What would Adam Smith think about the argued causes and consequences of the Lawson Boom of the late 1980’s?
During the late 1980’s the UK economy experienced a period of colossal economic growth and inflation essentially due to the method of recovery following the recession of 1981. Initially a surge in inflation reaching 9.5% in 1990(Economics Help, 2016) was the key issue caused by high growth whereby GDP growth was at 5% in 1988 above the long run trend rate of 2.5% (Economics Help, 2016).
Adam Smith, known as the “Father of Economics”, deemed that there were various key elements to procure economic growth. Primarily, Smith believed that a satisfactory level of self interest had to exist within the economy whereby producers and consumers undergo hard, efficient work where entrepreneurs earn a profit for risk whilst consumers receive a quality good or service. Secondly, Smith viewed the specialisation of labour derived from the division of labour; further developed into Taylorism; could optimize productive efficiency and output. Lastly, Smith placed confidence in the trickling down of wealth through the multiplier effect whereby once the wealthier individuals became wealthier there would be a trickle down via some pathway such as greater tax revenue, increasing government expenditure or through investment to create further employment.
One of the main causes of the Lawson Boom that was argued was the sharp reductions in income tax issued by the chancellor Nigel Lawson, where the high end of income tax was cut to 40% in 1988 (Economics Help, 2016). One could argue Smith would agree to an extent with this as a cause since he believed in limiting the intervention of the state and having low levels of income tax set proportionally to an individual’s total income. Smith said, “The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state.” (The Wealth of Nations, 1776). With low levels of income tax this would act as an incentive for people to become more productive and acquire a higher level of disposable income. When low income households have a higher level of disposable income this increases their marginal propensity to consume on necessity goods and their overall level of demand. As aggregate demand rises above the productive capacity of firms within the economy, firms are compelled to raise their prices leading to persistent rise in overall price levels.
However, one of the other argued causes of the boom was high levels of consumer confidence. During Q4 1998 house prices rose by over 30% (Economics Help, 2016) and many individuals experienced a period whereby their consumption increased due to their perceived increase in wealth. This is known as the wealth effect and as Smith said, “Wages, profit and rent are the three original sources of all revenue.” (The Wealth of Nations, 1776), we could say that as house prices increase, rent values would rise, increasing revenue to home owners. This would encourage an increase in consumer spending and investment leading to demand-led growth exacerbating the boom.
Eventually during the mid-eighties’ wage inflation arose and consequently unemployment heightened to just under 12% in 1986 (Economics Help, 2016). Smith would view this as a main consequence of the boom as Smith proposed that profits were a reward for risks undertaken by entrepreneurs and that they were the operator of the invisible hand. For Smith, this meant that the economy should operate effectively with an absence of regulation and in turn self-interested economic agents would compete freely, improving efficiency in markets. When economic agents become unemployed this reduces their level of disposable income used for consumption, investment and risk taking. This was made worse when interest rates increased to just under 12% in 1998 (Economics Help, 2016) seeing mortgage payments and individuals’ marginal propensity to save soar. A decline in consumer spending reduces living standards on a social level and economic growth overall.
To conclude it is likely Smith would agree with the proposed causes and consequences although it is important to remember that Smith was a theorist and in the Wealth of Nations unemployment, one of the main macroeconomic objectives of today was not discussed. Additionally, it could be argued that Smith would allow some unemployment to reduce the overheating in the economy. A reduction in consumer spending and investment would lead to a decline in aggregate demand leading to a fall in demand-pull inflation making general prices and mortgages more affordable to consumers, compressing the negative effects of unemployment. However, GDP, a measure of economic growth does not consider living standards and so although GDP may have fallen due to this, social conditions may have improved slightly.
Economics Help(2016) ‘The Lawson Boom of the late 1980s’. Retrieved from https://econ.economicshelp.org/2008/01/lawson-boom-of-late-1980s.html Date Accessed: 3rd November 2018
The Wealth Of Nations(1776) ‘The Adam Smith Institute’. Retrieved from https://www.adamsmith.org/adam-smith-quotes/ Date Accessed: 10th November 2018
The Wealth of Nations(1776) ‘Adam Smith Quotes’ Retrieved from https://www.goodreads.com/author/quotes/14424.Adam_Smith Date Accessed: 11th November