There is No Alternative

by Claire Berlinski

  Here’s an even simpler way of looking at it: Thatcher’s key economic reforms collided in mid-air and exploded.

  And yes, they should have predicted this.

  There is a consensus now among economists—to the extent that there is ever a consensus among economists—that Thatcher’s first government measured money the wrong way and thus chose the wrong monetary targets. Her last government confused matters inordinately with an incoherent policy toward entering the European Exchange Rate Mechanism. This is why Thatcher’s remedy did not work as quickly or as well as expected, and this is why British cities went up in flames.

  What is fascinating in this story is this: Despite Thatcher’s insistence that she was not confusing her country with a laboratory experiment, experimenting is precisely what she was doing. Obviously she was. That famous article by Friedman was published in 1975. No one in the world knew if this “monetarism” business would work. No one had really tried it before. As clearly evidenced by her government’s inability to figure out what to measure, no one was quite sure how to apply this theory in practice.

  CB: Now, were they aware that this [abolishing the corset] would have this effect? Or was it inadvertent?

  AG: No, they were aware of it, but they probably didn’t understand it.

  It is the consensus of everyone, and I do mean everyone who knew Thatcher—even her most devoted loyalists—that she didn’t understand the technical details of the policy upon which she staked everything. Yet she did stake it all, and she would not relent, because it just sounded right to her.

  Her policies appeared in these initial years to be an absolutely catastrophic failure. Economists the world over proclaimed Thatcher’s government to be the most disastrously incompetent in the history of postwar Britain. When asked in a debate in the Commons whether she could name just two economists who supported her, Thatcher managed to cough up the names of a pair of dogged loyalists who would have agreed with her had she pronounced her allegiance to the theory of phlogiston. Upon her return to Downing Street after this exchange, one of her civil servants apparently said to her, “It’s a good job you weren’t asked to name three.”

  Yet she would not relent, even in the face of overwhelming pressure, not only from the public, not only from the Opposition, but from her own party. She believed, with what seemed at the time an almost religious faith, that it would work—because it just sounded right.

  CB: Where does she get the confidence to do this?

  AG: I don’t know! I would posit—I think Keith Joseph thought he did understand these things, and he was very enamored with Friedman, so he thought there were explanations as to why this would all work . . . I don’t think Thatcher went into these arguments at all . . . I think she was a remarkably instinctive politician. I think that she probably sort of at some gut level thought, I’ve just got to kill this inflation, I think it will create unemployment, but I think somehow we’ll get through . . . She had no training as an economist, none, no intellectual equipment which would suggest that she would have thought it through . . . Her statements were the statements of somebody who thinks about the economy as—I mean, to put it crudely—as a housewife.

  Before concluding that monetarism was nothing more than the dimwitted delusion of a demented housewife, however, note this. In 1981, 364 highly trained economists, led by Frank Hahn (the very one who declared Thatcherism to be “intellectually without interest”) signed an open letter to the Times protesting her economic policies. Not long thereafter, the economy began rapidly to grow, entering the longest sustained period of expansion of the postwar era, and not long after that, unemployment began to come down—and it has stayed down to this date.

  Rates of both inflation and unemployment in Britain are now very low. In fact, since 1997, Britain has ranked top in both output and inflation stabilization in the Organisation for Economic Cooperation and Development. The prestige of highly trained economists has never quite recovered. Thatcher’s first chancellor, Geoffrey Howe, subsequently declared that he had “actually produced a definition of economists as a result: that an economist is a man who knows 364 ways of making love, but doesn’t know any women.”

  One may argue—and many do—that unemployment declined despite rather than because of Thatcher’s intransigent adherence to monetarist doctrines, but the fact remains that it did come down—a lot—which at least leaves the matter open to debate.

  So was it insanity, or was it uncanny intuition coupled with astonishing force of will?

  To be honest, I’m not sure. I think the jury is still out.

  Nigel Lawson, predictably, feels the monetarist perspective has been vindicated. Although economists certainly have not converged around the principle that you must control inflation above all, there is no longer much doubt that if you are attempting to control inflation, monetary policy is the tool of choice. “The Andrew Grahams of this world,” Lawson wrote to me,believed that you dealt with inflation largely by imposing prices and incomes policies, with perhaps some assistance from fiscal policies. What we said was no; all that is worse than useless, it is actively damaging. You deal with inflation by monetary policy. Since we now have an independent Bank of England, charged with keeping down inflation (and with nothing else), whose only tool is monetary policy, for which it is wholly responsible, I think it can fairly be said that it is game, set and match to us.107

  About this, he is right. Before Thatcher, there was a debate about the primacy of monetary policy in controlling inflation. There is no debate now. In this respect, the Labour Party did indeed go beyond anything Thatcher ever attempted to do: As Lawson points out, in 1997 it removed the authority to set interest rates from the Treasury and transferred it to an independent monetary policy committee. This is a measure often recommended by monetarists on the grounds that the key to controlling inflationary expectations is credibility: People must be given a good reason to believe that inflation will stay under control. If you take responsibility for controlling inflation away from elected governments—which are apt to manipulate the economy for short-term electoral gain—you are sending a signal: We’re not just yanking your chain. No matter what happens, your money will be good. I am not sure that I would describe this development as “game, set and match” for the monetarists, but I agree that it’s certainly not an outright loss.

  The Master of Balliol is not a great fan of Thatcher’s, but he is fair-minded enough to concede that the relationship between Thatcher’s experiments with monetarism and Britain’s now-vibrant economy is at least an open question. “It’s one of the very big unanswered questions in my mind about economics. She said there was no alternative.”

  He hesitates for a moment, then adds, “She might have been right.”

  “No alternative to—?”

  “No alternative to massive unemployment to stop inflation. I wrote an article in 1975 which more or less said I thought this would happen. I didn’t believe for a minute this rubbish that it would be peaceful and easy. I thought it would be difficult, and I’d much rather we hadn’t had to do it. We’ve had one huge recession under her and another one under John Major, and it’s killed off inflation in the British economy and it needed to be killed off somewhere along the way. I’d much rather we’d found an alternative. But if we didn’t have an alternative—”

  He pauses again, then sighs. “She had the guts to push it through.”

  If we see the heart of Thatcherism as an attempt to control inflation above all by using monetary policy alone, our judgment of Thatcherism will be ambivalent at best. The high costs associated with this policy—and her inability to bring inflation down immediately and keep it down—have tended to obscure the success of her other policies. But they shouldn’t. That would be to miss the point of Thatcherism.

  Recall the second part of Friedman’s prescription: To treat unemployment, you must fix the underlying problem—the distortions in the economy that are increasing the NAIRU. You must, in other words, target the supply
side of the economy. As successive Thatcher governments struggled to bring down the inflation rate, they simultaneously sought to increase economic productivity through a series of dramatic supply-side reforms. The reason Thatcher matters now, not the reason she mattered then, is the story of these reforms.108

  What did Thatcher do, specifically, to affect the supply side? For that matter, what is the supply side? When we speak of strengthening the supply side, we are talking about creating incentives for people to produce—in other words, supply—goods and services. When taxes are lower, for example (this is the classic supply-side remedy), people have more incentive to be productive.

  Foremost among the things Thatcher did to strengthen the supply side was smash the trade unions. (Economists would describe this as “augmenting labor market flexibility.”) When Thatcher came to power, some 70 percent of the British labor force was paid according to the terms of a trade union agreement. By 1998, this figure had fallen to 35 percent. Next in importance were changes made to the welfare benefit system: Prior to Thatcher, welfare payments had been indexed to average wages. Under Thatcher, payouts were linked to the Retail Price Index. Because wages rose faster than prices, over time this reduced payouts. These policies—together with reductions in income tax, the privatization of public industries and utilities, trade liberalization, and deregulation—were designed to heighten the ability of prices to convey information, create incentives to work, and ultimately lower the NAIRU.

  They did precisely what they were intended to do.

  These terms—supply side, incentives, NAIRU—may sound sterile. The everyday economic realities they describe, however, are nothing of the sort. John and Miranda Hoskyns, for example, recall what they meant in practical terms.

  CB: I want to know what the business environment was like in 1979. What does it really mean when you talk about the “British malaise”? I mean, I’ve heard the anecdotes about garbage piling up on the streets, and corpses going unburied, but let’s talk about someone who comes from an average, mid-sized city in Britain and has modest ambitions for himself or herself. What were the obstacles to, say, going into business, becoming a small businessman?

  Miranda: Well, you couldn’t send things by mail very easily, for a start, could you? I mean, the Post Office was—

  John: No, no—

  Miranda: A friend was having a baby . . . and all the electricity went off at the hospital. In the middle of giving birth. We had an elderly aunt in a nursing home who was left in pitch darkness because the lights went out. That kind of thing happened all the time. Every day.

  John: But those were at particularly critical times, like the Winter of Discontent—

  Miranda: Yes, but quite a few years—

  John: But there’s also the question of, sort of, what did people over the years think? I mean, what was their level of optimism—and did they have any ambition? And part of my answer would be, because you remember this in the company, the Hoskyns Group . . . if any of our people went to work in the States, they never came back. They simply couldn’t afford to! . . . I mean, I remember the way it was always put. It was, “I can save money for the first time in my life.” . . .The general level, the standard of living, the standard of earning, and everything else, was pretty low. Taxes very high. And it was just impossible for anybody to save money. You just could not do it . . . Not only was I subject to high taxes, but because I was living on investment income, which was regarded as practically criminal in those days, there was an extra level of tax. So the maximum—so my maximum tax rate . . . was 98 percent.

  Miranda: 98!

  CB: 98 percent is unbelievable. . . . Is that the highest tax rate that’s ever been imposed on a modern country?

  John: I suspect the Emperor Diocletian might have—didn’t he have higher taxes? I think he did.

  Miranda: You just felt absolute despair. You felt you couldn’t rise above it.

  That is what we’re talking about when we talk about the supply side.

  Thatcher’s policies resulted, as would be predicted, in what economists would call “a complete reassignment of resources,” leading to “an inevitable period of readjustment.” Now remember, many of those “resources” were human beings. Some of them never adjusted. What we mean, in simpler terms, is this: Thatcher took a sledgehammer to a dysfunctional semi-command economy, stepped back, and waited for the rubble to reassemble itself—sans government direction—in a more efficient configuration. It took many years for the dust to settle, and the collateral damage was considerable. But in the end, the restructured economy was, as she had predicted it would be, leaner and meaner. The fact that these effects were chiefly seen after, and not during, the Thatcher era should not obscure the fact that they were the consequence of her policies.

  Privatization generally saved the taxpayer a fortune and made privatized industries more competitive and innovative. The privatization of British Telecom resulted in a dramatic lowering of prices and improvement in service. The sale of council houses was and remains one of Thatcher’s most popular policies. But it would be wrong to describe privatization as an unalloyed success in every instance. Having taken British trains both before and after privatization, I can report that they were lousy and expensive before, and they are lousy and expensive now.

  Generally—and predictably—privatization was most successful in industries with natural competitors. As the Master of Balliol correctly pointed out, “Don’t mix up competition and privatization. They’re not the same thing.”

  CB: How would you introduce competition in a non-privatized industry?

  AG: Well, I’d say you have to come at it a different way. You have to make up your mind, on the basis of analysis, whether this industry is of the kind where competition is feasible—I mean, competition between restaurants—drop-dead easy. Do it. Nobody in their right mind would do anything else. Competition between electricity-generation stations, one generating a supply in Scotland, another one generating a supply in Kent—tricky!

  CB: Which do you consider the most successful privatizations, if any?

  AG: Um—probably in the long run, telecoms, but that’s—the rate of technical change in that area has been so huge that the industry would have transformed itself no matter what happened. I think that British Telecom was eventually put more on its toes. But British Telecom even in the old state-run way would probably have been put on its toes by the mobile phone industry, etc. You just can’t compare telephones today with telephones then. Buses? Maybe.

  CB: And which ones in your view were the least successful?

  AG: Railways? Energy, I don’t know about.

  CB: Well, that’s a shame, because that’s where I was going next—

  AG: I’m allowed to—much better to just be humble and say you don’t know!

  CB: I never thought so. Did you ever hear me admit I didn’t know the answer to something?

  AG: All that bluffing in my economics tutorials—I knew you were bluffing.

  Fair enough, I was, but I am still not persuaded that British Telecom would have been put on its toes by the growth of the mobile phone industry. Other nationalized industries, in the face of technological change and overseas competition, had simply grown more and more unprofitable. Coal, as we shall see, was a key example.

  If some of the privatized industries, such as rail, were not noticeably better than their nationalized predecessors, nor were they noticeably worse. And most were noticeably better.

  John Hoskyns: And you think, we had a government that had been making motorcars! Very bad motorcars. I mean, clearly this is ridiculous! Quite extraordinary. The Post Office—for the customer, this was the most dramatic change. . . . Our old state-owned Post Office, it was absolutely ludicrous. You’ll have experienced it yourself, when you were at Balliol. Six months to get a telephone line!109

  CB: I never did get one.

  John: And what was your telephone? Your telephone had a dial, and you could have it in one of three colors! No
w that the war’s over, they’re not black anymore. You can have a pale cream one, or even a pale green one!

  Miranda:—and also the queues at the Post Office, they did go on forever, you could never get anywhere . . . The customer was at the bottom of the pile.

  John: The customer just had to put up with—you know, you’re lucky to get a pink telephone.

  The withdrawal of state support to nationalized industries accelerated the restructuring of the British economy, hastening its transformation from one based primarily on manufactured goods to one based on services. Thatcher’s critics often charge that this transformation was undesirable. This criticism, because so often made, requires a response.

  When we talk about manufacturing, we are talking about making things, either manually or with machines. When we talk about services—very crudely—we are talking about everything else, save for the direct sale of natural commodities. Doctors, accountants, lawyers, software designers, hoteliers, theoretical physicists, massage therapists, veterinarians, and journalists, for example, all provide services, not manufactured goods. Is an economy based on the supply of services really based on anything? Many people instinctively say no. There’s no there there, they say. You’re not making anything; it’s all a chimera.

  But there is no special reason to believe this. As economies mature, they experience a predictable transformation in specialization: First they are agricultural, then industrial, then based upon services. This is a pattern that has been seen throughout the world, and there is nothing wrong with it—or if there is, most of the First World is now in worse economic condition than most of the Third World, which is an apagogical argument. Services are real economic goods, and civilization depends upon them. If you possess a comparative advantage in service provision, you are clearly better off providing services. The money I make writing books is no more or less real to me than money I might make by building toasters in my basement. However, given my particular set of competitive advantages, it would be ridiculous for me to try to make a living by building toasters.