Primarily under the influence of Keynes, but also of socialism, the emphasis during these years was on the ability of government to improve economic conditions by direct and constant intervention. It was held that the state, if its huge powers were directed in an enlightened manner, could break free of the constraints and limits which applied to the lives of individuals, families or businesses. In particular, whereas a household which spent beyond its income was on the road to ruin, this was (according to the new economics) for states the path to prosperity and full employment. Of course, matters were never expressed quite so crudely. Government deficits, for example, were intended to be ‘counter-cyclical’ — that is to compensate for the effects of recession — rather than open-ended. Lip-service was paid to the need to avoid setting welfare benefits at levels which discouraged work. But behind all this was an almost universally held view that government spending was both morally and practically preferable to private spending, because it was directed to higher and more rationally established objectives. Before I ever read a page of Milton Friedman or Alan Walters, I just knew that these assertions could not be true. Thrift was a virtue and profligacy a vice; and the world would not make sense if the laws of human behaviour could be suspended by political fiat. Perhaps the single greatest change which occurred over the years in which I was Leader of the Opposition and then Prime Minister was that the great majority of policy-makers (and even economists) came round to the view which I held.
There is now a general understanding that the effect of increasing government borrowing is to raise interest rates higher than they would otherwise be. This is particularly so if it is expected that the larger deficit will raise future money supply growth and so inflation. In this way, allowing budget deficits to swell arrests rather than accelerates economic growth. The 1981 Budget, which I have described elsewhere, was based on understanding of that truth.[103] The 364 economists who published a statement attacking the strategy we adopted had no doubt that it represented a direct challenge to the prevailing orthodoxy. The challenge succeeded. Economic recovery was heralded by figures in the summer of 1981 and confirmed by others in the following quarter; by 1983 economic conditions were so buoyant that, along with reaction to the successful outcome of the Falklands War, they ensured me my smoothest general election victory.
As with government borrowing, so with inflation. After decades during which governments fine-tuned the economy on the assumption that there was a ‘trade-off’ between inflation and unemployment — the so-called Phillips Curve — it is now widely agreed that in the long run it is micro-economic changes, affecting the structure of the economy — for example, deregulation — rather than macro-economic manipulation, which determines the number of jobs. And hardly anyone now professes to believe that ‘some’ inflation is economically desirable. For whereas in the past governments thought they were sufficiently clever and wage bargainers sufficiently stupid for the former to reduce the latter’s real remuneration by inflation, we now know that the boot has for years been on the other foot. Not only was future inflation discounted by wage bargainers — they frequently overestimated it and increased their demands accordingly. As a result, competitiveness was worsened, not assisted, by the so-called ‘money illusion’. Worse still, those inflationary expectations are immensely difficult to remove from the system, which is why the benefits of low inflation take many years fully to come through.
The great advantage I had over many of my contemporaries in politics was that whereas they had first to be persuaded of the theoretical advantages of monetarism, free trade and deregulation, the technical arguments and insights were so completely in harmony with my fundamental instincts and early experience that I was much more easily convinced — and my convictions helped me to convince others.
BRITAIN IN THE 1980s
As Prime Minister between 1979 and 1990 I had the opportunity to put these convictions into effect in economic policy — and I was fortunate to have three extremely able Chancellors of the Exchequer, Geoffrey Howe, Nigel Lawson and John Major, to assist me. We intended policy in the 1980s to be directed towards fundamentally different goals from those of most of the post-war era. We believed that since jobs (in a free society) did not depend on government but upon satisfying customers, there was no point in setting targets for ‘full’ employment. Instead, government should create the right framework of sound money, low taxes, light regulation and flexible markets (including labour markets) to allow prosperity and employment to grow.
As for government finances, there was, it is true, some limited continuity with the period before 1979. The Labour Chancellor Denis Healey’s £6 billion real cut in public spending between 1976/77 and 1977/78 the terms of the agreement with the IMF in December 1976 which marked the first overt use of monetary targets to guide policy, were significant steps towards the kind of approach in which I believed. But they were implemented from necessity rather than conviction and would have been jettisoned at the first available opportunity. Indeed, that jettisoning had already begun, as public spending was allowed to rise again in Labour’s final year. Moreover, the sound elements of policy pursued under IMF tutelage were not combined with the other crucial, complementary aspects — substantial cuts in marginal income tax rates, reform of trade union law, privatization and deregulation. They were, therefore, only half the remedy, for the vital ingredient of promoting enterprise was missing.
I came into 10 Downing Street with an overall conception of how to put Britain’s economy right, rather than a detailed plan: progress in different areas would depend on circumstances, both economic and political. For example, the priority in our first Budget was cuts in income tax — both because marginal rates, particularly on those with higher incomes, had become a deterrent to work and an incentive to migrate, and because we had made such a firm pledge in our manifesto. But when political and economic imperatives pointed in opposing directions it was the economic requirements which came first — as when we put up personal taxes in order to control the deficit and beat inflation in that unpopular but crucial 1981 Budget.
The economic strategy had four complementary elements. First, in time and in importance, was the fight against inflation. Inflation had become deeply rooted in the British political and economic system and in British psychology. It had risen to successively higher peaks in the post-war years and had, as I have described, come perilously close to hyper-inflation in 1975. As a result, it was all the more difficult to eliminate. Only a sustained policy to reduce monetary growth and change expectations would suffice. So from 1980 onwards monetary policy, supported by a fiscal policy which reduced government borrowing, was conducted within the framework of a Medium Term Financial Strategy (MTFS). Like any strategy worth the name it had to adapt to circumstances. When, for example, problems arose with one particular monetary aggregate as a measure of monetary policy, it was necessary to look to others as well. Again, like any strategy, it did not of itself remove the risk of error. But it limited the scope for such errors and, as it was adhered to in passing years and in spite of difficulties, it gained a credibility which itself inspired wider economic confidence. Between 1981 and 1986, when the MTFS was most consistently at the heart of policy, inflation was brought down from a high point of 21.9 per cent (May 1980) to a low of 2.4 per cent (summer 1986). During the mid-1980s it averaged around 5 per cent, until the shadowing of the Deutschmark in 1987–88, to which I was opposed, set off a sharp increase.[104] It rose rapidly until it peaked at 10.9 per cent in October 1990. It had begun to fall the month I left office, and it came down rapidly during 1991, by which time the high interest rates of 1988–90 had brought monetary growth under control once more. The assessment of domestic monetary conditions remained the final determinant of policy on inflation until I left office.
A month beforehand, however, the MTFS was supplemented by sterling’s membership of the Exchange Rate Mechanism of the EMS. This was intended to demonstrate to the financial markets that our commitment to low
inflation was unshakeable. But then maintenance of a parity within the ERM became an end in itself, as the ERM became both a more rigid system and a conveyor belt towards a single currency. This led to a monetary overkill which certainly brought inflation down very rapidly, but at the price of inflicting an unduly severe recession in the British economy. In the end, the policy proved unsustainable and Britain had to leave the ERM.
Since then the Government has pursued a prudent policy to keep down inflation by a return to a sort of domestic monetarism. This is a tribute to the importance which the Government rightly gives to getting as near as possible to price stability. The need now is to re-establish a credible framework much on the lines of the original MTFS, which will be a permanent damper on inflationary expectations. That should not involve sterling’s rejoining even a reformed ERM, since the markets know full well that what you have left once you can leave again. Nor should it entail giving new autonomy to the Bank of England. Ultimately, it is politicians who must be accountable for economic policy. But they have to learn from the mistakes of the past, so that they and their successors are not condemned to repeat them.
The second priority in the 1980s was to bring Britain’s public finances under control. In 1975/76 public sector borrowing as a share of GDP had reached 9.25 per cent. Under the impact of the IMF measures, the Labour Government reined it back, though it had started to grow again by the time of the 1979 election when it was over 5 per cent of GDP at the high point of the economic cycle. The 1981 Budget established a firm grip on public borrowing, which never loosened while I was Prime Minister. Between 1987/88 and 1990/91 we actually repaid £27,000 million of debt, reducing government debt as a proportion of national income to a level not seen since before the First World War. As for public spending, though the deep recession of 1980/81 pushed it up as more people became unemployed and government revenues fell, we reversed the previous long-term trend. Public spending as a share of GDP fell steadily between 1982/83 and 1988/89, when it reached a low point of 39.25 per cent. In 1989/90 and 1990/91 the proportion crept back up by 1 per cent, to 40.25 per cent — partly because of a massive overspend by local authorities (which knew that they could put the blame on the Community Charge), partly to ease the way for the NHS reforms introduced in 1990, and partly because the economy was moving into recession. Over the whole period, however, public spending as a share of GDP fell from 42.6 per cent in 1979 to 40.25 per cent in 1990.
The firm grip on public expenditure over these years also allowed tax cuts. Geoffrey Howe’s 1979 Budget cut the basic rate of income tax from 33 per cent to 30 per cent, shifting the balance from direct to indirect tax. The top rates of income tax were cut from 83 per cent to 60 per cent and from 98 per cent to 75 per cent on investment income. Nigel Lawson’s 1984 Budget made the fundamental changes in corporate taxation, cutting both capital allowances and corporation tax rates so as to encourage more efficient use of business investment. Nigel’s 1988 Budget completed the programme of income tax reduction, bringing down the higher rate to 40 per cent (for savings income as well as earnings) and the basic rate to 25 per cent. Sound public finances and low marginal tax rates were the goals in the 1980s: and they were achieved. Shortly after I left office, decisions were taken which led to large increases in public expenditure: in particular, the uprating of Child Benefit and extra money for the NHS, transport and local authorities. Combined with the recession, deepened as a result of sterling’s overvaluation in the ERM, this increase in public expenditure has also led to a succession of large budget deficits — peaking in 1993/94 at £45,000 million, over 7 per cent of GDP — and tax increases amounting to over 2 per cent of GDP. Clearly, the sooner both of these can be reversed the better: that will require keeping a stronger hold on public spending and judicious use of the most useful monosyllable in a Prime Minister’s vocabulary, ‘no’.
Public Expenditure 1974/5 to 1994/5
Some of the ground won in the 1980s has been ceded to the spending lobbies, but the significance of that decade’s rigorous public expenditure control has not diminished. Because we controlled public expenditure effectively in the 1980s — particularly by linking the basic retirement pension and other long-term benefits to prices rather than incomes and by scaling back the State Earnings Related Pension Scheme (SERPS) — Britain already enjoys an advantage over other European countries which failed to take such action, as the table below shows.
Government spending as a percentage of GDP—present and projected
The potential advantage for Britain will indeed become greater as the years go by. Other European countries generally have much more adverse demographic trends, with a rapidly increasing proportion of elderly people being supported by a smaller workforce. They will be faced with the necessity of large increases in taxation. Professor Tim Congdon has argued that as a result of these trends ‘in the late 1990s the tax burden could be 15 per cent to 20 per cent lower in the UK than in the rest of the European Community’.[105] Lower taxes, combined with a more favourable regulatory climate for business, will reinforce Britain’s position as the dominant location for inward investment into Europe.
The third element of our economic strategy in the 1980s was to promote private enterprise and ownership. I wanted to shift the balance away from the state for both economic and political reasons. Privatization had a crucial role to play in this. In 1979 the only specific pledges of denationalization were those of the aerospace and shipbuilding industries and the sale of shares in the National Freight Corporation. But we got bolder and we learned as we went along. One by one, state-owned industries were brought into better financial shape and, in an improving economic climate, were prepared for privatization. By the time of the 1983 election, the list of candidates for privatization had lengthened to include British Telecom, British Airways, Rolls-Royce, parts of British Steel, British Leyland and the airports. After British Telecom, other utilities were privatized with differing structures and regulatory systems — gas, water and electricity. By the time that I left office the state-owned sector of industry had shrunk by 60 per cent and, largely as a result of the wider share ownership schemes which accompanied privatization, about a quarter of the population owned shares. I had set out to recreate a predominantly freeenterprise economy and to encourage a capital-owning society: I felt I had gone a long way, further even than I expected, in achieving both.
Finally — and, of course, cutting marginal tax rates and privatization were also a part of this — there was a wide-ranging programme of structural reforms to make markets work more efficiently, what has been called a ‘supply side revolution’.[106] From 1980 we pursued a ‘step-by-step’ programme of trade union reform, of which the 1982 Employment Act which reduced trade union immunities was the most crucial. The outcome of the 1984–85 miners’ strike effectively cemented the new order in which jobs had to depend upon satisfying customers rather than wielding collective power to extort subsidies. There was a corresponding improvement in industrial relations. In 1990, my last year as Prime Minister, the number of industrial stoppages was the lowest in any year since 1935. Trade union reform was supplemented by Norman Fowler’s 1988 reforms of Social Security to make it more worthwhile to work by reducing the so-called ‘poverty trap’. Wages Councils which used to set minimum pay rates that priced people, particularly the young, out of work were reformed to exclude those under twenty-one, and have since been abolished. When I was first Leader of the Opposition the great debate in economic policy was between proponents of incomes policy and ‘free collective bargaining’. By the end of my time in office incomes policy, with all its cumbersome distortions, had been laid to rest and wage bargaining was far less ‘collective’. The proportion of the labour force in trade unions had fallen from 50 per cent to 35 per cent, an important cause (and indicator) of greater labour market flexibility.
But, of course, our reforms to make markets work better were not confined to the labour market: they touched every market. We abolished exchange contr
ols, and controls on prices, incomes and dividends. We promoted greater competition in financial services. We reduced controls over private rented housing to encourage supply, and gave public-sector tenants the right to buy their homes at large discounts. Further measures to promote competition — and so improve value for money and widen choice — in the public sector were made in education, the NHS and local government.[107]
Our objectives — bringing down inflation, controlling the public finances with its concomitant of tax cuts, privatization and supply side reforms — were in varying degrees achieved. Moreover, each was valuable in its own right, not least as part of reducing the role of the state and giving people more control over their own lives. But how far can it be said that the economic programme I pursued in the 1980s fundamentally improved the performance of the British economy? There is a large body of persuasive evidence, which is still accumulating, to suggest that it did.[108]
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