Productivity is the key. Countries with sustainably improving living standards are countries whose labour and capital are productively employed. Countries which fail to achieve high rates of productivity, although they may — and should — take some of the strain on their exchange rates, cannot in the long term enjoy high living standards. This is borne out by Britain’s experience. Before the Second World War there emerged a major productivity gap between us and the United States. Europe also rapidly overtook us in the 1950s and 1960s. And our performance in the 1970s was by far the worst of any leading industrial nation.
But the 1980s marked a major change. US Bureau of Labor Statistics figures for output per hour in manufacturing show UK productivity growth since 1979 to be faster than that of any other major industrial country, and particularly so since 1985. There is good reason to think that the long-term prospect for productivity growth has been permanently improved and that we have not just seen a one-off, ‘catch-up’ effect. Although the productivity growth was particularly dramatic in manufacturing, it occurred in services too. Output per worker in the UK non-oil economy as a whole grew by 1.7 per cent a year between 1979 and 1989 (that is over the economic cycle), compared with 0.6 per cent a year between 1973 and 1979.
A range of other evidence also suggests that the policies of the 1980s have resulted in structural changes in the British economy which, as long as they are not reversed by wrong policies, will put us in good shape in the year 2000.[109] One measure of an economy’s success — and of course the most politically sensitive one as well — is its capacity to create new businesses and new jobs. Although the immediate effect of an increase in productivity may be to shed jobs, productivity growth is essential to enabling businesses to compete and so to providing secure, well-paid employment. So it is no surprise that the number of people in jobs rose by 1.5 million in the 1980s. It is also significant that the peak in long-term unemployment reached at the end of 1992 was more than a quarter of a million lower than its peak in the last economic cycle.
International Productivity Growth
Output per hour in manufacturing, 1979–93 (1979 = 100)
Productivity growth, 1973–93
In Britain, as a result of our long-standing commitment to deregulation, we are also less badly affected than our neighbours by the European disease of controls, high taxes and corporatism which has aborted jobs that would otherwise have occurred. It would, though, be highly damaging if a future government were to sign up to the Maastricht Social Chapter, let alone move back towards minimum-wage regulations which would condemn us to Euro-sclerosis when what we need is American-style flexibility.
Along with inflation, industrial efficiency and job creation, the final significant criterion of economic performance is, of course, economic growth. That too confirms the overall picture of improvement. To reach a fair judgement one has, naturally, to try to allow for the effects of the economic cycle. When we do this, we can see that whereas Britain’s non-oil GDP grew at less than 1 per cent a year between 1973 and 1979 (compared with an EEC average of 2.5 per cent), it grew at 2.25 per cent a year in the 1980s. This was contrary to the international trend: the OECD area as a whole experienced no improvement in performance in the 1980s.
It is important to restate such facts about the 1980s — and not just to get the record straight. Undervaluing what occurred then may well lead governments to turn to alternative approaches which are in fact reruns of the disastrous prescriptions of the 1970s.
There is a parallel with the United States. There the attempt by leading Republicans to distance themselves from the Reagan years gave the opportunity to the Democrats in 1992 to claim the centre ground and successfully fight an election on the theme that it was ‘time for a change’. Only now has the Republican Party perceived that it is by developing rather than detracting from ‘Reaganism’ that success will be achieved. The economic record of the 1980s in both our countries — low inflation, more growth, more job creation, rising living standards, lower marginal tax rates — shows what works; and the 1970s show equally conclusively what does not.[110]
WHY THE WEST?
But of course the prescriptions of free-enterprise economics cannot be properly understood, let alone effectively applied, in a vacuum. They depend heavily for their success upon political and — as I have described elsewhere — social conditions.[111] Precisely why modern Western civilization uniquely gave rise to the sustained growth of prosperity which has transformed lives and prospects over the last quarter of a millennium is fertile ground for debate. The Marxist explanation is now clearly discredited: economic growth is not simply a mechanical result of combining capital and labour. Nor can economic progress simply be ascribed to advances in science or technology, which are not just engines of growth but are also themselves stimulated by cultural and other conditions. Just as significant, in fact, is the way in which science and technology are valued and exploited — and this is something which does indeed mark out modern Western civilization. The Chinese, for example, invented gunpowder and the mariner’s compass, but unlike the West they did not use them to build a maritime empire. The Tibetans discovered turbine movement, but were happy to use it for their prayer wheels. The Byzantines invented clockwork, but employed it as part of court ceremony to raise the emperor above visiting ambassadors.[112] But cultural/religious conditions do not offer a total explanation. The moral significance attached by Christianity to the responsible individual was undoubtedly an important element in the distinctive Western growth of liberal political and economic institutions, but its impact has clearly been very different in the Orthodox East. The Protestant Reformation and the values of Nonconformity also probably played a part — but this does not explain the growth of medieval banking and commerce or the rise of Venice. And, of course, any ‘explanation’ which overlooks the role of the Jews in the growth of capitalism would be no explanation at all.
But two special factors do stand out as of crucial importance — and not just as parts of a wider historical explanation, but also as pointers to future policy. The first is the growth over the centuries of a rule of law, which provided the confidence necessary for entrepreneurship, banking and trade to develop. This clearly has important implications for the strategies being pursued now to establish free-enterprise systems in the former communist states. The second vital condition was the fact that in the crucial period ‘Europe comprised a system of divided and, hence, competing powers and jurisdictions’.[113] As a result, no single government was in a position to pursue policies which frustrated the impulses of economic (or indeed political and religious) freedom without fear of loss of resources. Although the difficulties and cost might be considerable, talented individuals could ultimately take their skills and their money to some other more welcoming state. Today also competition between governments and their differing legal, fiscal and regulatory systems remains a check on the scope for abusing power and thus for impoverishing societies. There is an obvious lesson for those who now wish to submerge European nation states in a United States of Europe where a centralized bureaucracy, by harmonizing regulations, allows no enterprise to escape its clutches.
LATIN AMERICA
Within the broad framework of ‘the West’ there have, of course, grown up different kinds of political economy. A particularly instructive case is that of Latin America, because two different and opposing models have been tried. The first, which the economist Hernando de Soto has described as ‘mercantilism’, has the longer and less glorious tradition. Originating with the Spanish and Portuguese colonial administrations, subsequently perpetuated by corrupt authoritarian regimes of Left and Right, and then all too frequently sustained by international bodies promoting ‘development economics’, it was based on centralized economic power wielded in the interests of powerful individuals and groups and protected against foreign competition. It bears the main responsibility for the fact that Latin American countries have not enjoyed the advancing prosperity of North America
. Mr de Soto’s pioneering study of economic conditions in Lima, Peru, showed that as a result of corrupt, unpredictable over-regulation it was now the so-called ‘black economy’ which was operating to sustain the needs of the people for housing, markets and transport.[114]
Most Latin American countries had to spend much of the 1980s paying off debts incurred in order to finance the misdirected policies of the 1970s. But, with Chile leading the way, followed by Mexico, Argentina, Brazil and now Peru, there has been a fundamental change of direction away from ‘mercantilism’ and towards limited government, sounder finances, privatization and deregulation. Significantly too, this new direction apparent in Latin America, like the successful Asia-Pacific economies, has occurred often in spite of rather than because of advice and assistance from international institutions.
Chile, of course, because of the international hostility directed towards General Pinochet’s regime, was forced to take unilateral action to restore its economic fortunes by applying liberal economic prescriptions. These have subsequently continued under democracy. Monetary growth was curtailed to bring down hyperinflation; tariffs against imports were cut; foreign investment was welcomed; privatization was promoted (350 state companies have been sold) — even to the extent of bringing privatization to bear on the social security system. The beneficial results have been widely felt. Export-led growth has been consistently strong. Moreover, Chile’s economy is better balanced and more diversified and so more able to withstand adverse conditions: almost complete reliance on copper exports has given way to the export of computer software, wine, fish, fruit and vegetables, to such an extent that the European Community is clamouring to keep Chile’s products out. It is a remarkable transformation and a dramatic demonstration of how liberal economics makes the difference.
Mexico’s experience is similar. For decades the quasi-authoritarian corporatist regime kept Mexicans poor. At the time of the ‘North-South’ Summit, which I attended at Cancún in 1981, Mexico was still determinedly misdirecting investment into large capital projects, hiding behind tariff barriers and pursuing redistributive social policies. It was, indeed, a highly appropriate location for the Third World rhetoric of which so much was then heard. But the country I since visited in 1994 had, under President Salinas, undergone a huge and welcome change. Inflation had been brought down, the public finances were in order, tariffs had been cut, trade union powers had been curbed and 996 of the original 1,155 state-owned companies had been sold, merged or closed down — including the sale of eighteen state banks, representing the largest mergers and acquisition process ever executed in the financial services sector anywhere in the world. The recent Mexican currency crisis, which had ripple effects both within and beyond Mexico, was the result not of these reforms but of a traditional pre-election monetary splurge. When this ran up against the constraint of Mexico’s pegged exchange rate there was a flight of capital and the peso collapsed. What this experience establishes is that micro-economic reforms need sound money and orthodox finance if they are to be securely established.
At the time of my second visit in 1994, however, Mexico was on the verge of concluding its agreement on a North American Free Trade Area (NAFTA) with the United States. Such an initiative would have been unthinkable in earlier years when anti-American feeling and protectionist leanings were dominant. The NAFTA initiative has a wider significance. In the past, regional trade agreements in Latin America were generally a means of closing borders to wider international trade competition: nowadays, as with the Andean Group (Venezuela, Colombia, Ecuador, Peru and Bolivia), the Central American Common Market and the southern grouping of Mercosur (Brazil, Argentina, Paraguay and Uruguay), they are seen by the participants as vehicles for freer trade.
Whatever the Argentineans thought about it at the time, defeat in the Falklands War provided a shock which brought first democracy and more recently, under President Menem, the economic benefits of free-market policies. Inflation has been brought down. A far-reaching privatization programme has been undertaken. Subsidies, regulation and tariffs have all been cut. Economic growth has sharply accelerated.
Brazil — the world’s fifth largest and sixth most populous state, with enormous natural resources — undoubtedly has the greatest potential. Even when in the past fundamentally unsound policies were pursued, its growth rate testified to this. A serious start has now been made with policies to curb inflation and government borrowing and to promote privatization — though there is much still to do in order to limit the worst excesses of over-government and its concomitant corruption. Economic optimism tempered with political caution is also the appropriate reaction to events in Peru. Free-market economic policies are beginning to yield results, with a successful privatization programme and strong economic growth; but political stability will be necessary if the full benefits of free-enterprise economics are to overcome the legacy of ‘mercantilism’.
THE ASIA-PACIFIC REGION
The most successful economies in the world are in the Asia-Pacific region. They have the highest growth rates with output doubling every ten years, and savings ratios running at over 30 per cent of GDP which provide ample resources for investment. It is, of course, necessary to distinguish between systems, cultures and states. For example, Japan’s emphasis on decision-making by consensus, its social orderliness, its intricately interlocked financial and industrial complex and its relatively underdeveloped distribution system distinguish it from the classic model of Western capitalist economy. South Korea’s economy is similarly dominated by industrial conglomerates with close relationships with government.
But the picture is by no means uniform throughout the Asia-Pacific region. The rapid economic advance in China, though triggered by government decisions at the end of the 1970s to allow first in agriculture and then more generally the rise of a de facto private sector, is now advancing with a momentum of its own and independent of central government. Not only is its course unplanned: its final destination is unpredictable. Indeed, the Chinese people have shown themselves to be uniquely entrepreneurial throughout the region — as witness the success of Singapore, Malaysia and Taiwan. In Hong Kong Chinese flair operates within a British framework of political and financial institutions. With only six million people, Hong Kong’s lightly regulated and free-trading economy has the eighth largest share of world trade.
Yet, for all the differences between them, the Asia-Pacific economies have certain characteristics in common. Government spending, borrowing and taxation as a share of GDP are low. They are unencumbered with swollen welfare states. Workforces are highly motivated, efficient and increasingly well rewarded — the caricature of Asia-Pacific economic success achieved on the back of low wages rather than high productivity becomes ever less representative of reality. Even the relatively more regimented systems of Japan and South Korea are a far cry from the mildest socialism: government forswears social engineering, is keen that success be rewarded and values the role of small, independent business. As with the evolution of modern Western capitalism, cultural factors play an important part: but the fundamentals of economic success are the same.
The case of India, on the edge of the region and an emerging great power in its own right, is also instructive. Britain’s legacy to India was mixed. Among the benefits were a rule of law, a tradition of honest administration, a common language and, of course, an established democratic system. Corresponding disadvantages, however, were excessive bureaucracy, an overmanned state sector and LSE/Oxbridge socialism, which influenced two generations of indigenous politicians. Policies of wealth redistribution, industrial planning, subsidies, price and exchange controls, monopolies, import licensing and almost insurmountably high tariffs had the same result as in other countries and continents — poverty. The first steps away from this self-destructive economic regime began with agricultural reforms in the late sixties. They continued intermittently under Rajiv Gandhi. But it was only the jolt from the economic crisis of 1991 — and the appointment
of Narasimha Rao as Prime Minister and Manmohan Singh as Finance Minister — which set India firmly on the right road. Tariffs have now been cut sharply and are due to fall further. Foreign exchange controls have been liberalized. Foreign investment is encouraged — and foreign firms are taking full advantage of the opportunities. With the removal of controls on farm prices, grain production has increased and farmers can begin to afford up-to-date equipment. A new, self-confident middle class is emerging. India’s economy is growing strongly.
A similar economic experiment has been taking place at the other edge of the Asia-Pacific region. Australia and New Zealand were infected by socialism á I’anglaise long before India. Public (often monopoly) ownership and effective trade union control over the labour market went further in Australia. But in New Zealand too ‘socialism without doctrines’ had become the dominant slogan even before the First World War.[115] Both countries were able temporarily to withstand the debilitating effects of collectivist policies pursued by both left-and right-wing governments because of their ability to export commodities, in particular minerals and agricultural products, with which they were endowed. But by the early 1980s the extent of relative economic decline was apparent to all: a new course was required.
In Australia a Labor Government removed many financial controls and, most important, abandoned protectionism, though for political reasons the excessive controls on the labour market remained. This limited opening-up of the Australian economy to competitive pressures reversed the spiral of decline as regards economic growth; but the fact that this was not accompanied by measures to free up the labour market has kept unemployment relatively high.
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