Supply Side … Reaganomics and Thatcherism!

Margaret Thatcher and Ronald Reagan … Supply side reigns.

The modern Liberal, certainly subsequent to Franklin Roosevelt, no longer believes in the total “laissez-faire” of Adam Smith, and while believing that free markets are more efficient than centrally controlled markets, he finds it necessary to temper the excesses of totally free markets with a certain amount of State intervention. In this regard we look particularly at a Social Security net as well as the curbing of monopolistic practises.

Margaret Thatcher and Ronald Reagan, both signaled a move away from excessive State intervention in the economy toward a more “Conservative” view that is closer to 18th and 19th Century “laissez-faire”. Generally these policies tend to favour the wealthy at the expense of the poor.

That there was a need for the step change, is clear, as the love affair with Keynesian Economics had resulted in too much state control, and generally stagnant economies, with high rates of inflation.

Reagan's supply side economics was based largely around reducing taxation and giving further tax breaks to business. Regulatory frameworks were relaxed ultimately allowing Banks to merge cross state. Up until the time of Reagan, the USA prohibited commercial banks from operating cross state. This had had the effect of preventing the growth of monolithic Banks that would become too big to fail, it also allowed for differing monetary policies to be followed by the various States. Generally taxation was reduced allowing for a widening Federal deficit.

Most economists including people like myself (still clinging to my Keynesian ideas) thought that this had little hope of any success and was merely a game of smoke and mirrors. We saw, however, a slow upturn in the USA economy. The degree to which it could have been ascribed to Reagan's policies or non-policies was difficult to pin point. The large investment into research and development under the Carter presidency might certainly have had a more direct impact, particularly in regard to extraction of oil and gas from the large shale oil deposits.

This re-awakening of the general entrepreneurial spirit of the Americans soon began gathering momentum. The birth of companies that were little more than “garage” operations like Microsoft and Apple were soon to start having an impact. Silicon Valley became a reality. Oil prices began falling, and the USA economy began growing once again.

Whether this rebirth of the American economy could be totally attributed to the policies of Reagan is not as clear-cut as we might be led to believe. It could just as easily have been part of new trade cycle, or a dividend from the Carter administration. However, there can be no argument that a new found confidence in the American people played a part in creating an environment which encouraged that latent spirit within us all to take advantage of an opportunity, when it comes our way.

There were essential differences between the policies adopted by Reagan and those of Margaret Thatcher, although in essence they were both aimed at stimulating the supply side of the economy, their very differences could epitomise the current debate on the rights and wrongs of austerity.

Can we dig ourselves out of the current situation without austerity?

According to the Reagan fans the answer is yes, while those closer to the Margaret Thatcher camp will say no.

Both the USA and UK were in a state of stagflation, in the case of the UK there was a perception that part of the cause lay in excessively powerful trade unions and much of Margaret Thatcher's economic policy aimed at curbing that power.

Both Thatcher and Reagan placed reduction in income tax at the heart of their policies coupled with a certain amount of deregulation aimed at encouraging new business start ups. The essential difference lay in the UK still maintaining a semblance of a balanced budget, while Reagan argued that the future growth of the economy would balance the budget. (Very much like Labour in the UK to-day … “we need growth to cut the deficit”).

In the case of Thatcher, she used the proceeds of privatisation and sale of Council houses to help balance her budget (an indirect effect as it reduced the needs to borrow). This was never sustainable and the UK started increasing indirect taxation (the introduction of poll tax as an example). This movement toward a more regressive taxation system has vastly widened the gap between rich and poor in the UK.

The mystical balancing of the budget out of future growth in the USA failed to appear. In spite of Reagan's policies bringing about a resurgence in the USA economy. The USA deficit continued growing in absolute terms, even if it appeared to be marginally narrowing in percentage terms. The reduction of federal tax also had the effect of widening the gap between rich and poor in the USA.

In both countries the economic policies of the 1980's have increased their dependence on foreign countries. The USA primary trading partner of this time, Japan, developed indigestion from all the USA paper that it had to hold. They started converting this paper into physical assets in the USA with a significant portion of USA business and industry now controlled by Japan.  

In the UK we, increasingly, see a dependence on foreign investment for growth. This should have been clear in my analysis from the Keynesian perspective, but let me reinforce that picture. The most obvious, while we need nuclear power to supplement our power generation and reduce our dependence on our own dwindling supply of north sea oil and fossil fuels, we will not undertake this ourselves and rather look to France.
To make any utility viable the government will need to give fairly strong guarantees on pricing to the French, who already own a large portion of our electricity generation. These guarantees amount to a tax on the British People that we will be paying to the French government as EDF is largely French government owned!

From the above we see that by providing incentives, for business to develop, if coupled with a reduction in taxes (increasing the spending power of the consumer) we can bring about growth in an economy. The USA achieved this without austerity while in the UK austerity was very much part of the policy. Both policies have created long term weaknesses in their economies, that are quite possibly the main cause of the current situation.

Final thoughts on the Thatcher/Reagan supply side.

The belief of the Thatcher Government that “The City” freed of much of the regulation, would ultimately generate the employment opportunities to fill the void, by spawning a need for further service industry, should be tempered with some rationality. While “The City” with it's Financial Services network of Banking, Insurance, Investment, Lawyers is undoubtedly the power house of the British Economy, it is not and can never be the B-all and end-all of the economy. We need more than lawyers, accountants, wheeler dealers and con artists.

If you think the use of the term con-artists in referring to “The City” too strong, just consider the various cases of miss selling by highly regarded institutions over the decade. We are changing, culturally, not from the bottom (ordinary people) but insidiously, from the top down!

The position of eminence for “The City”, in world financial markets, was based on it's very integrity “Our word is our bond”. We are destroying that perception, not even our government keeps it's word.

If you think these are only isolated cases, let us look at a few which touch every one of us. The pricing mechanics of the Gas and Power utilities, the average person, is on to a hiding to nothing, almost needing advise of an actuary to work out the best deal. We are continually being exhorted to check out the prices and to switch providers. We are being encouraged to become wheelers and dealers! The telecoms industry is even worse! Listen to the personal finance programs on the radio, or follow them in the newspapers.

The wealth of a nation is fundamentally created by the butchers, the bakers and the candlestick makers!

Much as our Financial Services Industry brands itself as “creators of wealth”, they only create a perception of wealth no real wealth. They should be providing the oil for the wheels of industry, they are not the wheels in themselves.

I have tried to draw a picture of where Political leadership has led us culturally. We have  been fed a diet of “Pie in the Sky”, we look down on those doing the mundane. We no longer train the nurses we need, or the artisans that make up much of the engineering industry.

We are risk adverse. The small shops in the villages and towns are increasingly owned and run by people of Asian origin, there is less and less entrepreneurial spirit amongst people of purely British extraction.

While technologically there is nothing we cannot do, we look to foreigners to do things for us. Our hospitals and care industry are filled with foreigners, many from developing countries, we complain about the immigrants taking the jobs, but are not prepared to work as hard or at the same wage rates.

Our expectations are too high.

We need to rebuild our nuclear energy resources, we look to the French to do it for us! However, only after Gordon Brown failed to drum up any enthusiasm amongst the Arab oil countries for investing in the UK energy market.

Our utilities are increasingly foreign owned. Even David Cameron on his recent trip to China, brought back as inward investment from China a deal where China would take up a large stake in one of our water utilities, it might not have been as bad as Gordon Brown trying to gate crash one of the Arab summits, begging bowl in hand, as he looked for investment in the UK energy industry, however it is indicative of just how dependent we have become.

It was easy to see why the USA arrived at the point of becoming more and more dependent on their trading partners, Ronald Reagan having paid no regard to balancing the budget. This was more insidious in the case of the UK, here I don't think I can directly blame the Thatcher policies, even though they created the environment that led to a greater dependency on the outside world. The real issue began in the 1990's when we started looking on the money (investment) flowing in to “The City” as being tantamount to exports from which time we stopped looking at our trade deficit as being the most important economic indicator.

To answer the question.

It really depends what we mean by austerity!
The answer is basically no

If we rephrased the question and asked rather if we can avoid excessive cuts to Public Sector spending the answer is yes.
Provided we are prepared to go through the austerity implied by eliminating our trade deficit. To simply gamble on exports increasing is wishful thinking. It did not work for the USA and cannot work for us.

We need to accept that we are living beyond our means … that does not necessarily mean the Government Deficit is too high (although that could be an element), it means we must import less.

I have tried to show, with simple arguments that we have taken ourselves beyond the reach of easy Keynesian demand stimulation. See

I have also shown that supply side stimulus has little hope of success without creating even bigger distortions.

I have tried to show that we need to address a lot of issues in the economy, starting with our culture, through education to structural defects all of which will take a decade or more to resolve. The policies of both the current Government and the Opposition are not addressing the real issue, and can only result in the UK economy stumbling along for the next 10 or 20 years.

The golden rule in life (or business) is that when faced with a problem look at it squarely and face up to it don't simply try and buy time, in the hopes that the rain clouds will disappear, the sun come out and we can all play again. The problem will be far worse then, than it is today!






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