‘Crowding out'

Bacon and Eltis (1976) argued that the decline of British industry was due to its being displaced (‘crowded out’) by the growth of the non-market public sector. Some of the (then) public sector, such as steel, is itself industrial and markets its output in the same way as any private sector company.

We might usefully illustrate the ‘crowding out’ argument by first taking a closed economy with no government sector. Here the income generated in the market would equal the value of output. The income­receivers could enjoy all the goods and services they produced. However, they could no longer do so if a non-market (government) sector is now added, since the non-market sector will also require a proportion of the goods and services produced by the market sector. The market sector must therefore forgo some of its claims on its own output. It is one of the func­tions of taxes to channel resources from the market sector to support non-market (government) activity. The rapid growth of the public sector after 1945, it is argued, led to too rapid an increase in the tax burden (see Chapter 19), which adversely affected investment and attitudes to work, to the detriment of economic growth. Also, in the face of rising tax demands, workers in both market and non-market sectors sought to maintain or improve their real disposable income, thereby creating inflationary pressures.

If the market sector does not accommodate the demands of a growing non-market sector by forgoing claims on its own output, then in an open economy adjustment must be made externally. The higher overall demand of both sectors combined can then only be met either by reducing the exports of the market sector, or by increasing imports.

Bacon and Eltis saw the rapid growth of the non­market public sector as the cause of higher taxes, higher interest rates (to finance public spending), low investment, inflationary pressures and balance of payments problems. The growth of the non-market public sector has in these ways allegedly ‘crowded out’ the market sector, creating an economic environ­ment which has been conducive to UK decline.

These ideas provided intellectual backing to the Conservative Party’s approach to public spending and tax policies after 1979. The irony is that attempts to cut public spending and taxation after 1979 simply accelerated industrial decline, eroded the tax base and prevented the desired reduction of the tax burden (see Chapter 19). Bacon and Eltis’s ideas provide a coherent theory of industrial decline, helping us to appreciate some of the complex linkages in the process. However, experience since 1979 calls into question their basic propositions. High unemploy­ment during the 1980s made it impossible to argue that industry was denied labour, although it did lack capital investment. It may be that low investment had more to do with low expected returns than with the high interest rates said to be necessary to finance the growth of public expenditure. There are, of course, several other determinants of UK interest rates in addition to public expenditure. The ‘crowding out’ argument also neglects the importance of public sector services as inputs to the private sector. Of the non-marketed services, education is especially important in increasing the skills of the workforce.