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  • Writer's pictureAlan Stevens - AWAH - Libertarianism, Freedom.

It’s OK going Back to the Seventies?

Updated: Oct 28, 2020

Jeremy Corbyn nearly won the 2017 General Election.  People were angry about unaffordable housing costs.   Many younger voters rationalized Corbyn’s socialist policies as just a return to the 1970s.  But the 1970s were a disaster for prosperity.

Jeremy Corbyn nearly won the 2017 General Election.  People were angry about unaffordable housing costs.   Many younger voters rationalized Corbyn’s socialist policies as just a return to the 1970s.  But the 1970s were a disaster for prosperity.

In early 2017 Teresa May unexpectedly called a General Election.  The move was entirely opportunistic.  She thought she had a lead in the polls which she could convert into a larger Conservative Party majority in Parliament.  Instead she nearly lost the election.  The electorate doesn’t like being called repeatedly to the polls. It tends punish politicians for wasting their time with cynical opportunistic political games. 

The Labour Party had shown itself to be even more likely to betray the Leave vote in the June 2016 EU membership referendum than the Conservatives.  And it was led by Jeremy Corbyn, an intellectual doctrinaire Marxist with a comparatively left-wing manifesto.  Had Labour had a presentable and moderate leader and a somewhat stronger line on the EU, May would have been deservedly trounced in 2017.

Driving the Labour vote was dislike of May and a deep resentment at the way housing had been allowed to become increasingly unaffordable.  This is entirely due to the damage state interventions in the housing market have done (please see the posts on ‘Cheaper Better Housing after the Fall’ (May 24th) and ‘The Cantillon Effect’ (May 4)).  Younger people are worst affected by this wholly avoidable situation. 

Younger people were also most likely to claim that Corbyn’s policies would simply return Britain to the 1970s and would therefore be alright.  This may well have been a rationalisation of the uncomfortable, underlying desire to use state violence to lower housing costs.  But it does highlight an extra-ordinary ignorance about the past and the mess the state has always made of nearly everything it touches.

There is a great deal one can say about the 1970s.  They began with the final decision to abandon the last connection between money and gold when President Nixon abandoned the linchpin of the 1944 Bretton Woods international monetary system, US Dollar convertibility into gold.  The result was runaway inflation averaging nearly 14% annually with a peak of 25% in 1975. 

The postwar ‘New Jerusalem’ mix of an expensive welfare state and a mixed economy dominated by nationalised industries basically failed.  The Government could not meet the costs of welfarism and of loss-making state industry.  The British Government sought what was perceived to be a humiliating bail-out from the International Monetary Fund.  Industry was made unviable by inadequate public sector management, heavy taxation, and repeated strikes called by irresponsible and incompetent trades union leaders. 

It all ended with much of the public sector on strike in the 1979 ‘Winter of Discontent’.  The normal public sector bickering over sharing the proceeds of looting the productive sector became more intense as the tax take fell.  With unburied bodies piling up in morgues and temporary facilities, the population evidently decided Margaret Thatcher was needed to sort out the mess.

The point of this post is to ask younger people to consider whether committing their futures to a set-up – an unstable and ultimately unsuccessful set-up – like the 1970s, is really in their interests.  The device chosen to explain this is a thought experiment about a hypothetical investment in the 1970s.  We look at it from the point of view of an individual owner, manager and investor – ‘a capitalist’ – if you like to think in terms of Marxist propaganda.

What do people, especially young people starting out, most need?  Well, they really want to be in a high salary economy with plenty of available jobs.  This ought to be true whether people wish to work in the good, productive, essentially free market, sectors of society or the bad, parasitic sector comprising the state and its cronies. 

Compare a wealthy country like Britain with, say, India, which remains, despite recent progress, desperately poor.  What accounts for British salaries being so very much higher?  Lower levels of corruption, somewhat less regulation, and better skills are important.  But the real answer is fixed capital (see ‘Do Capitalists Oppress Workers? (April 25th)).  Fixed capital comprises productive facilities, machinery, vehicles, offices, laboratories and transport, energy, communications ‘infrastructure’. Britain has a very great deal more fixed capital per employee than does India.  That largely explains the gap in standards of living.

That is why I invite any young people, in particular, who may be reading this, to consider the plight of would be investors in an economic environment analogous to the 1970s.  Not many people in society have the connections, resources, knowledge, determination and courage to establish a successful business able to pay high salaries.  And yet they are key to everyone else’s well being.  The way such people are treated wholly determines how prosperous or grim life will be for all of us.

A young person, above all, needs others to make repeated successful investments in the latest productive equipment continuously during the several decades of a lifetime.  Let us look at how an independent owner investor making that very necessary investment in new fixed capital would fare under the Labour Party’s original 1970s tax system.

Our hypothetical investor entrepreneur puts together £1 million (in 1970 money terms, which is the equivalent to £15 million now, after years of state induced price inflation) to set up a new business. With it, he buys the most modern widget-making device available.  Under his skillful management, this productive facility will employ staff at high wages.  After meeting all current costs, it will generate an average annual cash flow equivalent to £200,000 in 1970 terms.  So far so good.  This success, repeated hundreds of thousands of times, is what you need if you are going to have a prosperous Britain.  

After ten years the machine will be worn out and/or commercially obsolete.  It will have to be replaced. Our investor owner will therefore make the normal provision for replacing his machine, i.e. his fixed capital. He will include in his accounts among his costs one tenth of the £1 million purchase price of the original machine. The £100,000 of depreciation annually he enable him to build up a fund of £1 million by 1980 to buy a new and probably still more productive machine. 

Meanwhile he proposes to pay out the remaining profit of £100,000 per year to himself as a dividend.  Thus, he will secure a 10% return on his investment.  A 10% return in competitive markets is historically about par for the course.  It is no higher than it should be, given the high risk of being out-competed or displaced by technological change.  

The first point to make is that in a free society (and in its Classical Liberal 19th century approximations in Britain and the US) this will work out as intended. This level of annual depreciation really will mean that the capital embodied in the machine will be replaced by the time it is worn out. The enterprise, with all its dependent jobs, will endure and prosper.

Nothing is certain for any particular business, but on average businesses will continuously reinvest.  People will have relatively high wages all their lives.  Prices will fall steadily as each replacement machine incorporates more technical improvements.  Owners and workers may save money and buy additional machines - bringing still more prosperity.  That is what happened in the previous couple of centuries.

But not in the post WWII period under Democratic Socialism, and certainly not in the 1970s.  The 1970s saw an unusually poisonous mix of high inflation and heavy taxation.  There was no attempt to adjust the tax system significantly for the effects of inflation.  The politicians were happy to take as much loot as possible in the short term.  They were not interested in anyone else’s longer-term prospects – and still are not interested in yours. 

The accountants, whose position rested on the state’s coercing businesses to employ auditors, lamentably failed, with very few exceptions, to take inflation accounting seriously.  The result was an almost accidental decapitalisation and destruction of much of Britain’s capital-intensive, productive base.

In 1974 the Labour Party came to power and found itself obliged to recognise the bankruptcy of the post war British state.  Money was borrowed from the IMF in return for promises to cut government spending.  To make cuts palatable to its left-wing supporters, Chancellor Denis Healey added an 85% top rate of income tax, with a 98% top rate on so called ‘unearned’ income, i.e. returns on investment.  The fact that income from the most difficult business task - earning a decent return for savers - could be described as ‘unearned’, speaks volumes about the lasting complacency, ignorance, envy and stupidity of the British political establishment.  The cavalier way the government introduced the recent lockdown, with no clue as to its dire consequences, suggests that that ignorance and complacency is alive and well in Westminster. 

The new 1970s top rates of tax directly affected only a small proportion of the population and were no doubt intended as a harmless bit of political theatre.  And yet the overall income tax yield fell heavily and never recovered until the Thatcher government reduced income tax rates sharply.  The economy staggered into more or less constant depression. it was characterised by ‘stagflation’, a nasty combination of high inflation and unemployment.

So, what happens to our hypothetical entrepreneur living in Chancellor Healey’s brave new world, the one lots of Corbyn voters in 2017 thought would be OK?  Well the business goes as planned, operationally and commercially.  That itself is already a great achievement. The expected £200,000 per annum free cash flow is achieved in ‘real’ terms (i.e. after discounting to allow for price inflation).  With the general rise in prices the cash flow even reaches £700,000 in 1980, the last year of the machine’s life. 

Every year the owner is allowed to deduct from his taxable profits the original £100,000 depreciation allowance, before paying the then 52% corporation tax.  Then he pays out the remaining sum, an apparently princely £300,000 in dividends by 1980, to himself.  On that he pays 98% income tax (he has a salary too, so all ‘unearned’ income will be at the top rate).  For 1980 he is left with just £6,000 (less than £2,000 in 1970 money) as an annual return on the £1 million risk investment he made in 1970.     

Let’s look at what happens next from your point of view.  You who are our hypothetical young Corbynista who would vote for a ‘Life on Mars’ style return to the world of 1970s left-wing Labour Party economic management.  Let’s say you have been working from 1970 at the plant set up by our courageous and competent entrepreneur.  You have yourself steadily gained in competence and confidence.  You are productive.  You deservedly have a good salary. You have been able to marry, buy a home (a lot easier in 1980 than now) and start a family.  The company is, and has always been, profitable under the determined and able leadership of its owner manager.  Everything is just fine. Or so it seems.

Then one sunny day you go down to work on Monday morning.  The plant is shut.  WTF!

How could this happen? And happen it did, again and again in the early 1980s as a huge mass of Britain’s industrial base vanished and took the future prospects of millions of innocent (if dreadfully misinformed) employees with it.

There were various explanations.  Britain had joined the EU in 1973 on the unstated understanding that British manufacturing and fishing would be sacrificed.  We still import twice as much from the EU as we export.  In return, the City of London could compete in EU financial markets. 

In addition, the discovery of North Sea Oil drove up the British Pound’s exchange rate (unrealistic exchange rates being another drawback of inconvertible paper money). And the world was back in recession.  This time too, Paul Volker at the Federal Reserve was squeezing the 1970s inflation out of the dollar and its franchisee currencies like the Pound.  Interest rates were put up to around 15%.

But British industry actually died because it was de-capitalised by years of destructive and confiscatory taxation (by the feckless, reprehensible Tories as well as by the Marxist Labour Party)..  People can be incredibly enterprising and resilient when they have a reasonable shot at improving their lot. They will stick with things through thick and thin.  But that wasn’t the case. After decades of culpably amateurish and ill-informed British policy making, the Healey squeeze had made the capital investment game finally and definitively not worth the candle.   While our young Corbynista was making his entirely meritorious way, working for his apparently profitable company, the government was accidentally stealing even more of his employer’s substance than it knew. 

All had been revealed in 1980 when the business owner looked at replacing the now outdated 1970 machine which had cost him £1 million.  A new and improved machine would be needed for the next decade.  He had dutifully set aside £1 million from ten years of depreciation allowance to make the purchase.  But, lo and behold, the new machine now cost over £3 million because of inflation.  The owner needs to find another £2 million to stay in the game. 

If you do the numbers after discounting for inflation (i.e. in ‘real terms’) you see what has gone wrong. The good news is that, in real 1970 pound terms, the business worked fine. It has indeed generated the projected £200,000 (in 1970 terms) in free cash flow after current expenses, including labour costs.  That is £2 million in the decade.  That £2 million was meant to be allocated - half to build up a £1 million fund to replace the machine in 1980, and half to provide a 10% annual return on investment, accounting for a cumulative £1 million by 1980.

But the depreciation allowance was not adjusted for inflation in the government’s tax calculations.  So, in real terms over the decade the enterprise had deducted the 1970 equivalent of just £500,000 to build a fund to replace the machine in 1980. Worse, this money has remained on the balance sheet and so has lost further value due to price inflation.  

The government has applied crushing punitive taxation. Stupidly it has applied it not just to the cumulative £1 million earned by the owner investor. They also taxed and stole an extra £500,000 of value which needed to be husbanded to enable a new machine in 1980. It taxed the businessman twice over.  First it took 52% at the corporate level, and then it confiscated almost all of the remainder as ‘unearned’ income at the 98% income tax rate.  The real value of the investor’s total return for the whole decade was basically nothing, about £10,000.  

During the decade (in real money of 1970 terms) the government has greedily taken nearly £1.5 million of tax out of the £1 million of new value created (that is after deducting the real £1 million cost of replacing this bit of society’s indispensable stock of productive fixed capital).  So, the company died because the predatory state ineptly and short-sightedly levied tax at nearly 150% of its genuine long term taxable capacity.  

But surely you say, the owner investor will want to keep things going.  For the sake of the workers? Now you think ‘evil capitalists’ want to keep things going for the sake of the workers?  Surely there is some confusion of narratives here.  Would you borrow personally to keep other people in jobs - with no hope of a return? Of course not. By 1979 British investment in capital intensive production was largely a mug’s game.   

It’s perfectly true that larger firms in particular, often foreign, and generally run by respectable but less able salaried corporate bureaucrats, could shield more of the company’s cash flow from the state.  Corporation tax, in particular, can be reduced by taking on debt and using international transfer pricing to shift profits out of high tax countries.  But, contrary to popular belief, large corporations run by corporate bureaucrats, especially foreign companies, do little for long term economic growth.

But our hypothetical owner has understandably had enough.  The government deliberately made sure he got no real return from risking his time and money to create value and employment.  Why continue?  The best thing to do is to scrap the plant and sell the company.  The owner could get something for the scrap, for the customer list and for the £1 million of depreciation cash. 

The £1 million depreciation provision in 1980 is now worth only £300,000 in 1970 money.  The investor has lost maybe two thirds of his original fortune in a decade, despite being an exemplary producer, manager and employer.  That £1 million in devalued 1980 pounds nevertheless is equivalent over £4 million in the even more devalued £s of 2020. It still represents a decent lifeboat for our put-upon hero. He is off to enjoy a much less stressful existence. Meanwhile our hard working back-to-the-1970s Corbynista voter faces a difficult future with many fewer breadwinner jobs around.

And that is what happened all around the country.  With inflation, corporate and income double taxation, and capital gains and inheritance taxes, the British government consistently, negligently destroyed much of the physical productive fixed capital on which living standards, especially outside London, depended.  A lot of the actual closures happened under Thatcher.  She and ‘capitalism’ wrongly got the blame.  But the rot occurred earlier and most especially in the 1970s. 

Ever since, the British establishment has been anxious to attract foreign capital and companies to fill the gap it stupidly created.  It has belatedly lowered taxes to do this.  But the truth is that growth and prosperity disproportionately depend on having a large number of well capitalized locally owned and managed small and medium sized companies.  Britain still faces great obstacles to recreating the industrial base it lost then.  

So please think again, all ye young Corbynistas who were keen in 2017 to go back to the 1970s.  They really weren’t that good for working people the first time around.

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