EC120 Spring 2016: Week 22, Topic 17, Slide 1

EC120: The World Economy in Historical PerspectiveTopics Week 22: Europe’s Golden Age of Economic Growth

(1950-1973) and Its Disintegration.• 1. Foundations of the Golden Age: More Than Trade.

• 2. Waning of the Golden Age: Was Its End Inevitable?

• 3. Early Attempts to Restore intra-European Exchange Rate Stability in the Wake of the Collapse of Bretton Woods: The “Snake” (1973- 79) and the European Monetary System, Phase 1 (1979-87).

Paris, c. 1965 Frankfurt a. Main, c. 1965

EC120 Spring 2016: Week 22, Topic 17, Slide 2

EC120: The World Economy in Historical Perspective1a. Foundations of the Golden Age (see Maddison (2001),

Table 3- 1a for evidence): Unusual Technological Opportunity

• Technological advances (particularly in factory electrification) made in the period 1914-1939, while widely known, had not been extensively deployed before 1939, especially (but not exclusively) in Europe and Japan.

• Remarkably, some R&D expenditure, in some places, increased even in the depressed 1930s.

Innovation at Alexandra Palace Early Marconi television Set, c. 1939

EC120: The World Economy in Historical Perspective1a. Foundations of the Golden Age: Unusual Technological

Opportunity [Con’t.]• The pressures of war brought forth more technological gains

potentially useful in peacetime, not least advances in communications, electronics (radar and computers), and the use of specialized equipment and machine tools for mass production.

• Large-scale reconstruction offered an unusually good opportunity to deploy widely modern plant and equipment

embodying new technologies. • Together these factors created an unusual backlog of technological

opportunity (especially in Europe and Japan) capable of fuelling atypically rapid growth, during which ‘learning-by-doing’ created further opportunities for productivity advance.

EC120 Spring 2016: Week 22, Topic 17, Slide 3

Turing’s “bombe”Bletchley Park,Englandc. 1944

Me 262, first operational jet fighter, c.1944

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EC120: The World Economy in Historical Perspective

1b. Foundations of the Golden Age: Recovery in Europe from the Traumatic Disequilibrium of 1945

• Much war damage to infrastructure, plant, and equipment could be repaired quickly, producing rapid gains in output.

• Reconstruction (as mentioned above) also created a favorable environment for technological advance as new

facilities were built and equipped with the latest equipment. • Much labour was concentrated in the agricultural sector due to

pre-war protectionism, war-time autarchy, and refugee displacement. This labour could be drawn on to man factories without putting great upward pressure on wages.

• Emigration from Eastern Europe, the British Commonwealth, North Africa, and Turkey provided another source of cheap, often skilled, labour for western European economies.

Mercedes 190SL assembly line, c. 1955

Turkish GastarbeitersRuhrgebiet, c. 1955

EC120 Spring 2016: Week 22, Topic 17, Slide 5

EC120: The World Economy in Historical Perspective

1c. Foundations of the Golden Age: The “Post-War Settlement” and Systematic Policy Bias towards High Demand Pressure

• The “post-war settlement” secured high levels of capital formation.

• Reaction to perceived policy errors of the inter-war years (especially high unemployment), reinforced by the ‘output miracle’ of the war.• Widespread extension of welfare benefits, especially in

housing, public utilities (including transportation), health, and education.

• Political pressure to raise real incomes, contributing to high levels of investment encouraged by public policy (notably tax incentives and subsidies, but also centralized wage and investment bargaining).

• Together, these factors combined led to persistently high levels of demand.Golden Lane

Council Estate, London, built c. 1955

EC120: The World Economy in Historical Perspective

EC120 Spring 2016: Week 22, Topic 17, Slide 6

1d. A Flexible, Effective International Monetary Regime• Systematic encouragement of international, especially intra-European, trade (ERP and EPU, followed by the ECSC and EEC), facilitated more efficient resource allocation through more effective competition and gains from specialization. • International trade, by widening markets, also facilitated the profitable deployment of scale-dependent mass-production techniques.

- A notable example: Japanese innovation in transistor radios in the early 1960s and the development of a strong semiconductor industry on the basis of the export of consumer electronics.

The Treaty of Rome 25 March 1957, creating the European Economic Community

EC120 Spring 2016: Week 22, Topic 17, Slide 7

EC120: The World Economy in Historical Perspective2a. Waning of the Golden Age: Exhaustion of the

Technological Backlog• It was much easier to emulate and extend existing

technologies than to invent new ones. Hence slowing growth was almost inevitable.

• By the 1960s there was a widespread slowdown of productivity growth, with attendant pressure on profitability (see

Marglin & Schor (1990), Figs. 2.1, 2.2, and 2.4).

• Real input costs began rising in the 1960s.• Tighter labour markets, made worse in Europe by the fading of

surplus labour in the agricultural sector, combined with reduced immigration, served to increase real wages, putting pressure on profitability and weakening incentives to invest. See Eichengreen (2007), Fig. 7.3.

• Intensified competition, especially in international trade.• Policy implications: could technological progress have been

accelerated? Could growth have been sustained by other (possibly inflationary) means?

EC120 Spring 2016: Week 22, Topic 17, Slide 8

EC120: The World Economy in Historical Perspective2b. Waning of the Golden Age: The Elimination of Extreme

Disequilibrium• Much war damage was indeed quickly repaired, especially

infrastructure and industrial facilities, resulting in a one-off spurt in output.

• As workers moved to (often back to) renovated urban areas, the surplus labour remaining in the agricultural sector grew old and faded away.– Moreover, as recovery proceeded, demand grew particularly

rapidly for skilled labour, whereas much rural and immigrant labour was unskilled.

– Upward pressure on wages and greater competition reduced profitability, making capital formation both less attractive and harder to finance.

West Berlin, c. 1965, some 20 years after the end of the Second World War

EC120 Spring 2016: Week 22, Topic 17, Slide 9

EC120: The World Economy in Historical Perspective2c. Waning of the Golden Age: Disillusionment with

Systematic High-Demand Pressure

• By the 1960s, as productivity gains waned, high levels of demand came to produce more inflation and less real growth.

• Accelerating inflation. See Barsky & Kilian (2003), Figs. 6 & 9.• Distributional conflicts increased, especially in Europe, over the

incidence of taxation and the direction of government spending as growth slowed.

• Widespread social discontent was manifested in strikes and political confrontation.

• Policy implications: have the costs of inflation been exaggerated?

R Boulevard St. Michel Paris, May 1968Laying the groundwork for devaluation (August, 1969)

EC 120: The World Economy in Historical Perspective2d. Waning of the Golden Age: Decline and Collapse of the

Bretton Woods System

• Increased inflation as the global money supply increased, especially in the 1960s. – Review in Extras for Week 22 Bordo (1993), Figs. 1.10 (Monetary gold and dollar

holdings) and 1.15 (International reserves). • The increasing threat of exchange rate volatility made trade riskier.

Deutsche Bundesbank Hauptverwaltung, Frankfurt

EC120 Spring 2016: Week 22, Topic 17, Slide 10

EC120 Spring 2016: Week 22, Topic 17, Slide 11

EC120: The World Economy in Historical Perspective

3a. The European Response to the End of the “Golden Age”: The First Step on the Long Road to the Euro – the “Snake”

• The end of Bretton Woods marked the end of the attempt to recreate a global system of fixed exchange rates, but not the end of attempts to peg exchange rates among close trading partners in Europe.

• The “Snake” a first, ultimately unsuccessful, attempt to create monetary stability in Europe in the context of the abandonment of fixed exchange rates globally. (See Eichengreen (2008), Table 5.1)

Pierre Werner, Prime Minister of Luxembourg, whose report on European monetary union was delivered in October, 1970

EC120: The World Economy in Historical Perspective

3b. Europe’s Second Attempt to Cope with Exchange Rate Instability: the European Monetary System (EMS).

• The experience with the “Snake” suggested that more systematic co-operation was needed.

• Thus the European Monetary System (EMS) was created to provide more extensive mutual support among European Community central banks and joint management of exchange rate realignments. Before the removal of intra-European exchange controls in 1987, which fundamentally altered the dynamics of exchange rate adjustments in the System, the EMS went through two phases: (1) 1979-1983; and (2) 1984-1987.

Valéry Giscard d’Estaing (left)

with Helmut Schmidt, c. 1979

EC120 Spring 2016: Week 22, Topic 17, Slide 12

EC120: The World Economy in Historical PerspectiveSumming Up: Interpretation and Assessment

• The “Golden Age” of economic growth was a global phenomenon, but, according to Maddison’s data, was especially manifest in Western Europe and Japan.

• The current historical consensus is that a unique conjunction of transient factors enabled most economies to grow at unprecedented rates for an extended period of time.

• As the Bretton Woods fixed exchange-rate system began to crumble in the 1960s, Western European governments sought to establish alternatives within their own control, a long-term project which led eventually, after many false turns, to the euro.

EC120 Spring 2016: Week 22, Topic 17, Slide 13