Input Price Shocks and the Slowdown in Economic Growth: The Case of U.K. Manufacturing

Abstract

This paper provides a theoretical and empirical analysis of the effects of input price shocks on economic growth, with a focus on United Kingdom manufacturing in the 1970s. The theoretical model predicts a discrete decline in output and productivity after an input price rise, and a longer-run slowdown in productivity growth, real wage growth, and capital accumulation. These features characterize the United Kingdom and most other OECD economies after 1973. The empirical results confirm the important role of input prices in recent U.K. adjustment, but also point to an important role for other supply and demand factors. Two types of explanations have been offered for the sharp deterioration in U.K. economic performance in the past decade, focusing respectively on demand and supply factors. A standard Keynesian view holds that macroeconomic demand management has been either too expansionary or too contractionary, and that rising unemployment and falling output reflect the burden of anti-inflationary policies. An alternative view holds that various supply shocks are the main source of the poor output performance. In this interpretation, higher raw material prices (particularly oil), competition from the newly-industrializing countries (NICs), and perhaps an independent decline in productivity growth, all have lowered output growth and raised unemployment.