The Path to Power m-2

by Margaret Thatcher

  New Zealand, first under the Labour Government’s Finance Minister, Roger Douglas, and subsequently under the National Party Government’s Finance Minister, Ruth Richardson, has gone much further — and the results have been that much better. Financial controls were lifted, import restrictions abolished, tariffs lowered, foreign competition in services welcomed, unemployment benefits reduced, income tax cut and the emphasis shifted to indirect taxes. Also — and crucially — unlike Australia, the labour market has been freed up. The result has been annual growth at over 4 per cent, more new jobs, falling unemployment and very low inflation, while productivity has increased and business is investing. The traditional similarities between New Zealand and Britain make the former’s success — achieved by following the same general policies as I implemented in Britain in the 1980s — of particular significance.

  THE AFRICAN PROBLEM

  Even more than Latin America or India, African countries have suffered from misdirected economic policies associated with the collectivist concepts of ‘development planning’.[116] But, as elsewhere in the Third World, the same implicit reason (or, depending on one’s point of view, excuse) for believing that the laws of economics can be defied with impunity is consistently advanced, namely that Africa is somehow ‘different’. A wide range of arguments was used to justify this — general underdevelopment, lack of local investment capital, over-dependence on a single commodity, the encouragement of ‘infant industries’ or, even more dangerous in its quasi-racist implications, the ‘special’ character of the African himself and his culture. It is, of course, true that cultural factors have played a role in Africa’s problems, particularly when departing colonial governments took insufficient heed of tribal and religious differences in putting together African states.[117] But, as Peter Bauer, above all, points out, experience in Africa (and elsewhere) shows two things. First, if two peoples live under the same regime of liberal capitalism, one will usually out-perform the other; but if one people lives under two regimes — capitalism and collectivism — that portion living under capitalism will out-perform its cousins. A commonsense conclusion is to choose the (capitalist) regime that makes everyone better off, even it if also allows some relative inequalities between ethnic groups with different cultural aptitudes. So anyone who understands the consequences of abandoning the tried and tested model of limited government, a rule of law and free markets can also understand why the post-colonial economic performance of African states is so abysmal.

  And abysmal it certainly is. Per capita output in Africa actually declined during the 1970s and 1980s and, as a result, Africa is poorer than in 1960. Yet Africans in the 1980s received per capita a larger share of development aid from the West than anyone else. Price controls imposed on agricultural products in order to subsidize urban élites undermined agriculture, as did the confiscatory policies associated with export marketing boards and brutal forced collectivization of farms. Foreign imports and investment were discouraged. Mountains of international debt were accumulated in order to construct ill-conceived prestige projects. Finally, over-centralized power had the inevitable result of turning government in many African countries into a giant kleptocracy. As a result of this catalogue of failure, there is a tendency to give up on Africa. This must be resisted. In any case, Western countries should recall that the record of institutions like the World Bank and the contribution of those Western development economists who prompted such follies hardly inspire pride.

  Moreover, closer examination of the realities of African economies challenges some preconceptions. Take South Africa, for example. In terms of mineral wealth, economic development and institutional sophistication it is outstanding. So far, the worst fears about a breakdown of order have not been realized, for which the country’s leading political figures deserve great credit. But it does South Africa no good at all to minimize the economic problems or to suggest that large inflows of foreign investment are likely to overcome them. There has been too much state direction of investment and too little competition. Industrial conglomerates have been immune to the beneficial threat of takeovers. The powerful general trade union COSATU has pushed up real wages, which in industry are about the same as in Taiwan, rather more than in Korea and about double those in Brazil. Not surprisingly in such circumstances, investment has gone into labour-saving equipment; and unemployment — with its resultant poverty — is very high. Unfortunately, socialist rhetoric and unrealistic expectations fuelled by the less responsible members of the ANC in the election campaigns will make these problems more difficult to solve. But the way forward is still to apply the same prescriptions as we would for any other over-collectivized economy — keeping down inflation and taxation, curbing public spending, cutting back regulations, promoting competition and avoiding protectionism. The only way to pay for the improved education and better living standards which the black population of South Africa need is to achieve the right conditions for wealth creation. Alas, there is no alternative — and no short cut.

  Other states’ experience confirms that free-enterprise economics can be just as effective a source of progress in Africa as elsewhere. A quiet revolution has been taking place in East Africa — so quiet that its lessons may not be learned.[118] Traditionally, Kenya, the most industrialized and economically advanced East African country, was the exception to the generality of mis-government in the region. But now Uganda, Zambia and Tanzania — all previously impoverished by incompetent and corrupt regimes — are moving ahead fast. Uganda has curbed its inflation, turned a budget deficit into a surplus, all but abolished exchange controls, welcomed foreign investment, privatized the agricultural marketing boards which had wreaked such damage on cotton and coffee production, and now plans to establish a stock market. Zambia, though its privatization programme is only proceeding slowly, has made major progress in bringing down inflation and has opened a stock exchange. Tanzania has reduced tariffs, ended price controls and has a vigorous privatization programme. Of course political instability still risks jeopardizing economic progress in many of these countries. But economic progress also itself creates the conditions for stable democratic government. And one of the most effective ways of entrenching liberal political systems in that continent is to promote liberal economics.

  CENTRAL AND EASTERN EUROPE

  Perhaps the most decisive test of the creative potential of capitalism has been its application in the ex-communist countries of Central and Eastern Europe and the former Soviet Union. For a number of reasons, Russia and the other states of the former USSR are in a separate category from the other new democracies of Central and Eastern Europe. (The Baltic states, because of their history and traditional Western orientation, must though be regarded as closer to the latter than the former: and the striking success of their economic reforms emphasizes that.) Although Russia enjoyed swift capitalist growth in the half-century between the end of serfdom and the First World War, there was only a very limited period — essentially after the 1905 Revolution — in which liberal institutions and attitudes could take root. Communism extinguished these memories and also destroyed the still small middle class who were capitalism’s hope. Seventy years after the Bolshevik Revolution, communist economic planning has bequeathed its own legacy of misdirected investment, wrongly located factories and power plants, ossified technology, ex-bureaucrats posing as industrial managers, an unmotivated workforce and ecological catastrophe.

  More should have been done — and earlier — to help Russia, Ukraine and other ex-Soviet states to build free-enterprise economies. In particular, we should have been prepared to provide backing for a currency board to bring some stability to the Russian rouble. The Russian people rightly had no trust in their government’s ability to provide a stable currency. The only solution was to take it out of the government’s hands, introduce a ‘hard rouble’ and set it firmly in the institution of a currency board similar to that which we set up in Hong Kong in 1983.[119] The currency board, preferably buttressed by r
epresentatives of the IMF or the Federal Reserve Board, would always exchange hard rouble currency for US dollar notes at a fixed rate of exchange. History shows that such transparent systems work, even under the most trying circumstances. To make this feasible Russia needed sufficient dollar reserves to give over 100 per cent backing to the hard rouble notes; the West could have found no more worthy form of aid than to have provided such backing.

  The secret of successful economic reform is always to ensure that all of the components work together, because then the process of adjustment is easier. On these grounds, some now criticize the Russian reformers of 1992 for freeing prices before breaking up the state-owned monopolies which dominated the economy. But at least price liberalization brought goods into the shops at a time when there was talk of Muscovites simply not having enough to eat. In any case, a far-reaching privatization programme using the voucher method pioneered in Czechoslovakia has since transferred large swathes of industry to the private sector. More than 70 per cent of Russian workers are now in the private sector. True, uncertainty about property rights, excessive bureaucratic regulation, high taxes and widespread corruption are still major problems, deterring foreign investment and driving enterprise into the mafia-controlled black economy. But, for all that, the most gloomy prognostications seem unjustified. Unreliable figures for the decline in production are more than balanced by others suggesting large increases in private consumption — which is in any case precisely the re-orientation which transformation from a production-led to a consumer-driven economy requires. And unpleasant as many of its manifestations may be in a situation where the law is not properly administered or upheld, no one visiting Russia today could claim that its people are failing to respond to the opportunities for entrepreneurship. In fact, the most important message which Westerners must impart in Russia now is that fully fledged capitalism requires a rule of law. Without that, private ownership in Russia will lack legitimacy and therefore stability.

  The economic challenges facing the ex-communist states of Central Europe, though formidable, are of a lesser dimension. East Germany, of course, was able to merge with the most economically powerful state in Europe. Hungary had already advanced some way towards a Western-style economy in the last years of communist rule. It is, though, significant that the two most striking success stories — Poland and, still more so, the Czech Republic — occurred where governments took the boldest and earliest decisions to move from socialism to capitalism.

  Poland’s great advantage was that the communists had largely failed to collectivize agriculture. Communism thus failed to gain total control of the economy — just as in the face of resistance from the Catholic Church it failed to gain total control of society. Communist attempts at economic reform, however, failed: indeed, their most significant legacy was hyper-inflation. The architect of the successful reforms achieved during the Solidarity-led Government, Leszek Balcerowicz, deliberately chose a radical course — the simultaneous introduction of measures to eliminate price controls, tighten monetary policy, cut the budget deficit and remove almost all restrictions on international trade. Inflation fell dramatically. New small businesses started up. Goods flowed into the shops — certainly, at prices which people found difficult to afford, but much of the alleged drop in living standards was a statistical fiction, since previously Poles had faced crippling shortages.[120] Subsequently, a programme of privatization added the final element to the reforms. The private sector now comprises 55 per cent of the economy. Success has not been unalloyed, however. Budget deficits under the burden of unchecked welfare spending seem likely to continue. The privatization programme appears to have slowed since the Left gained power in 1993. Partly in response to the European Community’s failure to open up its markets sufficiently to Polish produce, there has been a tendency for Polish tariffs to rise once more.[121] On balance, however, the successes of reform far outweigh the failures: to such an extent that Poland’s economy in 1993 and 1994 grew by some 4 per cent and looks likely to repeat the performance in 1995. Nor should the Right’s defeat in the 1993 elections necessarily be attributed to popular discontent at the reform process itself. The fragmentation of the anti-socialist vote among small competing parties under a system of proportional representation (adopted thoughtlessly by most of the new democracies) must bear most of the blame.

  The success of economic reform in the Czech Republic is also notable — as is the contrast with Slovakia, which has deliberately retained a more socialist orientation. The Czechs, of course, inherited a tradition of industrial success which not even forty years of communism could extinguish. Before the Second World War Czechoslovakia was one of the world’s most advanced economies with an income per head equal to France. Moreover, the Czech reformers, unlike their Polish equivalents, did not inherit hyperinflation; nor were they inhibited by the necessity to seek communist support for the reform measures. Under the determined leadership of Vaclav Klaus, first as Finance Minister and since as Prime Minister, a radical strategy was adopted with no concessions made to demands for a ‘third way’ between capitalism and socialism. Price controls were removed, subsidies cut back, public spending sharply reduced and the currency made convertible for trade purposes. A pioneering scheme of mass privatization through vouchers has transformed the pattern of ownership, with 80 per cent of Czech assets now in private hands. After the traumas of change, economic growth (at 2.5 per cent in 1994) has begun on a sound footing and, in spite of the shake-out of labour from old inefficient industries, unemployment (at 4 per cent in 1994) is low. Unlike in Poland and Hungary, those who pushed through the necessary economic reforms have in the Czech Republic also reaped the political rewards — which itself is the best guarantee that those reforms will continue.

  Yet it is perhaps the example of the smallest and poorest of the former Eastern bloc countries, Albania, which best illustrates the creative potential of uninhibited capitalism. Indeed, what has happened since the fall of communism gives a quite new understanding of Schumpeter’s description of capitalism as a process of ‘creative destruction’. Albania had lived in a time warp, cut off from political or economic contact with the outside world, without decent communications, burdened by hopelessly outdated industries, its agriculture totally collectivized, the landscape dotted with bunkers built by its paranoid rulers. The only way forward was to start again from scratch; and this is what happened. A sudden huge emigration, though presenting immediate problems for Albania’s neighbours, has since resulted in a substantial inflow of remittances which, with overseas aid, allowed the beginnings of a consumer society. Small businesses mushroomed everywhere. Everything which could be salvaged from the collective farms and the bunkers was dismantled and used in new private farms which sprung up and which — the government having abolished price controls — were soon able to feed the population. Albania is now achieving what almost everyone considered impossible: its economic growth has been in double digits for two years running — though, of course, from a very low level. Foreign investment is taking advantage of low wage costs, lack of regulation and the country’s mineral wealth and potential for tourism.

  The different rates of economic progress, therefore, in the former communist states bears out my central thesis — namely that although political, social and cultural factors are not without importance, the free-enterprise formula works whenever and wherever it is applied. Moreover, its application is crucial to the entrenchment of democracy too. As a recent survey of public opinion in ten ex-communist countries shows, in nearly every case nostalgia for the old communist regime is associated with failure to make a rapid transition to a free economy.[122]

  TWO MODELS — THE UNITED STATES AND GERMANY

  The economic reformers of Central and Eastern Europe naturally sought to study the most successful models of the capitalist system which they intended to recreate. Many of them looked to Britain, particularly in order to learn techniques of privatization, though these have had to be adapted to different ci
rcumstances. But it was the examples of the United States and Germany which have had most influence.

  There are significant differences between the American and European versions of capitalism. The American traditionally emphasizes the need for limited government, light regulation, low taxes and maximum labour-market flexibility. Its success has been shown above all in the ability to create new jobs, in which it is consistently more successful than Europe. Since the 1960s employment has grown on average by only 0.3 per cent a year in the EEC, compared with 1.8 per cent a year in the USA; moreover, in the US, by contrast with Europe, most of the jobs were created in the private sector. Over 40 per cent of the unemployed in the EC have been out of work for over a year, compared with 10 per cent in the USA.

  The European model — in particular the German version — has, however, recently attracted much sympathetic consideration by policy-makers in the American administration who favour an interventionist approach to training, industrial policy and managed trade. It is, therefore, particularly important to understand the weaknesses as well as the undoubted strengths of the European system as exemplified by Germany. For if the world’s greatest example and exponent of liberal capitalism were to turn away from it in either internal or external economic policies that would have momentous implications for the free-enterprise system generally.

  West Germany’s emergence as the major European economic power in the post-war years was rightly described as an ‘economic miracle’. A combination of very low inflation and high productivity characterizes the German success. This reflects both the character of the German people and the policies pursued by the German government, particularly in the 1950s and 1960s when the emphasis of the ‘social market’ approach was on ‘market’ rather than ‘social’. The 1970s and 1980s saw something of a reversal in that balance with a growth of state intervention and joint decision-making (Mitbestimmung) by unions and management. There was also a large increase in the tax and regulatory burdens on employers which, it has been suggested, now approach 100 per cent of wages. Although the German economic performance has been impressively consistent, under both these burdens and the shock of a not very well managed enlargement to take in the ex-communist East, some of the characteristics of German capitalism which made for past successes are already leading to serious problems — problems that threaten to get worse. Industrial consensus has degenerated into a more rigid corporatism, which reduces the ability of German industry to adapt flexibly to challenges from Asia and Central Europe. This applies both at the level of individual German companies and in sectors. Significantly, German employers agreed to raise East German wages to West German levels by 1994, which attempt proved deeply damaging — and ultimately practically impossible. But such a decision was only possible in an economy where centralization of wage bargaining was the accepted norm.