How Labour Embraced the City

by Robin Ramsay

Keynesian-influenced economics is the view that central government can manipulate investment and consumption to maintain economic demand in the national economy and thus prevent economic depression. Politically, that’s all there is to it. The dominant factions in all major British parliamentary parties in the post-WW2 era accepted this.

In the 1970s the increasingly transnational nature of some companies with plants in the UK—the American car companies, for example—and the UK’s entry into the European Economic Community led some within the Labour movement, notably Stuart Holland MP, to wonder if a nationally-oriented economic policy was still relevant or even possible. To complicate things politically, these debates were tangled up with the argument in the Labour Party about British membership of the European Union.

In 1976 James Callaghan had just become prime minister after Harold Wilson's resignation and in his speech to the Labour Party conference that year he outlined the government's economic plans. As had Prime Minister Heath, Callaghan wanted to create an industrial relations system like that in Germany;[1]  and he mentioned the government’s difficulties trying to emulate the French state’s system of planning agreements with the big British companies.[2]  None of that is now remembered. Only a short section about the relationship between inflation and unemployment, which apparently marked the death of ‘Keynesian’ economics, is now recalled.

The received story of British political economy since the Labour governments of the 1960s holds that inflation and stagflation—stagnation plus inflation—in the 1970s killed economic demand management. The ‘humiliation’ of the UK government having to make the loan application to the IMF in 1976 signalled its end; and its last rites were read over it by Prime Minister Callaghan in a speech to the conference written in part by Callaghan’s son-in-law, Times journalist Peter Jay, an early media convert to what became known as ‘monetarism’:

‘We used to think you could spend your way out of recession and increase employment by boosting government spending. I tell you, in all candour that that option no longer exists. And in so far as it ever did exist, it only worked on each injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step. Higher inflation followed by higher unemployment. We have just escaped from the highest rate of inflation this country has known; we have not yet escaped from the consequences: high unemployment. That is the history of the last 20 years.’

This was just nonsense.  In 1956, the beginning of the 20 year period offered by Jay (through Callaghan), inflation was 5% on average over the year; for most of the Labour governments of 1966-70 it was less than that; and it was 5% in January 1970. By contrast, for almost all of the 1980-1997 period of Conservative governments which were ostensibly primarily focused on keeping inflation under control, by controlling the money supply, inflation was above 5%.[3]   

The context of Callaghan’s speech was the great inflation of the mid-1970s, which peaked in August 1975 at 26.9%; and which was mostly the result of the ‘dash for growth’ made by the government of Edward Heath in 1972-73 and the tripling of crude oil prices in 1973. 

Prime Minister Heath was centrally interested in getting the UK into the then EEC. Anticipating that entry would cause an economic shock, by exposing British firms to new competition from abroad, and working with the Cabinet Secretary William Armstrong, he decided to ‘go for growth’. William Armstrong chaired a secret—from other cabinet members, secret—Whitehall committee set up in late 1971 to devise a framework for industrial expansion.[4]

Heath pressed the ‘go’ button, cutting personal taxes, making interest on bank loans offsettable against tax, and tripling the public sector borrowing requirement between 1971-72 and 1972-73. When the balance of payments began to deteriorate as imports were sucked in by the boom he was creating, Heath floated the pound in June 1972. (President Nixon had ended the system of fixed exchange rates in 1971.)  As late as September 1973, after the OPEC oil price rise, with inflation approaching 10% and rising every month, Heath told a meeting of the National Economic Development Council, ‘This time I am determined to swim through the whirlpool.’[5]      


In the late 1960s British high street banks were unhappy. They had pension funds, unit trusts, building societies, and increasing numbers of foreign banks as rivals for domestic savings, and yet were also

‘... unpaid agents of the state, bearing a great part of the considerable administrative burden of implementing exchange controls, in the post-war years their lending activities were almost constantly restricted by government, and they were the main agents through which the authorities tried to enforce periodic credit squeezes.’[6]     

On their behalf in 1971 the Bank of England introduced Competition and Credit Control (C3 for convenience), which ended lending ‘ceilings’ set by government. Under C3 credit in the economy would be ‘controlled’ by raising interest rates—i.e. by making it more expensive and, in theory, reducing demand for it. C3 effectively let the banks lend as much as they wanted to.  It was the perfect racket: the banks got to lend as much as they could and then, when there was ‘too much money’ in the economy, they got to raise their interest charges to ‘control’ it.

This new credit went not into industrial investment in the UK, as Heath wanted, but into property speculation, the growth of so-called ‘secondary banks’ (licensed moneylenders) and the expansion of consumer debt.[7]      

‘The policy [C3] was a spectacular failure. When it was de facto abandoned in December 1973, the money supply had grown by 62 percent and Britain was enduring its worst banking crisis for over a century.’[8]

Giving the bankers freedom to lend caused this ‘secondary banking crisis’ and also made a significant but unmeasureable contribution to the great inflation of 1975-76.

The mystery is this: why did Callaghan in 1976 and Labour spokespersons ever since carry the can for the inflation of the Heath years? 


The 1976 agreement between the Labour government and the IMF required reductions in public spending— which caused the agonising in the Cabinet— but also state control of the private creation of credit: lending limits were reinstated. For the Conservatives in opposition in 1976-79 the conclusion that the bankers had to be reined in again could not be drawn. (Three leaders of the ‘monetarist’  faction, Margaret Thatcher, Geoffrey Howe and Nigel Lawson, were all working in the City: Thatcher and Howe as lawyers and Lawson as a journalist.) They avoided blaming the banks by talking not about credit formation, as per the IMF agreement, but about the money supply. These may sound similar but they have different political implications. ‘The money supply’ appealed to the ‘monetarist’ Conservatives because it shifted focus away from the banks, obviously; and because it included state spending, enabling them to blame inflation on Heath’s increased state borrowing and spending.

The Thatcher government’s 1979 White Paper ‘The Government’s Expenditure Plans 1979-81’ began with the statement: ‘Public expenditure is at the heart of Britain’s economic difficulties.’

Yet beneath the monetarist gloss the Thatcher government reinstated C3. ‘Controlling’ credit creation would once again be done by raising interest rates.

In Chancellor Geoffrey Howe's budget of 1980 exchange controls were scrapped and wealth began leaving the UK. Interest rates were raised to 17% to 'control the money supply' (and thus inflation, said the theory) and the value of the pound soared. The trade deficit, which the economy is still running, began in 1981 as the rising pound made British exports uncompetitive. Manufacturing began to shrink but clever people wrote articles arguing that we wouldn't miss it; we had North Sea oil, instead.[9]  Deindustrialisation was happening in America, too, and the idea was abroad that this loss of manufacturing was OK, that the UK and America were undergoing a natural economic progression: after industrialisation comes globalisation and financialisation. But beneath the theories, the reality in the UK was just the pre-WWII order: inflation is ‘cured’ by raising unemployment (the poor spend less and prices fall), so create a recession by raising interest rates. And the City gets rich? It’s a twofer!

In 1981 the Confederation of British Industry (CBI) director-general Sir Terence Beckett promised a ‘bare-knuckle fight’ with the Thatcher government over the destruction of British manufacturing. But his members had no stomach for such a fight, several large companies resigned from the CBI, and Beckett had to make his peace with Mrs. Thatcher, who ignored the CBI from then on.

In the mid-1980s the Labour Party, embedded in the domestic manufacturing economy, embraced the thesis that there was a conflict between the interests of the financial sector and those of the manufacturing economy, and even included it in the final report of its 1989 policy review. But by then the leadership was already walking away from it, afraid to take on the City and its dominance of its economic narrative.[10]  From then on, taking baby steps to avoid alerting the party’s members, Labour’s leadership embraced the theory that we didn’t need manufacturing in the UK, the future lay in services. ‘The knowledge economy’ was the formulation offered by the Blair government as it encouraged hundreds of thousands of barely literate school-leavers off to university rather than into the ever-shrinking manufacturing sector.

Labour’s embrace of the City climaxed with Gordon Brown's speech to the City of London in 2007, which began: 


and which spoke of ‘an era that history will record as the beginning of a new golden age for the City of London’.[11]  

A year later the bankers crashed the British economy again; only this time, much of the world having copied the financial deregulation pioneered during the Heath years, the British crash was part of a global collapse.  

Keynes-influenced economics didn't actually disappear: no chancellor since 1940 has actually believed in laissez faire and the withdrawal of the state. The rise of the City in the 1980s and '90s as an international financial centre, and the resulting decline of the domestic manufacturing economy; the internationalisation of capital of British origin after the abolition of exchange controls in 1980; UK membership of the EU and the World Trade Organisation—these are constraints on the actions of a domestically-oriented government; but only constraints, not prohibitions. Germany is also a member of the EU and WTO and has a state-economy structure which fosters its domestic economy.  The real constraints which Labour politicians believe themselves to be under come from the City. But what are they?

There is only one: the threat that the international bankers will leave the UK. The days are gone when politically-motivated actions—‘a run on the pound’—by groups of anti-Labour bankers can be mounted. The international currency markets care only about value and profit, though of Labour economic spokespersons in the last quarter of a century, only Bryan Gould in the Kinnock shadow cabinet seems to have grasped this. Gordon Brown and Alistair Darling, for example, both lived in a world in which something nasty was just around the corner if they challenged the City’s interests.

So, if the only threat is the City leaving, how significant is the City to the UK economy? There are no definitive figures. What we have are educated guesses that the financial sector as a whole is currently worth somewhere between 6 and 8% of UK GDP;[12] that this sector includes the domestic/retail banking/mortgages/insurance sectors which cannot leave and which constitute about half of it; and thus that the international sector, which might relocate abroad in the event of less favourable conditions in the UK, makes up about 3-4% of GDP. And some of the latter wouldn’t move. So let’s say 2-3% of GDP at most would be lost if the City's interests were seriously challenged by a British government. Why does this matter? Labour presided over a 5% of GDP decline in manufacturing during its period in office without noticeable anxiety.[13]  In effect, the international trading sector of the City is about as important as tourism to the British economy.[14]      

The central error that Labour leaders made was when, having decided after the 1987 election defeat that Labour had to be acceptable to ‘business’, they identified ‘business’ as the City despite domestic manufacturing then being about three times the size of the financial sector.[15]  The figures who created New Labour, the late John Smith, Tony Blair and Gordon Brown, did not meet with the representatives of the domestic economy: the Confederation of British Industry and chambers of commerce, say. Instead they embarked on a ‘prawn cocktail offensive’ in the City of London and attended the annual Bilderberg meeting, on whose steering committee John Smith sat from 1989-92 while in the shadow cabinet.

Why did they choose the relatively insignificant City over the domestic manufacturing economy in which many of their party’s members and supporters worked? We don’t know, but my guess would be that had they been asked they would have given the financial sector a greatly exaggerated significance. In 1994, in the early days of New Labour’s embrace of the financial services sector, the Guardian reported that the financial sector ‘now generated one fifth of Britain’s national income’. Somewhat startled—a fifth?—I asked one of the journalists concerned about the figures and was referred to Labour’s then City spokesman, Alistair Darling, as the source. His office quoted the 1994 Central Statistical Office Blue Book (UK National Accounts) to the effect that ‘net income generated by financial intermediation, real estate, renting and business activities’ amounted to 18.5% of GDP. But 18.5% is not ‘one fifth’; and that 18.5% includes activities a good deal wider than those meant by ‘the financial sector’ or ‘the City’.  In 1996 Darling’s successor as Shadow Economic Minister with responsibility for City affairs, Mike O’Brien, was quoted as saying that the City—not the more complex category offered by Darling’s office—produced 18% of British GDP. But two years later, British Invisibles, the PR face of the City at the time, announced that the financial services sector—the City plus the domestic sector—‘accounts for 7% of the British economy’.[16]

The annual survey of tax paid by the financial services sector done by accountants PriceWaterhouseCooper for the City of London Corporation estimated:

‘...that for 2010 the financial sector as a whole made a Total Tax Contribution of £53.4 billion, which is 11.2% of total government tax receipts, from all taxes, for that year.’[17]

This is down from 12.1% in 2009, according to the same source.

Even if we assume that the figure is an accurate estimate (and it has been challenged)[18] about half of that is the domestic banking sector, so ‘the City’, the global hub, contributes about 6% of total taxation.

The depressing conclusion is that Labour’s financial spokespersons didn’t know what they were talking about. But it was the early 1990s; the New Labour people were infatuated with the Clinton Democrats who seemed to have found the way to win (i.e. back financialisation and globalisation) and they were determined to distinguish themselves from ‘old Labour’ and its vote-losing trade unions. So they plumped for the City for political reasons: because they believed (wrongly) it had to be placated; and having made that decision they didn’t ever bother to get any serious data.  And no wonder: the data about the British economy would have shown that they were making the wrong decision, as they have belatedly acknowledged after the crash of 2008-09.

This article is part of NLP’s series, Left Politics in an International Economy.

Robin Ramsay is the editor of Lobster magazine. He is the author, most recently, of 'Well, how did we get here? A brief history of the British economy, minus the wishful thinking'.

[1] Which had been created after WWII by a delegation from the TUC.

[2] The decade of debate about British economic failure between 1955-65 had frequently concluded that they did it better on the continent.

[3] 'UK inflation since 1948,' Guardian Datablog, 9 Mar 2009.

[4] John Campbell, Edward Heath (London: Cape, 1993), p. 44.  The committee was concealed from the free market faction in the Conservative Party, which wanted less state interference in the economy, not more.

[5] Geoffrey Howe quoted in ed. Michael Kandiah, "The Heath Government: a Witness Seminar," Contemporary Record, Vol. 9, No. 1, 1995, p. 199.

[6] Michael Moran, The Politics of Banking (London: Macmillan, 1986), p. 396.

[7] C3 is omitted from Heath’s memoir and I think he was persuaded to agree to something without understanding its implications.

[9] Samuel Brittan, for example, had a piece in the Financial Times, 3 Jul 1980, titled ‘Deindustrialisation is good for the UK’.

[10] Discussed at length in Robin Ramsay, 'The Two Goulds', Lobster 63. How the City, then about 3% of the UK GDP, came to control the British economic agenda is one of the central issues of our time.

[11] Speech at the Lord Mayor’s Banquet, Mansion House, London, 20 Jun 2007.

[12] At its peak, before the 2008 crash, it might have a bit bigger than that. Jeremy Warner, associate editor of the Telegraph, suggested 6% in his ‘If the euro goes up in smoke over the next year, then one thing is certain; it’ll be the City that is held responsible’, Daily Telegraph, 17 Nov 2011.

[13] ‘Manufacturing accounted for more than 20 per cent of the economy in 1997, when Labour came to power critical of the country having too narrow an industrial base. But by 2007, that share had declined to 12.4 per cent.’ Chris Giles, ‘Manufacturing fades under Labour’, Financial Times, 2 Dec 2009.

[14] Because the financial sector is highly paid, the international trading sector of the financial services contributes about—another guess—6% of taxes to the exchequer. This is discussed in Robin Ramsay, 'Back from the brink', Lobster 62.

[15] This is a guess based on the fact that at the time of the 2008 financial crash the economic commentariat woke up with a start to discover that manufacturing was around 13%, twice the size of the financial sector. Twenty years earlier it was around 20%. See note 13 above.

[16] Reported in a piece by Mark Milner in the Guardian, 7 Mar 1998.

[18] See ‘City State against national settlement: UK economic policy and politics after the financial crisis’, CRESC Working Paper Series, Working Paper No. 101, Jun 2011. The authors argue that the true figure is about half of this.


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First published: 15 December, 2012

Category: Economy, History, Politics

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