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The changing economic role of government Samuel Brittan: Contribution to 50th Anniversary Vol. Soc. of Bus. Economists 2003 Introduction At the risk of undermining my own subject, I will risk saying that the half century since 1953 has been excessively preoccupied with the economic role of government. We were at all times in danger of forgetting - until rudely awoken by the attack on the New York Twin Towers of September 11 2001 - that the primary role of government is to look after the physical security of the population and that all else is secondary. But even if we confine ourselves to traditional economic variables, the most impressive feature of British growth performance is how stable the underlying trend has been and how little affected by the huffing and puffing of governments. From 1870 until 1950 the best estimate is that UK output per hour grew by 1 per cent per annum. From 1950 to 1973 there was a temporary acceleration to 3 per cent. Much of this may have reflected post-war catch up. In fact this temporary acceleration, so far from being celebrated, was denounced very widely by commentators for not being fast enough compared with continental and Japanese competitors who were overtaking the UK in some imaginary league table. Since 1973, when governments have become even more preoccupied with boosting productivity, its trend growth rate fell back to 2 per cent and indeed may have been slightly less in the final half of that period. (1) Productivity is of course not the same as the overall growth rate which can be affected by variations in activity rates as well as by demographic changes. The slight acceleration in the growth rate predicted in UK government documents for the first decade of the 21st century is due mainly to a faster population growth, itself largely the product of expected legal immigration. Although, for such reasons, growth trends have been more variable than productivity ones, even they have still proved pretty stable and resistant to attempts to change them. Economic policy may thus make much less difference than those who argue about it like to think. That does not mean that we should stop criticising and appraising it. Growth emerges from animal spirits and the human instinct to truck and barter. But it is always possible for policy to have an adverse effect on performance. Sometimes, however, mistaken courses have provoked reactions that have led to their own reversals. For instance, when union power was threatening in the 1970s to make Britain the sick man of Europe, there were first the sterling crises of the mid-1970s and then the election of Margaret Thatcher in 1979, both of which produced salutary shocks and associated policy changes. The 1950s: Half Hearted Freedom. The year 1953 was a watershed, not only because of the foundation of the Business Economists Group! It was the first year of normality after World War II. The Korean War had come to an end, armaments were at last being run down; and most wartime rationing and control had been lifted. It was also the halfway stage in the somewhat under-discussed post-war Churchill administration of 1951-1955. By the time of his stroke of May 1953, Winston Churchill had abandoned his last remaining attempts to establish an overlord system. He himself retreated from the detailed conduct of affairs; and the pygmies took over. But unfortunately the main chance of a real dash for freedom had already been thrown away. After the Conservatives returned to power, a bold scheme to float the pound and free the country from the throes of never-ending runs on sterling had been proposed - Operation Robot - named after the two civil servants and one Bank of England official who devised it. The Chancellor, R A Butler, was in favour; but Churchill overruled him on the advice of his wartime confidant Lord Cherwell and the way was open for 20 or more years of preoccupation with sterling and the balance of payments. Meanwhile so-called league tables began to circulate showing that continental countries were growing at a faster rate than the UK. The gathering discontent was not a matter of mere numbers. There was a widespread feeling that, despite the expansion of educational opportunity and increased prosperity, the country was still run in a class-ridden way and what mattered was not what you knew but whom you knew - and possibly how you held your fork. One best selling book was Michael Shanks's The Stagnant Society. Some of these feelings emerged very clearly in John Osborne's play Look Back in Anger and in the early novels of Kingsley Amis. These had their counterpart on the business side. The electrical industry was dominated by three vast bureaucracies. One of them, AEI, was run by Lord Chandos who gave his real name, Oliver Lyttleton, to part of the National Theatre. The interviewer approached him through a series of carpeted rooms, each larger than the other. A journalist knew that if he said or wrote anything that displeased, he might be reported to his editor - or more probably - the managing director whom Chandos was more likely to know socially. Indeed I was once so reported by a Bank of England director whom I had the temerity to ask for some factual evidence to back the observations he was making off the record. If there is one word which summarises everything against which the reformers were reacting it was Fuddy Duddyism. The Decade of Growthmanship There was bound to be some sea change. The reformers were split between those who pinned their hopes on more competition and those who drew their inspiration from French type indicative planning. Businessmen were just as split as economists or politicians, and probably in an even more muddle-headed way. The economy did need a competitive shock. The successive rounds of world trade liberalisation had not yet gone far enough to make business anything like an international arena; the vestiges of Imperial Preference still provided soft external markets; and in many domestic areas restrictive practices abounded. The reappraisal began well before Harold Wilson formed his Labour government in 1964. There were some earlier acts of liberalisation, like the abolition of resale price maintenance by Edward Heath. There was also the first attempt at a forward look at public spending, following the Plowden Committee which reported in the early 1960s. Europe too put in its appearance. Having failed to take part in the negotiations which led to the Treaty of Rome, the Conservative government of Harold Macmillan applied belatedly in 1961 to join the EU (then called the Common Market) - only to have its application vetoed halfway through negotiations in the famous intervention by General de Gaulle. The latter was much mocked for announcing that Britain was an island; but he was not so far off the mark about the country's psychological unreadiness. Unfortunately both the planners and the free marketeers had the ground cut off from under their feet by the return of sterling and balance of payments crises. The first three years of the Wilson government of 1964-1970 were dominated by a futile attempt to prevent sterling devaluation and then, when that failed, by devaluing to another fixed exchange rate. Even after 1967 the Treasury could not divest itself of its balance of payments mentality; and when devaluation seemed slow to work, it threw up a ridiculous contingency plan Operation Brutus for going back to a wartime siege economy. Domestically, the government's main form of intervention was devoted to futile attempts at prices and incomes policies. The hope was to keep down costs that way and avoid the need to devalue. Amazingly, neither the Macmillan nor the Wilson government could see any virtue in stable costs and prices other than in their effect in promoting British exports. There were any number of wage freezes, guiding lights and solemn and binding concordats. Perhaps the worst effect was the attempt to control prices to give the unions an apparent quid pro quo for wage restraint. The Traumas of the 1970s The surprise return of the Heath government, which was in office from 1970-1974, proved in retrospect an interlude in a decade and a half of Labour rule. Most British political commentators regarded a free market approach with horror and raised the spectre of Selsdon Man: named after a conference of Conservative leaders before the 1970 election after which the press was briefed in a slightly free market direction. The prime minister Edward Heath undoubtedly began with a belief that British industry needed a cold shower. But this was not accompanied by any deeper economic philosophy; and it did not take him long to decide that the road of free competition and all that had been tried and failed and that the required bracing treatment would be applied through yet another attempt at incomes policy. He was not in fact enthusiastic about statutory wage controls, which he adopted as a fallback after he had failed to reach a voluntary concordat with the trades unions. Ideally he would have liked to govern by a corporate consensus in which agreements between a civil service mandarins and the TUC, rubber stamped by the CBI, would take the place of normal cabinet government. The Heath government did have to cope with an unfortunate legacy. After the 1967 devaluation, inflation did not retreat to its earlier creeping 2 or 3 per cent creeping level, but jumped to 6 - 7 per cent. Yet at the same time unemployment was a good deal higher than in the post-war period. In the 1971-2 recession, newspaper headlines celebrated the then horrific total of one million unemployed. The combination of unemployment and inflation, labelled stagflation, puzzled economists almost as much as it did politicians. If they had looked beyond their own backyard, they would have seen that the combination of the two evils was far from a rare event -- it was normal for instance in Latin America from which they were too proud to draw lessons. According to the accepted historical canon, it was the miners strike of early 1974 which brought down the Heath government. But far more significant in fact was an earlier strike in the same industry at the beginning of 1972. The miners' victory then was more significant precisely because it took place in a recession and before there was any thought of a world energy shortage. The economic cards should have been on the government's side. But it was defeated by the violent new tactics of the National Union of Mineworkers symbolised by the flying pickets which roamed around the country preventing fuel from being delivered. After its first defeat by the miners' union, the government moved back towards a dirigiste and supposedly expansionist approach. Despite the inflation figures, it began simultaneously to increase government spending and reduce taxes in an attempt to stimulate the economy. Bodies such as the PIB -- Prices and Incomes Board -- were expected to hold the lid on any inflationary consequences. Although there were some Conservative cynics who welcomed the second miners strike of 1974 as a vote-winning way of bashing the unions, this was far from what Heath wanted. His government blundered into the strike because of wage and price guidelines which made no sense against the new international inflation and because it had completely miscalculated the genuine economic strength of the miners during a world fuel crisis. The main economic event which affected British business in 1973-74 came from abroad in the shape of a fivefold increase in the price of oil following the Yom Kippur War. The proximate cause was that the Arab-dominated oil price cartel, Opec, had at last got its act together. But it was only able to do so because of a simultaneous economic boom in the industrial world which was reflected to a more moderate extent in the rise of other commodity prices apart from oil. Until 1971, world inflation has been held at bay by the Bretton Woods dollar standard. Under this system the main industrial countries tied their currencies to the US dollar under a system of fixed but adjustable exchange rates. The emphasis was on the fixed aspect with adjustment being regarded as a defeatist last resort. The counterpart was that the US itself acted as the anchor country and maintained reasonably sound money policies. These were thrown to the wind during the inflationary financing of the Vietnam war in the 1960s. When Congress belatedly enacted a tax increase which failed to stem inflationary forces, political interest was for the first time kindled in the Chicago monetarist school which advocated domestic monetary control. Even the US however adopted the statutory pay and controls in 1971 just before President Nixon floated the dollar and broke the last links of the US currency with gold. There was one more attempt to fix a new dollar parity; but by 1973 the world was on a floating exchange rate system unconstrained by domestic monetary discipline. Thus there was nothing to stop the main industrial countries from over-reflating in 1972-73 and indulging in wishful thinking about the rate of economic activity and economic growth which could be sustained without accelerating inflation. A more perfect recipe for the Opec cartel was hard to imagine. Few countries deliberately sought to inflate their money supply. It was much more that governments such as those of Richard Nixon and Edward Heath -- with some support from their central banks -- recoiled in horror from the interest rates that they thought were necessary to contain the monetary consequences of their own policies. (Germany and Japan were, however, more prepared to give priority to offsetting the inflationary impact of the world oil price shock than were the English-speaking economies). When Labour came back to office first under Harold Wilson in 1974 and then under James Callaghan in 1976 it inherited an inflation rate racing towards double digits. Its initial response was more of the same: that is pay and price controls which they hoped would more easily be accepted under a party which had been created by the union movement. It has to be said that under governments of both persuasions, the leaders of British industry proved far too compliant and accepted the wage and price control diagnosis, concentrating mainly on trying to ease the pressure on industry at the margin. During the whole Labour period of 1974-79, the Chancellor of the Exchequer Dennis Healey, who would have much preferred to have been foreign secretary, poured out anathemas on all schools of economic thought. He once declared that he wished to be to the economic forecasters what the Boston Strangler was to door-to-door salesmen. He came to share the alarm about the decline of the profitability of British industry and claimed that at tripartie meetings he had to make the case for industry himself. He was also prepared to make some pragmatic gestures towards the control both of public spending and of monetary growth. The monetary controls devised under his regime were however too dependent on complicated devices such as the corset which attempted to control bank loans directly and which the shrewder financial practitioners soon found a way round. The shift away from post-war full employment policies towards a preoccupation with limiting public sector borrowing and a tentative approach to monetary targets was thus apparent during the Labour period. It was dramatised by a series of runs on sterling invariably followed by public expenditure clampdowns, fiercer than anything attempted before or since. The conversion from demand management to a new sound money consensus was often attributed to the conditions imposed by the International Monetary Fund in its 1976 loan negotiations with the UK. In fact government policy had already moved most of the way before the IMF deal was done. The change was symbolised by James Callaghan's speech to the 1976 Labour party conference -- widely and correctly attributed to his then son-in-law Peter Jay -- in which he declared that governments could no longer spend their way into prosperity. While the world inflation and the accompanying energy price increases of the mid-1970s posed genuine policy dilemmas, the British crisis of the late 1970s was an unnecessary one. Although the UK was well and truly on a floating exchange rate, policymakers still had the reflexes of a fixed exchange rate system; and whenever the pound weakened they were afraid that it would do something described in City dining rooms as going through the floor. In retrospect once appropriate monetary and fiscal policies were introduced, the government could have left the pound to recover in its own good time and not bothered with the IMF. Indeed by 1977 sterling was already recovering too quickly for comfort and British policymakers experienced the first of a series of strange crises due to an excessively strong pound -crises for which their predecessor would have given a proportion of their anatomy to have. The public sector strikes of early 1979, in which the dead were notoriously left unburied, reflected the boy scout-like desire of the government to use a policy of belt, braces and suspenders against inflation rather than any one or two of these alone. The Advent of Thatcher The assessment of the Thatcher government is still a matter of acute political controversy which affects even the most highbrow academic attempts to be objective. In retrospect the two main innovations were the belated attack on union power and the privatisation of state-owned industries. The latter was at first regarded as an impossibly utopian project, but was later copied by governments of many different political colours all over the world. The attack on union power was spearheaded by a number of Acts designed to remove the legal immunities of these bodies and to introduce devices such as strike ballots before industrial action. But other aspects were just as important. The union legislation would not have been so successful had it not been for the governments courageous and successful resistance yet another miners strike in 1984-85, and one which had unmistakable political motives. But lest too much is attributed to government, one should also draw attention to the secular decline in manufacturing industry - much bemoaned at the time - a sector in which the unions were at their strongest (apart from public employment). There were also important clearing up measures. Wage, prices and dividend controls were quickly removed and did not return for the rest of the century. In addition confiscatory marginal tax rates of 80 per cent plus on higher earned incomes and 90 per cent plus on investment income were abolished. The two main tax cuts were in the Geoffrey Howe budget of 1979 and the Nigel Lawson budget of 1988. Although the last led to a such an uproar that a House of Commons sitting had to be suspended, there has so far been no attempt by the Blair government to restore these confiscatory rates, whatever may be thought of the overall drift of the tax burden. What the Thatcher government wished to be remembered for was its total impact in promoting what it called an enterprise culture. It may have had some effect in doing so, judging by business reaction, though there was no productivity acceleration then or later. Indeed the rhetoric about entrepreneurship was taken up again, in only slightly different words by Gordon Brown, who became Labour chancellor in 1997 and who was much influenced by US culture and academic writings, especially of the Harvard variety. Money and the Pound Unfortunately much of the discussion among economists and economic commentators during the Thatcher period was on pseudo-technical questions of monetary control. The dilemma started from the very beginning in 1979-80, when the official broad measure of the money supply, sterling M3 was rising much faster than target; but this apparent monetary expansion was accompanied by a severe recession and a further rise in the pound about which British exporters complained bitterly. The renewed upward pressure on sterling was widely attributed to the impact of North Sea oil, which was then just coming on stream, on the British balance of payments. One industrialist remarked that he wished that the bloody stuff had been left under the ground. A more highbrow reaction to the rising pound was to argue that the British government had used the wrong measure on the money supply and should have used some narrower aggregate. This view seemed to be adopted in 1984-85, when, to the fury of another school of monetarists - the government abandoned targets for Sterling M3 and moved over to a very narrow money aggregate called M0. This consisted of the banks balances with the Bank of England together with cash in the hands of the public. This aggregate was not however used as a form of monetary base control, for which the Friedmanites had argued, but as a rough guide to current economic conditions. The truth is that the government did not find any monetary indicator which conformed to common-sense observation of what was happening to the economy. One effect of all this squabbling was to put off the general public - and even non-specialist economists - from anything to do with monetarism. Another effect was to build support for British membership of the European Monetary System, which had started without the UK in 1979. It was noted that some countries, notably France, had managed to import German price stability by tying their currencies to the German mark inside the European Exchange Rate Mechanism and realigning as little and as seldom as possible. The clamour to join the ERM was shared by far more people than chose to remember it afterwards. There were two forms of the argument for a D Mark anchor. One was that the UK would have to follow a non-inflationary monetary policy if it was to avoid realignment; and the movement of the sterling market exchange rate would therefore send forth the right signals. Another argument was that the pressure of overseas competition, without the devaluation option, would put a lid on British costs and prices in international markets, and this would eventually percolate through to the domestic economy as well. Whether the external discipline and monetary control arguments were complementary or alternative, or amounted to the same thing, would take a lifetime of scholastic argument to determine. Business support for the ERM was based more simply on the hope of some exchange rate stability which would life easier. The case for the ERM as a monetary anchor was probably at its strongest in 1985 when the chancellor, Nigel Lawson first proposed it. Although it had a large amount of Cabinet support, it was vetoed by Margaret Thatcher who was by then relying increasingly on the advice of her own personal economic adviser, Alan Walters, much of it given from across the Atlantic. There was another attempt at a more informal link with the ERM through the policy of shadowing the D Mark, which Lawson adopted in 1987 and which led to a much publicised row with the prime minister in 1988 - a dispute culminating in the chancellors resignation in the following year. The third attempt on the ERM was that of John Major who succeeded him as chancellor and who managed to force through British membership in the autumn of 1990. By then the Treasury had no alternative policy to offer and Margaret Thatcher resigned near the end of that year after a disappointing leadership vote among conservative MPs. But by then the case for the D Mark anchor had been enormously weakened by the German reunification of 1989 which imposed a large budgetary burden on the German government. The Bundesbank, quite rightly in view of its mandate, maintained high interest rates to offset the inflationary effects. This interest rate policy was however quite unsuitable for the UK which had entered one of its worst post-war recessions and one which was particularly resented because it hit the talking classes in the south east of England. Thus by 1992 John Major, who was by then prime minister, was forced to take Britain out of the ERM and put the country back on a floating exchange rate which lasted for the rest of the 1990s and into the next century. The more stable 1990s The decade from 1992 witnessed first a gradual recovery from the recession and then a period of low inflation and moderate growth, with more stability than had been seen for many years past. The hallmarks of the new policies were inflation targets and a greater role for the Bank of England. Probably the pioneering country in the use of inflation targets was New Zealand. But someone in the Treasury had the sense to propose them for the UK as part of the response to the post-ERM panic. These targets were accompanied by a new obligation on the part of the Bank of England to produce a regular Inflation Report. These innovations, which were introduced by Norman Lamont who had succeeded Major as chancellor were reinforced when his successor Kenneth Clarke surprised many officials by agreeing to the publication of the minutes of the monthly meetings on interest rate policy between the Chancellor and the Governor of the Bank of England. Operational independence of the Bank came with the Labour victory of 1997. It had first been advocated by Nigel Lawson and then by Norman Lamont, but proved unacceptable to both Thatcher and Major. Tony Blair, who had no ambition to control monetary policy personally, was more easily persuaded. The new policy regime, under which interest rates were set by a seven person Monetary Policy committee was more of an evolution than the revolution which Gordon Browns supporters liked to claim. The most interesting feature of the 1990s was not so much low and stable inflation itself, but that it was accompanied by a continuing drop in unemployment to much lower levels than in the 1980s. In economic jargon, the NAIRU - the rate of unemployment consistent with non-accelerating inflation - seemed to have dropped. Some of the credit can legitimately be granted to the Labour New Deal, which put emphasis on retraining and on pressure on the unemployed to take jobs and temporary subsidies to employers to take them on. Even more important in my view was the belated effect of the reduction of union power to price people out of work arising from the Thatcher measures of the 1980s. Labour leaders could not of course publicly admit this. But privately they were keen to emphasise how little of the Conservative union legislation they had reversed. Nevertheless there was some quiet backsliding. The minimum wage was more objectionable to libertarians in principle than in practice as the government was keen to keep it low to the chagrin of its own left-wing. Nevertheless there was a creeping movement back towards so called social legislation which imposed high cost obligations onto employers. (At the time of writing British employers are up in arms against a draft EU directive which grants all temporary workers the same conditions and terms as their permanent colleagues - thus closing one route for pricing workers into jobs. The British government was mainly concerned to delay this rule for the first six weeks rather than to stop it altogether.) There were a great many specific domestic measures, which ministers undoubtedly believed were improving the supply side and making the economy more competitive; and it is true that most of them had been sanctioned by official economists as ways of tackling one or other externality which interfered with the optimal working of the market mechanism. But what the new government found it difficult to appreciate was that the cumulative effect of a great many individual measures, which in themselves might have been desirable, produced an irritating and cost-increasing business environment. Unfortunately the new governments academic praetorian guard was not as familiar with the US economic analysis of government failure as it was with the standard writing on market failure. The argument about Europe rumbled on, threatening to split the Labour party as it already had the Conservatives. The economic argument no longer related to an exchange rate anchor. Many supporters of British membership of the euro had originally seen it as the best way to establish an independent central bank. But with the coming of the MPC arrangement, this argument had largely vanished. What was at stake now was the pros and cons of a more stable exchange rate against the disadvantages of a one size fits all monetary policy. Or to put it another way: would stability be better ensured by the MPC or the European Central Bank. No amount of technical analysis was likely to weaken the conclusion that it was half a dozen of one and six of the other. the famous five economic tests for euro membership could be interpreted according to taste and their application was delayed as long as possible. In any case public opinion remained for long resolutely opposed to dropping the pound; and Tony Blair would have been well advised to put the whole issue on ice for his first two administrations. His reluctance to do so had little to do with euro technicalities and reflected far more the urgings of Foreign Office and Cabinet Office officials who wanted Britain to have a seat at some imaginary European top table. Conclusion: the new century As the new century began there was a distinct possibility of old errors coming back in a new way. The most likely route was by means of the European Social Model, which was not social, not a model and did not deserve the name European. It was characterised by high labour overheads, wage arrangements which made it difficult to fire, and therefore to hire and which were too insensitive to market pressures. The result was that an excessively low proportion of the EU population was at work, especially in the older age groups; and the coming explosion in the number of pensioners looked like having to be supported by an ever lower proportion of active workers. Too many people were being educated, unemployed or prematurely retired. The simple step of linking retirement age with longevity, which might at least have eased the pressure on the European Welfare State, was considered too revolutionary and reformers became obsessed with the minutiae of pensions arrangements. The UK debate was muddled by an unhelpful dispute between the little Englanders and the euro enthusiasts. Yet for those of us who treated government as a device rather than a totem, it did not matter so much exactly where the centre of power was located. The British economy was equally capable of flourishing under a strong European federal government with appropriate decentralisation and a single currency, or under a national government with an independent pound regulated by the Bank of England Monetary Policy Committee. The danger was that it would get the worst of both worlds: a weak European confederation, with enough power to stifle market forces and price people out of work, but without the power or drive for genuine reform. Yet, for all these problems, most British people had a far higher standard of living than the vast majority of the human race in all past history; and the time could be coming for Lord Keynes's Economic Possibilities for our Grandchildren, in which attention would shift to more important matters. That is if the attempts of religious and other fundamentalists to destroy the European Enlightenment and the appeasing reaction of Europe's leaders do not derail us on the way. (1) Nicholas Crafts: Britains Relative Economic Performance, 1870-1999, Institute of Economic Affairs 2002. Contribution to The Challenge of Change to be published by Profile Books for Soc. of B. Econ., 2003
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