The UK economy in the 1970s

The 1970s marked the end of the long period of economic expansion that followed the second world war, with ‘stagflation’ (economic stagnation and high inflation) common across advanced economies, including the UK.^[1] This briefing provides an overview of the events leading up to the stagflationary crisis in the UK, how the government dealt with the fallout and what it all meant for living standards.

1. Unemployment and the ‘Barber boom’

As highlighted in the previous briefing of this series,^[2] the profitability of British industry declined over the course of the 1960s, before recovering slightly towards the end of the decade in the wake of the 1967 devaluation of the pound. In the early 1970s this recovery continued alongside an increase in private investment. In 1967 the rate of return on capital was 20.3% and private investment as a share of GDP was 10.1%, whereas by 1972 the former had increased to 28.8% and the latter to 14.6%.^[3]

As profitability and private investment rose, GDP growth steadily increased, from 2.7% in 1970 to 4.4% in 1972. However, the unemployment rate also steadily increased over the same period, from 3.8% to 4.3%. Although an unemployment rate of 4.3% would come to be seen as relatively low in the decades that followed, it was much higher than the 2.4% average for the previous two decades. Furthermore, in 1971, the absolute number of unemployed rose to over 1 million for the first time since 1939.^[4]

Edward Heath’s Conservative government, elected in 1970, had initially been trying to reduce government intervention in the economy. However, in the wake of rising unemployment it changed course, implementing a significant fiscal stimulus.^[5] The public finances were in surplus at the start of the decade, but they quickly swung into deficit as taxes were reduced with the aim of raising personal consumption.^[6] Total tax revenues as a share of GDP fell from 40.0% of GDP in 1970/71 to 35.9% in 1972/73.^[7] This fiscal loosening followed a separate move by the Bank of England, in late 1971, to remove quantitative controls on bank lending, something which led to significant growth in the money supply.^[8]

In the short term this stimulus boosted GDP growth and this brief period came to be known as the ‘Barber boom’, in reference to the then chancellor of the exchequer, Anthony Barber.^[9] As illustrated in figure 1 below, Q-on-Q4 GDP growth (quarterly GDP relative to the same quarter the previous year) rose sharply to 9.6% in the first quarter of 1973, a post-war high. However, the rapid expansion quickly ran into a series of constraints, and in 1974 and 1975, for the first time in decades, GDP growth turned negative.

Figure 1. Q-on-Q4 GDP growth (%), 1970 Q1 to 1979 Q4

2. Industrial tensions, commodity price shocks and stagflation

Industrial tensions, which had been rising towards the end of the 1960s, increased during the early 1970s. The number of working days lost through disputes and strikes had been 2.8mn in 1967, before rising to 11.0mn in 1970 and then 23.9mn by 1972.^[10] As disputes proliferated and unemployment increased, the share of national income going to labour fell, from 67.6% in the first quarter of 1970 to 63.1% in the first quarter of 1973.^[11]

The Heath government attempted to reform the system of industrial relations with the 1971 Industrial Relations Act, which (amongst other things) removed trade union immunities and sought to resolve disputes with a newly established ‘National Industrial Relations Court’.^[12] However, the act and its provisions were largely boycotted by trade unions. Therefore, industrial tensions had not been resolved by the time the ‘Barber boom’ kicked in. Wage growth—which was relatively stable in the 1970–72 period—subsequently accelerated as unemployment started to fall again and the bargaining power of workers increased. By the first quarter of 1974 the labour share of income had risen back up to 67.8%, before rising further to 71.9% during the third quarter of the following year.

In addition to coming under pressure from labour costs, profit margins were strained further as a result of a series of commodity price shocks. Between 1972 and 1974 oil prices rose four-fold, while the cost of industrial materials and metals almost doubled.^[13]

The consequences of this cost pressure can be seen in figure 2 below. The rate of return on capital, which had risen to over 35% at the height of the boom in 1973, crashed to around 10% in 1975. This was lower than the interest rate set by the Bank of England, reducing the incentives for productive investment.

Figure 2. Profitability and interest rates, 1970–79

Therefore, although macroeconomic stimulus had led to increased production in the short run, businesses soon faced a significant surge in their costs and pressure on their profit margins. The increase in investment and reduction in unemployment that the boom helped achieve quickly unwound, and firms laid off workers and increased prices in an attempt to restore profit margins. The macroeconomic consequences of this can be seen in table 1 below. Unemployment falls and growth rises in 1973, but in 1974 and 1975 growth turns negative as inflation soars, then (with a slight lag) unemployment returns to an even higher rate than it was at before the boom. This combination of economic stagnation (slow or negative growth and rising unemployment) and high inflation came to be known as ‘stagflation’.

Table 1. Selected macroeconomic indicators, 1970–79

(GDP data from ONS data series ‘IHYP’, 15 February 2024; inflation data from ONS data series ‘CZBH’, 14 February 2024; unemployment data from Bank of England, ‘Research datasets: A millennium of macroeconomic data’, 2016; and private investment data calculated from ONS data series ‘BKTL‘, 15 February 2024, ONS data series ‘NPQS’, 15 February 2024, and ONS data series ‘ANSQ’, 21 February 2024)

3. Fiscal situation and the IMF bailout

The Labour Party returned to government in February 1974, just as the economy started to contract and inflation accelerated. It increased government spending sharply, in an attempt to mitigate the impact of the stagflation crisis on both industry and households. In 1973/74, government spending as a share of GDP was 40.3%, before rising to 44.7% in 1974/75 and 46.5% in 1975/76.^[14] Taxation did increase from the level it had been reduced to in 1972/73, but not enough to compensate for this. The public sector deficit therefore widened to 5.7% of GDP in 1974/75 and then to 6.3% of GDP in 1975/76, the highest it had been since 1946/47. This increase in borrowing, combined with contracting GDP, saw the government’s debt to GDP ratio increase between 1973/74 and 1975/76 (table 2), breaking a quarter-century long spell of annual reductions.

Table 2. Government borrowing and debt (% GDP), 1970–80

(Office for Budget Responsibility, ‘Public finances databank’, 6 March 2024)

As borrowing increased and the prospects for the UK economy deteriorated, the pound faced renewed pressure on the foreign exchange markets. The pound had begun floating freely in 1972, as the Bretton Woods system of fixed exchange rates (which had been in place since the war) broke down. After it floated, the pound had broadly remained at its previous exchange rate of $2.40 per pound up to early 1975, but then started to decline. By the start of 1976 the rate had decreased to $2.00 per pound, falling to around $1.65 by the autumn.^[15] In January 1977, James Callaghan’s Labour government borrowed dollars from the IMF to support the pound. However, this loan was conditional on fiscal restraint and the reduction of public sector borrowing.^[16]

Following the IMF loan the pound slowly recovered and macroeconomic stability began to return. Public sector borrowing decreased, with the deficit back down to 3.9% of GDP by 1977/78. Profitability recovered as commodity prices stabilised and wage growth was held below inflation in 1976 and 1977, as the Trades Union Congress cooperated with the government to implement its incomes policy.^[17] By 1978, inflation had fallen to 8.3%, GDP growth was back up to 4.2%, and unemployment had stabilised at around 5.5%.

As growth returned and borrowing fell, the government’s debt to GDP ratio resumed its long-term decline, falling to 39.1% by the end of the decade.

4. Living standards growth amidst deindustrialisation

Despite the macroeconomic turbulence of the 1970s, annual GDP growth still averaged 2.7% and living standards rose significantly. Growth in real household disposable income (RHDI) per head was either low or negative for much of the decade, but grew rapidly in 1972–73 and 1978–79, leaving RHDI per head almost 30% higher in 1979 than it was in 1970.^[18] This was a greater increase than was experienced in either the decade before (the 1960s) or the decade that followed (the 1980s).

This enhancement in living standards was underpinned by strong wage settlements, with 1976 and 1977 the only years in the decade where wage growth did not outstrip inflation.^[19] However, increasing labour costs contributed to the acceleration of sectoral shifts which began in the 1960s. Private sectors where labour compensation made up a high share of total costs, such as manufacturing (78%), transport, storage and communication (70%), and distribution, hotels and catering (66%), declined. Whereas private sectors where labour compensation made up a low share of total costs, such as financial services, business services, rent and real estate (33%) or oil and natural gas extraction (6%), expanded.^[20]

In 1970, manufacturing was by far the largest sector of the economy, contributing 30.1% of total output, whereas financial services, business services, rent and real estate, the next largest sector grouping, contributed 17.8%.^[21] However, by 1979, these positions had almost reversed. Manufacturing fell by 6.7 percentage points (its largest fall in any decade before or since) to 23.4%, whereas financial services, business services, rent and real estate rose to 22.1%. It would be in the 1980s that the latter would officially overtake the former to become the largest sector grouping; however, the roots of this reversal are evidently much deeper.

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Cover image by Jerzy Strzelecki on Wikimedia Commons. Image shows Piccadilly Circus, London, November 1975.