On the economic achievements and failures of Margaret Thatcher

I was not going to write anything on Mrs T, but then I just happened to read yesterday a journal article that says something important about her legacy today. I also decided to write something to challenge some of the myths and taboos created by the political right and left. The right in the UK tends to mythologise Margaret Thatcher, in a similar way I think the right in the US does with Ronald Reagan. So its worth pointing out two major macroeconomic errors that were made while she was Prime Minister. The left is less inclined to hero worship its own Prime Ministers (generally it does the opposite), but it has its own taboos when it comes to macroeconomic history.

What was the journal article? It is a paper [1] that looks at the causal impact of fathers' job loss on their children's educational attainment and later economic outcomes. The place and time is the UK recession of the early 1980s. The study concludes: “Children with fathers who were identified as being displaced did significantly worse in terms of their GCSE attainment than those with non-displaced fathers.” Not a very surprising result, but further evidence of the long term damage done by high and prolonged unemployment (what macroeconomists call hysteresis effects).

The UK recession at the beginning of the 1980s was the worst since the second world war. UK unemployment increased dramatically, from below 6% to nearly 12%, and stayed high until the end of the decade. The chart below boxes the Thatcher years. (Unemployment would have been higher still if the government had not encouraged the unemployed to register as disabled, as John Van Reenen relates and even George Osborne admits.)

UK Unemployment

Did the government led by Margaret Thatcher intend for this to happen? Almost certainly not. Their plan involved replacing traditional macroeconomic policy by monetarism, which meant gradually declining targets for the growth of a particular monetary aggregate. As Chris Dillow points out, they expected this would lead to a steady decline in inflation, with a minor and temporary dislocation in terms of output.

Many thought that a foolish thing to believe at the time, but in macroeconomic terms Mrs Thatcher’s administration were revolutionaries who despised conventional wisdom. When presented with Treasury forecasts telling them with unusual accuracy what would happen, they rubbished the Treasury advice. As unemployment rose rapidly, and many in her party urged her to change course, she gave her famous ‘this lady’s not for turning’ speech that is so eulogised by some Conservatives today.

The attempt to hit their monetary targets failed dismally: 81/80 target money growth 7-11%, actual 19.1%, 82/81 target growth 6-10%, actual 13.7%. After that monetary targets were effectively abandoned. One of the biggest experiments in UK macroeconomic policy turned out to be a disastrous failure. As GDP fell by over 2% in 1980, and remained flat in 1981, and manufacturing output fell by 15% in two years, it is not surprising that inflation fell rapidly, although too many on the left believed it would not.

Yet, as I have noted before, this period is regarded by many as Mrs. Thatcher triumphing over doubters, including most academic economists. This myth may be partly responsible for the current government's obstinacy about austerity. So how can it be regarded as a triumph? Output did recover - well of course it did, but as the chart shows unemployment stayed persistently high, with the long run costs that I noted above. Inflation came down rapidly, but far more rapidly than was intended.

Was this unintended cold turkey cure in any sense optimal? I think that is highly unlikely for many reasons. One is that the traded sector bore the main cost of the recession. The period coincided with North Sea oil coming on stream, which in itself would have led to an appreciation in sterling and a movement of resources away from the traded sector. In these circumstances, embarking on a policy that produced a further appreciation in classic Dornbush overshooting style led to the very uneven recession. Now the Dornbusch analysis was fairly new, so perhaps the government can be forgiven for not anticipating that this would happen, but by 1980 it was all pretty clear what was going on, and that was the point at which the lady refused to turn.

But the key point remains that this skewed, cold turkey policy to reduce inflation was never part of the plan. The plan itself was a complete failure, and if you think the outcome was optimal (which I do not) then that is down to luck rather than judgement.  

The second failure involved North Sea oil. I have compared how the UK and Norway responded to additional government revenue from North Sea oil before. The Norwegian government created a sovereign wealth fund, so that the gains from North Sea oil could be enjoyed by future generations. The UK government thought the people should make that choice, and so cut taxes. The people, for one reason or another, do not appear to have invested that money to replicate what a sovereign wealth fund would do. So Mrs Thatcher made the wrong choice, and whether it was for ideological reasons or more base electoral considerations is secondary. It was a major mistake that current and future generations will pay for.

Those are two major failures, but what about the successes? The Thatcher era saw the implementation of supply side reforms that ended and then reversed the relative decline of UK productivity. As Paul Krugman has pointed out, the lags here need to be long, but I think we have good reason to believe that they are. As Nick Crafts outlines here, and John Van Reenen here, this improvement came about partly through increased goods market competition, but of course it also reflected a reduction in union power that was one of the major aims of government policy. The taboo on the left is not to admit (at least publicly) that UK trade unions had grown too powerful in the 1970s, and that any benefits this had were outweighed by inefficiency and often severe dislocation.

The battles of the 1980s, and the path Mrs Thatcher took,  were not inevitable, and it is possible that the UK could have moved to something like the German model where unions retain a strong presence. However the path followed by the UK is at least partly the responsibility of the left as well as the right: some of the proposals later introduced by Mrs Thatcher were first tabled by the 1969 Labour government and Barbara Castle, and were defeated by the Trade Union Congress and the later Labour Prime Minister Jim Callaghan.

This post is not meant to be comprehensive: I have said nothing about the rise in poverty under Mrs Thatcher (briefly mentioned here), inequality more generally and the role that taxation had in increasing that (of which the poll tax was just one example), selling off state assets or under investing in what was left. (Van Reenen gives more detail on some of these.) A second major UK macroeconomic disaster also occurred right at the end of her premiership. The UK entered into the European Exchange Rate Mechanism at an overvalued exchange rate, which led to another major recession. That story, and my own very small part in it, will have to wait for another time.

   

[1] Gregg, P., Macmillan, L. and Nasim, B. (2012), The Impact of Fathers' Job Loss during the Recession of the 1980s on their Children's Educational Attainment and Labour Market Outcomes. Fiscal Studies, 33: 237–264