Rebirth of Free Market Ideology: case of Great Britain.
(“The Commanding Heights” – Chapter 4)

British economy performed very poorly in the 1970’s:
high inflation (peaking at an annual rate of 24% in
1975) and rising unemployment => another apparent breakdown of “Phillips Curve”
labor strife : Coal Miners strike of 1973 and “Winter of Discontent” in 1978-1979 (strikes by gas-tank truck drivers, railway engineers, ambulance drivers, gravediggers, garbage collectors)
4 Primary Causes of Poor Economic Performance:
1. High and progressive tax structure reduced incentives to work, particularly at the “upper end” of the income scale (rates as high as 83% on earned income)
2. Comprehensive “Social Safety Net” (i.e., the “Welfare
State”) reduced incentives to work at the “low end” of the income scale
3. Labor relations remained poor as the workforce remained highly unionized and militant => strikes became common, disrupting economic activity and driving away foreign investment
4. Large Public Sector appeared to be devoting a tremendous amount of resources to inefficient and economically declining nationalized industries

In short, Britain had reached a point where they relied very little upon “markets” to answer the “basic economic questions.”
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 Keith Joseph (the “Mad Monk”) and Margaret Thatcher
(Prime Minister from 1979-1990) both greatly influenced by the work of free market economist Friedrich von
Hayek (1899-1992; Nobel Prize in 1974)

Economist of the “Austrian School” – strong advocates of free-market capitalism as opposed to the socialist systems which arose in the mid-20 th century
 “Road to Serfdom” (1944): argued that socialism would often lead to totalitarianism as central planning replaced individual decision making o totalitarianism – a regime in which the state regulates nearly all aspects of public and private behavior

Strongly believed that all planned economies suffered from the
“Economic Calculation Problem” o Recall, this was the argument (first articulated by
Ludwig von Mises and later refined by Friedrich von Hayek) that a system of planning will never be able to achieve efficient outcomes, precisely because under such a system the planners do not have the information generated by market activities available to them

Views of von Hayek were arguments against
Keynesianism, simply because they argued for a much smaller role for government (whereas Keynesianism concluded that there was a clear role for government in the economy and called for active government policies to manipulate economic outcomes)
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Margaret Thatcher: Prime Minister, 1979-1990; thus far the only female to hold this position

In the view of Thatcher, the proper tasks of government are limited to:
1.
maintain sound finances and a stable economy (fiscal responsibility; control of macroeconomy through responsible monetary policy)
2.
ensure a proper foundation of law, so economic activity can flourish
3.
provide national defense
4.
provide education to the populace (as a tool for economic opportunity)
5.
provide a social safety net (but, one much smaller than what was in place; central question to her was: how can we provide an effective safety net without creating or strengthening a dependency culture ?)

She sought to return Britain to a reliance on markets and to replace Keynesian Policies with Monetarist Policies.
Primary elements of the policies which came to be known as “Thatcherism” included:
1.
reducing the scope of the “welfare state”
2.
reducing the levels and progressivity of taxation
3.
a comprehensive program of “Privatization.”
4.
a rejection of Keynsianism in favor of Monetarism

Early in her term she made huge cuts in government spending, but the economy did not recover quickly => popularity was suffering

Falklands War (April-June 1982) against Argentina was militarily a success for Britain, bolstering patriotism and support for Thatcher => remained in office following the June 1983 general election
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Curtailing Public Services (“shrinking the welfare state”)

Welfare spending accounted for 23% of GDP in 1979

While it did decrease as a percentage of GDP during the time Thatcher was in power, it rose to 25% of
GDP by 1995 (so any “decrease” was not permanent)
Tax Reform

Thatcher did implement substantial changes to tax structure => overall tax burden and progressivity both greatly reduced

Tax rates on earned income: high 1979 rate of 83% reduced to 40% by the time Thatcher left office

Subsequent administrations not only kept her changes in place, but further reduced levels and progressivity
Privatization – a return to private ownership and control of those enterprises which were acquired by the government through nationalization
Scope of Privatization under Thatcher:
 by 1992 about two thirds of nationalized enterprises were privatized; 46 major enterprises with 900,000 employees privatized
 In 1979 12% of British “value added” originated in government enterprises, by 1997 this figure was down to only 2%

Privatized enterprises included: British Aerospace,
British Telecom, British Steel, British Coal, British
Rail, North Sea Oil and Gas, state owned hotels and gas stations, and public housing
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Four Rationales for Privatization:
1. Boost for Productivity.
Profit seeking managers will operate an enterprise more efficiently/effectively than government bureaucrats.
2. Creating Popular Capitalism.
Privatization would expand the portion of the population that directly owned enterprises => 1979: 3 million Britons owned stock; 1991: 11 million Britons owned stock.
3. Reducing Government Borrowing.
The sale of nationalized enterprises generated revenue for the government, allowing them to reduce budget deficits.
4.
Reducing Problems with Government Pay
Determination.
Setting wages in government agencies was problematic.
Privatization and the Labor Market:

Privatization greatly reduced the “power of Unions.”
 Nationalized enterprises operate on a “soft budget constraint” (cannot go bankrupt). Privatized enterprises operate on a “hard budget constraint” (can go bankrupt if they continually earn negative profits)

Unions could not negotiate as aggressively with a privatized enterprise, since the enterprise would be more likely to go bankrupt when paying high wages.
 post-privatization, many enterprises experienced decreases in employment and wage increases that just kept up with inflation => could be argued that these values were simply “returning to their natural levels”
(part of what Privatization was intended to do)
 “working days lost to strikes for every 1,000 employees”: 1,274 in 1979…down to 108 in 1990
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Three Primary Methods for Implementing Privatization

Since such large scale “privatization” had never been attempted before => no “guidelines” to follow regarding how to privatize. Multiple approaches used, including:
1. Initial Public Offerings (IPO).

Underwriters examine financial statements, determine a fair market value for an enterprise, and offer shares of stock at a price which ensure a sale of all shares
 Most commonly used mechanism
 Intended to raise public participation in ownership process (“popular capitalism”) and make it much more difficult to “re-nationalize” the enterprise in the future
 Some IPO’s included the sale of a:
Golden Share – special share either retained by the government or sold to a pre-screened buyer, allowing the government to prevent control of the enterprise from falling into
“unsuitable hands” (i.e., “foreign ownership). Often done for “strategic enterprises” such as North Sea Oil.
2. Negotiated Sale.

The sale of an entire enterprise to a single buyer at a negotiated price (e.g., car company British Rover)

Criticized for “discretionary nature” and the ease to
“favor friends or political supporters” by selling assets at below market prices
3. Employee or Management Buyout.

Sale of enterprise to current managers and employees, at prices well below market values
 Example: sale of National Freight Corporation – assets of ₤93 million, but sold to employees for ₤53 million
(of which ₤46 million was put into employee pension funds – so it was effectively sold for only ₤7 million)
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Impact of policies on Growth and Income Inequality:
 Compared to 1970’s, Economic Growth greatly improved under Thatcher.

However, there was a substantial increase in income inequality (due to “shrinking of welfare state,” “reduced progressivity of tax system,” and “reduction of union power”).

Further, over this period the increase in the value of the
Gini-Coefficient was much greater than in other countries with comparable growth rates. For example over the period from 1980-1991:
 U.K., U.S., and France all experienced growth in GDP of roughly 28%

All three also experienced increases in their levels of income inequality

However, the percentage increases in the value of the
Gini-Coefficient were much smaller in France (less than 5%) and U.S. (between 5% and 10%) than in
U.K. (over 30%)
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