Page 163 - DECO303_INDIAN_ECONOMY_ENGLISH

Indian Economy

Notes That is, nations would try to run trade balances against each of their trading partners so as
not to run down their foreign currency and gold reserves. In 1950, the European Payments
Union (EPU) was formed to allow nations within Europe to trade more freely with each by
coordinating the settlement in gold and US dollars for each of member nations. This
provided a wider convertibility of currencies within Europe and made it easier for nations
to engage in multilateral trade arrangements. However, the foreign exchange transactions
were still conducted in segmented markets. First, each European currency traded against
the US and Canadian dollars in one market. Second, the European currencies traded against
themselves in another market. There were arbitrage arrangements provided for by the
EPU. At the end of 1958, full convertibility was achieved, which meant that all currencies
were to be freely traded against each other and against the North American currencies in
a unified market. All nations agreed to buying and selling rates for the US dollar with
limited variation permitted. By the late 1950s, British growth had fluctuated but was still
relatively robust (averaging 2.4 per cent). The problem was that growth became a stop-go
affair as the balance of payments imposed a persistent constraint on the capacity of the
economy to expand and maintain its exchange rate parity.
Britain saw its only solution was to expand exports and this led to its desire to join the
Common Market, established by the Treaty of Rom in 1957. However, this introduced
another challenge which would also be significant in 1976. Entering the Common Market
would be beneficial from an exports perspective if the economy’s competitiveness improved
and this required constraining the persistent wage-price spiral. The other major
development in trade was the signing of the 1960 General Agreement of Trade and Tariffs
which required the signatories, including the United Kingdom, to reduce tariffs by around
20 per cent across a broad array of products. Entrenched inflation was undermining Britain’s
competitiveness and the weakening external position was continuing to deplete Britain’s
external reserves. As a result, by the early 1960s, domestic economic policy was
contractionary but only partially successful in reducing the current account deficit.
As a result, there was increasing speculative pressure on the sterling and the Bank of
England tightened credit to further slow the economy down. In fact, the two reserve
currency nations – the US and Britain – we encountering persistent external deficits which
was leading to unsustainable net capital outflow in their respective currencies. There was
also recognition that most of Europe needed to reduce their trade surpluses and increase
net capital outflow to resolve the imbalance in the international trade and payments
system.
The role of the IMF expanded during this period and they negotiated an agreement among
the ten large industrial nations to provide a massive boost to the supplementary resources
held by the IMF, which was to provide the Fund with more capacity to assist national
currencies who were under speculative attack. By mid-1961, Britain had to take urgent
account to stop the drain on its foreign reserves, including increases in excise taxes, a
credit squeeze (higher interest rates), fiscal austerity, a concerted policy of wage restraint,
and a massive stand-by arrangement drawing from the IMF amounting to US 1,046 million.
The restraint led to falling real GDP growth and rising unemployment and by the end of
1961 the fall in imports and rise in exports reduced the deficit significantly and Britain’s
gold and dollar reserves rose substantially.
The wage restraint manifested in the form of an incomes policy (wage pause), which both
unions and employers accepted. However, there was no fundamental change in the
bargaining relationships and so the incomes policy was only a temporary solution. The
wages debate was another important issue which resonated into the 1970s. Through the
1950s, wage bargaining in the UK had increasingly been dominated by unions and peak
industry bodies exerting their respective market power to defend (and expand) their
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