pessimistic. However, Zank is basically inferring capital stock from estimated levels of output, apparently assuming constant capital-output ratios. Baar et al. (1993) have examined hitherto inaccessible material from East German archives to conclude that during 1944-8, East Germany lost about one-third otits industrial capital stock. However, their estimate of dismantling in absolute terms is very close to that of Melzer (1980), which underlies Table 16.6. Hence it is not quite clear where the discrepancies with existing estimates come from.

534 Albrecht O. Ritschl 5 The first two were handed over to Poland as a compensation for the territories it lost to the Soviet Union, whereas East Prussia was divided between Poland and the USSR. Together, the territories lost encompassed 114 000 square kilometres or 24 per cent of Germany's territory of 1937, with a total prewar population of 9.6 million or 13.8 per cent of Germany's total population (see Landerrat des amerikanischen Besatzungsgebiets, 1949: 8). 6 By Potsdam Germany I refer to four zones of occupation (which excluded the lost Eastern territories) plus the Saar region of south-west Germany, which remained under French administration up to 1953. Together, these territories are equivalent to present-day Germany after the unification of 1990. Data for both halves of divided Berlin are split between East and West Germany. 7 Results of the population census of 29 October 1946, residential population (Wohnbevolkerung) (see Statistisches Bundesamt, 1952: 12). 8 The reliability of East German population figures has been doubted by Zank (1987:197). Zank argues for large inaccuracies in the population census of 1946, concluding that East Germany's population must have increased by some 0.5 million from 1946 to 1950. However, his estimates crucially depend on the time profile of the return of released POWs to East Germany, which is unknown. Also, it is not clear how emigration of persons in transit camps (about 130 000 in 1946) was accounted for in East Germany's population statistics. Table 16.2 therefore adheres to traditional West German usage, which excludes the latter from the population census of 1946. 9 These results have not prevented later studies from using the nominal values again. In Melzer (1980: table 6), the official data for the pre-1950 period are used to splice later real output figures to the prewar index of production, thus obtaining a long series of output which, like the official data, is systematically upward biased. 10 To construct a real output series from the official data, and thus check into the validity of the other estimates, the official output data shown in row II of Table 16.9 can be deflated provisionally by using prices of capital goods series which are given in Kupky (1957) and Melzer (1980) (see Abeken (1957) for a discussion of proper GDP deflators for East Germany). Results were very close to the estimate reported as row I in Table 16.9. One reason for the difference with Stolper's series (and also with related attempts of Gleitze (1950) and Griinig (1950) may be that they substituted West German prices for their lacking East German equivalents, assuming price equality. This assumption is probably not quite justified. 11 In West Germany, the revolt of 17 June was commemorated in a public holiday which was abandoned only after the unification of 1990. 12 Data on the composition of output in Table 16.14 are taken from Melzer (1980), where it is attempted to regroup branches of industry such as to allow for comparisons with data on both Nazi Germany and postwar West Germany. Official archival material for 1950 to 1955 released in Steiner (1994: table 1) gives slightly different results, which are apparently due to differences in classification. According to these data, there is a shift towards primary products between 1936 and 1950. 13 It is noteworthy that official output data hide this slump almost entirely. Growth rates look quite favourable when measured by MPS national income data and by a companion set of official SNA-type national product data which are available for the 1980s (Merkel and Wahl, 1991). 14 On 9 November 1918, the revolution broke out, forcing the Kaiser into exile.

East German economic growth and decline, 1945-89 535

15

16 17 18

19

20

On the same day of 1923, Hitler launched the failed Munich Beer Hall putsch. On 9 November 1938 in what became known as Reichskristallnacht, Nazi stormtroopers waged an anti-Semitic pogrom, marking the route to the Holocaust. Under Article 23, any German-speaking part of the former Reich could join the Federal Republic by majority vote of its state assembly. This is the way actually chosen by East Germany in 1990. In contrast, Article 146 sketched the way to a confederation which would have altered the constitutional order. The preamble of West Germany's constitution, which pointed out its provisional nature, made it clear that Article 146 had been considered the default option for unification. Both articles and the preamble were abandoned after the unification, in exchange for gaining sovereignty from the former victorious powers of World War II. Siebert is also one of the more prominent members of the Sachverstandigenrat, Germany's equivalent to the US Council of Economic Advisors. Wissenshaftlicher Beirat is the advisory board to the Ministry of Commerce. As the Bundesbank Act included no provision for the conversion of East German currency, it was a matter of federal legislation, to the effect that the details of conversion had to be negotiated between the Federal Government and the Bundesbank. The Bundesbank's president at the time, Karl Otto Pohl, resigned in protest against the terms of planned currency reform in East Germany (Sinn and Sinn, 1991). It should be noted that conversion rates differed between stocks (which were converted at an average rate of 1.8 marks to the Deutschmark) and flows, including wage contracts, which were converted at par (see Bundesbank (1990b) for details). In a recent paper, Schwarzer (1994) has challenged this view, arguing that relative prices of non-traded goods in East Germany did not fall significantly when evaluated on a prewar basis. Thus, purchasing power parity would have been attained by a conversion rate far closer to export exchange rates than the actual one. However, Schwarzer's conclusions appear to hinge critically on the way he splices his price indices to the prewar basis. This involves assuming that, around 1950, East German domestic retail prices were more than twice as high as in West Germany, which appears rather questionable.

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536 Albrecht O. Ritschl Akerlof, G.A., A.K. Rose, J.L. Yellen and H. Hessenius (1991) 'East Germany in from the cold: the economic aftermath of currency union', Brookings Papers on Economic Activity, pp. 1 — 87. Baar, L. (1983) 'Zur okonomischen Strategic und Investitionsentwicklung in der Industrie der DDR in den funfziger und sechziger Jahren', Jahrbuch fur Wirtschaftsgeschichte, 1983/11, pp. 9 - 3 1 . Baar, L., R. Karlsch and W. Matschke (1993) 'Kriegsfolgen und Kriegslasten Deutschlands: Zerstorungen, Demontagen und Reparationen', mimeo., Dept of Economics, Humboldt University, Berlin. Barro, R.J. and X. Sala-i-Martin (1991) 'Convergence across states and regions', Brookings Papers on Economics Activity, 1, pp. 107 —82. Barthel, H. (1979) Die wirtschaftlichen Ausgangsbedingungen der DDR, East Berlin: Akademie-Verlag. Beintema, N. and B. van Ark (1993) 'Comparative productivity in East and West German manufacturing before the reunification', mimeo., Dept of Economics, University of Groningen. Berger, H. and A. Ritschl (1995) 'Germany and the political economy of the Marshall Plan, 1947-52: a re-revisionist view', forthcoming in B. Eichengreen (ed.), Europe's Postwar Growth, Revisited, Cambridge: Cambridge University Press. Birkenfeld, W. (1961) Der synthetische Treibstoff1933-1945, West Berlin: Duncker & Humblot. Borchardt, K. (1991) Perspectives on Modern German Economic History and Policy, Cambridge: Cambridge University Press. Buchheim,C. (1990a) Die Wiedereingliederung Westdeutschlands in die Weltwirtschaft 1945-1958 (Quellen und Darstellungen zur Zeitgeschichte Bd. 31), Munich: Oldenbourg. (1990b) 'Wirtschaftliche Griinde des Arbeiteraufstandes vom 17. Juni 1953 in der DDR', Vierteljahreshefte fur Zeitgeschichte, 38, pp. 415-33. Bundsbank (1990a) 'Die Bilanz des Zahlungsverkehrs der Bundesrepublik Deutschland mit der Deutschen Demokratischen Republik', Monatsberichte, 42 (January), pp. 13-21. (1990b) 'Die Wahrungsunion mit der Deutschen Demokratischen Republik', Monatsberichte, 42 (July), pp. 14-29. Bundesminister fur innerdeutsche Beziehungen (ed.) (1985) DDR — Handbuch, vol. 2, Cologne: Verlag Wissenschaft und Politik. Deutsches Institut fur Wirtschaftsforschung (DIW) (1971), in Bundesministerium fur gesamtdeutsche Fragen (ed.), Materialien zum Bericht zur Lage der Nation, Bonn: Bundesdruckerei. (1974) DDR-Wirtschaft: Eine Bestandsaufnahme, Frankfurt am Main: Fischer. (1979) 'Arbeitsproduktivitat', in Bundesministerium fur innerdeutsche Beziehungen (ed.), DDR Handbuch, vol. 1, Cologne: Verlag Wissenschaft und Politik. (1987) 'Vergleichende Darstellung der wirtschaftlichen und sozialen Entwicklung der Bundesrupublik Deutschland und der DDR seit 1970', in Bundesministerium fur innerdeutsche Beziehungen (ed.), Materialien zum Bericht zur Lage der Nation im geteilten Deutschland 1987, Bonn: Universitats-Buchdruckerei. CIA, Directorate of Intelligence (1986) Handbook ofEconomic Statistics, Washington, DC. Christ, P. and R. Neubauer (1991) Kolonie im eigenen Land: Die Treuhand, Bonn und die Wirtschaftskatastrophe der fiinf neuen Lander, Berlin: Rowohlt. Collier, I.L. (1985) 'The estimation of gross domestic product and its growth rate

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for the German Democratic Republic', World Bank Staff Working Papers No. 773. Dinkel, R. (1984) 'Haben die geburtenfordernden MaBnahmen der DDR Erfolg? Eine vergleichende Darstellung der Fertilitatsentwicklung in beiden deutschen Staaten', lFO-Studien, 30, pp. 139-62. Dumke, R. (1990) 'Reassessing the Wirtschaftswunder: reconstruction and postwar growth in West Germany in an international context', Oxford Bulletin of Economics and Statistics, 52, pp. 451-91. Eichengreen, B. and M. Uzan (1992) T h e Marshall Plan: economic effects and implications for Eastern Europe', Economic Policy, 14, pp. 14-75. Giersch, H., K.H. Paque and H. Schmieding (1992) The Fading Miracle: Four Decades ofMarket Economy in Germany, Cambridge: Cambridge University Press. Gillingham, J. (1991) Coal, Steel and the Rebirth of Europe, 1945-55, Cambridge: Cambridge University Press. Gimbel, J. (1976) The Origins of the Marshall Plan, Stanford, CA: Stanford University Press. Gleitze, B. (1950) 'Die Veranderungen in der wirtschaftlichen und sozialen Struktur Mitteldeutschlands', Vierteljahreshefte zur Wirtschaftsforschung, pp. 35-44. (1956) Ostdeutsche Wirtschaft: Industrielle Standorte und volkswirtschaftliche Kapazitdten des ungeteilten Deutschland, West Berlin: Duncker & Humblot. (1967a) 'Die Produktionswirtschaft der DDR im Wettbewerb mit der westlichen Industriewelt', in B. Gleitze et al. (eds.), Die DDR nach 25 Jahren, West Berlin: Duncker & Humblot. (1967b) 'Die wirtschaftliche Entwicklung Mitteldeutschlands zwischen dem VI. und VII. Parteitag der SED und die Perspektiven bis 1970', Aktuelle Beitrdge zur wirtschaftlichen und gesellschaftlichen Lage in Mitteldeutschland, (Bonn:) Forschungsbeirat fiir Fragen der Wiedervereinigung Deutschlands, mimeo. Gorzig, B. (1992) Produktion und Produktionsfaktorenfur Ostdeutschland, Kennziffern 1980-1991, Berlin: Duncker & Humblot ( = DIW Beitrage zur Strukturforschung 135). Gorzig, B. and M. Gornig (1991) Produktivitdt und Wettbewerbsfdhigkeit der Wirtschaft der DDR, Berlin: Duncker & Humblot ( = DIW Beitrage zur Strukturforschung 121). Griinig, F. (1950) 'Volkswirtschaftliche Gesamtrechnung fiir die sowjetische Besatzungszone', Vierteljahreshefte zur Wirtschaftsforschung, pp. 16-34. Harmssen, G. (1951) Am Abend der Demontage: Sechs Jahre Reparationspolitik, Bremen: Friedrich Triijen. Hartmann, T.T. (1971) Die Kooperation in der sozialistischen Landwirtschaft der DDR, West Berlin: Duncker & Humblot. Hayes, P. (1987) Industry and Ideology: The IG Far ben in the Nazi Era, Cambridge: Cambridge University Press. Hockerts, H.G. (1994a) 'Grundlinien und soziale Folgen der Sozialpolitik in der DDR', in H. Kaelble, J. Kocka and H. Zwahr (eds.), Sozialgeschichte der DDR, Stuttgart: Klett-Cotta. (1994b)'Soziale Errungenschaften? Zum sozialpolitischen Legitimitatsanspruch der zweiten deutschen Diktatur', in J. Kocka, H.J. Puhle and K. Tenfelde (eds.), Von der Arbeiterbewegung zum modernen Sozialstaat: Festschrift fur Gerhard A. Ritter zum 65. Geburtstag, Munich: Saur. Hoffman, L. (1990a) 'Wider die okonomische Vernunft', Frankfurter Allgemeine Zeitung, 10 February. (1990b) 'Integrating the East German states into the German economy:

538 Albrecht O. Ritschl opportunities, burdens and options', in P.J.J. Welfens (ed.), Economic Aspects of German Unification, Berlin and Heidelberg: Springer. Janossy, F. (1966) Das Ende der Wirtschaftswunder: Erscheinung und Wesen der wirtschaftlichen Entwicklung, Frankfurt am Main: Verlag Neue Kritik. Karlsch, R. (1993) Allein bezahltPDie Reparationsleistungen der SBZ/DDR1945-53, Berlin: Ch. Links. Krengel, R. (1957) 'Die langfristige Entwicklung der Brutto-Anlageinvestitionen der westdeutschen Industrie von 1924 bis 1955/56', Vierteljahresshefte zur Wirtschaftsforschung, pp. 168-84. (1958) Anlagevermogen, Produktion und Beschdftigung der Industrie im Gebiet der Bundesrepublik von 1924 bis 1956, Berlin: Duncker & Humblot ( = D I W Sonderhefte N.F. 42). Kupky, H. (1957) 'Die langfristige Entwicklung der Brutto-Anlage-Investitionen der mitteldeutschen Industrie von 1924 bis 1955', Vierteljahreshefte zur Wirtschaftsforschung, pp. 391-407. Kusch, G. et al. (1991) Schlufibilanz - DDR: Fazit einer verfehlten Wirtschafts- und Sozialpolitik, Berlin: Duncker & Humblot. Landerrat des amerikanischen Besatzungsgebiets (1949) Statistisches Handbuch von Deutschland, Munich: Ehrenwirth. Lentz, M. (1979) Die Wirtschaftsbeziehungen DDR-Sowjetunion 1945-1961: Eine politologische Analyse, Opladen: Leske Berlag & Budrich. Manz, M. (1968) [1985] Stagnation und Aufschwung imfranzosischen Besatzungsgebiet 1945-1948, Ostifildern: Scripta Mercaturae. Matschke, W. (1988) Die industrielle Entwicklung in der Sowjetischen Besatzungszone Deutschlands (SBZ) 1945 bis 1948, Berlin: Berlin Verlag Arno Spitz. Melzer, M. (1980) Anlagevermogen, Produktion und Beschdftigung der Industrie im Gebiet der DDR von 1936 bis 1978 sowie Schdtzung des kiinftigen Angebotspotentials, Berlin: Duncker & Humblot ( = DIW Beitrage zur Strukturforschung 59). Merkel, W. and S. Wahl (1991) Das geplunderte Deutschland: Die wirtschaftliche Entwicklung im ostlichen Teil Deutschlands von 1949 bis 1989, Bonn: Institut der deutschen Wirtschaft. Muhlfriedel, W. and K. Wiessner (1983) 'Drei Bemerkungen zu den fiinfzehn Thesen von Jorg Roesler zum Thema Perspektivplane und Investitionsrhythmus in der Volkswirtschaft der DDR 1949 bis 1980. Inhaltliche und methodologische Probleme', Jahrbuchfur Wirtschaftsgeschichte 1983/1, pp. 179-87. (1989) Die Geschichte der Industrie der DDR bis 1965, East Berlin: Akademie-Verlag. Neumann, G. (1980) Die okonomischen Entwicklungsbedingungen des RGW, Vol. 1: 1945-1958, East Berlin: Akademie-Verlag. (1989) Die Geschichte der Industrie der DDR bis 1965, East Berlin: Akademie-Verlag. Obst, W. (1973) DDR- Wirtschaft: Modell und Wirklichkeit, Hamburg: Hoffmann & Campe. Roesler, J. (1983) Terspektivplane und Investitionsrhythmus in der Volkswirtschaft der DDR 1949 bis 1980: Inhaltliche und methodische Probleme', Jahrbuchfur Wirtschaftsgeschichte 1983/1, pp. 169-78. (1991) Zwischen Plan und Markt: Die Wirtschaftsreform 1963-1970 in der DDR, Freiburg in Brisgam: Haufe. Roesler, J., V. Siedt and M. Elle (1986) Wirtschaftswachstum in der Industrie der DDR 1945-1970, East Berlin: Akademie-Verlag. Sachverstandigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung (1990a) Aufdem Wege zur wirtschaftlichen Einheit Deutschlands: Jahresgutachten 1990191, Stuttgart: Metzler & Poeschel.

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(1990b) Brief des Sachverstandigenrates vom 9. Februar 1990 an den Bundeskanzler, in Sachverstandigenrat (1990a), pp. 306-8. (1991) Die wirtschaftliche Integration in Deutschland: Perspektiven - Wege Risiken: Jahresgutachten 1991192, Stuttgart: Metzler & Poeschel. (1993) Zeit zum Handeln — Antriebskrafte startken: Jahresgutachten 1993194, Stuttgart: Metzler & Poeschel. Schmidt, M. (1953) Trobleme bei der Ermittlung der industriellen Bruttoproduktion', Diskussionsbeitrage zu Wirtschaftsfragen, 12, East Berlin: Verlag Die Wirtschaft. Schrdter, H. (1994) 'Olkrisen und Reaktionen in der chemischen Industrie beider deutsche Staaten: Ein Beitrag zur Erklarung wirtschaftlicher Leistungsdifferezen', mimeo., Dept of Economics, Free University of Berlin. Schui, H. (1991) Die okonomische Vereinigung Deutschlands: Bilanz und Perspektiven, Heilbronn: Distel-Verlag. Schwarzer, O. (1994) 'Kaufkraftparitaten-Koeffizienten zwischen Mark der DDR und DM', mimeo., Dept of History, University of Bamberg. Siebert, H. (1991a) 'German unification: the economics of transition', Economic Policy, 13, pp. 289-340. (1991b) Das Wagnis der Einheit: Eine wirtschaftspolitische Therapie, Stuttgart: Deutsche Verlagsanstalt. Sinn, G. and H.-W. Sinn (1991) Kaltstart: Volkswirtschaftliche Aspekte der deutschen Wiedervereinigung, Tubingen: Mohr. (1992) Jumpstart: Economic Aspects of German Unification, Cambridge: Cambridge University Press. Sinn, H.-W. (1992) 'Macroeconomic aspects of German unification', in P.J.J. Welfens (ed.), Economic Aspects of German Unification, Berlin and Heidelberg: Springer. Statistisches Amt der DDR (1990) Statistisches Jahrbuch der DDR 1990, Berlin: ReWi Verlag. Statistisches Bundesamt (1952) Statistisches Jahrbuch fur die Bundesrepublik Deutschland 1952, Stuttgart: Kohlhammer. (1992) Statistisches Jahrbuch 1992 fur die Bundesrepublik Deutschland, Stuttgart: Metzler & Poeschel. (1993a) Statistisches Jahrbuch 1993fur die Bundesrepublik Deutschland, Stuttgart: Metzler & Poeschel. (1993b) Vermogensrechnung 1950-1991, Fachserie 18,,Reihe S. 17, Stuttgart: Metzler & Poeschel. Steger, A. (1993) 'Riickrechnung einer Zahlungsbilanz fur die ehemalige DDR', in Statistisches Bundesamt (ed.), Riickrechnung gesamtwirtschaftlicher Datenfur die ehemalige DDR: Ergebnisse einer Statistiktagung in Berlin, Stuttgart: Metzler & Poeschel. Steiner, A. (1994) 'Wirtschaftliche Lenkungsverfahren in der Industrie der DDR 1954/55', mimeo., Dept of Economics, University of Mannheim. Stolper, W. (1960) The Structure of the East German Economy, Cambridge, MA: Harvard University Press. Suhr, H. (1991) Der Treuhand — Skandal: Wie Deutschland geschlachtet wurde, Frankfurt am Main: Eichborn. Summers, R. and A. Heston (1988) 'A new set of international comparisons of real product and price level estimates for 130 countries', Review of Income and Wealth, 34, pp. 1-25. Weber, H. (1988) Die DDR 1945-1986, Munich: Oldenbourg. Wilkens, H. (1976) Das Sozialprodukt der Deutschen Demokratischen Republik im

540

Albrecht O. Ritschl Vergleich mit der Bundesrepublik Deutschland, Berlin: Duncker & Humblot

(= DIW Beitrage zur Strukturforschung 115). Wissenschaftlicher Beirat beim Bundesminister fur Wirtschaft (1989) 'Wirtschaft politische Herausforderungen der Bundesrepublik im Verhaltnis zur DDR: Gutachten vom 17./18. November und 15/16. Dezember 1989', in Gutachten des Wissenschaftlichen Beirats, 13, Gottingen: Schwartz.

(1990) 'Schaffung eines gemeinsamen Wirtschafts- und Wahrungsgebiets in Deutschland', in Gutachten des Wissenschaftlichen Beirats, 13, Gottingen: Schwartz. Zank, W. (1987) Wirtschaft und Arbeit in Ostdeutschland 1945-1949: Probleme des Wiederaufbaus in der Sowjetischen Besatzungszone Deutschlands, Munich:

Oldenbourg. Zentralverwaltung fur Statistik (1958) Statistisches Jahrbuch der Deutschen Demokratischen Republik 1958, East Berlin: VEB Deutscher Zentralverlag. (1975) Statistisches Jahrbuch der Deutschen Demokratischen Republik 1975, East

Berlin: Staatsverlag der DDR. (1989) Statistisches Jahrbuch der Deutschen Demokratischen Republik 1989, East

Berlin: Staatsverlag der DDR.

17

Postwar growth of the Danish economy PEDER J. PEDERSEN

1

Introduction

The aggregate growth of the Danish economy since the Second World War has followed the same broad pattern as experienced in most other European countries. The overall growth of the period has been close to the average of the European OECD countries, but the profile of growth has been somewhat different. The 'Golden Age' of high growth and extremely low unemployment began later in Denmark than in the rest of Western Europe. During most of the 1950s, growth remained below the OECD average. The golden period began in the late 1950s and ended in 1973 with the first round of oil price increases. Since then, the average growth rate of the Danish economy has once again been rather low. The postwar growth outside the golden period is more or less in line with the long-run trend in economic growth based on prewar experience. Thus, looked at from a very long-run perspective, the period from the late 1950s to the early 1970s stands out as historically exceptional years. This is the case both when we consider growth rates and when we consider the long-run experience of unemployment.1 Around 1960 the Danish economy experienced a short spell of overall macroeconomic balance. The rates of unemployment and inflation were both low, and the current account as well as the public budget were in balance. In contrast to this, both the preceding and the subsequent years were characterized by persistent problems of macroeconomic balance, creating restraints on the actual growth of the economy. A number of factors underlying the persistent problems in relation to the balance of payments, unemployment and inflation are discussed in more detail below. As an introduction, a few important structural characteristics of Danish postwar development should be emphasized. Thefirstimportant factor is that Denmark was an industrial latecomer. Denmark entered the postwar period as a traditional major exporter of agricultural products, with industrial exports playing a minor role. The exclusion of agricultural exports from the liberalization of international trade following the Marshall Plan and administered by the OEEC created persistent problems in relation to the balance of payments, since the transfer of resources to the urban 541

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Peder J. Pedersen

sector and the subsequent expansion of existing and creation of new markets for Danish industrial exports necessarily took some time. Another fundamental sectoral change was a major shift of resources into sheltered sectors of the economy. Around 1950, the share of public sector employment in the economy was lower in Denmark than in any other OECD country except Switzerland. Especially during the golden period and in the period between the two rounds of oil price increases in 1974 and 1980, public sector employment expanded so rapidly that the public sector employment share by 1980 was second only to Sweden among the OECD countries. During the golden period, rapid employment expansion took place also in another sheltered sector, building and construction. The initial exclusion of a large sector in the Danish economy from the postwar boom in international trade, and later a rapid expansion of the sheltered sectors in the economy, are important facts in the postwar growth profile of the Danish economy. Another important factor is the existence of a structural savings deficit in the private sector. This may partly be related to the strong expansion of public sector income transfer programmes having a negative impact on the incentives for private savings. Partly, it may be related to Denmark's industrial structure, which is characterized by a dominance of small firms; this in turn may explain the relatively low R & D intensity in the Danish economy. A final set of structural problems are related to the functioning of the labour market. In some respects the Danish labour market is characterized by inflexibility: that is, the wage structure is very stable with low variance, barriers against skill mobility are in some cases high, and the sensitivity of real wages to unemployment is slow by international comparison. On the other hand, industrial relations are very peaceful and firing and hiring rules are very flexible by international comparison. Section 2 presents an overview of the aggregate growth performance of the Danish economy. The emphasis in section 2 is on postwar productivity performance. The section also includes Danish growth performance in a long-run international context. Section 3 contains a discussion of the importance for postwar growth of developments in the years from 1930 to 1950, including the great depression, the war years and the reconstruction period. The emphasis in section 3 is on the long-run effects of sectoral shifts and of changes in attitudes with regard to economic policy. Section 4 presents an overview of postwar growth determinants. The first part of section 4 includes a survey of a number of factors behind the growth process: capital accumulation, labour, participation in international trade and aspects of the development of the industrial structure. The emphasis in the second part of section 4 is on sectoral shifts of relevance for the growth process. In the Danish context, the change from agricultural to industrial products with regard to exports, and the shifts between sheltered and exposed sectors are important factors. In section 5 the emphasis is on economic policy of special relevance for growth and productivity in a number of subperiods in the postwar years. Natural dividing years in this discussion are 1957, representing the beginning of the period of high growth in the Danish economy, and 1973 and 1979, representing the two oil price shocks. The Danish economy was hit especially hard, since the dependency on imported oil at that time was nearly complete.2 The experience in the years after 1980 is the final topic in section 5. Like other OECD economies, Denmark

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1890 1895 19001905 1910 1915 19201925 19301935 19401945 1950 195519601965 1970 1975 19801985 1990

Figure 17.1 Log GNP per capita: Denmark, 1890-1990

experienced both a recovery and a cyclical downturn in these years - but in reverse order in relation to the OECD trend, with recovery preceding the downturn. Finally, a number of concluding comments are found in section 6.

2

The aggregate growth performance: an overview

2.1

The long-run growth performance of the Danish economy

The period under study coincides with the years for which official national account data are available. To consider postwar growth performance in a long-run setting, it is necessary to use national account estimates for earlier periods developed by Hansen (1974). Using these unofficial estimates in combination with official national account data covering the years since 1948 produces the long-run growth profile for the years from 1890 to 1990 shown in Figure 17.1. One possible explanation for the profile in Figure 17.1 is an economy with a stable long-run growth in GNP per capita at a level of 1.93 per cent per year in the quarter of a century before the First World War, to which the economy returns in the late 1960s following a number of major disturbances in the intervening period. The major setbacks are evidently the wars, especially the Second World War. During the 1920s, the economy nearly catches up with the long-run trend level. Return to the trend is broken by declines in GNP per capita at the beginning of the 1930s. Growth in the remaining part of the 1930s is close to the trend rate, but the level of GNP per capita is persistently below the long-run trend level. After the big decrease in real GNP during the war, the starting point of the postwar years is significantly below the trend level.

544 Peder J. Pedersen 201

% change in real GNP Three-year moving average

1946 1949 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 Source: Calculated from ADAM databank.

Figure 17.2 Growth in real GNP: Denmark, 1946-91

The economy catches up with the trend once again in the late 1960s. During the next quarter of a century, growth remains very close to the trend line. In this perspective, two questions seem to be of major interest in the interpretation of Danish postwar growth history. First, why did it take nearlyfifteenyears before the catch-up process began in the late 1950s? Second, what are the factors that explain the beginning of the Golden Age of catch-up growth from the late 1950s to the late 1960s/beginning of the 1970s? For the postwar years alone, Figure 17.2 shows the actual growth rate of real GNP along with a three-year moving average. Looking at the moving average graph, it is evident that growth performance is tapering off from the peak level of around 5 per cent per year attained in thefirsthalf of the 1960s. The major postwar episodes of negative growth occur due to international disturbances - that is, the raw materials price increases in 1951 due to the Korean War and the negative oil price shocks in 1974/5 and 1980/1 - while the positive supply shock of 1986 is not at all reflected in the growth rate. The negative growth rates in 1955 and 1963 reflect domestic policy shocks due to balance of payments problems. 2.2

Comparative growth performance

Following this summary description of the aggregate development, Danish growth performance will be considered from an international perspective. The very long perspective considered in Table 17.1 is calculated from Maddison's(1991: tables A2 and B7) estimates of GDP in 1985 US relative prices and of the total population in thirteen countries in 1820 and 1989.

Postwar growth of the Danish economy

545

Table 17.1. Long-run growth performance in international perspective (1820 and 1989 levels in 1985 US$ relative prices) Level in 1820 Relative position Austria Belgium Denmark Finland France Germany Italy Japan Netherlands Norway Sweden UK USA

1041 1024 981 639 1052 913 956 588 1307 856 947 1456 1047

5 6 7 12 3 10 8 13 2 11 9 1 4

Level in 1989 Relative position 12585 12876 13514 13934 13837 13989 12955 15101 12737 16500 14912 13468 18317

13 11 8 6 7 5 10 3 12 2 4 9 1

Average growth per year 1.47 1.5 1.55 1.82 1.55 1.61 1.54 1.92 1.35 1.75 1.63 1.32 1.69

Note: Calculated from Maddison (1991: tables A2 and B7).

In this very long-run perspective, the relative position of Danish GDP per capita is nearly stationary, going down from seventh place among the thirteen countries to be number 8. Average Danish growth per capita over the 169 years covered by Table 17.1 is 1.55 per cent relative to an average growth for all thirteen countries of 1.59 per cent. In terms of position, the big 'winners' from 1920 to 1989 are Japan, Finland, Norway and the USA. Except for the USA, these winners occupy the lowest positions in 1820. The big losers' are the UK, the Netherlands and Austria. In order to view the postwar productivity performance from a long-run perspective, Table 17.2 presents the relative performance, measured by GDP per work-hour in constant US relative prices, for Denmark and for an average of sixteen countries for different subperiods since 1870. It is evident from Table 17.2 that a 'golden' period of Danish comparative labour productivity growth occurred in the half century from 1880 to 1929. The 1930s represent a low point, also from a comparative perspective. In the postwar years, productivity growth is lower than average in all subperiods except the 1960s, when labour productivity grows at the average rate for the sixteen countries included in Table 17.2. Looking specifically at aggregate growth performance in the years after 1950, Table 17.3 shows the average growth rates for the Danish economy along with the average growth rates in two relevant groups of countries: that is, the major trading partners in the EC and the other Nordic countries. Table 17.3 demonstrates clearly the two periods of relatively low Danish growth in the 1950s and in the years between the two OPEC shocks.

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Peder J. Pedersen

Table 17.2. Annual change in GDP per work-hour in Denmark and average for 16 countries, decades 1870-1989 (1870-1979 measured in constant 1970 US relative prices, 1973-89 measured in 1985 constant US relative prices)

1870-80 1880-90 1890-1900 1900-13 1913-29 1929-38 1938-50 1950-60 1960-70 1970-9 1973-89

Average growth per year, 16 countries (%) 1.64 1.43 1.65 1.77 2.10 1.48 1.65 3.83 4.92 3.37 1.56

Ration between Danish Relative growth position of Danish and average growth economy rates 11 4(3) 7 4 3 12 10 12 7 8 13

0.90 1.36 1.15 1.25 1.22 0.29 0.75 0.78 1.00 0.91 0.69

Notes: 1870-1979 calculated from Baumol et al. (1991: table 5.1, p. 88; primary source: Maddison (1982)); 1973-9 calculated from Maddison (1991). Table 17.3. Average annual rate of growth of real GNP, 1950-92: Denmark, average for France, Germany, Italy and the UK (EC4), and average for the other Nordic countries, Finland, Norway and Sweden (%)

1950-7 1958-73 1974-81 1982-92

Denmark

Average EC4

Average other Nordic countries

2.64 4.45 1.27 2.21

4.89 4.49 2.17 2.25

4.29 4.41 2.84 2.01

Note: Calculated from Madsen and Paldam (1978) and OECD (1993).

2.3

Postwar productivity growth

Postwar development of some crude measures of labour productivity is illustrated in Figures 17.3 and 17.4. Figure 17.3 shows annual change in labour productivity for the whole economy as the relative change in real G N P per employed person: that is, without correcting for changes in annual hours and in part-time frequency, and a fortiori without any corrections for changes in education in the composition of the labour force. The profile is much in line with the profile for the aggregate growth rate shown in Figure 17.2, with growth in production per employed person falling from the mid-1960s and stabilizing at a new lower level from the mid-1970s. Figure 17.4 shows a somewhat more satisfactory indicator of the development in labour productivity measured as the change in hourly productivity in manufacturing industry, where this change is more pronounced. The very high growth registered in the mid-1970s was - mistakenly - at the time taken by some observers

Postwar growth of the Danish economy lO-i

Productivity per employed person Three-year moving average 194919521955 1958196119641967197019731976 19791982198519881991 Source: Calculated from ADAM databank. Figure 17.3 Change in aggregate real GNP per employed person: Denmark, 1949-91

15-1 Change in hourly productivity of labour, manufacturing Three-year moving average

194919521955195819611964196719701973197619791982198519881991 Source: Calculated from ADAM databank. Figure 17.4 Change in hourly productivity of labour, manufacturing industry: Denmark, 1949-91

547

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Table 17.4. Annual change in total factor productivity: Denmark, 1966-91 (%)

Agriculture Manufacturing industry Public utilities Building and construction Private service industries Private sector Non-market service industries

1966-73

1973-9

1979-86

1986-91

1966-91

3.33 5.77 3.84 1.15 2.87 3.45

3.98 3.40 5.97 -2.14 1.76 2.04

5.79 1.19 7.32 3.71 0.63 1.58

5.92 0.80 -1.33 -2.30 1.12 1.15

4.69 2.90 4.24 0.36 1.62 2.12

1.81

1.11

0.20

1.15

1.06

Source: Statistics Denmark (1993). as indicating that the increasing unemployment was technological in nature. The subsequent development showed a steep decline continuing until the mid-1980s, when labour productivity in industry was constant or falling from 1984 to 1987. It is well known that productivity decreased after the mid-1970s in most OECD countries. But the mid-1980s experience in the Danish economy was more troublesome due to the falling level of hourly productivity. Some possible explanations of the 1980s experience are taken up below. Estimates of more satisfactory measures of total factor productivity (TFP) are available for part of the postwar period from a number of different sources. For the years 1950-62, Denison (1967) found TFP growth to be 1.37 per cent per year on average. Groes and Bjerregaard (1978) report estimates for 1950-60 of 1.01 per cent per year and for 1960-72 of 1.70 per cent per year: that is, at the same level as Denison's estimate and showing an increasing trend like the growth rates. More recent estimates have been produced by Statistics Denmark covering the period 1966 to 1991.3 The average annual change in TFP in some major production sectors is shown in Table 17.4 for the whole period 1966-91, and separately for four subperiods divided by cyclical peak years. For the private sector as a whole, TFP growth is decreasing between each subperiod. The profiles in individual sectors differ from this pattern. In agriculture, TFP is accelerating. Manufacturing industry shows the same profile as the aggregate private sector, while TFP growth accelerates in private service industries in the last period from 1986 to 1991. In building and construction, no clear time pattern appears. A regression of TFP growth in building and construction on real growth in the sector shows a rather strong covariation considering the big cyclical swings in construction.4 The sector 'non-market service industries' practically identical with the public sector - follows the same pattern as the prime sector service industries. The annual change in TFP is shown in more detail in Figure 17.5 for the whole private sector and for the two major sectors manufacturing industry and private service industries. The decline in TFP growth for the whole private sector and for private service industries seems to stop around 1980. In manufacturing industry, on the other hand, the profile shifts from TFP growth above the private sector average to a steep decline with falling TFP in the mid-1980s. The profile for manufacturing

Postwar growth of the Danish economy

549

101

-5-

TFP, manufacturing industry Private service industries TFP, private sector

'••'

-10 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 Source: Statistics Denmark (1993).

Figure 17.5 Annual change in total factor productivity: Denmark, 1967-91 Table 17.5. Average change per year in total factor productivity, labour productivity and capital productivity in the private sector, 1966-91 (%) 1966-73 Total factor productivity Labour productivity Capital productivity

3.45 5.33 —0.57

1973-9 2.04 3.21 0.29

1979-86

1986-91

1966-91

1.58 2.24 0.12

1.15 3.16 -2.08

2.12 3.52 -0.62

Source: Statistics Denmark (1993).

industry is much in line with the profile for hourly productivity of labour found in Figure 17.4. TFP growth in the 1980s is very much influenced by a big shift in capital productivity in the second half of the decade, shown in Table 17.5. TFP and labour productivity show the same profile until 1986, but while the fall in TFP continues until the second half of the 1980s, the change in labour productivity increases after the low point between 1979 and 1986. The continued decline in TFP growth is due to the fall in capital productivity estimated to decline by about 2 per cent annually between 1986 and 1991. The Economic Council (1991) has made a more detailed study of the development in TFP between 1967 and 1989, with the purpose of analysing separately the development in sheltered and competition-exposed sectors of the economy. In contrast to the official estimates from Statistics Denmark discussed above, labour inputs in the study by the Economic Council are disaggregated and weighted together by income shares drawing on wage data for different educational groups.

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Peder J. Pedersen

2-

1-

-1-

TFP, sheltered sectors TFP, exposed sectors

\'

\

1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 Source: Economic Council (1991).

Figure 17.6 Factor quality corrected estimates of TFP change in sheltered and exposed sectors: Denmark, 1967-89

In the same way, capital inputs are broken down into quantity and quality. The resulting estimates of TFP growth in sheltered and exposed sectors are shown in Figure 17.6. Foreign trade intensity is used as the criterion to assign sectors to either the sheltered or the exposed part of the economy. This division is roughly comparable to the division between manufacturing industry and private service industries in Figure 17.5. With the reservation resulting from an imperfect comparability, the relative sector profiles differ in two respects. In Figure 17.5, TFP growth in manufacturing industry is higher than in private service industries until the beginning of the 1980s, while Figure 17.6 with adjustments for differences in factor qualities shows quite another development. In Figure 17.6, sheltered sector TFP growth is typically higher than TFP growth in the exposed sector through the whole period. Another difference is seen for the 1980s, when the sheltered sector increase in TFP growth is more pronounced than is found for the counterpart in Figure 17.5. For a small open economy, it is clearly a problem if TFP consistently grows at a slower rate in the exposed than in the sheltered sector. A full explanation of the pattern shown in Figure 17.6 is not available. A number of possible contributions to an explanation include that the sectors have faced different relative factor prices, that investment patterns have differed, and that the long-term allocation of labour has differed with respect to the composition of educational qualifications (see Economic Council, 1991).

Postwar growth of the Danish economy 551 3

The legacy from the 1930s and the war and reconstruction years

3.1

The 1930s

In this and the following two subsections, no attempt is made to present a comprehensive picture of growth determinants in the two decades before 1950. The purpose is to identify a number of fundamental characteristics of these decades that were of importance for the postwar growth process. As in most other countries, the 1930s were years of crisis and high unemployment in Denmark. But at the same time it was a decade of structural change in the economy and of employment expansion. In political history, the 1930s mark the beginning of a long period of social democratic dominance in the Danish parliament.5 In economic policy, this fact along with the major external shocks from the world depression implied a change from a very liberal attitude, both in domestic and in foreign trade policy, towards a very comprehensive regulation both of external trade and of the domestic economy. Two factors made the impact of the world depression especially serious for the Danish economy. Denmark was predominantly an agricultural exporter, and the shock of the depression was most severe in raw materials and in agricultural products. The other factor was that the country's foreign trade was not bilaterally balanced. Trade was very concentrated, with 75 per cent of exports being sold to the UK and Germany, and with 50 per cent of imports coming from these two countries. Trade with the two dominant partners was unbalanced, with a big surplus in the UK trade and a deficit in the trade with Germany. This presented no problem in a state of free trade and convertible foreign exchange, but it became a very grave problem when restrictions were placed on trade in combination with demand for bilateral trade equilibrium. The full impact of the world depression came in 1933. The terms of trade declined by more than 20 per cent from 1931 to 1932, and insured unemployment reached an all-time record level of 32 per cent in 1932. Unemployment declined from the 1932 level, but did not move below the 18 per cent reached in 1939.6 The terms of trade improved after the marked initial decline, and by the end of the decade the 1930 level was re-established.7 Average aggregate per-capita growth in real GNP was 1.66 per cent from 1930 to 1939. The structural change taking place during the decade is illustrated by a parallel increase of 60 per cent in both industrial production and employment from 1932 to 1939. Part of this was due to the trade restrictions under which many new, small and labour-intensive firms developed.8 The overall gross investment to GDP ration does not decline much in the 1930s, when it was 16.6 per cent compared to 17.2 per cent on average for the 1920s. On the other hand, the sectoral composition of investments changes considerably. Looking at the ratio between gross investments in agriculture and in the non-agricultural sectors, there is a large decline from an average ratio of 28.4 per cent for the 1920s to 14.5 per cent in the 1930s. There is a decrease in the share of employment in agriculture both before and after the 1930s. Except for the steep decline from 1929 to 1932, the overall decline throughout the 1930s is no faster than in the preceding and the subsequent decade. Concerning the sectoral terms of trade between agriculture and non-agriculture, the GDP deflator for agriculture declined on average by 0.57 per cent per year in the 1930s, while the GDP deflator for non-agricultural sectors

552 Peder J. Pedersen

increased by 1.26 per cent annually. Overall, this resulted in a 20 per cent deterioration of agricultural terms of trade in the domestic economy. Finally, the shifting weight between agriculture and the rest of the economy is illustrated by a fall in the export share of agriculture from 73 per cent in 1930 to 63 per cent in 1939 (Hansen, 1974: table XIII.6, p. 62) and a decline of the GDP share of agriculture of 2.5 percentage points in constant prices. Summing up, the most important legacies from the 1930s for postwar growth seem to concern three factors. The first is the sectoral shift from agriculture, which is permanent and reinforced after the war. The second is the fundamental change in attitude towards economic policy, from laissez-faire liberalism to very comprehensive regulation. Foreign trade and part of agricultural production remained regulated throughout the decade. Fiscal policy was mildly expansive - although not due to an early acceptance of Keynesian ideas (see Topp, 1987) - and was supplemented through most of the decade by a low interest rate policy. Finally, the change in the relative size and structure of industry had repercussions on postwar growth and trade. Protected by the restrictions on imports, most of the expansion of industry after 1932 occurred in small, labour-intensive firms.9 3.2

The war years

The outbreak of war implied a drastic 20 per cent deterioration of the Danish terms of trade between 1939 and 1940. In April 1940 Denmark was occupied and the regulated trade pattern broke down. Exports of agricultural products to the dominating UK market fell away, as did the normal pattern of imports of raw materials. Exports were - partly by force, partly voluntarily - going to Germany as payment for delivery of raw materials from Germany to keep industry functioning. The cutting-off of normal supply channels implied a decline in both the quantity and quality of available raw materials and a necessity to devote resources to develop and produce a multitude of low-quality substitutes. Reinvestments fell to a low level and the capital stock was being used up, while direct destruction through acts of war was rather limited. The consequence was negative growth during the occupation, with real GDP 11 per cent below the prewar level in 1945. The sectoral shift from agriculture to industry slowed down during the war because agricultural products were in high demand from Germany, and because major parts of industry were rationed in relation to energy and raw materials. Growth perspectives at the end of the war were both negative and positive. On the negative side was an unavailability - for obvious reasons - of raw material supplies from Germany in combination with a lack of foreign reserves. On the positive side, real capital and infrastructure were worn down but basically undamaged by war destruction. Another positive factor was the creation of nearly full employment as those who had been long-term unemployed back in the 1930s and at the beginning of the war were absorbed into jobs. 3.3

The reconstruction years, 1945-50

In the case of Denmark, the term 'reconstruction' is less applicable to the half decade after the war. The capital stock was largely intact, although reinvestments and maintenance had been at a low level. The main problems in this period were found in

Postwar growth of the Danish economy

553

the area of foreign trade. On the import side, the main problem was the supply of energy and raw materials in a situation where trade connections with the West had been cut off forfiveyears and where foreign exchange was extremely scarce. On the export side, the two traditional markets, Germany and the UK, were both hit hard. Germany had very little import capacity, and the UK entered the postwar period with huge economic problems. As a consequence, a major restructuring of exports occurred, with the share of exports going to the other Scandinavian countries and the USA increasing by 11 percentage points, and the share of exports going to the rest of the world tripling from 15 to 45 per cent (Henriksen and 01gaard, (1960: 42-5). The traditional structure, with a surplus earned in pounds sterling used to finance the import of raw materials from outside the sterling area, broke down as a sterling surplus was no longer convertible. Things improved in the area of foreign trade in 1948 and 1949 as the terms of trade increased considerably, by a total of 37 per cent over the two years. At the same time, Marshall Plan assistance reached its maximum in 1949 when Denmark received an amount corresponding to 2.6 per cent of GDP. This more comfortable situation in relation to the terms of trade came to an end with currency realignment in September 1949. Denmark followed the devaluation of sterling because of the importance of the UK market for Danish agricultural exports. Problems arose because agricultural prices were denominated in sterling in an earlier long-term trade agreement and a significant share of Danish imports was bought from the dollar area. As a consequence, the terms of trade deteriorated by 18 per cent from 1949 to 1950 and, due to the Korean War, by a further 17 per cent in 1951. Despite these serious problems related to the restructuring of foreign trade, growth was very high in thefirstfiveyears after the war, with real GDP rising on average nearly 7 per cent per year. Employment rose on average by 1 per cent annually, and the capital stock by more than 4 per cent. The normalization of the supply situation and increasing capital intensity resulted in productivity growing by between 5 and 6 per cent annually. Indicators of the development in agriculture and industry are given in Table 17.6. Production increased much faster in industry, where the prewar level was passed in 1946. Employment also increased very quickly in industry, in contrast to a fall of 12 per cent in agriculture. The increase in labour productivity was slightly higher in agriculture than in industry from 1945 to 1950. But compared to the prewar level of productivity, an important difference appears. In agriculture, the 1945 level of productivity was the same as the prewar level of 1938, so the 40 per cent increase from 1945 is a genuine postwar growth. On the other hand, in industry the 1938 level of productivity was not reached again until 1949, so the impressive growth of 1945-50 is really no more than a return to the level of 1938. The profile of productivity growth in agriculture is probably due to a shift in the composition of agriculture investments towards a greater share consisting of machinery and equipment. The long time needed to restore the productivity level in manufacturing industry was a topic of debate at the time. The main factors that entered this discussion were problems related to the supply of raw materials and the reduced capital stock mentioned above. Furthermore, part of the explanation could be labour substitution, due both to problems in relation to raw materials and capital stock, and to

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Peder J. Pedersen

Table 17.6. Indicators of sectoral shifts: Denmark, 1945-50 Agriculture

(1945-100)

Industry

Real GDP No. of Labour Production Employment Labour workers productivity index index productivity 1945 1946 1947 1948 1949 1950

100 105 97 97 110 124

100 97 91 90 89 88

100 109 106 107 123 140

100 141 158 176 188 208

100 123 137 139 145 158

100 114 115 126 129 132

Notes: Calculated from Hansen (1974). substitution in consumption towards more labour-intensive products. Finally, some - implicit - human capital arguments were made: for example, training had been substandard during the war and the long-term unemployed who re-entered production had to some extent lost both general and specific skills (Stevenius-Nielson, 1952). Overall, growth was high during the reconstruction period, in contrast to the first years of the so-called golden period (see below). In the long-run perspective, the main heritage from the 1940s was a new commitment to high employment modified by a balance of payments restriction. The counterpart to this in economic policy was a change in attitudes away from direct regulation and rationing, relying instead on demand management, with fiscal policy as the main instrument.

4

Growth factors and sectoral shifts in the postwar years

4.1

Growth factors

After the overview in section 2 of the aggregate postwar growth and productivity performance of Denmark, we proceed with a short presentation of some of the factors behind the growth process, using a traditional production function framework. Beginning with additions to the capital stock in the postwar period, Figure 17.7 shows the gross investment ratio for the aggregate economy. Relative to investment activity, the postwar years clearly fall into three phases: the low-growth years of the 1950s, with the investment ratio moving around a level of 0.22; the years of high growth from the late 1950s to the early 1970s, with cyclical movements around a higher level of 0.25; and finally the most recent twenty years, with a volatile investment ratio on a downward trend towards a level somewhat below that of the 1950s. The investment variable used in Figure 17.7 is a comprehensive measure, including public sector investments and dwellings. In a growth setting, De Long and Summers (1991, 1992) have pointed to the specific importance of investments in machinery and equipment. In Figure 17.8 we show the annual change in the stock of machinery capital per person in employment for the postwar years since 1949. In the

Postwar growth of the Danish economy

555

0.300.280.260.240.220.200.180.16-

0.14 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 Source: Calculated from ADAM databank.

Figure 17.7 Gross investments to output ratio, aggregate economy: Denmark, 1948-91

15

10-

5-

0 1949 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 Source: Calculated from ADAM databank.

Figure 17.8 Relative change in machine capital per employed person: Denmark, 1949-91

556

Peder J. Pedersen -0.11

llO-i

Q

-0.09 % 90

-0.08 j 0.07 't

1

-0.06 -g

70-

I -0.05

.8

^

I 50

Relative price Output share

40 ' . • • 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990

-0.04 g^ "3 0.03 ° 0.02

Source: Calculated from A D A M databank.

Figure 17.9 Relative price and output share of machinery investments: Denmark, 1948-91

very first years, growth in machinery intensity declines from a very high level, undoubtedly influenced by reconstruction needs. Then machinery intensity grows at a fairly constant and relatively high rate from the beginning of the 1950s to the end of the 1960s. It is interesting to note that a huge decline in the growth rate occurs before the OPEC supply shocks. In the years of negative supply shocks and stagflation, from 1974 to 1980, growth in machinery intensity nearly stops. Growth accelerates in the 1980s, but only to a level significantly below that of the high-growth years. Comparing Figures 17.7 and 17.8, the gross investment ratio stays at a high level some five years longer than the growth rate of machinery intensity. This reflects the growing importance of investments in dwellings and public sector activities towards the end of the high-growth period.10 The problems related to machinery investments are illustrated further in Figure 17.9, showing the output share of machinery investments in constant prices along with the relative price of machinery investments.11 The visual impression of a narrow relationship between the two curves is confirmed by a coefficient of correlation of 0.94. No obvious explanation is at hand of the distinct kink in the relative price curve in the late 1960s. But the factors responsible for ending the period of high growth may be a promising area for future research.12 In the postwar years, the total number of employed persons including self-employed has increased on average by 0.65 per cent per year. The total number of employed wage and salary earners has increased on average by 1.16 per gent per year. The total labour force has increased somewhat faster, with unemployment increasing strongly in the last fifteen to twenty years. The strongest increase in the participation rate

Postwar growth of the Danish economy

557

occurred during the low-growth years from the mid-1970s to the mid-1980s. Average annual hours have gone down and the net outcome has been a roughly constant number of working hours supplied in the Danish economy since the mid-1960s. As a consequence, the most interesting aspects in a growth context are shifts in the sectoral composition of employment and changes in the educational qualifications of the labour force, or more broadly in the stock of human capital, including specific skills acquired through work experience. Two major shifts have occurred in the composition of the labour force. First, the shift out of agriculture was completed by the end of the high-growth years. It occurred so smoothly, however, that it hardly contributes to explain the growth difference between the 1950s and the 1960s. Second, the share of the public sector grew until 1983. As mentioned above, the employment share of the public sector was extremely low by international standards at the beginning of the postwar period. The very fast growth from the beginning of the 1960s to the beginning of the 1980s meant that Sweden was the only OECD country with a higher public sector employment share than Denmark at the end of the period. The share of employment in private non-agricultural sectors reached a maximum a few years into the high-growth years and declined during the subsequent two decades. The composition of employment in the private non-agricultural sectors shows a maximum for the share of employment in building and construction in 1970. Private service industries are the major employer in the private non-agricultural part of the economy throughout the postwar years. In other words, manufacturing industry never became the dominant non-agricultural private sector, as was the case in most other OECD countries. As a consequence, manufacturing industry employs about 100000 persons fewer than neighbouring counties with the same share of employment in industry (Economic Council, 1978: 164). Data on the development of the stock of human capital - measured by the amount of formal education - are not available on an annual basis for the whole of the postwar period. From 1980 annual register data are available on education and labour market status on an individual basis. Before 1980, less reliable indicators of the level of education are available in census years. For these years, Groes and Bjerregaard (1978) report indicators displaying a slow decline in the share of the adult population without any formal vocational education, from 69.5 per cent in 1950 to 66.7 per cent in 1970. For the mid-1980s, Hansen (1992) reports the share without vocational education to be about 50 per cent for people between the ages of 15 and 59, excluding persons receiving education. Of the other 50 per cent, 9 per cent have long or intermediate theoretical educations and 41 per cent have vocational training. Defined by the type of education, 12 per cent had a theoretical or vocational training in technical professions. In relation to growth performance, it is interesting to note that the larger number of people with theoretical educations - a trebling since the end of the 1960s - has for the most part been employed in the public sector and in sheltered parts of the private sector (Economic Council, 1991). In 1988, only 9 per cent of people with long or intermediate theoretical educations were employed in the exposed sectors, while 30 per cent were employed by sheltered private sectors and about 60 per cent were in the public sector.13 This allocation is partly explained by the supply of trained labour in the new cohorts in the labour market having had for many years a

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Peder J. Pedersen

0.40-

0.35-

0.30-

0.25-

0.20 H . Exports/GNP Imports/GNP 0.15-L-T 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 Source: CalculatedfromADAM databank.

Figure 17.10 Aggregate export and import ratios: Denmark, 1948-91

predominance of education directed towards the sheltered sectors, including the public sector. Partly, it may be explained by a wage structure containing signals too weak to effect a reallocation.14 Hansen (1992) shows that the share of people with university training employed by industry is about three times higher in Germany than in Denmark, with 25-30 per cent against 10 per cent. This may reflect differences in the size of firms, to which we return below. For a small open economy, foreign trade is especially relevant in a growth perspective for several reasons. Exports are necessary in cases where economies of scale are an important factor in growth. In the same way,firmsize above a certain critical level necessary for systematic R & D activities is also tied to exports for firms operating in a small national economy. Finally, imports of capital equipment are an obvious way for a small open economy to acquire best-practice techniques in production processes. Aggregate export and import ratios for the Danish economy in the postwar years are shown in Figure 17.10. Obviously there is no simple positive correlation between growth and aggregate participation in foreign trade in this period. On the contrary, trade ratios reach their minimum in the years of high growth, stressing the importance of domestic growth generators in these years: that is, the expansion of the public sector and of building and construction mentioned earlier. The initial importance of agricultural exports should be emphasized once again. By the end of the 1950s, industrial exports had surpassed net agricultural exports. During the 1960s before Danish entry into the EC, agricultural exports were restrained because Danish EFTA membership implied free trade only in industrial products. This structural problem should be kept in mind when interpreting the foreign trade profiles shown in Figure 17.10.15 The factor contents of Danish foreign trade have been analysed for the years

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1966-80 by the Economic Council (1984). The analysis was based on input-output tables to obtain estimates of the factor intensities in exports and in competitive imports.16 The result is that Denmark was a net exporter of capital and labour, and a net importer of energy.17 Disaggregating the net flows on different educational groups of labour, it was found that Denmark was a net exporter of unskilled labour, and a net importer of skilled and theoretically trained labour. The same pattern is confirmed by Hansen (1992), using more reliable data on education for the years 1980-6. This factor composition paradox in a high-wage economy is no doubt to some extent related to the still important export of processed and semi-processed agricultural products. Many people working in agriculture and related industries have no formal training, and are therefore classified in the educational registers as unskilled - which, of course, in many cases, especially for farmers, is a measurement error in relation to the 'true' human capital variable that should be used in the analysis. Bearing this reservation in mind, one could still claim that the production of value added in foreign trade is more relevant in a growth perspective than the factor intensities of net trade. Factor intensities could, however, in the long-run perspective be useful as signalling structural imbalances or weaknesses in the industrial structure. It should finally be mentioned that the factor composition paradox, according to the available evidence, seems to be declining (Economic Council, 1984: 68ff). Scale economies and R & D are two different factors stressed by the new growth theory. In both areas the relative position of the Danish economy is weak, judged by available indicators. The averagefirmsize in Danish industry is small compared to most other OECD countries.18 No industrialfirmis big by international comparison. The biggest industrialfirm- Danfoss, producing electrical equipment for industrial and household uses - employs fewer than 10000 people. About 90 per cent of industrialfirmsemploy fewer than 100 people. In relation to growth, this lack of big industrial firms creates potential problems regarding scale economies, R & D and export performance. The Economic Council (1987: 172fl)findsindications of scale economies in a number of industrial branches in the Danish economy. It is thus clearly a problem, in relation to growth, that so few bigfirmswere generated during the wave of industrialization in the 1950s and the 1960s. A deterioration of Danish wage competitiveness throughout the 1960s and 1970s may explain part of this inability to generate big firms.19 R & D intensity in Denmark is low by international comparison. In 1983 the R & D share of GNP was estimated to be 1.17 per cent, compared to an unweighted average of 2.26 per cent for six other OECD countries.20 Growth in Danish R & D expenditure was on the other hand higher at the beginning of the 1980s than in the reference group of countries. Moller (1985) found that firms with more than 1000 employees (12.5 per cent of the firm in the sample) were responsible for nearly half (46.5 per cent) of R & D. On the other hand, the study showed that size is decisive for whether R & D is undertaken at all. For the firms who do engage in R & D, the intensity of R & D does not increase with firm size. Firm size is also important in relation to export performance and thus indirectly for growth performance. Indicators for this can be found in Economic Council (1987:187ff). Calculations of the direct export ratio for a great number of industrial

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branches result in a close relationship between firm size and export ratio in all branches. Taking the four most R & D-intensive branches (see above), the average export ratio for bigfirmsin these branches is six times higher than the average for all firms in these industries.21 For all branches, the unweighted average relative export ratio for big firms is 3.2. Based on these indicators, scale economies seem to be present in both R & D and export performance. The tentative conclusion is that the industrial structure has been a growth-restraining factor in the postwar Danish economy. 4.2

Sectoral shifts

In the domestic economy, major sectoral changes have occurred during the postwar period. The most important shifts are the decreasing importance of agriculture and the increasing share of the public sector in the economy. These trends are well known and common to all OECD countries. The special feature in the Danish case is the magnitude of the shifts. In contrast to most other European countries, agriculture was still the dominant exporting sector at the beginning of the postwar period. As regards the public sector, among the OECD coutries, only Sweden has experienced a stronger relative growth than Denmark in this area. Thus, while a big shift has occurred between the public and the private sector, major shifts have also occurred within the private sector of the economy. Indicators for this are found in Table 17.7, showing for each of the four postwar decades the average annual growth rate, the standard deviation and the coefficient of variation for the four major private sectors of the economy. Agriculture has the lowest average growth from 1950 to 1970. This low average growth is highly volatile. Growth is still low and volatile in the 1970s, but in this decade the lowest average growth is found in building and construction. Finally, in the 1980s agriculture has an average growth that is higher than in preceding decades, and higher than that of the other three major private sectors; furthermore, growth is more stable than before. This presumably reflects the impact of operating under the EC agricultural programme. Over the whole period 1950-90, the GDP share of agriculture in current prices goes down from 17.2 to 3.7 per cent. For building and construction, the last two decades represent a complete end to growth. From 1950 to 1990, the GDP share of building and construction, measured in current prices, goes down from 6.7 to 5.1 per cent. For manufacturing industry, the GDP share decreases by nearlyfivepercentage points between 1950 and 1990, from 22.9 to 18.2 per cent in current prices. For the period 1950 to 1979, service industries follow the general pattern, with the difference between decade averages being, as expected, somewhat smaller than in the goods-producing sectors. An exception to the general pattern is the accelerating growth in service industries from the 1970s to the 1980s. The GDP share of private service industries goes up slightly from 29.8 per cent in 1950 to 30.4 per cent in 1990.22 A summary illustration of the rapid postwar increase in the public sector is found in Figure 17.11, showing the tax-GDP ratio from 1948 to 1991. The initial level is clearly below the OECD average at the time, while the level in 1991 is surpassed marginally only by Sweden. The major part of the increase occurs within ten years, from the beginning of the 1960s to the beginning of the 1970s. A renewed increase in

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Table 17.7. Sectoral GNP growth indicators: Denmark, 1950-89 Agriculture Building and Manufacturing Private construction industry service industries 1950s Average annual 2.22 growth (%) Standard deviation 8.04 Coefficient of variation 3.62 1960s Average annual growth (%) 2.17 Standard deviation 5.09 Coefficient of variation 2.35 79705 Average annual growth (%) 1.26 Standard deviation 12.34 Coefficient of variation 9.80 79805 Average annual growth (%) 4.42 Standard deviation 8.37 Coefficient of variation 1.89

4.99 6.39

4.50 4.78

3.45 1.75

1.28

1.06

0.51

6.97 5.65

6.73 3.70

3.81 2.67

0.81

0.55

0.70

-1.60 6.15

3.06 2.83

1.97 3.42

-3.84

0.93

1.74

0.37 9.74

1.72 3.12

2.29 2.33

26.32

1.81

1.02

Source: Calculations from ADAM databank. the first part of the 1980s is partly redressed in the most recent years. The quantitative shifts in the relative importance of different sectors in the postwar economy were accompanied by equally big changes in relative sector price levels. In Figure 17.12 this is shown for agriculture, manufacturing industry and private service industries. The relative sector prices are calculated as the ratio between implicit sector GDP deflators and the aggregate GDP deflator. For the two goods-producing sectors, the relative price levels fall to between 30 and 60 per cent of the initial level for agriculture and manufacturing industry, respectively. Until the mid-1970s, the fall is approximately parallel for agriculture and industry. After that, the decline continues for relative agricultural prices, while the relative level stabilizes for industry. In a small open economy, an important factor is the terms of trade or the relative price levels between exposed and sheltered sectors. This is illustrated in a crude way in Figure 17.13. A relative sheltered sector prime level is calculated as a weighted average for the relative price levels for building and construction and for private service industries. Figure 17.13 shows the ratio between this and the relative price level in manufacturing industry, taken as representative of the exposed sector of the economy. Over the whole postwar period, the sheltered sector price level doubles relative to the level in the exposed sector.23 The shift in the price ratio is concentrated in time to the years of high growth from the late 1950s to the early

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0.55-1 0.50 0.45 H 0.40 0.35 0.300.250.200.15 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 Source: Calculated from ADAM databank.

Figure 17.11 Total taxes relative to GNP: Denmark, 1948-91

13012011010090807060504030-

Relative price, agriculture Relative price, private service industries Relative price, manufacturing industry

20 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 Source: Calculated from A D A M databank.

Figure 17.12 Sector GDP deflators relative to aggregate GDP deflator: agriculture, manufacturing industry and private service industries in Denmark, 1948-91

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240220200180160140 12010080-

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1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 Source: Calculated from A D A M databank.

Figure 17.13 Relative price between sheltered and exposed sectors: Denmark, 1948-91

1970s. The annual change in the price ratio is about 5 per cent, which is clearly higher than the productivity growth differential between the sectors. Consequently, the development shown in Figure 17.13 indicates the possibility of crowding out of the competitive sector due to a pressure on labour and other costs from a very strong expansion of the sheltered sectors in the high-growth years. Note that Figure 17.13 includes only the private sector part of the sheltered sectors and, as illustrated in Figure 17.11, public sector expansion was also very rapid in this period.

5

Growth and economic policy since 1950

5.7

The slow start, 1950-7

Economic growth was lower in Denmark in these years than in most other OECD countries, with the exception of Belgium and the UK. It is difficult to point to any one decisive factor to explain this fact. A standard explanation in Danish economic history is that the slow growth was due to a perceived balance of payments restriction: that is, there existed both for liberal and social democratic governments a shared conviction that it would be impossible or difficult to finance any major deficit on the international capital markets. In retrospect this conviction was hardly well founded. Anyway, governments at the time acted upon it and the result was that foreign net debt was nearly non-existent at the end of the 1950s. A negative development on the balance of payments induced, on a number of occasions, a contraction of economic policy, restraining growth. International price

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0.140.120.100.080.060.04-

0.02

1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990

Figure 17.14 Rate of unemployment: Denmark, 1948-91

movements had a negative effect during the Korean War and during the Suez crisis. On both occasions the effects were quickly felt in an economy which depended to a very high degree on imported raw materials and energy. A long-run factor influencing the balance of payments situation was the ongoing shift from agriculture to industry. It created problems because trade in agricultural products to a large extent remained regulated.24 At the same time, other problems were created by the liberalization of trade in industrial products, since major parts of Danish industry had emerged during the time of strict trade restrictions in the 1930s. Nevertheless, the export share of industrial production doubled from 10 to 20 per cent until 1957. Employment in industry surpassed agricultural employment in 1957. This, however, was due most of all to a decline in agricultural employment. Industrial employment was nearly constant and the growth in industrial production went almost exclusively to exports. As we have seen, in economic policy the main heritage from the preceding decade was a new commitment to high employment, and a commitment to low inflation and balance of payments equilibrium. The first of these targets is illustrated in Figure 17.14, showing the postwar profile of unemployment. Unemployment was higher between 1950 and 1957 than in most other OECD countries, and higher than in the subsequent fifteen years. Compared to the 1930s, however, the level was extremely low. Growth per se was, on the other hand, not a specific target in economic policy. Inflation, measured in Figure 17.15 by the rate of increase of nominal wages, was volatile but overall rather low in the period. It is interesting to note in Figure 17.15 the real wageflexibilityat the outbreak of the Korean War, and the very modest and temporary increase in unemployment. This is very much in contrast to the reactions to the first OPEC shock twenty years later (see below).

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2520151050

'

' x> Nominal wages Real wages

-10 ' • • • . 1949 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991

Source: Calculated from ADAM databank.

Figure 17.15 Rate of increase in nominal and real wages: Denmark, 1949-91

In economic policy the late 1940s saw a certain interest in national budgets and indicative planning. Neither planning nor incomes policy became dominant in actual policy making in the 1950s (Kindleberger, 1967: 70). Instead, the main principle became a policy mix, with rather restrictive fiscal policy to keep the external balance, and a more expansionary monetary policy to encourage investments and growth. Even though there was a surplus each year from 1950 to 1957 on the state budget, the policy mix was not realized with success. The rate of interest drifted upwards for most of the period, sincefiscalpolicy was not sufficiently restrictive to meet the external constraint. 5.2

Years of high growth, 1958-73

It is difficult to single out any one factor as being responsible for the slow growth of the 1950s until 1957. In the same way, no single factor explains the sudden shift in growth performance beginning in 1958. The external constraint became less binding as an international boom coincided with an improvement of the Danish terms of trade. Rather weak minority governments were succeeded in 1957 by a majority government. The possibility of financing an external deficit increased, and the attitude towards running a balance of payments deficit changed too. In the beginning this was rationalized by the need to accelerate the ongoing structural change from agriculture to industry. In the end it turned out to be a very difficult and painful process to end the running of external deficits. The government of the late 1950s also introduced a more expansionary fiscal policy. It turned out to be especially important that the tax treatment of investments was improved as the rate of interest declined.

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The combined effect of this set of factors, along with an ample supply of labour from unemployment and from migration out of agriculture, laid the foundation for an investment boom from the late 1950s to the mid-1960s, especially in the form of investments in machinery and equipment (see Figure 17.8). A few years into the high-growth period, expansion began in the public sector and in building and construction. From the mid-1960s these factors became dominant in the continuation of high, but decreasing growth rates. Not all aspects of external development were favourable to the growth of the Danish economy, however. A major problem for Denmark in the 1960s was that major trading partners joined the EC and others joined EFT A. As a member of EFTA, Denmark enjoyed free trade in industrial products, while agricultural exports both to EC countries and to most EFTA countries were restrained by direct regulation. As mentioned in the introduction, Denmark enjoyed only a short spell of macroeconomic balance and high growth around 1960. Soon, imbalances increased and became increasingly important towards the end of the high-growth period. Unemployment in Denmark was lower than the European OECD average and inflation was higher. Figure 17.15 shows cyclical movements around an increasing trend in nominal wage rises, while real wage increases remain stationary. A consequence of this was a steady deterioration after 1960 in international competitiveness, as measured by an increase of about 30 per cent in the real effective exchange rate of Danish kroner from 1960 to 1973 (Hoffmeyer, 1993: figure III.6, p. 69).25 The current account was in deficit throughout the high-growth period, with 1963 and 1972 as the only exceptions. During the 1960s this reflected a savings deficit in the private sector, as the public sector had a savings-investment surplus throughout the period (Pedersen et al, 1987, figure 10, p. 27). This marked the beginning of a long period of mounting foreign indebtedness, with the foreign debt to GNP ratio increasing from 1 per cent in 1960 to 10.8 per cent in 1973. As a consequence, the interest rate gap vis-d-vis Germany increased from 0 in 1960 to around 2-3 percentage points at the end of the high-growth period (Hoffmeyer, 1993: figure III.4, p. 55). Public sector expansion was very fast in the high-growth years. From 1960 to 1970 the ratio between public and private consumption doubled from 0.2 to 0.4, and income transfers rose in the same proportion as public consumption. Whether this development created further imbalances is another question. As illustrated in Figure 17.11, total taxes relative to GNP also rose very rapidly. The public sector was in surplus throughout the period 1960-73, with an average surplus of 2.6 per cent of GNP. Looking instead at the change in the public sector surplus corrected for automatic fiscal reactions, a different picture emerges (Christensen, 1993: table A.2.1, p. 125). In the 1960s, fiscal policy appears to have been on average neutral/slightly expansionary. In a setting with a private sector boom during most of the period, this indicates that the extremely strong expansion of the public sector was not accompanied by a sufficiently strong crowding out of private sector activities. A crowding out could have been effected by an accompanying monetary policy. Nominally, the long-term rate of interest doubled from 1960 to 1973. The real rate was stationary, moving around 3 per cent. But, reflecting unlimited tax deductibility

Postwar growth of the Danish economy

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120 n

100-

80

60-

40-

20-

0 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 Source: Calculated from ADAM databank.

Figure 17.16 Ratio between user cost of capital and industrial wages: Denmark, 1955-91 (1955 = 100)

for interest expenditures and the strong increase in taxation, the real rate net of taxes declined from 3 per cent in 1960 to —3 per cent in 1973 (Nielsen and Sondergaard, 1991: figure 11.8, p. 360). This could result in no crowding out, creating room for public sector expansion. On the contrary, the building boom during the latter part of the high-growth period was partly a crowding-m reaction to this profile of net real interest rates. Incomes policy was introduced in the 1960s and used with great vigour in 1963, and later on a number of occasions between 1967 and 1973. Apparently, this new instrument was unable to end the mounting imbalances in the economy. These imbalances, along with the sectoral changes and shifting trends in relative factor prices, signalled a fading out of the high-growth period before the actual occurrence of thefirstOPEC shock. Some of these shifts are illustrated in Figures 17.8 and 17.9, showing the drop in the rate of increase in machinery capital per person employed along with the end of the relative decline in the price of machinery investments. These shifts occurred simultaneously, four to five years ahead of the first OPEC shock. Looking at the broad pattern in the capital user cost to wage ratio, data available from 1955 show a more dramatic development than the one depicted in Figure 17.9, confirming the break in the ratio from the late 1960s (see Figure 17.16). 5.3

Shocks and stagflation, 1973-9

The international recession following the first OPEC shock had very serious repercussions on the growth of the Danish economy. The mounting macroeconomic

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imbalances had created a situation where economic policy options were restricted. Options became further restricted when the political situation went into turmoil after a general election in December 1973, resulting in a major break-up of established party patterns in the Danish parliament. The immediate impact of the price shock was reinforced in the labour market by an automatic indexation of wages, where indexation occurred with a short lag and high coverage. At the same time, wages were affected by a lagged impact from excess demand in 1973. Nominal hourly wages rose by nearly 40 per cent between 1973 and 1975 (see Figure 17.15). The consequence was a huge increase in real wage costs. The competitive situation was at the same time affected by the tying of Danish kroner to the German mark during the 'Currency Snake' period. The outcome was that Danish kroner appreciated by 8 per cent between 1972 and 1976. The combined effects of these domestic and external events were, not surprisingly, a huge increase in unemployment and two consecutive years with negative growth. Unemployment in these years was also affected by an unprecedented increase in labour force participation. Economic policy during the decisive years 1974—5 had a stop-go character, emitting unclear signals.26 Priorities shifted between the balance of payments problem and unemployment, until expansionary measures were given up in 1976, when the strategy of joint expansion failed internationally. In the following years a 'twist strategy' was applied, consisting of shifting demand from private to public sector activities. The purpose was to stabilize or increase total employment and at the same time improve the current account by shifting demand away from import-intensive private sector demand. From 1974 to 1979 major incomes policy measures were applied on nine occasions. But neither the twist strategy nor incomes policies were able to redress the initial decrease in employment from 1973 to 1976. Between 1979 and 1982 the strategy shifted towards devaluations of the currency supported by restrictions on wage indexation, ending with a complete abolition of indexation in 1982. As a consequence of this, real disposable wages for industrial workers decreased from the late 1970s to the early 1980s by no less than 20 per cent (Hoffmeyer, 1993:figureIV, p. 91). This was a foundation for the strong recovery which went on until 1987 (see below). Overall, the shocks of the 1970s were handled by inappropriate economic policy reactions, and institutional changes came too slowly. The consequence was a permanent shift to high unemployment and a sequence of years with low or no growth. Beyond the field of short-run economic policy, slower growth was also related to the fundamental changes in relative prices, discussed above, that began well before the external shocks. 5.4

Recovery and stagnation: the years after 1980

In the first years of the 1980s, the Danish economy felt once again the impact of an external shock. This time endogenous reactions were much more appropriate than during the 1974 shock. The initial position, however, was weaker and the size of the shock was bigger. The impact both on the domestic debt position of the state and on the overall foreign net debt position was alarming. In a rather despairing mood, a social democratic minority government resigned in 1982 and was relieved by a

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conservative-centre coalition, heralding a change of regime to afixedexchange rate, private sector strategy. The initial reactions were impressive. The nominal rates of interest and inflation came down very quickly, as in most other OECD countries, but at the same time employment, investment, private consumption and growth all went up equally quickly. The Danish recovery in the 1980s thus preceded the OECD recovery. It turned out, however, that credibility in relation to the change of regime was more difficult to establish than expected. In the capital market a sizeable interest gap remained vis-a-vis Germany, and in the labour market, too, credibility of the fixed exchange rate regime was hardly established until the end of the 1980s.27 The recovery came to an end in 1986 after a marked deterioration in the current account, making the foreign debt position critical. The Danish recovery thus ended at the same time as the general OECD recovery began. Fiscal policy was tightened in 1986 and reinforced by a tax reform in 1987. In the following years, the only expansionary element in the Danish economy was exports, helped first by the general OECD recovery and next by the effects of German unification. In a growth perspective, three important phenomena emerged, all in the mid-1980s. The first was a very big decline in the private sector savings rate. The second was the years with negative growth, both in conventional labour productivity and in TFP. Finally, labour market reactions to the recovery showed a lack of flexibility, as wage increases accelerated and reached 10 per cent in 1987, with unemployment at 8 per cent of the labour force. The net rate of saving in the private sector declined from 16 to 5 per cent of net disposable income during the recovery. This could be explained as a cyclical reaction, reinforced by capital gains due to the big decline in interest rates. In the long run, however, the private sector did have a structural savings deficit in the sense that savings fell short of investments as soon as capacity utilization reached a normal level. This fact may be related to the expansion of income transfer programmes having a negative impact on private savings motives, and to the full deductibility of interest expenditures until 1987. A sufficiently high level of public sector saving could in principle counteract negative long-run effects from the private sector savings deficit on capital formation. Public sector savings did move counter to private savings but, as evidenced by the persistent deficit on the current account, not to an extent to neutralize periods with a low private savings rate.28 Finally, there is the productivity problem of the 1980s. As shown in section 2, productivity growth had been on a declining trend since the end of the 1960s, in Denmark as in most other OECD countries. The specific Danish problem was the occurrence of negative productivity growth in 1986. In the Danish debate, Gjerding et al. (1990) have claimed that the 1986 occurrence marks a technological break, where installation of fundamentally new technologies created problems of adaptation for firms and their employees. Others (Clemmesen et al., 1993) argue that the 1986 occurrence is explainable as a reaction to adjustment lags in a highly volatile cyclical situation, and an extremely high utilization of existing capital equipment in 1986. In relation to the profiles in relative prices presented earlier, the latter interpretation seems convincing. The interpretation of 1986 data is further complicated due to the dramatic decline in this year in both raw material prices and the exchange rate of US dollars. As a result, specific deflation problems may exist for 1986. In conclusion, it seems that productivity growth in the 1980s returns to the level prevailing before the

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period of high growth. In this interpretation, it is productivity growth from 1957 to 1973 that is exceptional, and not the decline to a more normal level once again in the 1980s.

6

Concluding comments

Danish postwar growth has been more uneven than in many other OECD countries. Overall, growth has not differed much from the OECD average, but the time profile has been different. Growth was below average in most of the 1950s and after 1973, but above average in the rather short period of high growth from 1958 to 1973. Growth has been restrained by two sets of factors. An unfavourable initial sectoral allocation, with great importance attached to export-intensive agriculture, created external constraints in a postwar situation with liberalized trade in industrial products, but heavily regulated trade in agricultural products. Another set of factors have been macroeconomic imbalances, growing in some periods to an extent that restrained growth and restricted choices in economic policy. It was argued in section 2 that the lower post-1973 growth represents a return to the long-run rate of growth of the economy. Accepting that argument, it is of major interest to identify the factors that created the period of high growth, as well as the factors contributing to end this period. The beginning of the high-growth period was characterized by an unusual combination of factors, including an international boom, an improvement of the terms of trade, better access to and lower costs on international capital markets, a fall in the rate of interest, the coming to office of a majority government, and the implementation of a growth-promoting fiscal policy. Further, there was growth potential in the economy with an ample supply of labour and a favourable trend in relative prices. Some of the factors contributing to the return to a lower rate of growth began evolving in the high-growth period. International competitiveness deteriorated gradually, a structural savings deficit appeared in the private sector, and sectoral changes in the economy became gradually less favourable in relation to economic growth. Further, fundamental shifts in relative prices unfavourable to growth developed. The relative price of machinery investment, the relative prices between sheltered and exposed sectors, and relative factor prices all developed during the high-growth period in a way that was unfavourable to continued high growth. At the time of the 1974 supply shock, macroeconomic imbalances growing over a number of years, along with a rather confused political situation, created a highly inappropriate adaptation to the external shock. Real wages rose rapidly in a situation where Danish terms of trade deteriorated. The subsequent increase in unemployment further illustrates an inability in the labour market to adapt to fundamental changes. The only longer post-1973 recovery, in the 1980s, ended in 1986 due to policy reactions to an intolerable development in foreign net debt position. Since 1986, Danish economic performance has had an impressive record with regard to inflation and the current account, while growth has remained low and unemployment has shown an increasing trend. A number of problems were identified in Danish postwar growth history. Industrialization proceeded rapidly in the late 1950s and the 1960s, but very few big

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firms were generated during this process. In relation to size-dependent barriers to export, R & D and scale economies this aspect of the industry structure may have restrained growth. A final concluding comment concerns the eventual role of institutional characteristics. Minority coalition governments for most of the postwar period could be part of the explanation for the fact that, on several occasions during the postwar years, imbalances were allowed to reach the point at which they seriously restrained growth and created narrow options in economic policy on several occasions during the postwar years. NOTES Comments are gratefully acknowledged from Nick Crafts, Ingrid Henriksen, Lars Muus, Niels H. Skou, Nina Smith and Gianni Toniolo. 1 Rather few contributions on Danish postwar economic development are available in English. Different aspects of the postwar development are treated in Andersen and Risager (1990), Andersen and Akerholm (1982), Denison (1967), Garganas (1991), de Haan et al (1992), Johansen (1987), Kaergard (1991), Nannestad (1991), Nielsen and Sondergaard (1991), OECD country surveys, Paldam and Zeuthen (1988), Paldam (1991), Pedersen (1993) and 01gaard (1966). 2 In contrast to the situation at the time of the two OPEC shocks, Denmark was self-sufficient in oil and gas from the end of the 1980s because of fields in the North Sea. 3 The most recent estimates are found in Statistics Denmark (1993). Estimates for 1990/1 are preliminary. The methods are documented in Dalgaard (1989). Due to lack of data on income shares for different types of labour, no weighting of different labour inputs is undertaken. 4 The regression tracks TFP growth especially close in the very volatile 1980s. A possible interpretation is that new investments dominate in periods with positive growth in building, while maintenance and repairs dominate in periods with declining activity. The quite different technologies in these two areas could explain the close relationship between TFP growth and growth of production in the sector. 5 The Social Democratic Party was the leading party in coalition governments until the general election in 1973, when a rather stable pattern in Danish political life broke down. The party has never had a majority of the votes. 6 In Denmark unemployment insurance was (and still is) voluntary. As a consequence of this, it is difficult to compare unemployment before the war with the level in other countries, since only 50 per cent of blue-collar workers and 20 per cent of white-collar workers were insured in the 1930s. And the insurance incentive was highest for individuals with a high risk of unemployment (Pedersen, 1982). 7 The only exception was the decline in 1937 caused by the American fiscal policy-generated boom in this year, which raised dollar-denominated prices on Danish imports of raw materials. 8 Nearly half of this increase in industrial production and employment is estimated to be due to import substitution (Boserup, 1947). 9 High labour intensity was also partly a result of restrictions on foreign trade. In relation to the analysis by De Long and Summers (1991,1992) of the importance of investment in machinery for growth, it is interesting to note that the

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10 11 12

13 14 15

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20 21 22

23 24

authorities allocating scarce foreign exchange in the 1930s gave low priority to imports of machinery. If a firm got a licence to import machinery, it was conditional on old machinery being not resold, but taken completely out of use. The rationale behind this policy was to restrict the creation - based on the old machinery - of firms that would be completely dependent on protection (Boserup, 1947). The growth and productivity consequences of the first part of the policy were seemingly not considered. Looking at the share of machinery investments in gross investments, a maximum is already reached by 1960. The trend in the machinery share is falling throughout the years of high growth. The relative price is measured as the ratio between the GDP deflator of machinery investments and the aggregate GDP deflator. The development in machinery intensity and investment share is not closely correlated with year-to-year changes in growth and productivity. Regressions of the machinery investment share on growth or on growth in productivity show no relationship between annual observations. Regressions of the annual change in machinery intensity on productivity growth and on growth results in positive coefficients. But they are not quite significant at conventional levels. As mentioned in section 2, this allocational pattern may contribute to the explanation of higher TFP growth in sheltered than in exposed sectors, as depicted in Figure 17.6. Typically, human capital estimations on Danish data result in rather low returns to schools. A specific study in this area is Pederson et a\. (1990). From a very long-run perspective, Paldam (1991: 82) shows that the exports share has been moving around a certain level since the 1920s. The strongest increase in the exports ratio occurs from around 1870 to around 1930. It is interesting to compare this with the above average Danish growth in the decades from 1880 to 1929, found in Table 17.2. Imports that could not be produced domestically and imports for which no domestic counterpart exists (e.g. engines for aeroplanes) are excluded from the calculations. This has changed in recent years due to a big increase in domestic oil and gas production in the North Sea. The exceptions are the Netherlands and Norway, having size distributions close to what is found in Denmark. Whether a wave of mergers and acquisitions in Danish industry in the late 1980s can compensate for this is another question. In a study of mergers and acquisitions in 1989, Rasmussen (1990) concludes from stock market reactions that the merger activity was net value creating. The UK, the USA, West Germany, France, Sweden and Norway (Economic Council, 1987: 177). Big firms are defined as the eight biggest firms in each industrial branch. The GDP shares of the four sectors are heavily influenced by the increasing public sector share from 1950 to 1990. Looking at the relative distribution of GDP between the four sectors alone produces a somewhat different picture. From 1950 to 1990 the shares change as follows: agriculture from 22.4 to 6.4 per cent, building and construction from 8.7 to 9.1 per cent, manufacturing industry from 29.9 to 31.6 per cent and finally service industries from 38.9 to 52.9 per cent. The same phenomenon is found for Belgium, but for the post-1973 years (see Cassiers et aU 1993). Kindleberger (1967: 70) is critical of the agriculture-based explanation of slow

Postwar growth of the Danish economy

25 26 27 28

573

Danish growth in the 1950s. He points out that neither the employment share nor the migration out of agriculture was especially high in Denmark compared to a number of other European countries. However, this misses the point that the export share of agriculture was very high in Denmark. The real effective exchange rate is weighted by Danish industrial trade weights and corrected for differences in the development of wage costs. A very comprehensive analysis of Danish economic policy in the years 1974-9, with a comparative approach, can be found in Nannestad (1991). See the analysis in Andersen and Risager (1990). It could be argued that this problem is less important in a global environment with perfect capital mobility. But, as the savings deficit is a reflection of an insufficient level of international competitiveness, a country in this situation becomes less attractive for international investors. In any case, in spite of perfect capital mobility, national savings and investment rates are still highly correlated. Sectoral savings-investments balances are discussed further in Pedersen et al. (1987).

REFERENCES Andersen, P.S. and J. Akerholm (1982) 'Scandinavia', in A. Boltho (ed.), The European Economy: Growth and Crisis, Oxford: Oxford University Press. Andersen, T.M. and O. Risager (1990) 'Wage formation in Denmark', in L. Calmfors (ed.), Wage Formation and Macroeconomic Policy in the Nordic Countries, Oxford: Oxford University Press. Baumol, W.J., S.A.B. Blackman and E.N. Wolf (1991) Productivity and American Leadership, Cambridge, MA: MIT Press. Boserup, E. (1947) 'Dansk importregulering gennem 15 ar', Nationatokonomisk Tidsskrift, 85, pp. 37-67. Cassiers, I., P. Solar and P. de Ville (1993) 'Postwar growth in Belgium', working paper. Christensen, A.M. (1993) 'Finanspolitikken 1960-1990', in Hpffmeyer (1993). Clemmesen, F., H. Hofrnan and C. Koch (1992) 'Det danske produktivitetsmysterium?', Samfundsakonomen, 4, pp. 31-5. Dalgaard, E. (1989) 'Produktivitetsudviklingen i Danmark 1966-87', Nationalregnskabsnotat, Arbejdsnotat No. 25, Copenhagen: Statistics Denmark. De Long, B. and L.H. Summers (1991) 'Equipment investment and economic growth', Quarterly Journal of Economics, 106, pp. 445-502. (1992) 'Equipment investment and economic growth: how strong is the nexus?', Brookings Papers on Economic Activity, no. 2, pp. 157-211. Denison, E.F. (1967) Why Growth Rates Differ, Washington DC: The Brookings Institution. Economic Council (1984) The Danish Economy, May 1984, Copenhagen. (1987) The Danish Economy, May 1987, Copenhagen. (1991) The Danish Economy, May 1991, Copenhagen. Garganas, N.C. (1991) 'Discussion', in G. Alogoskoufis, L. Papademos and R. Portes (eds.), External Constraints on Macroeconomic Policy: The European Experience, Cambridge: Centre for Economic Policy Research /Bank of Greece/ Cambridge University Press. Gjerding, A.N., B. Johnson, L. Kallehauge, B.-A. Lundvall and P.T. Madsen (1990) Denforsvundne produktivitet, Copenhagen: Jurist- og okonomforbundets forlag. Groes, N. and P. Bjerregaard (1978) 'Real production, real factor input and productivity in Denmark 1950-1972', Memo 51, Institute of Economics, University of Copenhagen.

574 Peder J. Pedersen

Haan, J. de, C.G.M. Sterks and C.A. de Kam (1992) Towards budget discipline: an economic assessment of the possibilities for reducing national deficits in the run-up to EMU', Economic Papers No. 99, Commission of the European Communities. Hansen, C. (1992) 'Uddannelse som produktionsfaktor', Ph.D. thesis, Institute of Economics, University of Copenhagen. Hansen, S.Aa. (1974) 0konomisk vcekst i Danmark, Vol. II: 1914-1970, Copenhagen:

Akademisk forlag. Henriksen, O.B. and A. 01gaard (1960) 'Danmarks udenrigshandel 1874-1958', Studier fra Kobenhavns Universitets 0konomiske Institut, No. 2, Copenhagen. Hoffmeyer, E. (1993) Tengepolitiske problemstillinger 1965-1990', Dansk Pengehistorie No. 5, Danmarks Nationalbank, Copenhagen. Johansen, H.C. (1987) The Danish Economy in the Twentieth Century, London:

Croom Helm. Kindleberger, C.P. (1967) Europe's Postwar Growth: The Role of Labour Supply,

Cambridge, MA: Harvard University Press. Kaergard, N. (1991) 0konomisk vcekst: En okonometrisk analyse af Danmark

1870-1981, Copenhagen: Jurist- og okonomforbundets forlag. Maddison, A. (1982) Phases of Capitalist Development, Oxford: Oxford University Press. (1991) Dynamic Forces in Capitalist Development, Oxford: Oxford University Press.

Madsen, E.S. and M. Paldam (1978) 'Economic and political data for the main OECD countries, 1948-1975', Memo 78-9, Institute of Economics, University of Aarhus. Moller, K. (1985) En teoretisk og empirisk analyse afforholdet mellem pa den ene side danske virksomheders forskning og produktudvikling og pa den anden side Danmarks udenrigshandelsmonster samt forslag til forbedringer af dette forhold,

Copenhagen: Department of International Economics and Management, Copenhagen School of Business. Nannestad, P. (1991) Danish Design or British Disease? Danish Economic Crisis Policy 1974-1979 in Comparative Perspective, Aarhus: Aarhus University Press.

Nielsen, S.B. and J. Sondergaard (1991) 'Macroeconomic policy and the external constraint: the Danish experience', in G. Alogoskoufis, L. Papademos and R. Portes (eds.), External Constraints on Macroeconomic Policy: The European

Experience, London: Centre for Economic Policy Research /Bank of Greece/ Cambridge University Press. OECD (1993) Economic Outlook, June, Paris, (various years) Denmark: Country Survey, Paris. 01gaard, A. (1966) Growth Productivity and Relative Prices, Amsterdam: North-

Holland. Paldam, M. (1991) The development of the rich welfare state of Denmark', in M. Blomstrom and P. Meller (eds.), Diverging Paths: Comparing a Century of Scandinavian and Latin American Development, Washington, DC: The Inter-

American Development Bank / Johns Hopkins University Press. Paldam, M. and H.E. Zeuthen (1988) The expansion of the public sector in Denmark: a post festum?', in J.A. Lybeck and M. Henrekson (eds.), Explaining the Growth of Government, Amsterdam: North-Holland. Pedersen, P. J. (1982) 'Union growth in Denmark, 1911-39', Scandinavian Journal of Economics, 84, pp. 583-92. (1993) The welfare state and taxation in Denmark', in A.B. Atkinson and G.V. Mogensen (eds.), Welfare and Work Incentives: A North European Perspective,

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575

Oxford: Oxford University Press. Pedersen, P.J. and J.B. Schmidt-Sorensen, N. Smith and N. Westergard-Nielson (1990) 'Wage differentials between the public and private sectors', Journal of Public Economics, 41, pp. 125-45. Pedersen, P.J., C. Sorensen and C. Vastrup (1987) Traek af udviklingen i dansk okonomi efter I960', in Economic Council, Rdd og realiteter 1962-1987, Copenhagen. Rasmussen, M. (1990) Tusioner og virksomhedsovertagelser i Danmark', Nationatokonomisk Tidsskrift, 128, pp. 267-78. Statistics Denmark (1993) Input-output tabeller og analyser, 1989, Copenhagen. Stevenius-Nielsen, H. (1952) 'Nogle betragtninger over industriens produktivitet', Nationalokonomisk Tidsskrift, 90, pp. 109-29. Topp, N.-H. (1987) Udviklingen i de finanspolttiske ideer i Danmark 1930-45, Copenhagen: Jurist- og okonomforbundets forlag.

18 Reflections on the country studies NICHOLAS CRAFTS AND GIANNI TONIOLO

1

Introduction

The advent of new growth theory together with continuing improvements in historical statistics have combined to allow the authors of the case studies in this volume to develop a clearer and sharper picture of the process of economic growth in postwar Europe. In this final chapter, we wish to summarize the main messages which come from these studies. In doing so we wish not only to underline key insights for economic history students, but also to highlight some relevant findings for future work in growth economics. Research in growth economics since the mid-1980s had centred on models which feature endogenous productivity growth. Sustained growth of real GDP/person is seen as coming from investments in human and physical capital and/or profitmotivated production and use of knowledge. Technological change is no longer consigned to an exogenous Solow residual, even though for many purposes it is still useful to measure total factor productivity (TFP) growth. In turn, it follows that the potential impact of institutional arrangements and policy on growth outcomes must now be taken seriously, rather than being confined to transitional dynamics, as in the traditional neoclassical growth model. A much discussed aspect of growth is the catch-up of leading countries by followers, a familiar theme in European economic history at least since Gerschenkron (1962). It has become increasingly clear that catch-up growth is neither automatic nor universally achieved, but requires what Abramovitz (1986) called 'social capability', also making this type of productivity growth endogenous. During the 1950s and 1960s, Western Europe enjoyed a period of very rapid catch-up growth which had not generally been anticipated in the 1940s, but which dried up in the 1970s when the European countries had still not completely closed the productivity gap with the USA. Understanding this experience in the light of new ideas in growth economics has been the focal point of the country studies.

576

Reflections on the country studies

577

The idea of a 'Golden Age9 In Chapter 1 we emphasized that the rapid growth of the early postwar period was most unusual, and that the slowdown* since the early 1970s had seen a return to historically more normal growth rates. In setting out this argument we used a conventional periodization and called the years 1950-73 the Golden Age. The country studies without exception endorse the notion of a Golden Age of growth, as might be expected given the strong econometric support which can also be provided (Crafts and Mills, 1996). Indeed, so favourable was the economic environment that even in East Germany, where the ultimate growth failure was disastrous, growth of GDP/head was at least over 3 per cent per year (Chapter 16). Having accepted the basic idea, however, it is clear from the case studies that, at least for some purposes, a more nuanced view is required. First, in some cases the dates of the Golden Age are seen as marginally different (e.g. Denmark, Sweden), while in others a significant change in the pace of growth is discerned during the Golden Age as a result of important changes in policy. In this latter category we find Belgium, France, Ireland and Spain. In all these countries, growth accelerates around the end of the 1950s as a result of moves away from interventionist policies and towards liberalization of trade and/or stimulus from greater European economic integration, in line with the results in Ben-David (1993). Second, the explicit introduction of catch-up potential into judgements on growth performance leads to a move beyond the raw data to a consideration of whether growth outcomes were surprisingly good or bad on a normalized basis. Here the idea of a Golden Age is seen from a different perspective. Thus, despite growth which was rapid by the standards of their own historical record, we find distinctly adverse judgements in Chapters 12 and 13 on 1950s Spain and Ireland because opportunities for better performance were missed. Conversely, in Chapter 15, the years of the true Wirtschaftswunder in West Germany are seen to be over by the early 1960s. A striking feature of the Golden Age when viewed in terms of traditional growth accounting is the very rapid rate of TFP growth. This point was already apparent in Chapter 1, where we limited our exposition to those cases where the evidence stretched back to 1950. The additional information for part of the period given in Chapters 11 and 12 confirms the generality of this experience; Portugal is estimated to have had TFP growth at 2.9 per cent per year between 1959 and 1973, and Spain at 3.8 per cent per year between 1965 and 1974. In both cases, gains from technology transfer, more efficient resource allocation, structural change and improvements in education are clearly part of the story, as they were in the better-documented cases of France and West Germany. In the case of Italy (Chapter 14) a more sophisticated analysis was undertaken in an attempt to discover more about these points econometrically. This is very data demanding and has so far not been replicated for other countries. The results suggest that high measured TFP growth reflects catch-up in various guises, but should not be equated simply with rapid innovation. In the Italian case a significant part of the Solow residual is due to factors such as economies of scale, and during 1950-90 adjusted TFP growth is only 0.4 per cent compared with a grossfigureof 2.7 per cent per year.

578 Nicholas Crafts and Gianni Toniolo 3

The accumulation of capital and the acquisition of knowledge

The Golden Age is portrayed in these case studies as a time of exceptionally high investment. The part that this played in growth seems to have varied somewhat even in neighbouring countries: for instance, in Belgium productivity advance seems to have been less closely linked to investment (Chapter 7) than in the Netherlands (Chapter 10). The extreme example of high investment with disappointing results is, of course, to be found in East Germany, where as Chapter 16 shows, diminishing returns set in rapidly. This seems to have been even more the case in the USSR, associated with the very low substitutability of capital for labour (Easterly and Fischer, 1994). Western Europe seems to have avoided this outcome through market disciplines and a rapid rate of innovation. Evidence of increased human capital accumulation is found throughout the case studies, although detailed measurement remains elusive. Whereas years of schooling generally look rather similar, with the exception of Portgual and Spain, there seem to have been large differences in vocational training. The studies reveal very high proportions of workers with examined qualifications in West Germany and the Netherlands, compared with much lower proportions in France and the UK. Quantitative assessment of the implications of this for growth performance is still in its infancy, but Chapter 6 reports estimates of a substantial impact on relative Anglo-German productivity. The case studies endorse the need for further research into measurement of human capital formation and its implications. With regard to the acquisition of knowledge, the country studies confirm some of the basic insights of new growth theory, but suggest that quantification is more difficult than is often realized. In particular, own country R & D may matter much less than the incentive structures relating to the use of knowledge in different locations. The case studies on Belgium and Sweden underline this point. In Chapter 9 it is shown that much of the benefit from Sweden's revealed comparative advantage in R & D is transferred abroad, while in Sweden itself 'the process of creative destruction is stifled' (p. 279). By contrast, in Chapter 7 Belgian TFP growth is shown to have been substantially enhanced by the increasing participation of multinational firms, which readily compensated for deficiencies in home R & D. Particularly for small countries, the international spillover effects of R & D seem to have been substantial, as the econometric results in Coe and Helpman (1993) suggest. Institutions can have powerful effects on the incentives to invest in human or physical capital or in R & D, through their implications both for the appropriability and the certainty of returns. In this context the case studies highlight especially capital market rules, industrial relations and arrangements to protect investment in the training of workers. Contrary to what is sometimes supposed, these may make for significant differences within Western Europe. The West German case (Chapter 15) seems to epitomize a set of institutions which on the whole work strongly to promote investment in broad capital and growth. In particular, a dense structure comprising employers, unions, government and the financial sector has facilitated investments and innovations with long-term payoffs, and has eschewed the short-termism characteristic of Anglo-American institutions. Perhaps the best-known manifestation of this is in its output of workforce skills. The UK case study (Chapter 6) describes a much less successful situation. In all

Reflections on the country studies

579

three aspects the UK seems to have had inferior arrangements, but particular attention is paid to industrial relations, which are formally analysed. Here it is suggested that, prior to the 1980s, the fragmented nature of British bargaining with multiple unions deterred innovation through threatened appropriation of rents. This seems consistent with the spirit of the standard endogenous growth literature, while indicating that the detailed construction of such models may need to be adapted to historical circumstances. 4

The impact of economic policy

New growth theory suggests that policy may have an important role in growth outcomes. In post-1945 Europe, three aspects have been given particular prominence, as emerged in the overview Chapters 1-5. One is the role of government in establishing an environment in which investment rates would be high and technology transfer would be rapid. A second concerns policy effects stemming from trade policy, and a third relates to the impact of the political system on opportunities for rent seeking, on 'social capability' and on the development of Eurosclerosis. The case studies do tend to regard the policy choices of the early postwar period as a major influence on relative growth performance. Equally, however, these decisions are not seen as breaking completely with the past, or as being unconstrained by historical factors. Even in West Germany elements of continuity are stressed in Chapters 5 and 15, although here currency and market reforms together with reshaping of industrial relations and trade liberalization were all important in realizing potential. In general, the thrust of policy, as Eichengreen suggested (Chapter 2) was towards trying to promote investment together with responsible behaviour by workers. Perhaps the clearest examples of this are in the Netherlands (Chapter 10) and the more famous development of the so-called Swedish model reviewed in Chapter 9. In some cases, this involved accepting strong restrictions on reform which would eventually have more or less serious consequences for growth performance. For example, Chapter 14 stresses that in Italy the priority given to isolating the Communist Party and the structures created in the reaction to Fascism were conducive to the protection of vested interests and limited the modernization of Italian institutions. In the UK case, Chapter 6 stresses that attempts at informal 'social contracts' had to be pursued in the context of an unreformed industrial relations system. With regard to trade policy, defined widely to include industrial policy, a strong consensus emerges which will be familiar to economists examining postwar trends in the wider world. Outwardly oriented development and relatively free trade seem to promote growth in the long term. Obviously the overall situation is one of moves to freer trade from the late 1940s through to the 1970s, strongly encouraged, especially at the outset, by the United States. Countries which initially embraced these moves half-heartedly, and which attempted various interventions aimed at import substitution, are seen as sacrificing growth as a result. This is a strong theme in the chapters on France, Ireland, Portugal and Spain. In later decades, as selective industrial subsidies begin to

580

Nicholas Crafts and Gianni Toniolo

proliferate, these interventions are generally regarded also to have been unhelpful, as is shown, for example, in the chapters on Belgium, Sweden and the UK. The shocks of the 1970s and the exhaustion of catch-up growth are seen in most chapters as creating pressures which tended to exacerbate the growth slowdown, and which perhaps also reflected the downside of the postwar settlements that had originally proved growth promoting. The very general tendency after 1970 to larger government outlays relative to GDP is seen as growth retarding, as has generally been found in cross-section econometric analyses (Dowrick, 1992). The extreme version of this phenomenon is analysed in Chapter 9 on Sweden.

5

Growth economics

It is apparent from the case studies both that new ideas in growth economics are starting to have a considerable impact and that the empirical implementation of these models will be a difficult and lengthy process. In particular, it is important, but an intricate task, to assess the impact of institutions and policy on growth. It is clear that a full understanding of the differences between the interwar period and the Golden Age or between the European winners and losers in post-1945 growth requires just this. In the meantime, the Western European experience reinforces some of the central messages of new growth economics, while suggesting that these may not always be well captured by the variables available for cross-section regressions on growth performance. Postwar economic history certainly supports the ideas that accumulation of human capital is an important part of the growth process, and that innovation/ technology transfer should be placed firmly in a profit-seeking context and made endogenous in growth models. It is much less favourable to suggestions that growth should be modelled as if accumulation of more physical capital and labour force skills were per se sufficient to account for long-run growth in a world freed from diminishing returns. Understanding where TFP growth comes from seems a better long-run goal than constructing models in which it is absent. Conventional growth regressions fulfil a useful function, but they should be taken more as providing some helpful benchmarks than as offering complete accounts of the growth process. Three points should be emphasized. First, measurement of human capital formation remains problematic. The country studies confirm that analysis based on school enrolment ratios and/or years of schooling is inadequate. Second, in a world of transnational companies and strong international spillover effects, an undue emphasis on discovery as opposed to factors conducive to technology transfer seems unwise. Yet this characterizes current attempts at quantification. Third, it seems clear that the impact of institutions on investment and innovation turns on interactive effects which at present defy ready quantification. In sum, the research reported in this volume marks no more than the very beginning of what promises to be an exciting phase of research into applied growth economics. It is to be hoped that this will be carried out in part through careful exploration of historical experience, as a complement to the more routine econometric analysis of contemporary large data sets.

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REFERENCES Abramovitz, M. (1986) 'Catching up, forging ahead, and falling behind', Journal of Economic History, 46, pp. 385-406. Ben-David, D. (1993) 'Equalizing exchange: trade liberalization and income convergence', Quarterly Journal of Economics, 108, pp. 653-79. Coe, D.T. and E. Helpman (1993) 'International R & D spillovers', NBER Working Paper No. 4444. Crafts, N.F.R. and T.C. Mills (1996) 'Europe's Golden Age: an econometric investigation of changing trend rates of growth', in B. van Ark and N.F.R. Crafts (eds.), Quantitative Aspects of Postwar European Economic Growth, Cambridge: Cambridge University Press. Dowrick, S. (1992) 'Estimating the impact of government consumption on growth', Australian National University Discussion Paper No. 258. Easterley, W. and S. Fischer (1994) 'The Soviet economic decline: historical and republican data', mimeo., World Bank, Washington, DC. Gerschenkron, A. (1962) Economic Backwardness in Historical Perspective, Cambridge, MA: Bellknap.

Index

Aarts, L.J.M., 319 Abeken, G., 534 Abelshauser, W., 466, 467, 499, 506 Abert, J.G., 67, 304, 323 Abraham, K.G., 475, 479 Abramovitz, M, 14, 20, 21, 34, 38, 132, 241, 256, 465, 499, 576 Ackley, G., 120 Act on Economic Competition (Netherlands, 1958), 323n.l4 Acton Society Trust, 145 Act on Wages (Netherlands, 1970), 307 Adam, A., 181 Adams, J., 58 Adams, W J , 210, 221, 234, 235 Addison, P., 138 ADGB, 98, 99 age/wage profile Japan, 277 Sweden, 276-7 Aghion, P., 154 agricultural sector Denmark, 541, 551-2, 553, 560-2, 564 East Germany, 517 Ireland, 398-9, 400, 410, 413, 418-19 Italy, 429-30, 441 Netherlands, 294, 306, 308 Portugal, 331, 334, 339, 341, 342 Spain, 368, 371, 374 Sweden, 251 Akerholm, J., 246, 571 Akerlof, G.A., 490, 525, 526, 529 Albert, M, 455 Aldcroft, D.N., 105 Alford, B.W.E., 131 Allen, C, 480

582

Allsopp, C.J., 470 Alogoskoufis, G., 69 Altvater, E., 120 Andersen, P.S., 246, 571 Andersen, T.M., 571, 573 Anderson, C.W., 369 Anderson, J.E., 422 Andersson, M., 277 Andre, C , 233 Andres, J., 19, 20, 318, 360, 375, 377, 380, 381, 383 Anglo-American sclerosis, 82, 90-1 Anglo-Irish trade agreements, 401, 410 AP fund, 257-8, 262 Appels, A., 67 apprentices, West Germany, 475-6, 487 arbitration, Germany, 99, 463, 468 Armstrong, J., 25 Armstrong, P.,'113, 119, 121, 459, 470 Artis, M, 148 Artus, J.R., 111 Aschauer, D.A., 320 Asselain, J.-C, 93 Atkinson, A.B., 152, 273 Atkinson, A.G., 145 Attlee government, 140 Australia growth, 4 institutional sclerosis, 80 Austria domestic institutions, 46, 47-8, 49, 52 Eurosclerosis, 85 growth, 7 automobile industry, Belgium, 176, 202n.6 Baar, L., 516, 533

Index Bacon, R.W., 132, 136 Baethge, M, 480 Baganha, M.I., 350 Bahr, J., 104 Bairoch, P., 126 Bajo, O., 370, 382 Bakker, B.B., 321 balance of payments Belgium, 181 Denmark, 541, 563-4, 568 East Germany, 521-2, 525-6, 527 Ireland, 401 Italy, 443 Netherlands, 303 Sweden, 251 United Kingdom, 138, 139, 141 Balassa, B., 13, 125 Balderston, T., 104 Baldwin, R., 109, 125, 409, 422 Ballabriga, F.C., 377 Balthazar, H., 177, 180 Banco de Portugal, 352 Bank deutscher Lander, 464 Bank for International Settlements (BIS), 54 banking system, West Germany, 488-9 Barca, R., 446, 449 Barciela, C , 362, 365 Barendregt, J., 302, 324 Barnett, C, 140, 142 Barro, R.J., 4, 15, 20, 27, 28, 270, 273, 318, 358, 368, 380, 388, 390, 404, 407, 408, 466, 490, 529 Barry, F., 403, 404 Barthel, H., 504, 509, 512 Batchelor, R., 470 Baudelot, C, 232, 237 Baudhuin, F., 179, 181 Baum, W.C., 58, 352 Baumol, W.J., 390, 457, 546 Bean, C , 31, 110, 112, 151, 156, 377 Beaupain, T., 67, 195 Becker, G.S., 274 Beckerman, W., 12, 108, 110 Beckers, J.-P., 193 Bedau, K.D., 473 Beintema, N., 503 Belassa, B., 176 Belgium, 173^, 201-2 domestic institutions, 46, 4#, 49, 50 features of economic growth, 174-80 phases of economic growth, 180-97 structural change and industry control, 198-201 Bencivenga, V.R., 487 Ben-David, D., 19, 577 Bentolila, S., 375 Bentzel, R., 246

583

Berger, H., 53, 512, 533 Berghahn, V.R., 462, 484 Bergman, L., 246 Bergman, M., 250 Bergmann, T., 47 Bergstrom, V, 260, 283, 284 Berry, R.A., 408 Beuthe, M, 183 Beveridge Report, 142 Bevilacqua, P., 452 Bhagwati, J., 56 Bhaskar, V., 457, 474 Binner, J., 158 Birkenfeld, W., 505 Bishop, M., 149 Bismans, F., 181, 182, 184, 186 Bjerregaard, P., 548, 557 Bjorklund, A., 284 Blackaby, F.T., 148 black market, West Germany, 464 Blanchard, J., 375 Blanchard, O., 27, 104, 229, 384 Bleaney, M., 24 Bloch-Laine, F., 232, 237 Blomme, J., 173 Bloomfield, G., 176 Board of Mediators, Netherlands, 306 Boddewyn, J.J., 179 Boekestijn, A.J., 183, 188 Boelaert, R., 186, 200 Bogaert, H., 193, 195 Boltho, A., 11, 66, 69, 113, 441, 470 Bond, E.W., 412 bonding, 48-9, 50 Borchardt, K., 66, 103, 104, 117, 461, 463, 499 Bordo, M.D., 25, 57, 69 Boserup, E., 571, 572 Bosworth, B.P., 284 Bouvier, J., 232, 237 Boyer, G.R., 421 Boyer, R., 66 Bradley, J., 401, 403 Brakman, S., 310 Brech, M.J., 112 Bretton Woods system, 56-7 breakdown, 61-2 growth, effects of, 25 Italy, 442 Portugal, 339 Sweden, 254 Brito, J.M.B. de, 352, 353 Broadberry, S.N., 19, 21, 66, 140, 141, 179, 475 broad capital, UK, 131, 132, 153 Brosio, G., 445 Brown, A.J., 110

584 Index Brown, W , 148, 151 Brunia, N., 321 Bruno, M., 50, 178, 193, 223 Buchheim, C, 514, 533 Budd, A., 118 Buechtemann, C.F., 486 Buhmann, B., 473 Bundesbank, 526, 527, 531, 535 Bundesminister fur innerdeutsche Beziehungen, 514 Burda, M., 237, 490 Burnham, P., 142 business cycles, 3 Portugal, 334-5 Sweden, 248-50 Buyst, E., 192, 194 Caetano, Marcello, 339 Cairncross, A., 138, 140 Calmfors, L., 50, 104, 138, 268, 284, 388, 415, 416, 459, 473 Camarero, M., 376, 377, 383 Cameron, D., 270 Camu, A., 174, 176, 181, 184, 188, 200 Canada convergence, 19 growth, 4 Caniels, M, 300 capital accumulation, 15, 18, 21, 578 Belgium, 177, 183-5 Denmark, 549-50 East Germany, 505-6 France, 217, 229, 230 growth accounting, 8-9 Italy, 443 mobility, 62-3 Netherlands, 297-301 Portugal, 340, 341, 343 Spain, 358, 368-9, 372, 374 Sweden, 260-3 United Kingdom, 138-9 West Germany, 459, 467, 471 Capital Nationalization Law, Portugal, 331 capture, Olsonian, 59-61 Carew, A., 142 Carli, G, 440 Carlin, W., 151, 464, 465, 466, 467, 468, 471, 472, 474, 490, 491 Carre, J.-J., 120, 122, 124, 210, 219, 220, 221 Carreras, A., 371, 384 cartels Belgium, 199 Eurosclerosis, 83, 84 Germany, 100-1, 462 Casey, B., 479 Cassa del Mezzogiorno, 440

Cassiers, I., 179, 180, 181, 572 Castles, F.G., 11 Catalan, J., 362, 380 catch-up growth, 19, 21-3, 30, 38, 63-5, 576 Denmark, 544 France, 210, 221 Spain, 358 Sweden, 256-7 United Kingdom, 132 West Germany, 456, 466 Catholics Ireland, 397 Netherlands, 304 CEB, 200 Central Bureau of Statistics (CBS), 291, 293, 294, 296, 303 centralization, 50, 52-3 Central Planning Bureau (CPB, Netherlands), 305, 308 Chamorro, S., 367, 370 Chan, S., 93 Chandler, A.D., 139, 145, 200, 462, 483 Channon, D.F., 145 Chatterji, M., 14 Chenery, H., 352 China, 78 Choi, K., 93 Christ, P., 517, 519, 530 Christensen, A.M., 566 Christian Democrats, Italy, 439 Chrystal, K.A., 146 Church, K., 153 CIA, 503 Ciocca, P.L., 441 Clague, C, 92 Clemmesen, F., 569 Clerx,'J.M., 304 coal industry, Belgium, 176 coalitions, distributional, 75, 76 Germany, 97 Cobham, D., 148 Co-Determination Law (Germany, 1951), 47 Coe, D.T., 237, 578 Coi, K., 93 Collier, I.L., 503 Colonial Act (Portugal, 1930), 331 Comin, F., 361, 363, 366, 367, 370 comites d enterprise, 48

Commissariat General du Plan, 234 Commission on Emigration and Other Population Problems, 412 commitment mechanisms, 47-50 Committee on Industrial Organization (Ireland), 402, 414, 415 Communism, East German transition to, 511-12 Communist countries, 77, 78, 83-4

Index Communist Party, Italy, 439 Companies Act (UK, 1948), 145 comparative advantage Belgium, 176-7 Ireland, 410, 418 Italy, 442 Spain, 371 Sweden, 279 United Kingdom, 139^*0 United States of America, competitiveness Belgium, 192, 193, 195 Denmark, 566 East Germany, 531 and exchange rate, 107-26 Netherlands, 302, 307 Spain, 370, 371, 375-6, 378 Sweden, 263-5 West Germany, 461, 470, 476-82 compliance, monitoring, 47-8 conditional convergence, 15-16 long-run perspective, 19 Confraria, J., 352 consociational democracy, Belgium, 177 consumption East Germany, 513, 517 Italy, 448 Portugal, 339, 342, 344, 345 Sweden, 251 convergence, 28 competitiveness and exchange rate, 107-12 Ireland, 389-98, 408, 417 long-run perspective, 19 Portugal, 332 recent research, 15-16 Spain, 359 West Germany, 457 coordinating mechanisms, 49-50 Corbett, J., 48 Cornwall, J., 110, 178 corporatism, 50, 52-3 Belgium, 177-8, 180 Eurosclerosis, 88 Ireland, 415 Portugal, 330-1 Correia, I.H., 334,353 Cotis, J.-P., 237 Cowling, K., 146 Cox, D., 410 Crafts, N.F.R., 9, 11, 16, 28, 31, 66, 135, 136, 140, 150, 152, 159, 176, 179, 182,198, 233, 257, 284, 309, 382, 388, 389, 404, 460, 473, 577 Cravinho, J., 334 crawling-peg, Portugal, 343 Craxi government, 448 creative destruction, 277-8, 279

585

credit France, 232-3 Italy, 438 Portugal, 342 Sweden, 254, 255, 262 West Germany, 465 Cripps, T.F., 14 CRISP, 199 Crouch, C , 50 Cruz, M.B. da, 352 Culem, C, 176, 200 Cumann na nGaedheal, 398-9 current account Denmark, 566, 569 East Germany, 527 France, 215-16 Portugal, 341, 342-3, 345 Spain, 367, 373, 376 Sweden, 244, 251 West Germany, 477-8 Cvetkov, P., 199 Czechoslovakia, 7 Daems, H., 177, 197, 198, 199, 200 DAG, 104n.3, 104n.6 Dahrendorf, R., 47 Dalgaard, E., 571 Daly, A., 485 Daly, M.E., 411 Dancet, G., 49, 50, 182, 184, 188, 195 Danfoss, 559 Daniel, T.K., 398 D'Antonio, M, 118 Darby, J., 147 David, P.A., 64 Davis, D., 410 Davis, Thomas, 419 Deakins, D., 489 de Biolley, T., 174 De Borger, B., 197 De Brabander, G., 173, 183, 184, 187, 189, 203 De Cecco, M., 438 deferred payment contract, 276 De Geest, J., 199 De Grauwe, P., 193, 203 deHaan,J., 317, 320, 571 de Hen, P.E., 301 deindustrialization, UK, 153, 159-60 de Jong, H.J., 323 De Jong, H.W., 200 de Jong, P.R, 319 de Kam, C.A., 312, 319, 321 de Kleijn, J.P., 293 de la Dehesa, G., 365, 367, 369, 370, 371, 373, 381, 382 Deleeck, T, 188

586

Index

Dell, E., 148 De Long, B., 358, 380, 404, 405, 465, 554, 571 De Long, J.B., 111, 136, 143, 262, 268, 363 Delorme, R., 233 Delsen, L, 283 demand stabilization, 11-12 den Bakker, G.P., 18, 323 de Neubourg, CRT., 313 den Hartog, H., 314 Denison, E.F., 8, 10, 13, 14, 134, 135, 173, 183, 198, 202, 241, 548, 571 Denmark, 541-3, 570-1 convergence, 28 growth and economic policy since 1950, 563-70 growth factors and sectoral shifts, 554-63 legacy of 1930s and the war and reconstruction years, 551-4 overview of aggregate growth, 543-50 public sector, 29 Department of Economic Planning and Development (Ireland), 401 depreciation Belgium, 183 Netherlands, 302 West Germany, 465 Dercksen, W.J., 306, 323 De Staercke, J., 183 Deutsches Institut fur Wirtschaftsforschung (DIW),477, 499, 503, 517, 518 Deutsche Wirtschaftskommission (DWK), 512 De Valera, Eamon, 399, 410, 414 devaluations Belgium, 182 and competitiveness, 107, 109-10, 114, 117, 122-5 Denmark, 553 Ireland, 403 Netherlands, 304, 316 Portugal, 336, 339, 343 Spain, 370, 373, 376 Sweden, 253-4, 255, 267-8 De Villi, P., 193, 194, 201 de Voghel, L., 183 Devos, G., 177 de Wolff, P., 307 DGB, 97, 98, 99 Dickhaus, M., 55 Dicks, G., 118 Dilnot, A.W., 142 Dimsdale, N.H., 148 Dinkel, R., 501 disability benefits, Netherlands, 319-20 Disability Insurance Act (WAO, Netherlands, 1967), 319 Dolado, J.J., 375, 408, 467, 469

domestic institutions, 43-4 evolution, 50-3 structure, 45-50 Donges, J.B., 362, 363, 364, 365, 369, 370, 371, 380, 381 Dornbusch, R., 403, 490 Dosi, G., 30 Dow, J.C.R., 141, 146 Dowling, S., 11, 18, 30, 136, 176, 182, 184, 256, 257, 359, 388, 390, 404, 455, 580 Dreze, J., 176, 377 Driehuis, W., 306, 307, 314, 324 Driffill, J., 50, 138, 388, 415, 416, 473 Drukker, J.W., 301 Dubois, P., 210, 218, 220, 221, 237 Dumke, R.H., 182, 362, 458, 466, 533 Dupriez, L.H., 181, 182 Duquesne de la Vinella, L., 176, 178 Durkan, J., 415 Durlauf, S.N., 16, 390 Durviaux, R., 179 Duverger's Law, 86 Dyas, G.P., 145 Easterlin, R., 408 Easterly, W., 31, 318, 578 East Germany, 498-9, 532-3 1950s, 513-17 1960s, 517-19 1970s, 519-22 1980s, 522-8 Communism, transition to, 511-13 legacy of 1930s and war, 504-8 overview of macroeconomic performance, 499-504 productivity gap in the making, 508-11 unification, aftermath, 528-32 and West German growth, 489-91 Eckstein, O., 324 Economic Council, 549, 550, 557, 559, 572 economic policy, impact, 579-80 Economic Reconstitution Law, Portugal, 331 economies of scale see scale economies Edgren, G., 263, 264 Edin, P.A., 275, 277, 284 education, 578 Belgium, 180, 189 Denmark, 557-8, 559 East Germany, 503 France, 230-1 Ireland, 408 Netherlands, 299, 300 Portugal, 351-2 Spain, 358, 368 Sweden, 274-5 United Kingdom, 136, 139, 158-9 West Germany, 467

Index Edwards, J., 489, 491 Ehrlich, E , 25 Eichengreen, B., 14, 22, 24, 31, 34, 69, 113, 141, 142, 154, 182, 303, 304, 363, 533 Ekinsmyth, C , 158 Elder, N., 68 electricity industry, Belgium, 199-200 Elfring, T., 26 Eltis, W.A., 132, 136 encompassing interest, 75-6, 85-90 energy Belgium, 192 East Germany, 523-4 Engen, E.M., 270 Englander, A.S., 143, 144, 191, 197, 452, 478-9 English-speaking sclerosis, 82, 90-1 Englund, P., 262 Erhard, L., 117,464 Ersson, S., 93 Eschenburg, T., 103, 104 Esping-Andersen, G., 46, 52, 67 'Estado Novo', Portugal, 330 European Coal and Steel Community (ECSC), 45, 54, 55-6 Italy, 440 European Currency Unit (ECU), 256 European (Economic) Community Ireland, 402 Portugal, 344, 347 Spain, 375-6 European Free Trade Area (EFTA) Denmark, 558, 566 Portugal, 340, 346, 348 European Monetary System (EMS) Belgium, 202 creation, 27 France, 225 Ireland, 403 Italy, 447 Netherlands, 316 Portugal, 345 European Payments Union (EPU), 45, 54^5, 56 and Bretton Woods system, 57 standard of living, 22 United Kingdom, 142 European Recovery Program see Marshall Plan Eurosclerosis, 10-11, 73-81 distinctive institutions, 81-92 Sweden, 279-80 Exchange Rate Mechanism (ERM) Ireland, 403 Netherlands, 316 Portugal, 345 Spain, 375-6

587

exchange rates Belgium, 178, 192, 193, 195 and competitiveness, 107-26 Denmark, 566, 568, 569 East Germany, 526, 530-1 France, 214, 215-16, 225-7, 229 Ireland, 400, 403 Italy, 439, 447 Netherlands, 310, 315-17 Portugal, 337, 339, 341, 342, 343, 345 Spain, 364, 369-70, 373, 375-6, 377-8 Sweden, 252, 255, 256, 258 United Kingdom, 141 West Germany, 472, 474 Expansion Laws (Belgium, 1959), 187-8 export-led growth, 12-13, 41, 42, 54 and exchange rate, 110, 118 exports Belgium 176, 177, 181, 182, 185-6, 188, 190 Denmark, 541-2, 551, 552, 553, 558-60, 569 East Germany, 526, 527 France, 234-5 Ireland, 400, 411 Netherlands, 305, 308, 315-17 Portugal, 334, 341, 343, 345, 347-50 Spain, 367, 368-9, 370, 371 Sweden, 247, 251, 255 West Germany, 475, 476-7 Eyskens governments, 186 factor reallocation, France, 221-3, 224 Fagerberg, J., 108, 200 Fagerlind, I. 275 Fahey, Tony, 421 Falklands War, 150 family firms, Belgium, 200 Farber, H.S., 104 Fascism, 78 Feinstein, C.H., 18, 139, 141 Fianna Fail, 399-400 Finegold, D., 158 'first past the post' system, 86 First Programme, Ireland, 401 Fischer, K., 489, 491, 578 Flaig, G., 491 Flam, H., 264 Flanagan, R., 45, 46, 67, 459, 470 Floud, J., 139 Fohlen, C , 120 Fonds de Developpement Economique et Social (DFES), 232 Fonds de Modernisation et d'Equipement, 232 Fontana, J., 114, 120 Fonteneau, A., 237

588

Index

Ford, R., 320 foreign direct investment Belgium, 187, 200 Ireland, 412 Portugal, 341, 343, 345 Spain, 370, 375 foreign exchange Belgium, 180 Denmark, 553, 572n.9 East Germany, 525, 527, 528 foreign firms, Belgium, 177, 187, 200 Fornwall, M, 275 Forslund, A., 284 Foundation of Labour, Netherlands, 304, 306 Fraile, P.B., 363, 371, 380 France, 210-11 aggregate performance, 211-17 and Belgium, comparisons, 176 convergence, 28 Eurosclerosis, 84 exchange rates, 114-16, 120-5 growth, 28, 77 growth accounting, 8, 9 human capital, 229-32 instability, 26 institutions 41, 45, 47, 48, 55, 57, 58, 232-6 legacy of 1930s reconstruction, 217-19 partial recovery, 226-9 shocks and stagflation in 1970s, 223-6 and UK, comparisons, 133-5 'vingt glorieuses' (1954-76), 219-23 and West Germany, comparisons, 456-8 Franco, D., 445 Franco, Francisco, 362-3, 366, 369, 371 Franks, J., 488 Franz, W., 469 Freeman, R.B., 388, 416 Friedman, M., 422 Fritzell, J., 284 Frognier, A.-P., 177 Fua, G., 118 Fuentes Quintana, E., 369 full employment Italy, 442, 443, 444 Sweden, 247, 250, 253, 265-6, 268 Fullerton, D., 31 Funke, M, 490 Gaballero, 278 Galloway, L., 93 Galy, M., 371, 373 Gandoy, R., 371 Ganugi, P., 442 Garcia, J., 375, 377, 383 Garcia Delgado, J.L., 373 Garcia Santos, N., 361

Garganas, N.C., 571 gas, Netherlands, 308, 309-10, 312, 315 Gatz, W., 117 General Agreement on Tariffs and Trade (GATT), 56 France, 235 Ireland, 410 and non-tariff barriers, 60 General Disability Act (AAW, Netherlands, 1976), 319 Gennard, J., 68 Gerfin, H., 468, 469 German Metalworkers' Union, 98 Germany and Denmark, trade, 551, 552, 553 Eurosclerosis, 76, 79, 85 exchange rate, 113, 115, 116-20, 124-5 and France, comparisons, 211-13, 224, 229-31 growth, 28 growth accounting, 8, 9 institutions, 45-7, 48, 49, 52-4, 55 non-Olsonian interpretation, 95, 100-3 Olsonian interpretation, 95-100 and UK, comparisons, 133-5, 143-5, 151-2 see also East Germany; West Germany Gerschenkron, A., 576 Gertler, 488 Ghymers, C, 193 Giarda, P., 445 Giavazzi, F., 403, 438 Giersch, H., 81, 94, 97, 101, 103, 104, 117, 119, 120, 455, 467, 469, 474, 477, 479, 482, 483, 491, 533 Giesinger, S.E., 412 Gigliobianco, A., 444 Gilbert, M., 113 Gillingham, J., 55, 179, 512 Gilot, A., 174, 187, 197, 200 Gimbel, J., 506, 533 Ginsborg, P., 444, 448 Gjerding, A.N., 569 Glaude, M., 232, 237 Gleitze, B., 508, 516, 534 Glyn, A., 23, 25, 34, 457, 459, 473, 474 gold standard, 301 Gomulka, S., 14 Gonzalez, M.J., 362, 368, 370, 380 Gonzalez-Paramo, J.M., 374 Goossens, M, 179 Gorbachev administration, 524 Gordon, R.J., 481 Gornig, H.M., 503 Gorzig, B., 503 * Gourvish, T.R., 139 Granick, D., 199, 201

Index Graziani, A., 118, 120 Green, F., 460, 473 Gregg, P., 153 Grier, K.B., 318 Griffith, Arthur, 419 Griffiths, R.T., 305, 311, 323 Griliches, Z., 69, 220 Groes, N., 548, 557 Groot, W., 319 gross domestic product (GDP), 2, 4-6, 8, 39-40 Australia, 33n.9 Belgium, 174, 175 Denmark, 544-6 Eastern Europe, 5 and exports, 42 France, 211-13 Ireland, 390-3, 395-7, 399 Italy, 428, 439, 442, 445-6, 447 Japan, 33n.8 Netherlands, 291-2, 298, 302, 305, 311 North America, 8, 33n.9 Portugal, 332-3 Spain, 356-7, 359-60, 368 Sweden, 242-4, 247, 248 United Kingdom, 133 gross national product (GNP) Denmark, 543^, 546-7 Ireland, 394, 395 Grossman, G., 154, 277 Grout, P.A., 43, 154 growth accounting, 8-10 Portugal, 332-3 Sweden, 241 United Kingdom, 131 Gruchy, A.G., 67 Grunig, F., 508, 534 Grunner, H.-P. 237 Gustafsson, B., 273 Haas, B., 323 Hall, F.G., 412 Hannah, L., 139, 145 Hansen, C, 558, 559 Hansen, S.A., 18, 543, 552, 554 Hansson, B., 246 Hansson, I., 273 Hansson, P., 245, 257, 270, 273, 274, 284 Hardach, K., 117 Hardiman, N., 422 Hardin, R, 92 Harm, C , 489 Harmssen, G., 505, 506 Harris, R., 410 Hartmann, T.T., 517 Hartog, J., 306, 310,313 Hartwich, H.H., 99, 104

Haskel,J., 151, 153 Hatton, T.J., 146 Haveman, R.H., 319 Hayes, P., 505 healing-of-divisions sclerosis, 83-4 Helliwell, J.F., 19, 417 Hellwig, M., 477 Helpman, E., 154, 277, 578 Hemmer, H.-O., 98, 104 Hennessy, P., 140 Hennings, K.H., 117 Henrekson, M., 257, 265, 270, 273, 276, 284 Henriksen, O.B., 553 Hernandez Andreu, J., 361 Hernes, G., 89 Herrigel, G.B., 480 Heston, A, 332, 353, 421, 503 Hibbs, D.A., 275 high-technology industry, UK, 160 Higuchi, Y., 277 Hill, T.P., 111 Hindley, B., 148 Hjerppe, R., 18 Hockerts, H.G., 520 Hodrick, R., 353 Hoel, K., 67 Hoffman, L., 530, 531, 532 Hoffmann, W.G., 104 Hoffmeyer, E., 566, 568 Hogan, A., 358, 368, 372, 374, 379, 380 Hogan, Patrick, 399 Hogg, R.L., 179, 180, 198, 199 holding companies, Belgium, 198-200 Holmes, M., 150 j Holmlund, B., 275, 277, 284 Holtfrerich, C.-L., 104 Honecker administration, 519-20 Honohan, P., 404, 414 Hooper, P., 491 Horn, H., 165 Houard, J., 193 hours worked Denmark, 557 Netherlands, 295-6, 309, 312 Spain, 361 Houseman, S.N., 475, 479, 482 housing sector, Sweden, 262 Houthakker, H.S., 12, 13 Howitt, P., 154 Huitker, T.A., 291 Hulten, C.R., 451 human capital accumulation, 21, 578 Belgium, 177 Denmark, 554, 557-8, 559 East Germany, 502-3

589

590

Index

human captial (cont) France, 229-32 growth accounting, 8, 9 Ireland, 407-8 Netherlands, 299, 300 Portugal, 340, 350-2 Spain, 358, 363 Sweden, 273-7 theory, 16, 18-19 United Kingdom, 143-4, 158-9 West Germany, 459, 467, 475-6 IG Metall, 98, 468-9, 474-5 illiteracy, Portugal, 351 Imber, J., 156 imports Belgium, 176 Denmark, 551, 553, 558-9 East Germany, 526 France, 235-6 Ireland, 400, 410-12 Italy, 446 Netherlands, 301 Portugal, 337, 341, 343, 345, 347-50 Spain, 367, 369, 370 United Kingdom, 141 import substitution Ireland, 410 Portugal, 334 Spain, 364-5, 371 income and growth, 5-7 income distribution Italy, 448 Netherlands, 319 West Germany, 460, 473 industrial conditioning, Portugal, 330, 339, 346, 347 Industrial Development Authority, Ireland, 412 industrialization Italy, 442 Netherlands, 306 Portugal, 329, 334, 338 Industrial Organization Act (Netherlands, 1950), 304 industrial jproduction index, France, 213 Industrial Relations Act (UK, 1971), 146 Industrial Reorganization Corporation, 146 Industrial Training Act (UK, 1964), 146 inflation, 3 Belgium, 193 Bretton Woods system, 57 Denmark, 564, 566, 569 France, 215, 223-4, 225, 227-8 Italy, 443, 446, 447, 448 Netherlands, 303 Portugal, 334, 336, 337, 341, 343, 344

Spain, 364, 367, 370, 374, 376 Sweden, 250-1, 253, 255, 256, 258-9, 265, 268 United Kingdom, 137-8, 471, 148 West Germany, 464, 472-3 information, disseminating, 47-8 Ingham, G.K., 68 INSEE, 123, 234 Instituto Nacional de Industria (INI), 366 interest rates Belgium, 181, 194 Denmark, 565, 566-7, 569 Italy, 442 Netherlands, 303, 311, 317 Portugal, 341 Spain, 376 Sweden, 254, 260 international institutions, 44-5 structure, 53-8 International Labour Office (ILO), 48, 67 International Monetary Fund (IMF), 56-7 Italy, 439 Portugal, 342-3, 344 investment, 578 Belgium, 174^-6, 179, 181, 183, 187 Denmark, 551, 554-6, 565-6 East Germany, 502, 514-16, 518-19, 521-3 France, 218-19, 228, 233-4 and GDP growth, 40 growth theory, 15, 30, 31 Ireland, 400, 404-7, 417 Italy, 443, 447 Netherlands, 297-301, 304-7, 314 Portugal, 339, 340, 344, 345 and productivity, 111-12 rates, 23-4, 38 Spain, 365, 368, 374 Sweden, 251, 255, 260-2, 277-9 United Kingdom, 136, 137, 139, 143, 146 and wage restraint, 43-4, 45-53, 62 West Germany, 461-2, 465, 469-72, 474-6, 487-8 Investment Tax Credit (WIR, Netherlands), 312 Ireland, 388-9, 419-21 cross-section evidence, 416-19 domestic institutions, 41, 47 economic convergence debate, 389-98 economic history, 398-404 human capital and emigration, 407-9 investment, 404-7 rent seeking and interest groups, 413-16 trade policies, 409-13 ISE, 440 Istituto per la Ricostruzione Industrial (IRI), 438

Index Italy, 427-8, 449-51 domestic institutions, 41, 47 'economic miracle', 441-2 Eurosclerosis, 76, 79, 83 exchange rate, 114, 115, 116-20, 124^5 instability, 26 legacy of Fascism and war, 438-9 malaise, 1963-73, 442-5 overview of aggregate performance, 428-30 productivity slowdown, 1973-92, 445-9 reconstruction and stabilization, 439-41 TFP, market structure, scale economies and capacity utilization, 430-7 and West Germany, comparisons, 456-8 Jacquemin, A.P., 200 Jaffe, A., 159,278 James, H., 103, 104, 461, 462, 463 Janne, M.-H., 188 Janossy, F., 16, 17, 499 Japan age/wage profile, 277 growth, 4, 76, 79 Jaumotte, A.L., 200 Jenkins, S.P., 152, 473 Johansen, H.C., 571 Johnman, L., 141 Johnson, P.A., 16, 152, 390 Jones, G., 160 Jones, R., 141 Jonsson, L., 277 Jonung, C, 284 Jonung, L., 250, 260, 262, 283 Jorberg, L., 246, 283 jurisdictional integration, 77, 79 Kaergard, N., 571 Kaldor, N., 13, 69, 108, 132 Kalecki, M., 491 Karlsch, R., 506, 512, 513, 514 Kato, E., 461, 462 Katzenstein, P J , 48, 180, 477, 481 Keesing, F.A.G., 301 Kendrick, J.W., 241,381 Kennedy, K.A., 389, 395, 401, 404, 411, 414, 422, 423 Kervyn de Lettenhove, A., 187, 202 Kestens, P., 202 Kester, W.C., 488 key bargaining, Netherlands, 314 Keynes, J.M., 67, 400 Kiker, B.G., 351 Kindleberger, C.P., 14, 23, 69, 105, 127, 181, 182, 202, 441, 466, 565, 572 King, M.A., 31

591

King, R.G., 31,482, 487,488 Klacek, J., 10 Klevmarken, A.N., 273 Klode, H., 482 Kmenta, J., 417 Knoester, A., 321 Kohl administration, 532 Konings, M., 192, 198 Korean War, 113, 465, 475, 490, 553, 564 Kormendi, R.C., 11, 12,318 Kouwenoven, R.D.J., 313 Kramer, A., 465 Krantz, O., 18, 242 Krapels, F.J., 321 Kremers, J.J.M., 309, 317 Krengel, R., 463, 467, 505, 506, 507, 533 Kruedener, J. Baron von, 104 Krugman, P.R., 13, 108, 109, 128, 159 Krul, N., 177, 182, 183 Kuper, G., 321 Kupky, H., 505, 534 Kurgan-van Hentenryk, G., 181, 199 Kurzer, P., 48, 69 Kusch, G., 501, 521, 522, 523, 524, 526, 527 Kuznets, S., 1, 2, 33 labour input, Netherlands, 295-7 labour mobility, France, 221 labour supply, 13-14, 23 Netherlands, 310 Lains, P., 353 Lamfalussy, A., 12, 110, 173, 183, 202, 203, 442 Lanaro, S., 443, 444, 448 Lancaster, K., 43, 484 Landau, D., 270 Landell, E., 274 Landerrat des amerikanischen Besatzungsgebiets, 534 Lane, J.-E., 93 Larin, K.A., 491 Laroque, G., 228 Lash, S., 88 Law of Industrial Formation and Reorganization (Portugal, 1945), 338 Layard, R., 13, 14, 138, 149, 152, 156, 158 Lazear, E., 276 League of Nations, 114, 127 Leal,J.L., 368, 371 Leddin, A.J., 402, 403, 404, 412, 422 Lee, J.J., 389, 401 Lee, J.W., 358, 368, 380 Lenin, V.I., 352 Lentz, M., 514 Leonard, J., 197 Lesthaeghe, R.J., 174

592

Index

Levine, R., 17, 18, 31, 32, 111, 134, 143, 150, 318, 482, 487, 488 Lewis, W.A., 113, 114, 127 liberalization of trade, 120, 123-4, 125 Liberman, Evsey, 517 licences, Sweden, 278-9 Lichtenberg, F.R., 278 Lieberman, S., 124 Lijphart, A., 177 Lindbeck, A., 61, 81, 88, 94, 104, 279, 283, 285 Lohmann, S., 68 Lopez Garcia, S., 362, 363 Lorwin, V.R., 67 Lowenthal, P., 188, 193, 198 Lucas, R.E., 30, 134, 154, 159, 229, 273, 353, 466, 484 Lundberg, E., 246, 248, 274, 283, 284 Lundberg, L., 245, 274 Lutz, V., 234 Luyten, D., 180 Lynch, P., 401, 412 Mabille, S., 237 Machin, S., 136, 151, 157 Maddison, A., 2, 4, 5, 6, 7, 8, 9, 11, 14, 16, 18, 19, 20, 33, 39, 66, 119, 121, 126, 133, 134, 135, 138, 160, 175, 182, 198, 202, 230, 240, 242, 243, 257, 291, 295, 297, 298, 299, 302, 309, 323, 324, 353, 358, 380, 428, 439, 453, 465, 470, 544, 545, 546 Madsen, E.S., 546 Magee, S.P., 12, 13, 416 Magnus, J.R., 308 Maier, C.S., 22, 25, 26, 46, 51, 66, 461, 465, 467 Mairesse, J., 233 Maizels, A, 470 Maldaque, R., 200 Malefakis, E., 362 Malo de Molina, J.L., 375 Mankiw, N.G., 15, 19, 20, 273, 278, 388, 390, 404, 407, 408, 482 manufacturing sector Denmark, 546-8, 553-4, 557, 560-2 East Germany, 504, 507, 509 France, 58, 212, 220-1, 236 Ireland, 399 Italy, 441 Netherlands, 293-5, 301, 306, 307 Portugal, 338 productivity, 21 Spain, 371 Sweden, 251, 266, 274 United Kingdom, 136, 159-60 West Germany, 457-8, 471, 473, 476-7, 482

Manz, M., 499 Marchese, C , 445 Marglin, S.A., 34, 470 Marseille, J., 234 Marshall Plan Belgium, 180, 181 Denmark, 553 and European Payments Union, 55 France, 218 Netherlands, 303-4 Spain, 363 standard of living, 22 United Kingdom, 142 West Germany, 463, 464, 466 Martin, A., 283 Martin, C , 374, 376, 382, 383 Martin Acena, P., 361, 362, 363, 366, 383 Martinez Serrano, J.A., 122, 124 Mason, G , 323, 480, 481, 485 Matschke, W., 505 Matthaus-Maier, 530 Matthews, R.C.O., 139, 198, 221 Maunder, A., 92 Mayer, C.P., 482, 488, 490 McAleese, D.F., 411 McCain, R.A., 67 McDonald, I., 164 McGuire, M.C., 93, 94 McGuirk, A.K., 111 McKee, M.J., 320 Meade, J.E., 68 Meeks, G., 146 Meguire, P.G., 11, 12, 318 Mehta, F., 190, 196 Melitz, J., 228 Mendershausen, H., 461 Melzer, M., 503, 506, 507, 509, 515, 519, 533, 534 mercantilistic sclerosis, 82 Mercer, H , 141 mergers Netherlands, 308 United Kingdom, 145-6 Merigo, E., 122 Merkel, W., 499, 500, 501, 503, 515, 518, 519, 521, 522, 523, 525, 534 Messina treaty, 120 Metalkartell, 98 Metcalf, D., 156 Meyersen, P.M., 285 Michalski, W., 117 Middlemas, K., 142 migration patterns East Germany, 501, 506-7, 531 Ireland, 390, 397, 399, 401, 408-9 Italy, 442 Portugal, 342, 343, 350

Index Spain, 371 West Germany, 459, 463, 466-7, 468-9 Mihoubi, F., 237 Mills, T.C., 16, 577 Milward, A.S., 183, 188, 199 Mincer, J., 275, 277 minimum wage France 237n.l6 Netherlands, 310, 311-12 Ministry of Economic Affairs (MEA), 181, 303 Minne, B., 299, 300 Mistral, J., 122 Mitchell, B.R., 18, 139 Mittelstadt, A., 143, 144, 191, 197, 452, 478-9 Mitterrand, Francois, 226, 227 Mobus, M., 231 Moesen, W., 197 Mokyr, J., 422 Molinari, A., 438 Moller, K., 559 Mommen,A., 173, 179,200 Mommens, T.E., 183 Moncloa Agreements, 373 Mond-Turner talks, 68n.33 money supply, UK, 138, 139 Monopolies and Mergers Commission, 148 Morcaldo, G., 445 Morris, D.J., 132, 146, 148 Morrison, C.J., 93, 430, 431 Moses, J.A., 104 Moura, F.P. de, 353 Mowery, D.C., 139, 159 Muellbauer, J., 147, 153 Mueller, D.C., 93 Muet, P.-A., 229, 237 Muhlfriedel, W., 511, 512, 516 Muller-Jentsch, W., 47, 471 multinational companies Belgium, 177, 187, 197, 200 Ireland, 402 Mulvey, C , 324 Murphy, K., 275 Murrell, P., 92, 94 Musgrave, R.P., 146 Musgrave, R.A., 146 Musu, I., 445 Myrdal, G., 283 Myro, R., 371 Nadal, J., 114,120 Nannestad, P., 571, 573 National Bank of Belgium (NBB), 184, 187, 198 National Curriculum, UK, 158

593

national debt Ireland, 400, 402 Netherlands, 303 United Kingdom, 138, 139, 146 National Economic and Social Council (NESC), 421 National Economic Development Council, 146 National Economic Development Office (NEDO), 146 National Enterprise Board, 148 nationalized firms France, 233 United Kingdom, 148-9 National Labour Conference, Belgium, 180 National Union of Mineworkers, 150 National Vocational Qualifications, 158 natural gas, Netherlands, 308, 309-10, 312, 315 Neary, J.P., 410, 422 Neild, R.R., 146 Nelson, R.R., 12, 19, 21, 139, 144, 160, 273, 465 Netherlands, 290-301 and Belgium, comparisons, 176 continuity and change during 1980s, 311-12 convergence, 28 domestic institutions, 45, 46, 48, 50, 52, 68n.35 export sector and exchange rate policy, 315-17 'golden years' (1950-1973), 305-8 growth, 77 labour market and wage policies, 312-15 legacy of the 1930s, 301-2 public sector and economic growth, 317-22 shocks and sluggish growth during 1970s, 309-11 World War II and reconstruction, 302-5 Neubauer, R., 517, 520, 530 Neumann, G., 504, 512, 517 Neumann, M., 477 Neves, J., 334, 351, 352, 353 New Economic System (NES), East Germany, 517, 518 Newell, A.T., 50 new international order, 23 New Zealand, 80 Nguyen, D.T., 30, 136, 176, 182, 184, 256, 257, 359, 388, 390, 404, 455 Nickell, S.J., 138, 156 Nielsen, S.B., 567, 571 NIESR, 118, 119, 121 Nilsson, C.A., 18, 242 North, D.C., 66

594

Index

Norton, D.A.G., 401 Norway domestic institutions, 46, 48, 49, 52 Eurosclerosis, 85, 88, 94n.l8 Nunes, A., 352, 353 Oberbeck, H., 480 O'Brien, G., 399 O'Brien, P.K., 371, 381 Obst, W., 516, 518, 519 Obstfeld, M., 109 OECD, 2, 7, 10, 18, 119, 121, 122, 123, 126, 128, 133, 136, 137, 144, 159, 160, 292, 312, 319, 320, 324, 477, 486, 546 Ofer, G., 5 0 Grada, C, 24, 34, 398, 408, 410, 411, 422 O'Halloran, S., 68 O'Higgins, M , 152, 473 Ohlsson, L., 278 oil shocks, 61 Belgium, 191, 194 Denmark, 567-8 France, 223-5 Ireland, 391, 392, 402-3 Italy, 435, 446, 447 Netherlands, 309, 311, 312 Portugal, 344 Spain, 372, 373, 374 Sweden, 254, 255 United Kingdom, 147 West Germany, 472 01gaard, A., 553, 571 Olson, M, 10, 50, 60, 93, 94, 95, 98, 101, 103, 279, 282, 283, 285, 413, 414, 415, 459 O'Mahony, ML, 9, 32, 136, 143, 144, 151, 152, 155, 156, 158, 467, 479 on-the-job training (OJT), Sweden, 275-7 Organization for European Economic Cooperation (OEEC), 54, 58 organized capitalism, West Germany, 483-4 O'Rourke, K., 24, 34, 390, 410, 414, 421, 422 Oswald, A., 104 Oudiz, G., 225, 237 Oulton, N., 9, 32, 136, 155, 156 Owen, N., 125 Pact of Madrid, 24 Paelinck, J., 183 Pagano, G., 192, 195, 198, 403 Palafox, J., 361 Paldam, M., 546, 571, 572 Palme, M, 275 Panitch, L., 51 Paque, K.-H., 11, 101, 103, 104, 105, 467, 468 part-time employment Netherlands, 296 Sweden, 251

Pastor, R., 68 Pasture, P.T., 184, 188 patents, UK, 143, 144 Pavitt, K., 143, 144 PBOs, Netherlands, 48 Peacock, A., 142 Pedersen, P.J., 566, 572, 573 pension schemes, 49 Netherlands, 321 Sweden, 257-8, 262 Person, I., 284, 319 perverse policy syndrome, 82 Petit, P., 193 Phelps, E.S., 273 Philpott, T., 489 pignoracion, 38O-ln.26 Pilat, D., 313, 457, 476, 486, 491 Pindyck, R.S., 31 Piva, F., 438 planes de desarrollo, 370 planification indicatif, 370 planning Denmark, 565 East Germany, 504, 505, 511, 516, 518 France, 232-4 Ireland, 401-2 Portugal, 331 planning councils, Norway, 48 Pianos de Fomento, 338, 339-40, 351 Plunkett, Horace, 419 Pohjola, M., 485 Pohl, Karl Otto, 535n.l8 Pollard, S., 55, 138 Pombeni, P., 443 Pontusson, J., 260, 262 population East Germany, 501-2, 507 Netherlands, 290, 291 Poret, P., 320 Porter, M.E., 413, 488 Portugal, 329 external relations, 347-50 growth, 24 human capital, 350-2 institutions, 52, 346-7 phases of postwar growth, 335-46 setting for postwar growth, 329-35 Postan, M.M., 69 postwar settlement, 22, 58-65 poverty Italy, 448, 449 United Kingdom, 151-2 Prados de la Escosura, L, 355, 356, 357, 361, 363, 364, 366, 367, 368, 370, 371, 379, 380,381 Prais, S.J., 132, 145, 158, 485 Prasada Rao, D.S., 381

Index Pratten, C.F., 145 Prescott, E., 353 Presidencia do Conselho, 353 Preston, P., 24 Price, S., 132, 150 privatization France, 229 Italy, 440 Portugal, 344 production committees, Norway, 48 Productivity Agreements, Belgium, 46 profitability Belgium, 191, 193, 195 East Germany, 518 France, 124 Italy, 120, 432-3, 435-6 Netherlands, 307, 308 Spain, 124 Sweden, 255 West Germany, 120, 462, 465, 471-2, 474, 476 protectionism Belgium, 179, 182, 188 Ireland, 410-13, 414 Netherlands, 301 Portugal, 330, 331, 345 Spain, 363-4, 365, 370 Przeworski, A., 66 Psacharopoulos, G., 351 public debt Belgium, 189-90, 194 Portugal, 334, 338, 339, 341, 343, 345 Spain, 369, 374, 375 Sweden, 255 public sector Denmark, 542, 557, 558, 560, 566 Ireland, 406-7 Italy, 438 Netherlands, 317-22 Sweden, 247, 250, 251, 266, 268-70 public sector borrowing requirement (PSBR), Ireland, 402, 403 public spending Belgium, 177, 196, 197 Ireland, 402 Italy, 445 Netherlands, 310, 317-20 Portugal, 345 Spain, 366-7, 369, 374 Sweden, 247, 254, 255, 269-70 Puissant, J., 199 Purcell,J., 153 Quah, D., 422 Ragionieri, E., 440 Rasmussen, M., 572

595

Rauch, J., 93 Rausser, G., 92 Rebelo, S., 15, 31, 318 Reciprocal Agreements Act (USA, 1934), 56 reconstruction, 21 red devolution, 82-3 Rehn model, 49, 50 Reis, J., 353 Renborg, U., 92 Renelt, D., 17, 18, 32, 111, 134, 143, 150, 318 research and development (R & D), 578 Denmark, 542, 559 Netherlands, 299-300 Sweden, 277-9 United Kingdom, 139, 143, 144, 151 Resnick, S.A., 235 Restrictive Practices Act (UK, 1956), 146 revealed comparative advantage (RCA), 118-19, 122-3 Revue Nouvelle, 200 Rey, G.M., 118,451 Ricardo, D., 352 Richardson, R., 148 Rioux, J.-P., 219 Risager, O., 571, 573 Ritschl, A., 10, 53, 104, 512, 533 Rivera-Batiz, F., 410 Rivlin, A.M., 284 Roberts, B.C., 68 Robinson, P., 158 Roesler, J., 504, 511, 516, 517, 518 Romanis, A., 183 Romer, D., 15 Romer, P.M., 15, 134, 154, 156, 157, 163, 277, 410, 485 Rosas, F., 352 Rosenberg, N., 159 Rosselle, E., 177, 182, 198 Rossi, N., 18, 428, 429, 430, 439, 445, 449, 451,452 Rostas, L., 149 Roubini, N., 487, 488 Rowthorn, R.E., 14, 459, 473 Rustow, H.J., 491 Sachs, J.D., 50, 178, 193, 223, 237 Sachverstandigenrat, 500, 503, 504, 530, 532 Saint-Paul, G., 218, 237 Sala-i-Martin, X., 4, 15, 21, 27, 28, 388, 390, 422, 452, 487, 490, 529 Salazar, Antonio de Oliveira, 330, 331, 339 Salvati, M., 444 Samuelsson, K., 246, 283 Sanders, D., 132, 150 Sanderson, M., 139 Sandier, T., 93 San Juan, C , 371

596

Index

Santos, C , 351 Sargent, T.J., 377 Sassoon D., 444, 446 Saunders, P., 270 Sautter, C , 122, 210 Savage, R., 190, 191, 192, 193 savings Belgium, 183, 202n.5 Denmark, 542, 566, 569 France, 234 Netherlands, 321 Sweden, 257-60 Sawyer, M , 473 scale economies, 26 Denmark, 559, 560 Italy, 431, 432, 437, 439 Schalck-Golodkowski, Alexander, 523 Schelling, T., 67 Schettkat, R., 491 Schmidt, M., 508 Schmitter, P.C., 50 Schmitz, K.T., 98, 104 Schneider-Lenne, E., 488 Scholliers, P., 173, 178, 179, 182 School Pact, Belgium, 186 Schor, J.B., 34, 470 Schroter, H., 524 Schultz, T.W., 274 Schuman Plan, 55 Schwarzer, O., 535 Schwerin, 49 Scott, M., 141, 455, 465, 470, 485 Second Programme, Ireland, 401 sectoral bargaining, 44, 52 Segerstrom, 277 selective incentives, 74-5 Serrano Sanz, J.M., 380 services sector Denmark, 560-2 Italy, 446 Netherlands, 294 Portugal, 334, 339, 341 Spain, 371 Sevestre, P., 231 Sheahan, J., 69 Sheehan, J., 408 Shonfield, A., 45, 49, 66, 488 Siebert, H., 529, 530 Siemens, 462 Silva, Cavaco, 344 Simpson, J., 371 Singh, A., 146 Sinn, G., 525, 526, 529, 531, 535 Sinn, H.W., 525, 526, 529, 531, 535 Sinn, S., 216 Siven, C.-H., 277 Skedinger, P., 277

Skinner, A., 93 Skinner, J., 270 Sleuwaegen, L., 177, 200 small numbers, advantage of, 74 Smith, A.D., 149 Smith, B.D., 487 Smith, D., 270 Smith, J.D., 146 Smith, R., 69 Smoot-Hawley Tariff, 56 Smulders, S., 15 Snake Denmark, 568 France, 225-6 Netherlands, 316 Sneessens, H.R., 190, 196, 197, 377 Snower, D., 61, 104 SNS Economic Policy Group, 256 social capability, UK, 132 Social Democrats Denmark, 551 Netherlands, 304 Sweden, 246, 253, 255, 256, 260 Social Economic Council, Netherlands, 304-5, 306 social overhead capital, Italy, 446, 449 Social Pact, Belgium, 46, 49, 184 social programming, Belgium, 188, 195 social security see welfare state Societe Generate, 199, 200 Sodersten, J., 260 Soderstrom, H.T., 265 Soete, L., 144 Sohlman, A., 274 1 Solar, P.M., 181, 189 Soligo, R., 408 Solimano, A., 31 Solow, B., 413 Solow, R.M., 164,431 Sommariva, A., 18 Sondergaard, J., 567, 571 Sorge, A., 490 Sortia, J.-R., 200 Soskice, D., 158, 159, 470, 473, 478, 485, 487, 489, 491 Soto, A., 361 SOU, 283 Soviet Union, and East Germany, 511-14, 523-4 Spaey, D., 193 Spain, 355, 378-9 economic performance in the long run, 355-61 exchange rate, 114, 116-17, 120-5 Golden Age, 369-72 growth, 24, 28 legacy of the 1930s and Civil War, 361-2

Index reconstruction, 362-9 recovery of late 1980s and its legacy, 375-8 shocks and stagflation, 372-5 special-interest legislation, 75 Spitaels, G., 188 Spitaller, E., 371, 373 Sprumont, Y., 198 Staatliche Plankommission, 512 Stahl, I., 81, 94, 279 standard of living East Germany, 514, 530-2 guarantees, 22 wage moderation, 23 Statistics Denmark, 548, 549, 571 Statistisches Amt der DDR, 500, 502, 519, 520, 521, 522, 525, 526, 527, 528 Statistisches Bundesamt, 500, 507, 509, 526, 527, 528, 529, 534 Steedman, H., 144, 475, 485, 487 steel industry, Belgium, 200 Steger, A., 521, 526, 527 Steiner, A., 534 Steiner, V., 491 Sterdyniak, H., 225, 237 Stern, R.M., 118 Stevenius-Nielsen, H., 554 Stewart, M., 157 Stiglitz, J.E., 273 Stockholm School of Economics, 252-3 Stolper, W., 504, 508, 509, 511, 518, 534 Stoneman, P., 151 Storms, B., 200 Stout, D.K., 112, 132, 146, 148 Streeck, W., 47, 480, 483, 485, 490 strikes Belgium, 178, 180, 184, 188 East Germany, 514 Italy, 443, 444 West Germany, 459, 472 Strikwerda, C , 180 Sturm, J.E., 320 Suarez, F.J., 358, 359, 371, 372, 375, 380 subsidies Belgium, 190, 197, 200 as bonds, 48 France, 233 Italy, 440 Netherlands, 308 Sweden, 266 Suedosclerosis, 279-80 Suez crisis, 564 Suhr, H., 522, 523, 530 Summers, L.H., 104, 111, 136, 143, 262, 268, 358, 380, 404, 405, 465, 554, 571 Summers, R., 32, 353,431, 503 supervisory boards, West Germany, 488

597

Svennilson, I., 114 Sweden, 240-2, 280-2 aggregate performance, 242-52 causes of economic performance, 256-80 Eurosclerosis, 10, 79, 85, 88-91, 94n.l8 institutions, 49, 50, 68n.28 macroeconomic policies, 252-6 public sector, 29 Symons, J., 50, 151, 156 Syrquin, M., 352 Tabellini, G., 319 takeovers Belgium, 197 United Kingdom, 145-6 Tamarit, C , 376, 377, 383 Tanzi, V., 132, 136 tariffs, France, 235 Tarling, R.J., 14 taxation Belgium, 190 as bond, 48-9 Denmark, 562, 565, 566-7 and growth, 30-1 Netherlands, 312, 318-19, 320-2 Portugal, 342 Sweden, 247, 256, 260, 271-3 United Kingdom, 136, 142 West Germany, 465 Taylor, A.M., 380 technology Belgium, 200 catch-up growth, 19, 21, 256 East Germany, 508 Italy, 430-1, 438 Portugal, 333, 340 Spain, 375 Sweden, 257 United Kingdom, 151 Temporary Employment Agencies, 324n.l8, 500, 503, 504, 530, 532 Tew,J.H.B., 112 textiles sector Netherlands, 308 Portugal, 331 Thanheiser, H.T., 145 Tharakan, P.K.M., 177, 200 Thatcher, Margaret, 149 Theeuwes, J.J.M., 306, 310, 313, 321 Thelan, K., 63, 68 Thirlwall, A.P., 12, 112, 159 Thompson, D., 149 Tinbergen, J., 303 Tjan, H.S., 314 Tolbert, S.IvI., 352 Tomlinson, J., 140, 141, 142 Toniolo, G., 113, 430, 438, 442, 452

598

Index

Topp, N.-H., 552 Torres, A., 370, 382 total factor productivity (TFP), 577 Denmark, 548-50 East Germany, 501 France, 219-21, 222-3, 236 growth accounting, 8, 9-10, 241 Italy, 430, 433-5 Netherlands, 298-9, 300, 301, 309 Spain, 358-60, 371, 374 Sweden, 244^5 United Kingdom, 133, 138-9, 151, 155 West Germany, 457, 474, 479 Trades Union Congress, 143 trade unions Belgium, 17-18, 182 Eurosclerosis, 86 Germany, 97-100 Italy, 443, 445, 446 Netherlands, 307, 314 Spain, 370, 375 strength and unemployment, 27, 59 Sweden, 266 United Kingdom, 141, 153-7 wage moderation and investment, 45-7, 51 West Germany, 461, 467-9, 471-2, 483 training, 578 East Germany, 503 France, 230-1 Netherlands, 323n.5 Portugal, 351-2 Sweden, 275-7 United Kingdom, 143-4, 158-9 West Germany, 467, 475, 485-7 transfer system, 48-9 transport sector, 406-7 Trevitchick, J.A., 324 Triffin, R., 25, 113 Truman, E.M., 235 Tullio, G., 18 Tullock, G., 318 Ulbricht, Walter, 517, 519 understanding, economic, 78, 80 unemployment, 5, 7, 8 Belgium, 182, 188, 190, 193, 196 Denmark, 548, 551, 564, 566, 568 France, 215, 223, 225, 227, 229, 230-1 Germany, 100-1, 102 Ireland, 395, 415-16 Italy, 442, 443, 447, 448 Netherlands, 296, 297, 301-2, 307, 309, 310,311,314 Portugal, 337, 340, 343, 344 Spain, 371-2, 374, 375, 376-8 Sweden, 250, 252, 254, 264^5, 268

United Kingdom, 137-8, 141, 149, 150, 152 West Germany, 459, 467, 473, 476 Unger, B., 11,467 United Kingdom, 131-8, 160-2 bargaining models and productivity change, 153-8 and Belgium, comparisons, 174, 200-1 convergence, 28 deindustrialization, 159-60 and Denmark, trade, 551, 552, 553 domestic institutions, 41, 46, 47, 67-8n.27 Eurosclerosis, 10, 76, 80, 91 exchange rate, 112 Golden Age, 142-7 growth, 28-9, 77 growth accounting, 8, 9 human capital formation, 158-9 and Ireland, comparisons, 389, 390, 395, 404^5 labour supply, 13 legacy of 1930s and World War II, 138-40 Marshall Plan, 55 productivity, 27 reconstruction, 140-2 recovery in 1980s and its legacy, 149-53 shocks and stagflation, 147-9 trade union strength, 84 and West Germany, comparisons, 456-8, 483 United Nations, 143 United States of America Bretton Woods system, 57 convergence, 19 GATT, 56, 59 growth, 4, 76-7 instability of international payments, 25-6 institutional sclerosis, 80, 92 Marshall Plan, 55 postwar settlement, 22 productivity missions, 23 and Spain, 24 and United Kingdom, comparisons, 139-40, 145 and West Germany, comparisons, 462 US Department of Labor, 297, 313 Uzan, M., 141, 142, 303, 304, 533 van Ark, B., 134, 294, 295, 307, 313, 317, 457, 458, 476, 486, 491, 503 Van Audenrode, M., 197 van Bochove, C.A., 291, 302 van de Klundert, T., 15, 136, 455, 456 Van den Broeke, C , 188 Van Den Bulcke, D., 177, 197, 200 Vanden Houte, P., 177, 187, 188 Vandeputte, R., 173, 190

Index van der Eng, P., 303 Van der Linden, B., 201 van der Ploeg, F. 43 Van der Rest, J., 183 Vandersmissen, G., 187, 189 Van der Wee, H., 173, 177, 187, 198, 199 van der Windt, N., 321 Van de Stadt, H., 293 Vandewalle, G., 173 Van de Weyer, P., 177, 197, 200 van Hulst, N., 306 Van Impe, W., 197 Van Meershaeghe, M.A.G., 187 van Meerten, M., 174, 179, 181 van Ravestein, A., 321 Van Rijckeghem, W., 173, 184, 187 Van Rompuy, P., 197 Van Rompuy, V., 187, 190 van Schaik, A., 136, 301, 455, 456 van Sorge, W, 302, 323 Vanthemsche, G., 179 van Veen, T , 283 van Waarden, F., 11,68,467 van Waterschoot, W., 188 van Zanden, J.L., 305, 311, 323 Vedder, R., 93 Verdoorn's Law, 13, 14 Vereinigungen Volkseigener Betriebe (VVB), 517 Verspagen, B., 9, 273, 300 Veugelers, R., 177, 187, 188 Vickers, J., 146, 148 Victorsson, J., 274 Villa, P., 18, 210, 217, 220 Vinals, J., 375 Viotti, S., 265 Visco, I., 446, 449 Vleminckx, A., 190 von Kruedener, J., 491 Vuchelen, J., 177, 194, 197 Wadhwani, S., 137, 151 Waelbroeck, J., 177, 181, 182, 198, 200 wages Belgium, 181-2, 188, 189, 192-3, 194^5 Denmark, 542, 558, 565, 566, 567, 568 East Germany, 529, 531-2 France, 228, 231-2 and investment, 43-4, 45-53, 62 Ireland, 408-9, 415-16 Italy, 441, 445 and labour supply, 14, 23 Netherlands, 296-7, 306-7, 310, 311-15 Portugal, 342, 344 postwar settlement, 22 Spain, 373, 375, 377-8 Sweden, 244, 260, 266, 268, 275-7

599

United Kingdom, 141 West Germany, 459, 461, 464, 468-72, 474-5, 485 Wagner, K., 144, 158, 485 Wahl, S., 499, 500, 501, 503, 515, 518, 519, 521, 522, 523, 525, 534 Wallerstein, M, 66 Wallich, H.C., 465 Walsh, B.M., 402, 403, 404, 408, 412, 416, 422 Walshe, G., 145 Ward, T.S., 146 wars, effects of, 2-3, 4, 21 Belgium, 178-9 Denmark, 543, 552 East Germany, 505-6 France, 217 Ireland, 400, 413 Italy, 438-9 Netherlands, 302 Portugal, 336, 340, 341 Spain, 355, 362 Sweden, 252, 253 United Kingdom, 138, 150 West Germany, 96, 459, 460-1, 466 Waterson, M, 146 Weaver, F., 142 Weaver, K., 283 Webb, S., 152 Weber, M, 187, 188, 191, 517, 518, 519 Weede, E., 93 Weil, D.N., 15 Weingast, B., 66 Weisbrod, B., 463 Welch, F., 275 welfare state, 52 Belgium, 49, 182, 194 East Germany, 520 Italy, 445 Netherlands, 312, 319 Spain, 374 United Kingdom, 67-8n.27, 142 West Germany, 461 Wellink, A.H.E.M, 312 Wells, J, 156 West Germany, 455-60 and East Germany, 489-91, 499-501, 507-11, 515-16, 522-3, 526-32 economic model, 482-9 Eurosclerosis, 10, 11 Golden Age growth, 1961-73, 468-73 growth weakness of Weimar Republic, 460-3 non-Olsonian interpretation, 101 slow growth, 473-82 Wetenschappelijke Rand voor het Regeringsbeleid, 310-11

600

Index

Whalley, J., 410 wheat campaign, Portugal, 331 Whitaker, T.K., 412 Wickens, M, 14 Wickman, K., 94, 279 Wiessner, K., 511, 512, 516 Wigle, R., 410 Wikstrom, 81 Wilkens, H., 503 Williamson, J.G., 390, 394, 408, 421, 430 Williamson, O.E., 488 Willis, R.J., 274 Wilson, T., 93 Windmuller, J.P., 46, 50 Wiseman, J., 142 Wismut AG, 514 Wissen, P., 244, 264 Wissenschaftlicher Beirat, 530, 531 Wolf, H.C., 490 Wolfe, B., 319 Wolff, E.N., 474, 476 Wolinsky, A., 165 Woltjer, G., 306 women, labour force participation East Germany, 501 Netherlands, 295, 310, 311, 313-14

Spain, 372 Sweden, 251, 267 Workers' Charter, Italy, 445 Work for Everybody programme, Norway, 46 Works Constitution Act (West Germany, 1952), 467 works councils Belgium, 48 Germany, 47, 485 Wren-Lewis, S., 147 Wright, A., 123 Wright, G., 12, 19, 21, 139, 144, 160, 465 Wright, M., 68 Wright, R.E., 275 Wyplosz, C, 237 Yarrow, G., 146, 148 Young, A., 410, 418 Zank, W, 506, 508, 533, 534 Zeckhauser, R.J., 93 Zentralverwaltung fur Statistik, 502, 507, 509, 526, 527, 528 Zeuthen, H.E., 571 Zysman, 64