British politicians have been brought up on the assumption that elections are won or lost on economics, and for most of the 20th century they have been broadly right. But the 2005 general election will not be determined by economics.
Ever since detailed polling data on the political salience of individual issues started being tabulated by Mori in the early 1970s, economic problems—unemployment, inflation, trade unions, interest rates or taxes—have normally topped the list of voters' concerns. For almost the whole of this period, one or other of these items (usually inflation or unemployment) has been identified by more than 70 per cent of voters as "one of the most important issues facing Britain today." Today there is no economic issue that excites more than 14 per cent.
Why has economics lost its sway over British voters? Partly, of course, because the economy has performed rather well, reducing to irrelevance many of the previous worries about inflation, unemployment and strikes. Gordon Brown understandably tries to claim credit for this economic transformation, while the Tories say that what turned the tide was the years of Thatcherism, followed by the demand management reforms introduced by Norman Lamont and Kenneth Clarke after Black Wednesday. But rather than continuing this argument—for the truth is that Britain's economic renaissance reflected a fortunate combination of Thatcherite supply-side reform with skilfully activist demand management under both Tory and Labour governments from 1992 onwards—it is worth considering some deeper reasons for the declining political salience of economics, not only in Britain but throughout the affluent world.
With the benefit of hindsight, we can see that the slogan which famously won Bill Clinton the 1992 US presidential election—"It's the economy, stupid"—marked the zenith of the political ascendancy of economics. While conventional wisdom still holds that Americans ejected the first President Bush in November 1992 because they were smarting from the after-effects of a mild recession, this kind of naive economic determinism had already been refuted in Britain. In April, John Major had been re-elected in the midst of the longest and most painful economic downturn in a generation. Back then, economic determinists could still defend their position by claiming that Major did not really win the 1992 election; it was John Smith who lost it, by threatening to increase by half the marginal tax rate on upper middle-class voters. Since the mid-1990s, however, the idea of economics as the dominant factor in British, American or European elections has become untenable, as in country after country economic and electoral performance have diverged.
The waning power of economics to decide elections since 1992 is first and foremost a function of the worldwide ideological transformation that began in 1989. This was the moment when the only alternative economic model to modern capitalism disappeared. The end of communism and the rottenness revealed in the heart of every communist regime destroyed the last remaining hopes among socialists of creating an economic system that was fundamentally different from capitalism. Of course, politicians could continue to disagree over differences in taxation or public finance, but it was almost impossible for any serious politician to question the bedrock principles of the capitalist economy: private ownership, competition and the profit motive.
At the same time as the only theoretical alternative to capitalism was self-destructing, another very practical change was happening in the nature of capitalism itself. From its earliest days, the political hegemony of capitalism had been marred by a seemingly incurable flaw—the booms and busts which seemed to get wilder and more unpredictable with each economic cycle. Today, this Achilles heel of the capitalist system, if not quite eliminated, seems to have been safely bandaged up.
The fact that Britain has been enjoying one of its longest ever periods of uninterrupted growth reflects not only the good husbandry of the Labour government and the competence of the Bank of England, but also some profound changes in the nature of market economics in the world as a whole.
The clearest reason for Britain's unaccustomed economic stability is the new approach to the management of fluctuations in demand and employment, which has been seen as the core problem of macroeconomics since Keynes wrote his General Theory in 1936. This new approach to demand management was led by the US and Britain, but has now become a worldwide trend. Only continental Europe is still moving in the opposite direction because of the institutional rigidities built into the eurozone.
Based on a long overdue synthesis between the monetarist obsession with stable prices and the Keynesian preoccupation with growth and employment, the new approach to demand management has kept the US and British economies very close to full employment and their long-term paths of growth trend. After decades of unproductive debate between Keynesians, who believed that business cycles could only be tamed with stimulative public spending, and monetarists, who insisted that using government borrowing to boost the economy would only produce inflation, it turned out that both sides were right—and wrong. A synthesis has emerged, in which active demand management plays a crucial role in stabilising the business cycle and sustaining growth, but in contrast to the old Keynesian approach, this stabilisation is performed by manipulating interest rates instead of public borrowing and spending. Moreover, the responsibility for managing demand now falls on an independent central bank.
This new neo-Keynesian or post-monetarist approach to demand management has been the proximate cause of the remarkable growth and stability enjoyed by the British economy since the mid-1990s, but the new methods could not have been attempted before several anterior conditions were satisfied. The use of monetary policy for demand management only became possible after the trauma of Black Wednesday ended a century of treasury obsession with "defending" the level of sterling. Even more fundamentally, the neo-Keynesian objective of keeping the economy permanently on its long-term growth trend was symbiotically linked with the Thatcher reforms of the 1980s. Without the anti-union legislation and deregulation of the 1980s, the use of low interest rates to maintain economic growth would simply have created inflation, as it did in the 1960s and 1970s. It was only when the demand management reforms of the mid-1990s were combined with the supply-side reforms of the 1980s that their combined benefits became clear.
A good reason for confidence in Britain's continuing economic stability is that both major parties seem to be committed to the key elements of this policy symbiosis—politically independent demand management through the Bank of England, prudent control of the public finances, labour market deregulation, a floating exchange rate and stable, moderate tax rates.
Beyond the new activism in demand management, there are several other deep changes in the nature of modern capitalism which mean that the great boom-bust cycles of the 1970s and 1980s are unlikely to recur, whichever party is returned to power.
In the past 20 years, the British economy has undergone three great structural transformations which have made it inherently more stable than it was in the past. The most important is the shrinkage of Britain's manufacturing sector, which now accounts for just 12 per cent of total employment, compared with 28 per cent in 1979 and 17 per cent when Labour came to power in 1997. These manufacturing cutbacks have been painful and politically unpopular, especially among Labour voters. The good news, however, is that the shrinkage of manufacturing has made the British economy more stable.
Manufacturing businesses are naturally much more prone to cyclical fluctuations than service providers because they need to hold physical stocks of products and to invest in additional machines when they want to boost production. Because they must hold large stocks of finished goods, manufacturers must cut back production much more drastically than service providers whenever their sales decline. Cutbacks in one factory's output ripple rapidly through the system because of cancelled orders for components and new machines. The capital goods manufacturers, who sell machinery to other factories, are doubly prone to demand fluctuations because their orders depend not just on the level of other manufacturers' orders but on their rate of growth. Indeed, inventory and investment fluctuations have long been recognised as the main causes of classic business cycles. A service-based economy, which does not hold stocks of haircuts, insurance policies and legal contracts, is much less likely to experience big fluctuations in output and employment as a result of quite small changes in demand.
The shrinkage of manufacturing has also contributed to economic stability in another, more subtle, way. Since the traumatic shake-outs of the Thatcher period, Britain has gradually pulled out of many economic activities, such as textile production, steel-making and low-tech component assembly, which are now subject to intense global competition. Britain, as a result of abandoning production of relatively low-value manufacturing goods whose prices are falling while specialising in service activities whose international prices are rising, has enjoyed a huge gain in its terms of trade. This has been reflected in the strength of sterling and the rapid rise of Britain's GDP per head relative to the rest of Europe.
There is another powerful trend in the structure of global capitalism that has benefited many British companies. This process has been described by Charles Gave, a French economist, as the birth of a new business model, the "platform company." Platform companies are a hybrid of manufacturers, retailers and service providers, who do not seem to produce anything anywhere yet sell everywhere. These companies know where their clients are, and they know where to source their goods at the lowest cost. They keep for themselves the high added-value parts of their products—marketing, development and research—and farm out all the rest to external producers. Prime examples of platform companies are Dell in computing, Ikea in furniture and Wal-Mart in consumer goods. Other manufacturing businesses, ranging from cars and electronics to food and pharmaceuticals, are rapidly adopting the platform concept.
British manufacturing companies have been forced to outsource aggressively because of competition and the strength of sterling—and they have been able to do so because of the relative weakness of British trade unions and employment regulations. As a result of this outsourcing, much of the instability in what was left of Britain's manufacturing sector—and significant parts of the service sector as well—has been exported to other countries, especially in Asia and the low-cost periphery of Europe. In a sense, economic volatility has been one of Britain's few successful manufacturing exports.
Exporting volatility has not been a cost-free option. Not only has the loss of manufacturing jobs created misery and dislocation in some parts of the country, it has also arguably damaged the economy's long-term growth potential because manufacturing activities are more susceptible to automation than services and are naturally the first to embody technological progress. Manufacturing therefore tends to generate rapid productivity growth.
On balance, however, the increased stability produced by macroeconomic reform and industrial change has been a major boon to the economy. But as economic stability has become an established fact of life in modern Britain, voters are naturally less grateful to the politicians who try to take credit for its achievement—and less susceptible to warnings about the economic disasters that lie in store if they vote for the "other lot."
