Sunday, March 8, 2009

Partisan politics and the economy

The history of postwar British economic policy is in many ways a history of economic policy in advanced democracies, in microcosm. In the 1950s and 1960s, governments of both right and left were committed to full employment, collective wage bargaining, and some role for the state in planning the future use of resources. The dominant economic orthodoxy of that time held that governments could usefully intervene to manage the business cycle and enhance the productive capacity of the economy by making investments with public money and regulating markets. Clement Attlee did it, Winston Churchill did it. Even Republican Presidents of the US did it.

In the 1970s, things changed. The Philips curve - an inverse relationship between inflation and unemployment, which allowed governments to interpret and manipulate the business cycle - broke down. Attempts to stimulate demand failed to increase output, but increased prices: what was called stagflation at the time. Keynesian ideas about how to run the economy were discredited, the 'monetarist' doctrine of Milton Friedman - which held that governments could not control the business cycle - gained ground.

The election of Margaret Thatcher's Conservatives in 1979 saw the abandonment of demand management as a tool to secure full employment. In the recession of 1980-2, the government raised taxes and interest rates to push inflation down, successfully. But the Philips curve was not quite dead - unemployment leapt to well over 3 million. Economic planning was abandoned, the welfare state was curbed, government enterprises were privatized, the financial sector was liberalized and attempts were made to reduce government expenditure and taxation and contain budget deficits. Similar policies were followed in the US (without the 'containing budget deficits' bit).

By the 1990s, many of these ideas and policies had become widely shared, even on the left. Bill Clinton and Tony Blair did not reverse Reaganomics and Thatcherism, although they adopted some policies to alleviate the growing poverty and declining public sector which had emerged as a new focus of public concern. Finance was deregulated further, and only half-hearted attempts were made to address the growing inequality of incomes driven in part by astronomical earnings at the very top of the income scale.

At the end of the 2000s, the world financial system collapsed. Vast amounts of public money were poured into a bankrupt banking system in the US by a Republican administration, a Democratic administration, and in the UK by a Labour government. Banks - the frontline of free market capitalism - came under effective government control.

What does this fable tell us?

Well, although there is nothing that surprising about a Labour government nationalizing the coal industry in the 1940s, and a Conservative government privatizing it in the 1980s, a lot of the time governments of both sides follow whatever policies are consistent with the economic fashions of the moment. So, Conservative governments in the 1950s did not reverse Labour's nationalizations, and Blair and Brown have not (except when forced into it) reversed Conservative privatizations. Moreover, however much the current Conservative leadership may protest, it is not obvious whether they would handle the current crisis in any fundamentally different way.

So does this mean elections change nothing? Not quite. Thatcher may have been doing similar things to Reagan in the 1980s, but France under Mitterrand and Spain under Gonzalez - both Socialists - did not follow the same path as the Anglo-Saxon countries. All western countries faced similar pressures in the past 2-3 decades - globalization, deindustrialization, slower growth, changing patterns of family life - but not all of them have seen inequality and poverty rise quite as fast as in Britain and the United States. Similarly, economic performance under these constraints also varies.

In short, the changes in British economic policy since WWII have been political choices made by elected politicians. Although not, of course, in circumstances of their own choosing, to coin a phrase. Not only are politicians constrained by events and global trends, they are constrained by available knowledge about how the economy works, and - probably more so - intellectual fashion. Until a year or so ago politicians could confidently dismiss the notion that more regulation was necessary to safeguard the financial system. That view is not heard quite so often now.

But in a democracy, intellectual fashion doesn't necessarily win elections. So the question to ask is not just why did British Conservatives get interested in the ideas of Milton Friedman in the 1970s. We also need to understand how they managed to convince British voters - including some who had little obvious reason to embrace these ideas - that inflation was more important than unemployment, and that free markets would make most people better off.