0 Article from the American eriodical 'FORTUNE' 10 Se tember 1979

Despite much current skepticism, there are reasons for ar uinq thatMargaret Thatcher's rigorous conservatism may ultimately prove

popular as well as corrective.

by HERBERT STEIN

Herbert Stein was chairman of the Coun-cil o' Pco"On,ic Advise s under Presidentst'iron and Ford. He now is A Willis Rob-ertson Professor of Economics at the Univer-sity of Virginia and a senior fellow at theAmerican Enterprise Institute for Public Po!-icy Re,earch in Washington, and he writesregularly for the Institute's monthly AEIEconoomist, from which this article is adapt-ed. Fee recently spent three weeks in GreatBritain , scanning the econom y and interview-ing gu, 'ernment leaders, and came to a san-guine judgment of the Tory government'schao s for future success-economically andpotiti.ally.

Britain', new Prime Minister is a wom-an and a politician . Because she is a woman,it is easy to romanticize her as a Joan ofArc of conservatism, obedient to voicescommanding that she free Britain from theSocialists and Keynesians. But because sheis a politician, it is also easy to be skep-tical i:t her. She could finally emerge as a

Prime Minister like many of her predeces-sors , prepared at the first whiff of adver-sity to sacrifice principle and to choose thesoft policy options.

In my opinion , neither of these extremeviews is altogether realistic. The Thatchergovernment will continue - and signifi-cantly accelerate-a change in British eco-nomic policy that began before it came topower and will last after it is gone . The re-sult will be a major transformation in Brit-ish policy and in British economic life,albeit one for which Mrs . Thatcher will notbe solely responsible.

The Thatcher prescription

The Thatcher government faces a list ofproblems that are common in our times-slow economic growth , inflation, hightaxes, poor government services, unem-ployment , disruption of economic life. Butthe To ry leadership also regards itself ascalled upon to deal with two other condi-tions not usually ranked so high in polit-

ical discussion . First, the regime isdedicated to restoring the work ethic, ini-tiative , personal responsibili ty , and free-dom. It stresses these values not only asspurs to G.N.P. growth but also as ends inthemselves-quite simply the right way tolive. Thatcher and her counselors do notlike the extent to which the British rely onBig Bro ther- not only because Big Brotheris inefficient but also because the relianceis Intrinsically wrong.

Second, the government wants to cor-rect what it regards as the intellectualerrors that have dominated British think-ing for the past forty years. It finds the So-cialist-and Keynesian doctrines by whichBritain has been gove rned since WorldWar II to be intellectually uncongenial andeconomically self-defeating. To replacethese obnoxious doctrines, it is resolved topreach what it holds to be economic truthand sense.

The Th atcher idea of the " Right Ap-proach" to economic policy rests upon a

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number of key propositions. Specifically:1. The Prime Minister and her advisers

do not believe that real quantities -the lev-els of employment and unemployment,total output and its rate of growth-can bemanaged by manipulating monetary vari-ables , such as the growth of nominalG.N.P. In particular, they reject the ideathat full employment and rapid growth canbe achieved by expansionist fiscal andmonetary policy.

2. They reject " fine tuning " and believeit essential for the government to estab-lish known lines of policy to which it willadhere and to which the private sectorcan adapt.

3.They reject "incomes policy" as a failedapproach to the inflation problem and onethat is inconsistent with the free market.

4. They are monetarists who hold that re-straint in expansion of the money supplyis the essential condition for achievingprice-level stability. They also believe it isnecessary for the government to keep therate of growth of the money supply con-stant . And a reduction of the gove rnmentdeficit is essential to holding monetarygrowth within lower limits.

5. They want to reduce taxes to increasethe freedom enjoyed by private citizens tod+spn se of their own earrlrgs and to re-store incentives for work, investment, andproduction. They are not Lafferites, andthey do not believe that broad-based tax re-duction will increase the revenue . There-fore, given the need to reduce thegovernment deficit , the effecting of anysubstantial overall tax reduction will de-pend on restraining government expendi-tures. Even before that is achieved,however, it is possible and important to re-form the tax structure by reducing the mar-ginal tax rates on income and increasingthe tax rates on consumption.

6. They want to hold down governmentexpenditures not only to permit tax reduc-tion but also to release resources from gov-ernment employment, which clearly is oneof the least efficient sectors of the Britisheconomy. They do not, however, intendany major contraction of the welfare state.

7. They propose to reduce government

subsidies for inefficient firms and indus-tries, thus channeling resources into moreefficient uses.

8. They want to curb the power of laborunions to disrupt production, discourageInvestment , and deprive workers of theirindividual rights.

This certainly does not read as a surpris-ing agenda for a Conservative gove rn ment.But what has been surprising so far hasbeen the vigor and speed with which theThatcher government has moved to ad-vance its program in its first months in of-fice. In four months, it has cut income taxeson the average by about 15 percent, includ-ing a cut in the top rate on earned incomesfrom 83 percent to 60 percent and on in-vestment income from 98 percent to 75percent. It has compensated for the result-ing revenue loss by raising the value-addedtax substantially. It has cut gove rn ment ex-penditures by about 3 percent below theCallaghan budget, and it has announcedits intention to sell about f1 billion worthof gove rn ment investments in industry,such as British Airways and British Petro-leum. It has raised interest rates sharply aspart of its policy of restraining monetarygrowth . It has Initiated a program for trim-ming down support for backward areasand his announced plans to introducethree pieces of legislation to curb the pow-ers of labor unions and their leaders.

Grounds for skepticism

Despite the new government's excep-tionally strong start , the conventional viewIs still that the Thatcher program will not"work." What that means is that the pol-icy will not survive because , however ben-eficial its long -run results, the shorter-runconsequences will be considered so ad-verse that it will become politically unsus-tainable , probably well before the end ofMrs. Thatcher 's normal term of five years.

The scenario for this frustration of pol-icy follows a certain logic. According to thisscript, the collision between the demandsof labor unions for big wage increases andthe government 's policy of restrainingmonetary expansion will cause sharply ris-ing unemployment . The unions will not re-

treat from their demands, and neitherprivate nor public employers will be ableto meet these demands without reducingthe number of workers on their payrolls.Unemployment will also be increased bythe government's policy of reducing sub-sidies for inefficient economic activity,thus causing layoffs in an economic envi-ronment where workers do not easily findnew jobs.

Some forecasts see unemployment-now around 1.3 million-rising to twomillion by 1981. At the same time, the in-Ration rate will be high. The rate was morethan 10 percent when the new governmentcame in, and it is being boosted right nowby the increase in the value-added tax.Even after that, the Treasury anticipateis arise in retail prices of around 14 percent inthe next year, while other estimates rangeeven higher.

Demand for results

As this skeptical scenario unfolds,the atmosphere will become dangerouslycharged with labor conflict. There will notonly be struggles over wages and layoffs.The unions will also be roused to do battleagainst labor legislation that they regardas hostile and a government of which theysre suspicious . The gcvecnment has al-ready made its easiest expenditure cutswithout being able to make a net tax cut.Further expenditure cuts will be hard toachieve , and the government will be un-able to meet the citizens' expectations oftax relief. Under these circumstances, therecan be little improvement in the growthof real incomes.

Finally, there comes the political reck-oning to end this dark prophecy. While theThatcher government may discount thesesocial ordeals as the birth pains of a bravenew world, the British public will not lookat them that way. The electorate did notvote for monetarist, libertarian, conserva-tive theories. They voted for certain results.If these are not forthcoming, all devotionto an economic theory will fast wither. Asthe loss of public support appears in pollsand by-elections, many Conservativemembers of Parliament will panic. Most of

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them are not subscribers to Thatcheritetheories. Politically, they want only to getalong by going along. Concluding that theywill not get along by going along with Mar-garet Thatcher, they will urge a turn tomore moderate and less dogmatic policy-toward monetary expansion and in-comes policy, and all that. And in the endeither Mfrs. Thatcher will bow to the partyor the party will bow out by 1984.

Signs of realism

The sweep of this glum vision does fol-low the terms of past experiences . Yet thereare some persuasive reasons fc,: thinkingthat the course of future events may wellprove to be different.

A great deal depends on the quality ofthe inner circle of the new government.Here five figures are dominant . Sir Keith Jo-seph, sixty-tine, an Oxford- educated busi-nessman with toughly conse rvative fiscalviews, set up Thatcher's pre-election braintrust, now heads the Department of Indus-try, and is widely regarded as a guru ofthe Thatcher team. The Chancellor of theExchequer, fifty-two-year-old Sir GeoffreyHowe, is a once-liberal Tory who convert-ed to the way of tight money . The Secre-ta.y of State for Trac e is Joha Nott, forty-seven, once fired for economic inflexibilityby the Edward Heath gove rn ment. JohnBitten, forty-eight, is an ardent conserva-tive in the post of Chief Secretary to theTreasury, i.e., effectively the director of thebudget. And lie works closely with NigelLawson, 'forty- seven , another dedicatedmonetarist who is Financial Secretary tothe Treasu ry. By and large, these men ap-pear to be realistic ideologues. They havecommitted themselves so seriously as truebelievers in the libertarian, monetarist,conservative doctrine that it would be agreat - 'rench privately--- and a great em-barrassment publicly--for them to veeroft course.

The government's realism seems appar-ent, mreover, in its awareness that glow-ing results are not likely to be achievedquickly. Mrs. Thatcher and her associateshave been cautious in their promises aboutcontrolling in flation and increasing real in-

come . Credibility is essential to the gov-ernment's success , especially in thestruggle against inflation. Here, the pop-ular perception of the new leadership asbeing doctrinaire, and outside the usualpolitical mold , can be an important asset.Moreover, the government has tried tonourish the trust that it means what it says.The radical shift in the tax structure, thebig rise of interest rates , and the willing-ness to ride with a rising exchange rate-despite the moans of British exporters-are all signs of determination that thecountry recognizes.

While the skeptics recall that Conserva-tive Prime Minister Heath made a U-turnin 1972 , when he shifted to a policy of mon-eta ry expansion ( following the example ofPresident Nixon ), it is wrong to assumethat Thatcher will repeat the pattern.Heath's action Is widely considered to havebeen a serious mistake , and Thatcher wasswift to challenge him. The ability of thisgovern ment to hold fast to its line is great-ly strengthened by its for ty-three- seat ma-jority over other parties combined in theCommons . This fact makes it possible forThatcher to lose a few dissidents and stillcount on having five years for her policiesto reach ft action.

The uneasy triangle

The stubborn doubters commonly pointto two rocks on which the government'spolicy is expected to founder-unemploy-ment and the labor unions . By the stan-dard theory of British political economy,the unemployment rate cannot be helddown to a politically tolerable level with-out the accompaniment of either inflationor an incomes policy. But this doctrine as-sumes that the unemployment rate can beheld to a politically acceptable level by ei-ther inflation or incomes policy. If this ideais rejected-and the Thatcherites do em-phatically reject it-there is no choice orany temptation.

Even if one accepts the existence of theuneasy triangle of unemployment, infla-tion, and incomes policy-or accepts thefact that many people do believe in it-thegovernment's policy need not necessarily

be frustrated . The present generation inBritain does not feel the same anxiety aboutother people 's unemployment as their ic<thers felt in the 1920's and 1930's. There i.,more consciousness that some unemploy-ment is voluntary , if not also deceitful. Theability of the Thatcher vovernment to bearunemployment is re inforced by the natureof her constituency , which is not in the ar-eas where unemployment is highest o:•likeliest -the economically backward andhighly unionized north of England antsScotland.

Labor Party pains

Obviously, much will depend on the be-havior of the labor unions. If they are ad -amant , they can aggravate unemploymentand put the country through another pain-ful period of industrial strife . The initial re-sponse of the union . leadership to thegovernment 's policies has been vehement,but one still doesn't know how forceful th{-action will be. The union leadership mustrecognize that the unions' obstinacy andcallousness last winter had much to dowith Labor' s loss In the 1979 election. TLunions have been cast by many in the roleof enemies of the people. The leaders donot like that personally, and they realiz-that it is bad for their organizations. Theyalso recognize that this government is hereto stay for a while and is very determined.If pushed too hard, the government coudget through union-restrictive legislationmore severe than what it has alreadyproposed.

The apparent weakness of the Labor Par -ty further enhances the chances for t::eThatcher government to carry on its pol-icy for its statutory term and to retaingood possibility of reelection in 1984. T h,Labor Party is sharply divided into its cormservative and radical factions. The conservative wing of the party, which manage(the government for the past five years, ha:run out of distinctively "Labor" solution.for Britain's problems. What it essentiall,,offers as an alternative to the Tories ispromise to do the same things as they d(more gradually, cautiously, and pragm itically. This is unlikely to stir the voter

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unless the results of Tory policy are disas-trous . As for the radical wing of the party,it seems to offer nothing but symbolic acts,like abolishing the Flouse of Lords or es-tablishing more machinery for economicplanning , which are irrelevant to Britain'simmediate problems.

I have suggested some reasons for think-ing that the policies of the Thatcher gov-ernment will have more public supportthan they might have had some years ear-lier. The experience of the recent past-andthe passage of time since the Great De-pression--have made the public both moretolerant of unemployment and more re-sentful of inflation and high taxes thanthey used to be. The sympathy for unionsand their leadership has notably dimin-ished. rhere is a large and growing num-ber of people-mainly situated in the southof England, employed in technologicallymodern industries , and largely untied tolabor unions-- who are less worried aboutunemployment than people elsewhere andform a reliable core of Conservative partysupport.

Althoug h the average EnglishmanKnows little of conservative economic ide-ology, and certainly is not devoted to it,neither is he immersed in a flood of pro-paganda hostile to it.'i he British voter doesnot know much about the economic the-ories guiding Mrs. Thatcher and her ad-visers, but he does not know much againstthem either. Conceivably, what will getthrough to the public is that these theoriesare modern, fashionable , scientific, and notat all to be disdained.

A little bit of luck

The ability of th e government to stickto its line (if economic policy during itsfive-year term, and to get reelected, maynot entirely depend on economic results,unles , these are catastrophic . As Sir KeithJoseph has said, by way of explaining howthe government might survive even if ittails to deliver much economic improve.-me rit in the next years: "Economic policywill Ii.ive to be convoyed by social pol-icy." The British voters are affected bymany issues other than strictly economic

ones . They are interested in law and or-der, capital punishment, abortion, immi-gration and race relations , the quality ofmedical care, and education , among oth-er things. On most of these issues, thepositions of the Conservative party in the1979 election seemed to be close to thesentiments of the British majority. If theConse rvatives can maintain this posture,the public may give Mrs. Thatcher a chanceto continue her experiment, even withoutits producing any immediately dazzlingeconomic results.

Great ventures rarely succeed without atleast a little bit of luck, and there are sev-eral sources from which Mrs. Thatcher'sluck can come. The most nearly assuredsource is oil . Its increasing production willmake a large and rising contribution of rev-enue to the Treasury over the next fewyears . By 1983 -84, this sum may reachabout C6 billion a year-or about 8 per-cent of the present level of governmentspending. Such a bounty could be extreme-ly helpful in allowing the government tomake some tax cuts and simultaneously toreduce the deficit. Already, this prospecthas raised the exchange rate of the pound-a development which holds down thecosts of imports and assists in restrainingBritish inflation.

Avoiding political disaster

It is a good bet, I think, that the Thatch-er government will stick to its announcedpolicies through the five years of its nor-mal term in office. Even the most enthu-siastic Thatcherites do not think that thisterm in power will suffice to correct defi-ciencies in a British economy that they con-sider to he 100 years old. But some thingswill have been accomplished.

The Conservatives will have demon-strated that it is possible to adhere to apolicy of slow expansion of demand, im-plemented by monetary restraint, withoutresults that are disastrous either politicallyor economically. Five years of British Con-servative policy can make monetarism thestandard doctrine. The government willalso have made an irreversible'step towardchanging some of the structural conditions

that have for so long bedeviled the Britisheconomy. The ridiculously high top mar-ginal rates of income tax already have beensubstantially reduced. Following the ac-tion, there was no outc ry that this was fa-voritism for the rich, and it seems unlikelythat such tax rates would be restored un-der any future government.

Five years from now, furthermore, thisConservative government will have bornethe brunt of the transitional pains con-nected with trimming down subsidies forthe support of inefficient industries, andit may have demonstrated to its successorsthat the way to avoid such pain in the fu-ture is to refrain from the subsidies inthe first place. Also, the power of laborunions will have been somewhat reducedby new labor legislation . In these circum-stances, union leadership will have lostits position as a dominant authority andclaimant in the British society and will;have settled into a more balanced rela-tionship with other elements in the pri-vate sector.

Creating a new atmosphere

The full Thatcher agenda, however, willnot have been completed. There will nothave been a big ch ange in the size of thebudget, relative to the national income,and there will not have been a big reduc-tion in the total tax burden. The presentgeneration of British businessmen proba-bly will still not have acquired new will-ingness to take risks and to innovate. If anychange is achieved in the long-term rateof growth of productivity, it will have beensmall, and obscured by short- run fluctu-ations. Now much time must pass beforethere is clear improvement in the growthrate -and how big this improvement maybe-are questions that no economist todaycan predict with confidence.

Yet even if the visible results in mea-sured G.N.P. are small, the British mayhave discovered that the atmosphere ofpersonal responsibility, competition, andfreedom that the Thatcher government iscreating is valuable in itself. If so, nogovernment will soon turn in a diffe rentdirection.

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