Devaluation and Pricing Decisions

A Case Study Approach

Douglas Hague, W. E. F. Oakeshott, A. A. Strain

• Éditeur: Routledge
• Année: 2022
• ISBN:
  9781000534160
• Édition: 1
• Sujet: Business
• Sous-sujet: Governmental Accounting

First published in 1974, Devaluation and Pricing Decisions is based on case studies of the export pricing decisions made by nineteen major British companies after the 1967 devaluation.The aim was to look in detail at the decisions that major British firms took after devaluation and to see how they had responded to this major change in government policy. This book shows how far the firms had anticipated the devaluation; what company objectives were at that time and what changes in these objectives, or in pricing and marketing policies, were made to take advantage of new opportunities for exporting and for import substitution. The researchers also examined the actual process of decision making to find what information was available to the decision makers and how they used it.

The book is directed to businessmen taking decisions on export prices and marketing in the world of today where foreign exchange rates change frequently. It is also directed towards those responsible for shaping national economic policy. For students of economics, it represents a study showing, in considerable detail, how a number of businesses responded to the 1967 devaluation.

Part I

DOI: 10.4324/9781003261032-1

CHAPTER 1 Introduction

DOI: 10.4324/9781003261032-2

At 9.30 p.m. on Saturday 18 November 1967, the Chancellor of the Exchequer, Mr James Callaghan, announced the devaluation of sterling by 14·3% from $2·80 to £1. While the precise timing of this move may have come as a surprise, it was certainly not unexpected. Devaluation rumours had been growing stronger for some months, and economists and economic journalists had been forecasting, and indeed advocating, devaluation with steadily increasing enthusiasm since the major payments crisis in 1964. To remind readers of the situation at the time of devaluation, we shall first outline briefly the development of the balance of payments of the uk from 1964 to 1970.

1.1 The Background: 1964-67

1.1.1 THE PAYMENTS IMBALANCE: 1964-66

Even before 1960, Britain’s balance of payments had often been unhealthy, but the slowdown in the economy in 1961 and 1962 temporarily improved the position. As Table 1.1 shows, there was a current surplus of £122m in 1962. With relatively rapid growth of the GNP resuming in early 1963, the position on current account

TABLE 1.1 UK balance of payments 1962-70

Year	Visible exports	Visible imports	Visible balance	Invisible balance	Current balance
1962	+3993	-4095	-102	+224	+ 122
1963	+4282	-4362	- 80	+204	+ 124
1964	+4486	-5005	-519	+ 143	-376
1965	+4817	-5054	-237	+ 185	- 52
1966	+5182	-5255	- 73	+ 156	+ 83
1967	+5122	-5674	-552	+254	-298
1968	+6273	-6916	-643	+355	-288
1969	+7061	-7202	-141	+581	+440
1970	+7885	-7882	+ 3	+576	+579

Source: National Institute Economic Review, No. 58 (November 1971)

and on long-term capital account worsened sharply. While there was still a current account surplus of £124m in 1963, in 1964 the current deficit was £376m. During 1964, the combined deficit on the current and long-term capital accounts was running at an annual rate of nearly £800m. In addition, in the latter half of 1964 there was a dramatic outflow of short-term funds, due both to fears of devaluation and to the attractions of relatively high interest rates abroad. The Labour government which came into power in October 1964 decided not to devalue, but instead brought in a series of restrictive measures, the most controversial of which were the introduction of a tax rebate on export earnings equivalent to about 2% of their value, and the imposition of a temporary surcharge of 15% on all imports except of food and some raw materials. (This was reduced to 10% in April 1965 and removed in November 1966.) Despite these measures, which were reinforced by a moderately restrictive budget in November 1965, and a sharp rise in bank rate, heavy selling of sterling continued until the government announced, around the middle of November, that it had secured substantial foreign credits.

The balance of payments situation eased somewhat during the next two years. The import surcharge and the slowing-down of economic growth within the uk between them meant that the volume of visible imports did not rise in 1965 and rose by only 4% in 1966. Since the volume of exports rose by 6% in 1965 and 4% in 1966, the visible trade deficit fell in both years. As usual, the uk had a surplus on invisible trade, and the current balance improved to show a deficit of about £50m in 1965 and a surplus of about £80M in 1966. Nevertheless, there was continued nervousness among those who were in a position to take funds out of Britain. Their anxiety was not eased by the continuing increase in the domestic price level in the uk, or by the fact that the budgets of 1965 and 1966 were only mildly deflationary. By June 1966 it became clear that more drastic action was necessary if there was not to be a further run on sterling.

Confidence in Britain’s ability to maintain the sterling parity was low, and heavy selling of sterling took place through the early summer. At the same time, interest rates abroad were rising relative to those in the uk. In July 1966, therefore, the government introduced a series of measures designed to restrain demand in the uk and so to restore foreign confidence. Bank rate was increased, taxes were raised and a six-month standstill was decreed for wages and prices, to be followed by a period of ‘severe restraint’. Once again, large credits were obtained from abroad.

1.1.2 DEVELOPMENTS IN 1967

These measures were unsuccessful, though it is difficult to judge precisely why. It is true that the balance of payments actually went into surplus in the fourth quarter of 1966, but this was probably due to special factors, including the delayed effects of the seamen’s strike and a fall in imports as traders waited for the import surcharge to be ended towards the end of 1966. Nonetheless, this improvement was taken by the authorities to be the first sign of a more favourable trend, and the feeling spread that there would be a substantial surplus on the balance of payments in 1967. A modest degree of reflation was allowed, to counter uncomfortably high unemployment. Bank rate was reduced in three steps, each of 1/2%, in January, March and May 1967. The budget in April was neutral, with increases in expenditure roughly matched by increases in revenue. The situation did not seem to warrant more restriction.

However, the current balance deteriorated sharply in the first two quarters of 1967. For the year as a whole, the volume of visible imports was to fall by 7%, and the volume of exports to fall by 2%, but these two figures are misleading. They were affected by a dock strike. But there was a current deficit of about £300M in 1967.

It is not surprising that confidence in sterling remained weak. In March 1967 the authorities had to negotiate a large credit from the Bank for International Settlement in order to counter pressure on the reserves. The situation worsened considerably after the outbreak of the ‘Six-day’ Arab-Israeli war at the beginning of June and the closure of the Suez Canal. This delayed exports and increased the cost of some imports, especially fuel and raw materials. The unfavourable balance of payments deficit on current account was accompanied by a heavy outflow of short-term funds, attracted in part by higher interest rates abroad. Yet the authorities remained confident of achieving a surplus on the balance of payments, and the leading ‘unofficial’ forecaster, the National Institute of Economic and Social Research, in the August issue of its Economic Review, was still predicting a small current surplus for 1967 as a whole. The government felt able to continue the gentle domestic expansion which it saw as desirable, given the continued high level of unemployment. At the end of August, it made some small reductions in hire purchase restrictions.

The devaluation monetary crisis really got under way at the beginning of October 1967. Despite official optimism, rumours of devaluation had been growing stronger month by month and its possibility was being discussed, if not quite openly, at least in private. Confidence in the pound was badly damaged by an unfavourable report on the economic position of the uk, made by the International Monetary Fund at the beginning of September. A month later, the EEC Commission reported on the application for membership which the UK had made in May 1967. It severely criticised the British economic and financial situation, and implied that the current sterling exchange rate could not be sustained. Indeed, the British press reported that the Commission’s unofficial view was that a large devaluation of sterling would be a prerequisite for British entry to the EEC. With these comments, with a continuing trade deficit, and with relaxation of the hire purchase restrictions, the outflow of short-term funds reached crisis proportions at the end of September 1967.

Over the next week or two, several factors reinforced the devaluation rumours. On 12 October the Finnish mark was devalued by 32% in order to counteract the effect of Finland’s domestic inflation on its balance of payments. Combined with the weakness of sterling, this development unsettled the foreign exchange markets. On the next day, the influential London and Cambridge Economic Bulletin appeared in The Times. It forecast a continuing, and indeed increasing, deficit on the current balance of payments unless drastic action was taken. Then came the announcement that the reserves were at the lowest level since April 1965 and that the deficit on visible trade in September was the highest since the crisis month of July 1966. A few days later, the effects of a strike in the London docks were estimated to be equivalent to a reduction in exports of over £100M. On 19 October the Bank Rate was raised by 1/2% to 6%; ‘to defend the pound against rising interest rates abroad’. But this was much less than had been anticipated and there was further selling of sterling. By the end of the month, the Chancellor of the Exchequer felt obliged to state formally that sterling would not be devalued.

Heavy selling of sterling continued into November and by the first week of the month sterling was at its lowest price for a decade. It was obvious that the rise in Bank Rate had not stemmed the wave of speculation, and the financial press began to suggest that devaluation was almost certain within the next two or three weeks. Bank Rate was raised again on 9 November, but only by 1/2% because of the high level of unemployment. Once more, this increase was less than had been expected and heavy selling of sterling continued. On 13 November the Financial Times carried a report that the government was trying to negotiate yet another massive credit from the Bank for International Settlement, but it was soon rumoured that the loan would be made conditional on sterling being devalued. On 15 November a statement by the Treasury ruled out the use of import controls to reduce the pressure on sterling, which was seen as implying that devaluation was the only alternative. On the same day the Chancellor, speaking in the House of Commons, refused to confirm or deny the press rumours about the bis negotiations, or indeed to say anything specific about the crisis. This was taken by the City as an admission that immediate devaluation was being seriously contemplated, and a further wave of selling of sterling ensued. Finally, on 18 November devaluation was announced.

1.2 The Results of Devaluation

1.2.1 THE DEVALUATION PACKAGE

When devaluation came, there was little surprise. It is now known that for the previous fortnight Britain had been conducting secret negotiations with other major industrial countries in order to forestall a wave of retaliatory devaluations. As a result of these discussions, substantial credits were secured, but the Chancellor had to give an undertaking that strongly deflationary measures would be introduced within the uk. Indeed, domestic economic policy was to be kept under scrutiny for a time by the IMF.

In addition to devaluation, Bank Rate was raised to 8%, the export rebate was cancelled and the SET premium was withdrawn from all manufacturing activity outside the development areas. Increased restrictions on hire purchase and bank lending were announced, and it was explained that in the next budget Corporation tax would be increased from 40 to 42½% together with other unspecified deflationary measures. Initial cuts of £200M were to be made in government expenditure. A month later, on 19 December, a further review of government expenditure was begun. This resulted in further cuts, amounting to about £300M, being announced in the middle of January 1968. The Prices and Incomes Board was instructed to monitor price increases in the home market resulting from devaluation, in order to prevent profits rising. When the 1968 budget was introduced in March, the net increase in taxation amounted to £923M for a full year.

1.2.2 THE INITIAL REACTION

The initial reaction of most businessmen to devaluation was cautious. Much press comment argued that the deflationary measures accompanying devaluation would reduce the buoyancy of the home market, while any increase in exports would take a considerable time to materialise. This was certainly the view of the Confederation of British Industry, which sent out a newsletter couched in these terms to its members a few days after devaluation. There were also complaints from business that the removal of the export rebate would rob devaluation of much of its effectiveness. All the businessmen who gave press interviews confirmed that they would increase their export effort, though not necessarily through price reductions. A significant number of businessmen we interviewed in this study claimed that the general tenor of ministerial speeches was in favour of price cutting, though a study of the speeches themselves does not confirm this view. In his broadcast after devaluation, the Prime Minister claimed that it had been forced on Britain by foreign speculators, and that it was up to the British exporter now to show his mettle. However, while again some of those we interviewed claimed that Mr Wilson implied that cuts in export prices would be the most desirable response to devaluation, he certainly did not say so explicitly.

1.2.3 THE RESULTS OF DEVALUATION

In his Letter of Intent to the International Monetary Fund a few days after devaluation, the Chancellor of the Exchequer explained that the measures accompanying it were designed to secure an improvement in the balance of payments of about £500M per...