Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday 10 April 2013

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


  1. "The taboo on the left is not to admit (at least publicly) that UK trade unions had grown too powerful in the 1970s,"

    This isn't right. Francis Cripps of Cambridge who was working for Left political parties had models for the UK economy where trade union bargaining power was explicitly included.

    Others were struggling to explain the huge rise in inflation while he forecasted it in advance.

    It was in fact Monetarists who said little about bargaining power and blamed everything on the lack of control on the money stock.

    The Monetarist "experiment" was a smokescreen to bring down the power of bargaining by deflating demand to the point of creating super-high-unemployment.

    As for productivity rise - as Wynne Godley argued - unless it is accompanied by a rise in production just distributes income from those who become unemployed to those who don't.

    1. In the 1970's it was the trade unions which were to blame for our low labour productivity.

      Given they are very weak today, what is to blame for our current poor labour productivity?

      As I understand it employers would rather employ people from eastern Europe because they have a better work ethic than people from the UK.

    2. No - they employ them because they're cheaper - which means their lack of standard English and often their differing standards of work are more attacks on the socius here. Thatcher's legacy is a decimated North, the loosing of the feral elite who rob from the poor every day to the tune of hundreds of billions (quod erat demonstradum). Affordable housing anyone?

  2. The parallels between the UK and US are interesting. I was an American kid in the 70s (when The Clash corrupted my innocent brain) and developed an antipathy towards the rightwing.

    American conservatives love Reagan and Thatcher because they broke organized labor. Reagan broke the air traffic controllers signaling an all out war which has decimated organized labor since. Clinton and Blair de-emphasized the labor connection in their parties.

    Here in the States Volcker overshot in his fight against inflation as well, raising rates too high too fast.

    How different would things be if the U.S. and U.K. had greater labor involvement in policy decisions as in Germany which weathered the recent downturn much better? (Granted Germany labor needs to better regarding Germany's Euro policies.)

  3. OK she could have relied less on monetarism to control inflation, but that would have meant relying more on making compromises with trade unions so as to get wage restraint. And trade unions would have demanded more subsidies for clapped-out industries as a price. So would GDP have been any better?

    1. No, that is not what I meant at all. Inflation had to come down, so monetary and fiscal policy needed to be tight. But it could have been done in a controlled and balanced way, so as to minimise the output costs. Instead, by adopting monetary targets, it was done in an uncontrolled and imbalanced way.

    2. Simon: overall, a fair and balanced post. Yes, it would have been better if Mrs T had adopted inflation targeting gradualism in 1979 rather than monetary targeting. But it's a bit (what's the right word?) ahistorical(?) anachronistic(?) to say that. IT hadn't been invented yet. "Caesar should have used tanks!" And IIRC (I left the UK in 1977) the prevailing orthodoxy at the time was that inflation had nothing to do with monetary policy. They/we really were that daft back then. The actually existing alternative strategy to bring inflation down would probably have been a repeat of "prices and incomes policy".

    3. Nick: I disagree. Although there were still some on the left who denied it, the existence of a Phillips curve was acknowledged by most macroeconomists at that time. The incoming government could have - quite rightly - disowned prices and incomes policy, but retained the discretionary management of demand and inflation that had gone before, but in a more anti-inflation manner. In terms of plans, they did not need to fall head over heels for monetarism.

      More seriously, when the policy almost immediately started to go wrong, and we saw a massive appreciation in sterling, they should have eased off. The trouble was that the lady was not for turning. Yes, it would have meant losing political face, but good leaders do that. Bad leaders stick to bad plans when they are not working either through blind face or obstinacy.

      The tragedy is that the right's myth making machine has turned this episode of bad government into a triumph. In that sense the parallel with today's austerity is very real.

    4. If they had stuck doggedly to the £M3 targets that argument would make sense, but the massive overshoots of £M3 in the early Thatcher years are surely evidence both that policy remained highly discretionary and that they did "ease off" because of strength/speed of the disinflation?

    5. Perhaps the best way of thinking about it is that in 1980 and 1981 interest rates went as high as the government thought politically possible so as to get as close as possible to meeting the M3 targets. The focus was on the M3 targets, and not the damage being done to the economy. So you are right, it could have been worse, and the policy could have been continued for longer. But it remains the case that the policy was seriously wrong in 1980 and 1981, and pretty well everyone, including probably most of the cabinet, wanted to ease off during that time, but the lady was not for turning.

    6. And five years into a gradual disinflation, with high unemployment and inflation at 16% (a 1% reduction per year from the 1980 rate, assuming you think the inflation rate in 1980 was too low) would any government have had a chance of re-election?

      Gradual inflation-targeting might make sense in a dictatorship with an annual NGDP growth rate of 17%, but not in the UK in 1979. If anything, it was only the Falklands war that made a strategy as gradualist as the MTFS into a politically viable one.

      I'm also astonished by the suggestion that Jack Jones and Arthur Scargill would have gone along with (1) an agglomeration of British trade unions into concentrated German-style unions, such that (2) a German-style corporatist model could have secured Thatcher's re-election prospects. Wouldn't it just have been better for Thatcher to wave a magic wand and eliminate unemployment altogether?

  4. "Major UK macro-economic disaster" or "recession" as they're more usually known by people fluent in "human".

  5. Conservative paeans to Ms. Thatcher notwithstanding, her economic legacy is sub-optimal.

    Compared to Germany and France, which dealt with labor unrest in different ways, GDP growth was no better and no worse during the Thatcher era.

    But compared to Germany and France, inequality and intergenerational mobility significantly worsened in the UK during and after Thatcher. In 1979 13% of children lived in households where income was less than half of the average income. By 1996 this had risen to 33% (Gregg, Harkness and Machin, 1999). And per Blanden & Machin (2002) the cohort that came of age under Thatcher had less intergenerational mobility than previous cohorts.

    We in the US have certainly done no better on inequality and intergenerational mobility post Reagan than has the UK post Thatcher. So the question must be asked of these two iconic conservative heroes; where's the beef?

    1. Of course you answer your own question. For those at the top of the income distribution, who have a significant role in defining public opinion, they are heroes indeed.
      From memory, in terms of unemployment the US in the 1980s and early 1990s did a lot better than the UK: Germany did significantly better, while France was similar to the UK.

    2. The US and the UK unemployment levels (and their arcs) were roughly equivalent during that period. The UK went from about 12% to 7%. The US rate declined from 11% to 5%. France never got their rate below about 9% during the same period.

      However, I think the safety nets of the UK and the US were considerably less generous than France's. For a married couple with two children and one breadwinner (in 2006) redundancy meant a drop in income of 30% in France and roughly double that in the US. I can't find comparative numbers for the UK, but assume they are closer to the US figures.

    3. When I look at the data, the average unemployment rate in the US was higher than in the UK in the 1970s, but significantly lower in the 1980s and 1990s.

    4. "GDP growth was no better and no worse during the Thatcher era."

      Two points: UK GDP/head today is about 88% of the German level. Back in 1970 it was about 60%. So over the whole period UK GDP/head must have grown faster than German.

      Next, Thatcher was involved in economic reforms. I am not getting into a discussion of whether they were perfect, but my recollection is that monetarism wasn't as well understood then as some people seem to remember. Reforms are supposed to have long-term effects. If the economy had done very well under Thatcher, but not since, the reforms would have been pretty short-lived.

      And on Simon's wider point, yes, inequality has grown quite a bit in the UK, but as I pointed out a few weeks ago, it has widened in Russia and China as well, in the latter case to an almost grotesque degree. But what do you want? Brezhnev's Russia? Mao's China?

      This has been Maggie Derangement week, I hope the last one, but the Guardian polled the question whether Maggie had been good or bad for the country, and people who answer polls split 50/34 in favour overall, and as someone joked the other day, in an election that would be a landslide.

      Personally I think most people take the pragmatic view that we've got the prosperity, and now we can afford to address some of the inequality.

    5. Might your 1970 figure be limited to just West Germany?

  6. beat article on Maggie I have seen.

    Mind you this is a high quality blog.given i am an aussie and simon is a pom that is high praise indeed.

  7. Capitalism is's easy to make money if you have it so the rich will keep getting richer always and forever. Simple example....if I put 100k in the bank and you put 10k in the same bank then I will
    Make 10 times what you make for doing nothing

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  9. Probably way too late to get a reponse but... In the case of the long lag between thatcher slash and burn and 1990s improvements - is it not more plausible to attribute that to a) our crashing out of the erm and the fall in the pound (which seems like the very opposite of thatcher an inflation obsessions) and b) the rise of finance (which as I think you prob agree is a very dubious form of success). I am not economist so this may all be quite wrong.


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