The second half of the 20th century divides neatly in two. The divide did not come with the rise of Ronald Reagan or the fall of the Berlin Wall. It is not discernible in a particular event, but rather in a shift in the world economy, and the change continues to shape politics and society in much of the world today.
The shift came at the end of 1973. The quarter-century before then, starting around 1948, saw the most remarkable period of economic growth in human history. In the Golden Age between the end of the Second World War and 1973, people in what was then known as the ‘industrialised world’ – Western Europe, North America, and Japan – saw their living standards improve year after year. They looked forward to even greater prosperity for their children. Culturally, the first half of the Golden Age was a time of conformity, dominated by hard work to recover from the disaster of the war. The second half of the age was culturally very different, marked by protest and artistic and political experimentation. Behind that fermentation lay the confidence of people raised in a white-hot economy: if their adventures turned out badly, they knew, they could still find a job.
The year 1973 changed everything. High unemployment and a deep recession made experimentation and protest much riskier, effectively putting an end to much of it. A far more conservative age came with the economic changes, shaped by fears of failing and concerns that one’s children might have it worse, not better. Across the industrialised world, politics moved to the Right – a turn that did not avert wage stagnation, the loss of social benefits such as employer-sponsored pensions and health insurance, and the secure, stable employment that had proved instrumental to the rise of a new middle class and which workers had come to take for granted. At the time, an oil crisis took the blame for what seemed to be a sharp but temporary downturn. Only gradually did it become clear that the underlying cause was not costly oil but rather lagging productivity growth – a problem that would defeat a wide variety of government policies put forth to correct it.
The great boom began in the aftermath of the Second World War. The peace treaties of 1945 did not bring prosperity; on the contrary, the post-war world was an economic basket case. Tens of millions of people had been killed, and in some countries a large proportion of productive capacity had been laid to waste. Across Europe and Asia, tens of millions of refugees wandered the roads. Many countries lacked the foreign currency to import food and fuel to keep people alive, much less to buy equipment and raw material for reconstruction. Railroads barely ran; farm tractors stood still for want of fuel. Everywhere, producing enough coal to provide heat through the winter was a challenge. As shoppers mobbed stores seeking basic foodstuffs, much less luxuries such as coffee and cotton underwear, prices soared. Inflation set off waves of strikes in the United States and Canada as workers demanded higher pay to keep up with rising prices. The world’s economic outlook seemed dim. It did not look like the beginning of a golden age.
As late as 1948, incomes per person in much of Europe and Asia were lower than they had been 10 or even 20 years earlier. But 1948 brought a change for the better. In January, the US military government in Japan announced it would seek to rebuild the economy rather than exacting reparations from a country on the verge of starvation. In April, the US Congress approved the economic aid programme that would be known as the Marshall Plan, providing Western Europe with desperately needed dollars to import machinery, transport equipment, fertiliser and food. In June, the three occupying powers – France, the United Kingdom and the US – rolled out the deutsche mark, a new currency for the western zones of Germany. A new central bank committed to keeping inflation low and the exchange rate steady would oversee the deutsche mark.
Postwar chaos gave way to stability, and the war-torn economies began to grow. In many countries, they grew so fast for so long that people began to speak of the ‘economic miracle’ (West Germany), the ‘era of high economic growth’ (Japan) and the 30 glorious years (France). In the English-speaking world, this extraordinary period became known as the Golden Age.
What was it that made the Golden Age exceptional? Part of the answer is that economies were making up for lost time: after years of depression and wartime austerity, enormous needs for housing, consumer goods, equipment for farms, factories, railroads and electric generating plants stood ready to drive growth. But much more lay behind the Golden Age of economic growth than pent-up demand. Two factors deserve special attention.
First, the expanding welfare state. The Second World War shook up the social structures in all the wealthy countries, fundamentally altering domestic politics, in particular exerting an equalising force. As societies embarked on reconstruction, no one could deny that citizens who had been asked to sacrifice in war were entitled to share in the benefits of peace. In many cases, labour unions became the representatives of working people’s claims to peacetime dividends. Indeed, union membership reached historic highs, and union leaders sat alongside business and government leaders to hammer out social policy. Between 1944 and 1947, one country after another created old-age pension schemes, national health insurance, family allowances, unemployment insurance and more social benefits. These programmes gave average families a sense of security they had never known. Children from poor families could visit the doctor without great expense. The loss of a job or the death of a wage-earner no longer meant destitution.
Second, in addition to the growing welfare state, strong productivity growth contributed to rising living standards. Rising productivity – increasing the efficiency with which an economy uses labour, capital and other resources – is the main force that makes an economy grow. Because new technologies and better ways of doing business take time to filter through the economy, productivity improvements are usually slow. But in the postwar years, productivity grew very quickly. A unique combination of circumstances propelled it. In just a few years, millions of people moved from low-productivity farm work – more than 3 million mules still plowed furrows on US farms in 1945 – to construction and factory jobs that used the latest machinery.
In 1940, the average working-age adult in western Europe had less than five years of formal education. As governments invested heavily in high schools and universities after the war, they produced a more educated and literate workforce with the skills to produce far more wealth. Advances in national infrastructure gave direct boosts to national productivity. High-speed motorways enabled truck drivers to carry bigger loads over longer distances at higher speeds, greatly expanding markets for farms and factories. Six rounds of trade negotiations between 1947 and 1967, ultimately involving nearly 50 countries that signed the General Agreement on Tariffs and Trade (GATT), brought a massive increase in cross-border trade, forcing manufacturers to modernise or give up. Firms moved to take advantage of technological innovations to operate more productively, such as jet aircraft and numerically controlled machinery.
Between 1951 and 1973, propelled by strong productivity gains, the world economy grew at an annual rate of nearly 5 per cent. The impact on living standards was dramatic. Jobs were just for the asking; in 1966, West Germany’s unemployment rate touched an unprecedented 0.5 per cent. Electricity, indoor plumbing and television sets became common. Stoves burning coal or peat were replaced by central heating systems. Homes grew larger, and tens of millions of families acquired refrigerators and automobiles. The higher living standards did much more than simply bring new material goods. Retirement by 65, or even earlier, became the norm. Life expectancy jumped. Importantly, in Western Europe, North America and Japan, people across society shared in those gains. Prosperity was not limited to the urban elite. Most people began to live better, and they knew it. In the span of a quarter-century, living standards doubled and then, in many countries, doubled again.
The good times rolled on so long that people took them for granted. Between 1948 and 1973, Australia, Japan, Sweden and Italy had not a single year of recession. West Germany and Canada did almost as well. Governments and the economists who advised them happily claimed the credit. Careful economic management, they said, had put an end to cyclical ups and downs. Governments possessed more information about citizens and business than ever before, and computers could crunch the data to help policymakers determine the best course of action. In a lecture at Harvard University in 1966, Walter Heller, formerly chief economic adviser to presidents John F Kennedy and Lyndon B Johnson, trumpeted the success of what he called the ‘new economics’. ‘Conceptual advances and quantitative research in economics,’ he declared, ‘are replacing emotion with reason.’
Wages and investment were private decisions, but Schiller hoped government guidelines would contribute to ‘collective rationality’
The most influential proponent of such ideas was Karl Schiller, who became economy minister of West Germany, Europe’s largest economy, in 1966. A former professor at the University of Hamburg, where his students included the future West German Chancellor Helmut Schmidt, Schiller was a centrist Social Democrat. He stood apart from those on the Left who favoured state ownership of industry, but also from extreme free-market conservatives. His advice called for ‘a synthesis of planning and competition’. Schiller defined his philosophy thus: ‘As much competition as possible, as much planning as necessary.’
Most fundamentally, Schiller believed that government should commit itself to maintaining high employment, steady growth and stable prices. And it should do this all while keeping its international account in balance, within the framework of a free-market economy. These four commitments made the corners of what he called the ‘magic square’. In December 1966, when Schiller became economy minister in a new coalition government, the magic square became official policy. Following Schiller’s version of Keynesian economics, his ministry’s experts advised federal and state governments how to adjust their budgets to achieve ‘equilibrium of the entire economy’. The ministry’s advice was based on an elaborate planning exercise that churned out five-year projections. In the spring of 1967, the finance ministry was told to adjust taxes and spending plans to increase business investment while slowing the growth of consumer spending. These moves, Schiller’s economic models promised, would bring economic growth averaging 4 per cent through 1971, along with 0.8 per cent unemployment, 1 per cent annual inflation and a 1 per cent current account surplus.
But in an economy that was overwhelmingly privately run, government alone could not reach perfection. Four or five times a year, Schiller summoned corporate executives, union presidents and the heads of business organisations to a conference room in the ministry. There he described the economic outlook and announced how much wages and investment could rise without compromising his national economic targets. Of course, he would add, wages and investment were private decisions, but he hoped that the government’s guidelines would contribute to ‘collective rationality’. Such careful stage management cemented Schiller’s fame. In 1969, for the first time, the Social Democrats outpolled every other party. The election that year became known as the ‘Schiller election’.
Schiller insisted that his policies had brought West Germany to ‘a sunny plateau of prosperity’ where inflation and unemployment were permanently vanquished. Year after year, however, the economy failed to perform as he instructed. In July 1972, when Schiller was denied control over the exchange rate, he stormed out of the cabinet and left elected office forever.
Schiller left with the West German economy roaring. Within 18 months, his claim that the government could ensure stable prices, robust growth and jobs for all blew up.
The headline event of 1973 was the oil crisis. On 6 October, Egyptian and Syrian armies attacked Israeli positions, starting the conflict that became known as the Yom Kippur War. By agreeing to slash production and raise the price of oil, Saudi Arabia, Iraq, Iran and other Middle Eastern oil exporters quickly backed the two Arab countries. Shipments to countries that supported Israel, including the US and the Netherlands, were cut off altogether.
Oil-importing countries responded in dramatic fashion. Western European countries lowered speed limits and rationed diesel supplies. From Italy to Norway, driving was banned on four consecutive Sundays in order to save fuel. The Japanese government shut down factories and told citizens to turn out the pilot lights on their water heaters. US truck drivers blocked highways to protest high fuel prices, and motorists queued for hours to top off their gasoline tanks. In a televised address, the US President Richard Nixon warned Americans: ‘We are heading toward the most acute shortages of energy since the Second World War.’
Faced with higher petroleum prices, economic growth in 1974 collapsed. Around the world, inflation soared. When oil prices receded, the world economy failed to bounce back. Double-digit inflation dramatically undermined workers’ wage gains. From 1973 to 1979, average income per worker grew only half as fast as it had before 1973. Help-wanted signs vanished as unemployment rose. The economic experts, only recently so confident that their rational mathematical analysis had brought permanent prosperity, were flummoxed. Stable economic growth had given way to violent gyrations.
The underlying problem, it turned out, was not expensive petroleum but slow productivity growth. Through the 1960s and early ’70s, across the wealthy world, productivity had risen a strong 5 per cent a year. After 1973, the trend shifted clearly downward. Through the rest of the 20th century, productivity growth in the wealthy economies averaged less than 2 per cent a year. Diminished productivity growth translated directly into sluggish economic growth. The days when people could feel their living standards rising from one year to the next were over. As the good times failed to return, voters turned their fury on political leaders. In fact, there was little any Western politician could do to put their economies back on their previous tracks.
To give a short-term boost to an underperforming economy, central banks and governments have a variety of tools they can use. They can lower interest rates to make it cheaper to buy a car or build a factory. They can lower taxes to give consumers more money to spend. They can increase government spending to pump more cash into the economy. They can change regulations to make it easier for banks to lend money. But when it comes to an economy’s long-term growth potential, productivity is vital. It matters more than anything else – and productivity growth after the early 1970s was simply slower than before.
Turning innovative ideas into economically valuable products and services can involve years of trial and error
The reasons behind slowed productivity growth had nothing to do with any government’s economic policy. The historic move of rural peoples to the cities, around the world, could not be repeated. Once masses of peasant farmers and sharecroppers had shifted into more productive work in the cities, it was done. The great flow of previously unemployed women into the labour force was over. In the 1960s, building thousands of miles of superhighways brought massive economic benefits. But once those roads were open to traffic, adding lanes or exit ramps was far less consequential. In rich countries, literacy had risen to almost universal levels. After that historic jump, the effects of additional small increases in average education were comparatively slight. If higher productivity growth were to be regained, it would have to come from developing technological innovations and new approaches to business, and putting them to use in ways that allowed the business sector to operate more effectively.
When it comes to influencing innovation, governments have power. Grants for scientific research and education, and policies that make it easy for new firms to grow, can speed the development of new ideas. But what matters for productivity is not the number of innovations, but the rate at which innovations affect the economy – something almost totally beyond the ability of governments to control. Turning innovative ideas into economically valuable products and services can involve years of trial and error. Many of the basic technologies behind mobile telephones were developed in the 1960s and ’70s, but mobile phones came into widespread use only in the 1990s. Often, a new technology is phased in only over time as old buildings and equipment are phased out. Moreover, for reasons no one fully understands, productivity growth and innovation seem to move in long cycles. In the US, for example, between the 1920s and 1973, innovation brought strong productivity growth. Between 1973 and 1995, it brought much less. The years between 1995 and 2003 saw high productivity gains, and then again considerably less thereafter.
When the surge in productivity following the Second World War tailed off, people around the globe felt the pain. At the time, it appeared that a few countries – France and Italy for a few years in the late 1970s, Japan in the second half of the ’80s – had discovered formulas allowing them to defy the downward global productivity trend. But their economies revived only briefly before productivity growth waned. Jobs soon became scarce again, and improvements in living standards came more slowly. The poor productivity growth of the late 1990s was not due to taxes, regulations or other government policies in any particular country, but to global trends. No country escaped them.
Unlike the innovations of the 1950s and ’60s, which were welcomed widely, those of the late 20th century had costly side effects. While information technology, communications and freight transportation became cheaper and more reliable, giant industrial complexes became dinosaurs as work could be distributed widely to take advantage of labour supplies, transportation facilities or government subsidies. Workers whose jobs were relocated found that their years of experience and training were of little value in other industries, and communities that lost major employers fell into decay. Meanwhile, the welfare state on which they had come to rely began to deteriorate, its financial underpinnings stressed due to the slow growth of tax revenue in economies that were no longer buoyant. The widespread sharing in the mid-century boom was not repeated in the productivity gains at the end of the century, which accumulated at the top of the income scale.
For much of the world, the Golden Age brought extraordinary prosperity. But it also brought unrealistic expectations about what governments can do to assure full employment, steady economic growth and rising living standards. These expectations still shape political life today. Between 1979 and 1982, citizens in one country after another threw out the leaders who stood for the welfare state and voted in a wave of more Right-wing politicians – Margaret Thatcher, Reagan, Helmut Kohl, Yasuhiro Nakasone and many others – who promised to tame big government and let market forces, lower tax rates and deregulation bring the good times back. Today, nearly 40 years on, voters are again turning to the Right, hoping that populist leaders will know how to make slow-growing economies great again.
More than a generation ago, the free-market policies of Thatcher and Reagan proved no more successful at improving productivity and raising economic growth than the policies they supplanted. There is no reason to think that the populists of our day will do much better. The Golden Age was wonderful while it lasted, but it cannot be repeated. If there were a surefire method for coaxing extraordinary performance from mature economies, it likely would have been discovered a long time ago.