This chapter is in two main parts: the first gives a brief account of developments in the economy in 1981; the second contains the short-term forecast to end-1983. In addition, two short notes are appended addressed to topics of particular current interest and concern: the impact of the recession on company profitability and liquidity and recent trends in productivity.

High real interest rates and high rates of unemployment were the main characteristics of the world economy in 1981, with relatively low growth rates as the link between them. Rates of inflation moderated.

Since the huge increases in oil prices during 1979 gave a fresh and powerful upward twist to the inflationary spiral, the chief priority of governments in most OECD countries has been to get this turning down again. To this end they have followed strict monetary policies and fiscal policies which despite big budgetary deficits in some countries would be restrictive on a full-employment basis.

During 1981 manufacturing output remained virtually flat, with a small further fall in the first two quarters balanced by a very weak recovery in the third and fourth (statistical appendix table 2). By about the middle of the year, virtually all industries had stopped declining, and a few, notably chemicals, metals and motor vehicles, were showing significant increases in output. The slow recovery in output is expected to continue (table 1); the rise of about 2 per cent a year expected in 1982 and 1983 is indeed rather slower than the rate between the two halves of last year. For total industrial production the pattern is similar, but the fall in the first half of the year was greater and the recovery has been slower because construction output has continued to decline; it will lower the growth in total industrial output this year as well.

Throughout the 1950s and 60s the framework within which macroeconomic policy was conducted in the UK appeared to be relatively uncontentious. Government policy was designed to achieve certain economic objectives, which typically included full employment, stable prices, economic growth and balance of payments equilibrium, by appropriately setting various instruments of policy, such as tax rates and the exchange rate. The relationship between particular instruments and objectives was often disputed, and the advisability of ‘fine tuning’ was questioned, but the basic ‘instruments to objectives’ approach to policy was generally accepted.

The background to the White Paper proposals for changes in the organisation of skilled training, published in December 1981, is to be found six months earlier in a detailed Review by the Manpower Services Commission (MSC) of the workings of the Employment and Training Act of 1973. That Review concluded that ‘current training arrangements have made little advance in securing fundamental reforms of training’ (paragraph 4.34), and that ‘in general, in the traditional crafts, it is still the passage of time rather than objectively assessed performance standards, which decides whether a trainee is accepted as skilled’ (paragraph 4.16).

The consumption function is probably the most widely researched area in macro-economics and until the early seventies it seemed to be one of the most stable relationships. However, in the 1970s there was a sharp and rapid rise in the saving ratio of the personal sector that was not predicted by existing equations. Moreover the rise in the saving ratio coincided with an increase in the rate of inflation and the conventional view had been that inflation would discourage saving. This prompted a search for theories that would explain the ‘paradox’ of saving behaviour.

This article examines the conduct of fiscal policy since 1974. It is in two parts. The first contains a chronological narrative of what policy-makers did during the period. It describes, in rapid summary, the major policy developments and the setting within which policy formation evolved. The style of part I is more journalistic than scientific, the intention being to convey some sort of impression of what things were like at the time—of the pressure of immediate problems and the unexpectedness of many economic developments—an impression which would perhaps be lost in a more analytical and abstract treatment. The second part is concerned with the more technical task of measuring the effects of policy changes. It emphasizes the leverage of fiscal instruments—the first impact' of policy upon the level of demand—rather than the more indirect effects on the balance of payments and inflation, important though these may have been as target variables.