THE ECONOMIC JOURNAL

SEPTEMBER 1968

WHY HAS BRITAIN HAD FULL EMPLOYMENT

SINCE THE WAR?i
IF one were asked to pick out the most important single respect in which
the experience of the British economy in the post-war period has differed
from that of earlier times, most people would agree in saying " full employ-
ment of labour." There are other notable distinguishing features of the
post-war period—chronically rising prices; an abnormally high ratio of
domestic investment to income by historical standards; rapid growth of
income per head—but full employment is the most striking and most
pervasive in its effects.
I am not here concerned with the question whether employment has
been full in some absolute sense, or over-full, or rather less than full. The
question I shall discuss is why employment has been so much more full, or
more nearly full, than it was in the past.
That it has been is not open to doubt, even when all due allowance is
made for imperfections in the statistics. The unemployment percentage has
averaged about 1-8% in the post-war period; in the inter-war period, if
the figures are adjusted to a comparable basis, it averaged about 10^%;
before 1914 the statistics show an average of about 4f %—not nearly so high
as in the inter-war period, but still substantially above what we have had
since the Second World War.^
When the question is asked, why have we had full employment since the
war? most people tend to reply, without thinking very much, that it is
because we have had a full-employment policy—we have had the Keynesian
• A revised version of a University of London Special Lecture delivered at University College
London on February 1, 1968. I am much indebted to Moses Abramovitz for helpful criticisms of
the original text; to G. H. Feinstein and J. C. Odling-Smee, my collaborators on a forthcoming study
on Growth in the British Economy, sponsored by the Social Science Research Gouncil (New York),
for access to unpublished material; and to Mrs. P. Yudkin for research assistance.
^ The official unemployment percentages for the inter-war period need to be adjusted downwards
to make them comparable with post-war figures on account of differences in coverage. The reli-
ability and comparability of the pre-1914 figures are doubtful, as is well known, but when account
is taken of offsetting biases it is unclear whether they need to be adjusted upwards or downwards.
The evidence is surveyed by W. Galenson and A. Zellner, " International Gomparison of Unemploy-
ment Rates," Appendix J, in Universities—^National Bureau, The Behaviour and Measurement of
Unemptoyment (1957).
N o . 311—VOL. LXXVIII. NN
556 THE ECONOMIC JOURNAL [SEPT.

revolution. Now supposing this were the right answer, it would be a

remarkable thing. It would mean that the most important single feature
of the post-war British economy has been due to an advance in economic
theory. It would be a most striking vindication of Keynes' celebrated
dictum about the ultimate primacy of abstract thought in the world of
affairs.
However, this interpretation of events, at least in its simple form, is
open to serious objections.
The figures just quoted suggest that the inter-war unemployment problem
was of a different order from the pre-1914 unemployment problem. I shall
therefore deal separately with the comparison of the post-war period with
the inter-war period and the comparison of the post-war period with the
longer sweep of British economic development. I shall put forward two
propositions. The first is that as compared with the inter-war period there
has certainly been an increase in effective demand, in the Keynesian sense,
relative to supply; but that it is non-proven that this has been due to govern-
ment policy, at least in any simple sense. The second is that the decline
in unemployment as compared with before 1914 is to a large extent not a
Keynesian phenomenon at all.
First, then, the comparison with the inter-war period. Throughout the
whole ofthe inter-war period after 1920 there was clearly Keynesian demand
deficiency. Certain bottlenecks were encountered in the late 1930s, chiefly
in the industries affected by rearmament, but not to such an extent as to
invalidate the proposition that a substantial increase in output could have
been brought about by a general increase in demand.
Why did this deficiency of demand disappear in the post-war period ?
In particular, was it due to government action ? The question at issue here
is not whether the Government was or was not pledged in the post-war period
to the policy of maintaining full employment or something near to it—of
course it was. The question is whether the high level of demand that
actually occurred was due to government action or whether it was due to
other forces, as a result of which government action was not needed.
The hypothesis that the change was due to fiscal policy is open to a simple
basic objection. This is that throughout the post-war period the Govern-
ment, so far from injecting demand into the system, has persistently had a
large current account surplus. This surplus has varied in amount; but
government saving has averaged about 3 % of the national income. This is
much larger than at any previous time in the twentieth century. Fiscal
policy as such therefore appears on the face of it to have been deflationary
in the post-war period, quite strongly deflationary in fact, rather than the
reverse.
This is not to deny that in various post-war years fiscal policy has been
adjusted with the object of increasing demand above its existing level. But
in the years when this was done it was a matter of reducing the size of the
1968] WHY HAS BRITAIN HAD FULL EMPLOYMENT SINCE THE WAR? 557

surplus rather than turning it into a deficit. The overall effect has therefore
been one of restraint.
There are a couple of ways in which the argument can be refined in an
attempt to avoid the prima facie conclusion that fiscal policy was in net
more deflationary than in earlier periods.
In the first place, compared with before the war, there has been an
increase in the levels of both government expenditure and revenue relative
to national income, as well as a rise in revenue relative to expenditure.
Therefore there may have been some inflationary effect of the type analysed
in the theory of the balanced budget multiplier: that is to say, the extra
taxation may have been partly at the expense of private saving. It is
difficult to estimate the magnitude of this effect, because our understanding
of what determines private saving is very inadequate. As an example one
can assume that private saving varies proportionately with private disposable
income, other things equal. One can estimate the net effect of fiscal policy,
including both the effect of the balanced budget multiplier and that of the
budget surplus, by asking what would have been the effect on the level of
demand in 1937 (the last pre-war cyclical peak) if government expenditure,
direct taxes and indirect taxes in 1937 had all borne the same ratio to national
income as they did in 1964 (the last post-war cyclical peak), on the assump-
tion that exports, investment and the propensities to save and to import
had remained unchanged. It comes out from this calculation that income
in 1937 would in that case have been 1 % lower than it actually was. That
is to say, the balanced-budget multiplier effect is less than sufficient to out-
weigh the budget surplus effect. Alternative assumptions are possible, some
pushing the result one way, some the other; but it does not seem possible,
even on the most favourable assumptions, to get more than a mild overall
net stimulus—certainly not enough to explain the magnitude of the increase
in activity that actually occurred. So while the balanced budget multiplier
point has to be acknowledged as valid in principle, it does not appear to
alter the argument qualitatively. More exact research on this must await
a better understanding of the saving function.
The second possible refinement ofthe argument is a point that has come
up in recent discussions of fiscal policy in the United States.^ Granted that
there was a budget deficit in 1937 and a budget surplus in all post-war years,
this is to some extent the result of the differences in the level of activity; for
a high level of activity raises tax revenues. It could conceivably be argued
that the level of government expenditure and tax rates prevailing in 1937
would at a full-employment level of activity have produced an even larger
surplus than there was in the post-war period, and that fiscal changes were
therefore in net inflationary. This is scarcely tenable statistically. But
supposing it were true—or that it were true when taken in conjunction
* A very explicit earlier discussion is in N. Kaldor's Appendix G to W. H. Beveridge, Full
Employment in a Free Society (1944).
558 THE ECONOMIC JOURNAL [SEPT.

vfith the effects of the balanced budget multiplier—it could not be taken
as the main explanation of the increase in activity without assuming an
unstable structure of demand. If a lowering of the government saving
schedule, which is what is in effect implied, leads to a new equilibrium in
which government saving is actually higher as a proportion of national
income, it follows that the rise in national income brought about by the
change in government policy must have raised investment by more than it
raised private saving. This is not impossible. But it means that fiscal
policy is of a pump priming character, setting in train a potentially unstable
upward movement, rather than a direct and continuing support to demand.
It is therefore rather different from the straightforward notion of the Govern-
ment maintaining full employment through fiscal policy. The question of
pump priming will be reverted to presently.
It seems, therefore, that these refinements in the argument about fiscal
policy, though valid in themselves, are not sufficient to upset the conclusion
drawn from the simple fact of the observed budget surplus, that fiscal policy
has not in any direct way been the explanation of the increase in activity
compared with before the war.
In order to analyse properly what the reasons have been, it would be
necessary to have a full-scale econometric model of the various elements of
demand, a model that could embrace both the inter-war period and the post-
war period. We do not have such a model of the post-war period alone,
far less one which covers the inter-war period as well. But inspection of the
components of demand in elementary Keynesian terms may help to identify
the elements in the situation.
If we include government expenditure as a form of consumption we can
write the familiar identity
Y = I+C + X-M
Writing as usual s for the ratio of saving (including government saving) to
income and m for the ratio of imports to income, we have

Y
s -{- m
For completeness, account has also to be taken of income from abroad,
which though not part of G.D.P. is a source of disposable income and there-
fore affects the level of consumption demand. Taking 7 to mean G.D.P.,
but measuring m and s as the ratios of imports and savings to G.N.P., we
then have (writing A for income from abroad)

s+m
We are interested for the present purpose not in 7 but in the ratio of
1968] WHY HAS BRITAIN HAD FULL EMPLOYMENT SINCE THE WAR? 559

Y to potential full-employment income, F. Dividing through by F, we

have

The relative importance of the proximate causes of the changes in

compared with pre-war can then be ascertained by inspecting the move-
ments of these five items. In this way we consider changes in consumption
and imports in terms of propensities, and we consider changes in the other
three items, which are less directly determined by current income, in terms
of their relation to full-employment income.

Components of Expenditure at Inter-war and Post-war Cyclical Peaks in the

United Kingdom {Percentages)

(2) (5) (6) (7) (8)

A{\ -s - m) I + X + A{\ - s -m)
f f f
1929 91 88 21-3 3-0 33-1 11-7 24-6 36-4
1937 91 10-3 14-1 3-6 27-9 11-6 18-7 30-4
1955 100 15-6 21-8 0-6 38-0 15-6 22-5 38-0
1960 99 17-2 20 0 06 37-8 17-7 20-6 38-2
1964 99 186 18-5 08 380 18-9 19-5 38-4

For definitions, see text and footnote below. Components do not necessarily add to totals
because of rounding.
Sources: For 1955, I960, 1964, National Imome and Expenditure 1966; for 1929, 1937, London
and Cambridge Economic Service, The British Economy, Key Statistics 1900-66, Table A, adjusted
to exclude property income from exports and imports of goods and services.

Columns (2), (3), (4), (6), and (7) in the table show the values of these
ratios in two inter-war cyclical peak years and in three post-war cyclical
peak years.^ In the post-war years all five of the ratios are higher than in
1937, except that relating to income from abroad. The rise in investment
and exports relatively to full-employment G.D.P. serve to raise the level of
activity; the increase in the saving and import propensities and the fall in
income from abroad tend in the opposite direction. The positive changes
are larger than the negative ones, so F/F duly rises.
The investment item is the one which shows the biggest change compared
with inter-war. This is true, even when the post-war period is compared
' All figures relate to values at current market prices. The figures given for YIV are rough
approximations; the exact values chosen do not affect the argument in the text. X is defined as
exports of goods and services. / is measured as gross domestic capital formation plus half stock-
building, and imports are measured as imports of goods and services minus half stockbuilding.
Stockbuilding is allotted in this way because it is estimated that about half of stockbuilding in post-
war years has consisted of stockbuilding of imports (cf. " Short-Term Economic Forecasting in the
United Kingdom," Economic Trends, August 1964, p. 9). The simpler procedure of including all
stockbuilding in investment would give exaggerated figures for m and I, because of the well-known
tendency of stockbuilding and imports to be abnormally high in cyclical peak years.
560 THE ECONOMIC JOURNAL [SEPT.

with 1937, when investment was high by inter-war standards. It is even

more marked if the post-war period is compared with 1929.
As compared with 1929, changes on the overseas side have not contributed
significantly to the high level of activity in the post-war period. This holds
whether we look merely at the effect of the changes in the export item or at
the net effect of the changes in all three of the balance-of-payments items in
the table. As compared with 1937, however, changes on the foreign-trade
side have made a significant contribution, as might be expected. One
would expect the recovery of exports from their depressed level in the 1930s
to have been of some importance in raising the level of activity. A signifi-
cant positive net contribution from the foreign-trade side to the change in
the level of activity, compared with 1937, remains even when account is
taken of the deflationary effects of the fall in income from abroad and the
rise in the propensity to import (which, it will be remembered, is at current
prices and is defined to include services as well as goods). But this contribu-
tion is smaller than the contribution arising from the investment-saving side.
It is thus clear that, comparing the post-war period with the inter-war
period as a whole, the explanation of the rise in investment must lie at the
heart ofthe explanation ofthe rise in the level of activity.
What have been the reasons for the high level of investment? This
subject is a relatively unresearched one. Economists have been so pre-
occupied with explaining why investment in this country has been low
compared with other countries that they have devoted little attention to
considering why investment has been so much higher relatively to national
income than it has ever been before in this country.
It is legitimate here to focus attention on private investment. Public
investment has certainly played its part. But investment in the public
sector has been on average a smaller proportion of total investment in the
post-war period than it was in the inter-war period, if we define the public
sector, as we obviously must do, to correct for the effects of nationalisation.
To put it more exactly, investment in those industries that fall within the
public sector now has been a smaller proportion of total investment than
investment in those industries was before the war. (This statement relates
to investment excluding dwellings, which cannot be assigned wholly to
either the public or the private sector, and which in any case has been a
much smaller proportion of total investment since the war than it was in the
1930s.) We may therefore reasonably concentrate attention on investment in
the private sector, while not forgetting that public investment has also risen.
Two broad types of view can be put forward to explain the high level
of private investment in the post-war period. The first is that the marginal
efficiency of investment schedule—the investment demand function—has
been abnormally high, because of such reasons as the pressure of demand
on capacity and the scope for innovatory investment. The second is that
the investment supply function—the willingness to do investment at any
1968] WHY HAS BRITAIN HAD FULL EMPLOYMENT SINCE THE WAR? 561

given expected rate of return—has been subject to some upward shift com-
pared with before the war, because of a change in entrepreneurial attitudes,
itself possibly due to government policy.
On the first hypothesis the high post-war investment has essentially the
nature of a gigantic cyclical boom. By this I do not mean that it will
necessarily lead to a slump, but that the forces sustaining it have not been
different in essence from those of traditional cyclical booms. The economy
was given a once-for-all hoist upwards during the war. When the war
ended income was therefore high. Moreover, the capital stock was low as
a result of the low level of investment during the war itself and also during
the inter-war period. Hence there was great scope for investment. The
feed-back from this investment combined with the favourable effects of the
foreign-trade situation combined to keep income up and keep up the demand
for more investment.
This view of what happened is related to the pump-priming idea men-
tioned earlier. It says that government finance did play a role, in that
during the Second World War itself it brought about a once-for-all increase
in the level of activity, and that once this had been done cumulative forces
were set in train that kept investment high, so that the Government could
then assume a passive or even restraining role without activity falling
seriously below the full-employment level.
The following question now naturally arises. Granted that the forces
encouraging investment in the post-war period did to some extent resemble
those of past cyclical booms, why did the resulting investment boom last
so much longer than cyclical investment booms have normally lasted?
Could this have happened if there had not been some change as well in
entrepreneurial attitudes towards investment?
It is not possible to give a simple or definitive answer to this. But it is
arguable that the stage was set for an investment boom of unusual propor-
tions, because of the amount of investment opportunities that had accumu-
lated as a result of historical circumstances. There had not been a single
real boom in domestic investment in the whole of the twentieth century up
to the end of the Second World War. Investment was low during the Second
World War; it was low in the inter-war period, apart from house-building,
because of the slump; it was low during the First World War; and even the
period immediately before the First World War constituted a downward
phase of one of the long swings in home investment which at that time
characterised the British economy. In the forty years preceding 1948 the
domestic stock of fixed capital is estimated to have risen at a rate of scarcely
more than 1 % per annum.^ In this way very substantial arrears of invest-
ment opportunities were to be expected.
An interesting question concerns the role of technical progress in all this.
It is probable that technical progress has been more rapid in the post-waj
1 Key Statistics, Table I.
562 THE ECONOMIC JOURNAL [SEPT.

period than it used to be; this appears to be a world-wide phenomenon.

This has helped maintain investment opportunities and so keep up the level
of demand. This acceleration of technical progress can be regarded on one
view as a consequence of the boom. On this reckoning it is part of the feed-
back mechanism, part of the cumulative process. Alternatively, it can be
regarded as independent in its origins, in which case it ranks as a separate
factor making for high investment and activity. To what extent it is due to
government policy—British Government policy—is debatable. In so far as
it is (probably only to a minor degree), it is due mainly to government policy
in the technological and educational sphere rather than to the activities of
the branches of government concerned with the management of demand.
Arguing along these lines, one cannot rule out of court the hypothesis
that the post-war investment boom was the result of a favourable conjunction
of objective circumstances affecting the marginal efficiency of investment
rather than the result of a shift in the investment supply function.
Let us now consider the hypothesis that there was an upward shift in the
investment supply function. This provides more scope for attributing the
result directly to government. The possibilities here include, first, that
monetary policy has operated so as to make finance relatively cheaper;
secondly, that tax policy has encouraged investment; thirdly, that the belief
on the part of entrepreneurs that the Government would not permit a slump
has improved confidence—a safety net theory of the role of government,
implying that although the acrobat has not actually fallen, his knowledge
of the presence of the safety net has given him confidence and improved his
performance.
The general way in which such factors would operate if they did would
be to make businesses willing to do investment with the prospect of a lower
pre-tax rate of profit than they would otherwise have required or than they
did require before the war. Has this been the case? The realised rate of
profit on all capital appears to have been lower than it was before the war,
at least if measured net of depreciation.^ This movement of the profit rate
may be taken as a support ofthe hypothesis that the investment supply func-
tion has shifted, for why otherwise would businesses have been willing to do
so much investment in face of the relatively low rate of profit ? But the
profit rate on all capital is not necessarily a good guide to the expected profit
rate required on new investment. This is the concept that we should in
principle like to be able to identify. The impression one has from qualita-
tive indicators of business attitudes is that it has not been particularly low
in the post-war period.^
* C. H. Feinstein, " Evolution ofthe Distribution ofthe National Income ofthe United King-
dom since 1860," paper read to International Economic Association Conference on the Distribu-
tion of National Income, Palermo, September 1964.
" Sir Robert Shone, " Planning for Economic Growth in a Mixed Economy," ECONOMIC JotmNAL,
March 1965, p. 16, suggests that the rate of return on new investment usually aimed at, after depre-
ciation but before tax, was around 20% in the early post-war years and around 15% more recently.
1968] WHY HAS BRITAIN HAD FULL EMPLOYMENT SINCE THE WAR? 563

This same conclusion, that required profit rates have not been particularly
low, can be derived from looking at earnings yields on ordinary shares, which
on certain assumptions can be taken to measure the real rate of return on
investment which has to be achieved if the investment is not to prejudice the
interests of a company's existing shareholders. On the average, earnings
yields have been higher in the post-war period than formerly, not lower. ^
They do not therefore suggest that the target rate of return on investment
has iaeen particularly low.
At this point it is necessary for a moment to give up the simplification
adopted so far of treating the post-war period as a whole. It is fairly clear
that witkin the post-war period there have been changes tending to shift the
investment supply function upwards. Otherwise we can hardly explain
why the ratio of private investment to G.N.P. has not merely been high by
historical standards but also has been rising quite steeply within the post-
war period, at least until fairly recently. This is the opposite of what might
have been expected in a period starting with once-for-all arrears of invest-
ment opportunities. It has happened notwithstanding a downward trend
of pre-tax profit rates (a trend which is what might have been expected to
result from gradual catching up with arrears). The most important cause
tending to raise the investment supply function within the post-war period
has probably been the increasingly generous tax treatment of investment,
culminating in the payment of actual investment grants.^ This has reduced
the level of the real rate of return that is needed in order to yield a given
private post-tax rate of return. This must have served to prolong the invest-
ment boom. What is not so clear is whether taking the average of the post-
war period as a whole, factors of this kind have lowered the required rate
of return on investment compared with that prevailing before the war.
It is in this sense that we cannot rule out the first of the two broad hypo-
theses about investment, that its high post-war level has not been due to any
upward shift in the investment supply function.
To summarise the argument so far. The increase in the level of demand
compared with before the war has not been due to deficit financing. It has
been partly due to world developments, as reflected in our export markets.
But the main cause has been the unprecedently high level of investment. It
is possible that there has been some upward shift in the investment supply
function due in one way or another to government policy, as compared with
before the war. But it is unclear just how big this has been, if it has occurred
at all. The alternative hypothesis is also perfectly tenable, that the main
cause of the high investment has not been an upward shift in the investment
supply function but a conjunction of circumstances similar to those that
have caused past booms of a cyclical character.
• Key Statistics, Table M .
' This is convincingly argued b y j . R. Sargent, " Recent Growth Experience in "me Economy
of the United Kingdom," ECONOMIC JOURNAL, March 1968, pp. 19-42, where the profit rate figures
are quoted.
564 THE ECONOMIC JOURNAL [SEPT.

Before drawing any general conclusions, let me go on to the second topic

of this lecture, the consideration of trends over a longer period going back
to before 1914. The points involved here are rather different in kind.
Before 1914 unemployment was on average lower than in the inter-war
period, but it was still substantially higher than we have become accustomed
to since the Second World War. Unemployment was most severe in cyclical
depressions, but it was not confined to them. " Distress from want of
employment, though periodically aggravated by depressions of trade, is a
constant feature of industry and commerce as at present administered," said
the Minority Report of the Poor Law Commission in 1909, summarising the
evidence they had received.^ Does this mean that as compared with that
time there has been an increase in effective demand relative to supply in the
Keynesian sense ?
Defective demand in the Keynesian sense is a situation in which an
increase in demand would lead to an increase in final output. It is not
.sufficient that there should be an excess supply of labour; there must be
an excess supply of all relevant factors if output is to be capable of responding
to a change in demand. At most cyclical peaks before 1914 it does not seem
that this was so. In general, the evidence from such sources as The Econo-
mist's Annual Commercial Histories is that capital capacity at pre-1914
cyclical peaks was pretty fully stretched in the major industries. It follows
that there cannot have been much demand deficiency for the final product.
Naturally the situation was different in depressions, and then there norm-
ally was excess capacity. However, the amplitude of cyclical fluctuations
in output relative to trend appears to have been only moderately greater
before 1914 than it has been since the Second World War—a fact which
is perhaps not generally appreciated. Since the Second World War the
average shortfall of real G.D.P. in cyclical trough years below its peak-to-
peak trend has been nearly 4%; between 1870 and 1914 it was 5%.^ So if
there was not demand deficiency at cyclical peaks before 1914, it cannot
have been all that severe relative to our post-war experience over the average
of the whole cycle.
This is the first reason for supposing that the unemployment of the pre-
1914 period cannot be viewed in Keynesian terms as the result ofa deficiency
of demand for final product.
The second reason is the evidence we have about the nature of unemploy-
ment before 1914. When one reads the accounts of unemployment in those
times one is irresistibly reminded of the characteristics of urban unemploy-
ment in underdeveloped countries at the present time. There is the same
contrast between the more fortunate members of the working classes, who
^ The Public Organisation of the Labour Market: being Part Two of the Minority Report of the Poor
Law Commission (1909), edited by S. and B. Webb, p. 173. This conclusion was not a matter of
disagreement between the Majority and Minority Reports.
^ R. C. O. Matthews, " Post-War Business Cycles in the United Kingdom," in Is the Business
Cyrle Obsolete?, edited by M. Bronfenbrenner (forthcoming).
1968] WHY HAS BRITAIN HAD FULL EMPLOYMENT SINCE THE WAR? 565

have more or less permanent jobs, and the body of unskilled casual labourers,
who rarely succeeded in getting a full week's work even in periods of general
prosperity. The parallel to the situation in underdeveloped countries is
further illustrated by the regional incidence of unemployment before 1914.
Regional differences in unemployment were scarcely less marked then than
they were in the inter-war period and have been since. But the geographical
pattern was almost exactly the reverse. Unemployment was low in the
industrial north, and about twice the national average in London, where
industrial development of a modern kind had as yet made relatively little
impact.^ There were similar regional disparities to the disadvantage of the
south in wage levels.^ The only exception to this geographical transformation
in the relative amount of unemployment between regions across the First
World War is Ireland, the one major part of the United Kingdom that re-
tains characteristics of an underdeveloped country to the present time. In
Ireland unemployment was above the United Kingdom average before
1914, just as it has been ever since.
What is being suggested can be put into schematic theoretical terms as
follows. Unemployment of a factor can be caused either by defective de-
mand for the final product or, if the scope for varying factor proportions is
limited, by defective supply of a co-operating factor. The characteristic of
an underdeveloped country is that the supply of the co-operating factor capi-
tal is inadequate for jobs to be available for all the labour. There is there-
fore the phenomenon of a dual economy, with some workers engaged in
relatively capital-intensive industries such as manufacturing or railways, or
else in privileged occupations such as government service, while the rest of
the labour force remains outside the circle in low-productivity employment
or else without any employment at all. This state of affairs had not entirely
ceased to hold in Britain in 1914. The unskilled labour that jostled for
jobs at the docks, on the building sites and in many other trades was the
remnant of the chronic labour surplus associated with incomplete develop-
ment. An increase in demand for final product at cyclical peaks would not
have permitted the absorption of this labour surplus unless it had been ac-
companied by a switch in the structure of demand towards more labour-
intensive goods and services.
Now it is to be expected that unemployment of this sort should diminish
as economic development proceeds. Capital is accumulating, and, moreover,
there is also an accumulation of human capital in the form of education which
widens the range of occupations where people can be usefully employed with-
out the assistance of much physical capital. Within the nineteenth century
there was duly a reduction in this kind of unemployment in this country.

' W. H. Beveridge, Full Employment in a Free Society (1944), pp. 73-A.

« A. L. Bowley, Prices and Wages in the United Kingdom 1914-20 {192\), pp. 170-1; E. H . Hunt,
" Labour Productivity in English Agriculture, 1850-1914," Economic History Review, 1967, pp. 280-
92.
566 THE ECONOMIC JOURNAL [SEPT.

This was noted by contemporaries, for example, Marshall.^ Marshall con-

trasted the problem of industrial unemployment with the unemployment
and underemployment typical of pre-industrial societies. He quoted as an
example of the latter the conditions of artisans as he had observed them
during his celebrated stay in Palermo. " Scarcely anybody was ever thrown
out of regular employment, because scarcely anybody ever was in it." ^ He
pointed out that the development of industry in this country had progres-
sively lessened the proportion of the labour force in this situation.^
But although the underdeveloped country type of unemployment had
diminished by the end of the nineteenth century, it had not disappeared.
One reason for this was that the outflow of labour from agriculture continued.
The rural surplus labour moved to the towns, and part of it became urban
surplus labour. The urban surplus, especially in London, was in this way
continuously replenished. This partly explains why, despite the favourable
underlying tendency, there is not any downward trend in the recorded
unemployment percentage in the sixty years or so before 1914. Unemploy-
ment and underemployment were diminishing, but the unemployment was
being increasingly transferred away from agriculture, where it was not
measured, to the towns, where it was measured to a greater extent. This
has, of course, been characteristic of many countries in the process of
development.
By the First World War the absorption of the rural surplus had largely
run its course. Since then, the agricutturat labour force has continued to
decline, but the quantitative importance of the flow relatively to the total
labour force has been much less than in the nineteenth century. The
stage might therefore seem to have been prepared for a more pronounced
movement towards labour scarcity. But the long-run tendency towards
increasingly full absorption of the labour force and increasing scarcity of
labour relatively to capital as development advances was entirely overborne
and concealed in the inter-war period by Keynesian demand deflciency on
a large scale. This was due to the peculiar circumstances of the inter-war
period, in particular the structural shift to Britain's disadvantage in the
pattern of world trade. The potentially beneficial effects on the demand for
labour of an increase in the supply of the co-operating factor capital was
therefore outweighed by a deficiency of demand for all the factors of produc-
tion.

1 A. Marshall, Principles of Economics (8th edn.), pp. 687-8, and Official Papers, pp. 92-101.
" Official Papers, p. 93.
° Writing as he was in the cyclical depression of the 1880s, Marshall was cagey about making
a specific assertion that unemployment had recently declined. He spoke rather of strong forces
tending in that direction. But he does in the end commit himself to the effect that unemployment
has declined in the following characteristically oblique sentence. " All these considerations sup-
port the belief that if the average steadiness of employment throughout the country had remained
stationary, changing neither for better nor for worse, the unemployed benefit of the trade unions
would have increased faster than it has done " {Official Papers, p. 97).
1968] WHY HAS BRITAIN HAD FULL EMPLOYMENT SINCE THE WAR? 567

As a result, when overall demand deficiency was corrected after the

Second World War, the effect felt in the labour market was particularly
sharp. The trend towards increasing labour scarcity had been concealed
by the special circumstances of the inter-war period. After the war the
economy experienced for the first time a situation in which there was neither
demand deficiency ofthe inter-war type nor the characteristics of incomplete
development present still before 1914.
It may be noted here in parentheses that the model of the dual economy
with infiexible coefficients of production, combined with the notion of em-
bodied technical progress, implies that when the supply of capital catches
up with the supply of labour, so that the labour surplus is eliminated, scrap-
ping of old equipment will have to proceed more rapidly than before, so as
to prevent the capital stock from outrunning the labour supply. We have
no direct data on scrapping, but the indicators do seem to be consistent with
this idea and to suggest that the service life of capital is shorter now than it
used to be in the nineteenth century.^
One particular and important way in which the long-run increase in
labour scarcity has manifested itself is in the response of employers to cyclical
fluctuations in demand. As stated earlier, the amplitude of cyclical fluctua-
tions in output in the post-war period has not been much greater than it was
before 1914. But this is not true of fluctuations in employment. Fluctua-
tions in employment have been of far smaller amplitude than they were
before 1914. In the post-war period fluctuations in employment have been
only about one-third of the amplitude of fluctuations in output. This is a
new phenomenon. Before 1914, and also in the inter-war period, the
amplitudes ofthe two were about the same.^ But although it is in this sense
a new phenomenon, it can be regarded as a continuation of a longer-term
trend: a trend away from the situation where the employer hires labour
casually as he needs it towards a situation where an employer hires labour
on a more or less permanent basis. The unemployment problem ofthe late
nineteenth century manifested itself very largely in the excess supply of
casual labour—the surplus labour crowded into those occupations where there
was some chance of work some times. However, the proportion of industries
in which regular employment was offered progressively increased. This
was recognised as an important phenomenon at the time. It was quoted by
Marshall as a result of industrial development and as one of the chief causes
making for more regular employment. " In many directions there is a
steady increase in the proportion of employees who are practically hired by
the year." ^ The tendency exhibited in the post-war period for employers
* Thus the rates of depreciation on plant and equipment allowed by the Inland Revenue im-
plied a longer life before the First World War than they did in the inter-war period and have done
subsequently. C. H . Feinstein, Domestic Capital Formation in the United Kingdom 1920-1938 (1965),
p. 22.
" Matthews, " Post-War Business Cycles in the United Kingdom," cit.
» Principles, p. 688.
568 THE ECONOMIC JOURNAL [SEPT.

to keep labour on through cyclical recessions can be regarded as a further

extension of the same process. From having been hired by the hour, labour
passed on to being hired by the week and then on to a situation in which it
was hired more or less permanently. When the labour supply is very
abundant, employers lack inducement to move away from a system of casual
hiring. As labour becomes more scarce relative to capital, the costs of hir-
ing and firing increase, and the employment contract becomes de facto a
longer one. In this way the non-Keynesian force—the trend increase in the
supply of the co-operating factor capital—has lessened the sensitivity of
employment of labour to Keynesian fluctuations in expenditure.^
I will now sum up. Part of the reason for low unemployment in the post-
war period has been the trend increase in the scarcity of labour relative to
capital. This is non-Keynesian, it can confidently be expected to persist,
and it has little or nothing to do with government policy. Not only has it
been important in itself but also it has provided a measure of protection to
labour from the eiTects of fluctuations in the demand for final product. In
addition, there has been a major change compared with the abnormally
depressed inter-war period in the level of effective demand relative to supply.
It is unclear how much of this has been due to government policy. It was
certainly not directly due to fiscal policy except in so far as war-time fiscal
policy started the post-war period off at a high level of activity. It is possible
that government encouragement to investment has prolonged the boom, but
there were in any case powerful forces independent of government action
making for an investment boom of unusual proportions.
The argument presented in this lecture has, of course, been greatly over-
simplified in a number of respects. For a proper analysis, much more would,
in particular, need to be said about trends within the post-war period, and
also about fiuctuations in the post-war period. Moreover, there is one final
point. In playing down the Government's role, I do not at all mean to
deny that a different policy on behalf of the Government could have pre-
vented there being full employment. The underlying balance-of-payments
situation in the post-war period was more difficult than in the inter-war
period in a number of respects, notably because of the loss of property
income from abroad. If the Government had tried to deal with this ex-
clusively by deflation we should not have had such a high level of activity.
As it was, the Government protected the balance of payments by a number
of other measures, the most important of which has been the maintenance
throughout the post-war period of fairly strict control over capital exports.
In the absence of such measures, and given the tendency of demand to be
high for other reasons, the budget surplus would have had to have exceeded
^ It is not suggested that this is the sole reason for the reduction in the short-period output-
elasticity of employment. Other forces have probably also played a part, such as the increase in
the ratio of salary-earners to wage-earners and the increase generally in the number of workers
engaged on overhead functions relatively to those engaged directly in production.
1968] WHY HAS BRITAIN HAD FULL EMPLOYMENT SINCE THE WAR? 569

what it was in the past by an even greater extent than it actually did, or else
monetary policy would have had to be still more restrictive, or both. In
this way the tendency for demand to be high for reasons independent of
government action would have been checked by government action. That
this was not done is something for which economists and the Keynesian
revolution can take some credit.
R. C. O. MATTHEWS
All Souls College,
Oxford.