Are we all Thatcherites?
Dear Nick,
How should we view the recent economic history of Britain? There is now a broad but unspoken consensus, encompassing many on the right and left, which runs as follows: whatever the excesses of Thatcherism, something had to be done about the unions; the reforms of the 1980s and 1990s have at least laid the ground for steady growth and declining unemployment. A new Labour administration should therefore pursue a "steady as it goes" course.
These views are variously wrong, missing the point and complacent. First, some facts. Despite the benefits of North Sea oil and the unsustainable Lawson boom, GDP grew at a rate of only 2.4 per cent between the peak years of 1979 and 1989. The effects of Thatcherite economic policy were particularly damaging on the manufacturing sector. Over 1979-89, Britain's manufacturing output grew by a total of only 15 per cent-an average growth rate of barely 1 per cent a year.
Certainly, manufacturing productivity grew in the 1980s, but our productivity levels still lag the other leading industrial countries and any improvement was largely due to job cuts rather than increased output. Part of the increased output per person was actually due to a one-off increase in labour inputs per person through increased production-line speeds, reduced break times and so on, which is not acknowledged in the official productivity calculations.
And what productivity growth there was went mainly into increased profits rather than the reduced prices which could have increased market share, employment and exports. The increased profits themselves went disproportionately into dividend payments rather than investment.
True, the investment record of manufacturing in Britain had been relatively poor for decades; but it became even worse after 1979. It is a major cause of Britain's indifferent growth performance, constraining technological progress and the expansion of demand. The cumulative effect of this record is that British workers lack the plant and machinery used in other leading industrial countries. If Britain is to compete effectively with them this investment shortfall will have to be reversed. Some have suggested Singapore-style compulsory saving as a potential "big idea" for Tony Blair. But what is really needed is compulsory investment.
Turning to macroeconomic policy since 1979, this has encouraged an overvalued exchange rate and high interest rates. Erratic monetary policy discouraged investment and business confidence. This was particularly apparent during the early 1980s when high interest rates and an overvalued currency created cash flow problems for companies, often leading to bankruptcy.
Meanwhile, industrial policy has been ineffectual, with little attempt to use the public sector as a modernising force. The attack on trade unions has been at best an irrelevance, and by encouraging a "hire and fire" mentality has exacerbated short-term behaviour. The increased inequality which has resulted from these policies has also proved a costly social burden.
Yours,
Michael Kitson and
Jonathan Michie
28th February 1997
Dear michael and Jonathan,
Your letter came as a surprise since views of this kind have now generally been discarded. Your heavy emphasis on manufacturing and physical investment strikes me both as very "Old Labour" and as harking back to the growth theory of 25 years ago. There are much better ways to attack the Thatcherite record. Your failure to complain about the government's record on education and training surprises me, as does your only passing mention of the growth in inequality which some might feel is too high a price to pay for economic modernisation.
The mainstream view that long run growth performance has improved is soundly based. Economic growth has improved relative to Britain's peer group of countries, and the current outlook compares well with most of those countries. And it is axiomatic that the growth experienced has been better than would have resulted from carrying on with 1970s policies.
This does not imply that Britain has experienced a miracle or that there have not been important errors in economic policy, but simply that economic decline relative to Europe has ceased and that the government deserves some credit for this. Incidentally, the growth rate of GDP before the inclusion of North Sea oil output is almost the same as total GDP since 1979 so the oil does not account for any improvement in that period.
There have been positive aspects of the government's record, none of which you mention. First, the improvement in industrial relations has encouraged investment and innovation. Second, privatisation and deregulation, although mishandled in some ways, has led to better investment decisions and has raised productivity. Third, the tax system requires further adjustment, but it is a vast improvement on the ridiculous distortions of the 1970s. The record also shows that the quality of investment as reflected in the output to capital ratio is higher, and that while Britain was 15th in the OECD total factor productivity league table for 1973-79, it had jumped to 5th for 1979-95. Not surprisingly, New Labour does not plan to reverse any of these reforms.
Your emphasis on manufacturing output and investment is misplaced. Two points stand out. First, since about 80 per cent of employment is now outside manufacturing, improving productivity performance there must be the key to future British growth. Second, the case for intervention is much stronger with regard to human capital than for physical investment. Moreover, if you do care about investment so much, it seems perverse to complain about the small improvement in the rate of return since the 1970s because, even now, it is still the lowest in the G7.
Your view of the growth process seems rooted in an old-fashioned "capital-fundamentalist" framework and is out of sympathy with modern views which emphasise the importance for growth of the capacity to innovate. (The Singaporeans are deeply worried that their future prospects will be jeopardised by their weakness in innovation and low total factor productivity growth.) Your suggestion that the government should make investment compulsory would surely seem bizarre even to capital-fundamentalists and is not feasible in an open economy.
We are, however, in sympathy on one point: that macroeconomic policy has been conducted in a damaging fashion during the past 18 years. Either of the two obvious ways forward-enter Emu or stay out but make the Bank of England independent-would seem preferable to the status quo. Nevertheless, it is supply-side policy which matters most for growth and, regrettable though these monetary and exchange rate policy failings have been, they must not detract from those supply-side improvements.
Best wishes,
Nick Crafts
1st March 1997
Dear nick,
You cite three positive aspects of the government's record since 1979: improved industrial relations; privatisation; and a reformed tax system. It is true that strike levels in the 1980s and 1990s have been far lower than in the 1960s and 1970s. But this has been true internationally. The main reason has been widespread unemployment. The anti-trade union legislation in Britain which has encouraged more macho management methods has also reduced pressure for improved managerial efficiency, better training, new investment, and other means of enhancing productivity. These should be the means for reducing unit labour costs, but are actively discouraged when companies can so easily reduce wages and worsen working conditions.
Second, privatisation has led to "cream skimming," and a huge increase in regulation. The ban on British Telecom offering cable television through its network-a sector where we held a technological lead-means that most of Britain's cable television industry is now in American hands. Recent OECD research comparing G7 countries found Britain to have the best productivity performance in only two sectors of the economy: the nationalised post and railways. Whether this will survive their privatisation remains to be seen.
Third, governments since 1979 have exacerbated the socially regressive effects of their labour market policies by their tax and welfare policies. The elimination of higher tax brackets, the switch to indirect taxation and increases in national insurance have favoured the rich. Meanwhile, the least well off have been hit by the elimination of the earnings related elements from unemployment and sickness pay, and by restrictions on eligibility for out-of-work benefits.
Best wishes,
Michael and Jonathan
3rd March 1997
Dear Michael and Jonathan,
Perhaps it is time to face the facts. You seem reluctant to acknowledge the gains from escaping the 1970s nightmare, yet the evidence is clear. As my daughters would say: "Get real!"
The abysmal return on investment in nationalised industries is well known and it must surely be welcomed that their share of industrial investment has fallen to about 5 per cent from nearly 40 per cent in the early 1980s. Your own colleagues in Cambridge have estimated that the net benefits of privatising the electricity industry were equivalent to a cost saving of 5 per cent forever. Certainly, mistakes were made but the overall success of the privatisation programme has led to its imitation abroad.
Similarly, industrial relations specialists talk of a "transformation" which has been shown to account for a substantial part of the reduction in the manufacturing productivity gap with Europe during the 1980s. Do you really think that this was irrelevant to the regeneration of the car industry? Do you honestly believe that this would have happened under Old Labour?
In the 1960s and 1970s the top rate of income tax was 83 per cent and the share of public spending in GDP rose rapidly to over 40 per cent. Since 1979 the top rate of income tax has been reduced to 40 per cent and public spending share has been held back in contrast to Europe, where it has continued to rise to 50 per cent or more. Econometric analysis indicates that the lower taxes implied by bucking this trend is likely to have improved growth by perhaps about 1 per cent per year.
It is fine for you to argue that in your judgement the Thatcher experiment was not worth it because the benefits in terms of growth were not worth the costs in terms of inequality. But, at the same time, it would be nice to see you acknowledge that British economic decline relative to Europe has not continued as if we were still in the 1970s and to accept, as New Labour has done, that supply-side reform since then has improved growth prospects.
Yours hopefully,
Nick Crafts
6th March 1997
Dear Nick,
Whenever the Tory party political broadcasts run out of things to say, out come the old clips of the 1970s -the winter of discontent, rubbish uncollected, the dead unburied, "Labour isn't working." You seem obsessed with the 1970s and with what you call "Old Labour"-and our supposed support for both.
You admit that Thatcherite policies increased inequality. But you do not say whether you think this was a price worth paying. We do not accept that increased inequality has improved growth prospects. The policies which have been pursued since 1979 to engineer the huge increase in the absolute and relative wealth of the rich have made the economy short-term in outlook, unstable in economic performance, and weaker in productive capacity.
The long-standing balance of payments constraint on Britain's growth was only relieved in the 1980s by North Sea oil-although even so the Lawson boom managed to bring about a large overall trading deficit. As the benefit of North Sea oil runs out, the longterm damage of deindustrialisation since 1979 will become only too painfully apparent.
It was the North Sea oil revenues-along with privatisation receipts-which allowed the post-1979 government to cut taxes for the rich. Not even New Labour will be able to prevent these two sources of revenue from drying up. The question is: what will replace this Thatcherite agenda? We appear to agree that under New Labour the answer is "not a lot." Aside from the odd reference to post neoclassical endogenous growth theory, New Labour's economic thinking demonstrates little that is new and plenty that is reminiscent of the pre-1930s Treasury orthodoxy. Having embraced Thatcherism, New Labour is neither New nor Labour.
Best wishes,
Michael and Jonathan
8th March 1997
Dear Michael and Jonathan,
You seem to be confused on why I disapprove of the economic policies of the 1970s. In terms of the accelerating relative economic decline we saw in the postwar years, the problems lay primarily with supply-side policy. That means failures were to be found in poor industrial relations, the structure of taxation, the misconceived enthusiasms for picking winners and the runaway growth of public expenditure. Dealing with those problems required ending the trade unions' policy veto, not merely adopting a particular style of macroeconomic management.
It would also be nice if you could get North Sea oil in perspective. Since the mid-1980s fall in the oil price its fiscal importance has greatly diminished: petroleum revenue tax brought in ?7.4 bn in 1985, in 1995 it was only ?0.8 bn. Taken together with privatisation proceeds this adds up to the equivalent of say 3p on the standard rate of income tax.
You ask whether the increase in inequality resulting from the Thatcher years was acceptable in my view. I believe it was, for two main reasons. First, the conventional estimates based on income overstate the change; the distribution of consumer expenditure as opposed to income has changed far less. Second, there has been a real pay-off in terms of a modest improvement in long run growth prospects. You do not accept this last point, because your assessment of future growth is based on an obsession with a shortfall in a certain type of investment whereas mine derives from an emphasis on incentives and productivity performance as the key to long run growth.
Optimistically yours,
Nick Crafts
