ECON 1100 Global Economics (Fall 2013) The Rebirth of Free Market Ideology: the Case of Great Britain

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1 ECON 1100 Global Economics (Fall 2013) The Rebirth of Free Market Ideology: the Case of Great Britain Relevant Readings from the Required Textbooks: Commanding Heights Chapter 4, The Mad Monk: Britain s Market Revolution Guide to Definitions and Concepts: The British economy performed quite poorly during the 1970 s: characterized by high inflation and rising unemployment (apparent breakdown of Phillips Curve), along with labor strife (Coal Miners strike of 1973 and Winter of Discontent in ). 4 Primary Causes of Poor Economic Performance of 1970 s Britain: high and steeply progressive tax structure greatly reduced incentives to work at high end of income scale; comprehensive Social Safety Net reduced incentives to work at low end of income scale; labor relations remained poor; large Public Sector devoting a tremendous amount of resources to inefficient and economically declining nationalized industries. Friedrich von Hayek strong advocate of free-market capitalism (as opposed to socialism) who wrote the Road to Serfdom (1944), in which he argued that socialism would often lead to totalitarianism as central planning replaced individual decision making. The views of Hayek were arguments against Keynesianism, simply because they argued for a much smaller role for government (whereas Keynesianism concluded that there was a clear role for government in the economy and called for active government policies to manipulate economic outcomes) Totalitarianism a regime in which the state regulates nearly all aspects of public and private behavior. Margaret Thatcher British Prime Minister from (thus far the only female to hold this position). Her policies sought to return Britain to a reliance on free-markets and to replace Keynesianism with Monetraism. Margaret Thatcher felt that the proper tasks of government are limited to: (i) maintaining sound finances and a stable economy (fiscal responsibility; control of macroeconomy through responsible monetary policy); (ii) ensuring a proper foundation of law, so economic activity can flourish; (iii)providing national defense; (iv) providing education to the populace (as a tool for economic opportunity); and (v) providing a social safety net (however, one much smaller than had previously been established). The primary elements of policies which came to be known as Thatcherism included: (i) reducing the scope of the welfare state ; (ii) reducing both the levels and progressivity of the tax system; (iii)a comprehensive program of Privatization ; and (iv) a rejection of Keynsianism in favor of Monetarism.

2 Privatization a return to private ownership and control of those enterprises which were acquired by the government through nationalization Tax Reform Under Thatcher: tax code substantially changed under Thatcher => overall tax burden and progressivity both greatly reduced Tax rates on earned income: high 1979 rate of 83% reduced to 40% by the time Thatcher left office Subsequent administrations not only kept her changes in place, but further reduced levels and progressivity Scope of Privatization under Thatcher: by 1992 roughly two thirds of enterprises which were initially government owned had been returned to private ownership; 46 major businesses with 900,000 employees had been privatized; in % of British value added originated in government enterprises, by 1997 this figure was down to only 2%. Four Rationales for Privatization: 1. Boost for Productivity. Profit seeking managers will operate more efficiently and effectively than government bureaucrats with other objectives. 2. Creating Popular Capitalism. Transferring ownership to the public would increase the number of people who owned enterprises. 3. Reducing Government Borrowing. The sale of nationalized companies raised revenue for the government, thereby reducing budget deficits. 4. Reducing Problems with Government Pay Determination. Setting wages in government agencies was problematic Labor Unions could negotiate aggressively, knowing that a government agency could not go bankrupt due to having to pay increased wages. Privatization and the Labor Market Privatization greatly reduced the power and influence of Unions, thereby altering labor market outcomes. o Nationalized enterprises operate on a soft budget constraint, in that they could not go bankrupt; Privatized enterprises operate on a hard budget constraint, in that they would have to go bankrupt and cease operating if they continually earn negative profits. o Unions could not negotiate as aggressively with a privatized enterprise, since the enterprise would be more likely to go bankrupt when paying high wages. o post-privatization, many enterprises experienced decreases in employment and wage increases that just kept up with inflation => could be argued that these values were simply returning to their natural levels (part of what Privatization was intended to do) Privatization greatly reduced the frequency of strikes: working days lost to strikes for every 1,000 employees decreased dramatically from 1,274 in 1979 down to 108 in 1990.

3 Three Primary Techniques of Implementing Privatization: 1. Initial Public Offerings (IPO). Underwriters with access to financial statements determined a fair market value for an enterprise, and offered shares of stock at a price calculated to ensure a sale of all shares. Intended to raise public participation in ownership process ( popular capitalism ) and make it much more difficult to re-nationalize the enterprise in the future. Some IPO s included the sale of a golden share. 2. Negotiated Sale. The sale of an entire enterprise to a single buyer at a negotiated price (e.g., automotive company British Rover). This approach was criticized for its discretionary nature and the ease to favor friends or political supporters by selling assets at below market prices 3. Employee or Management Buyout. Sale of enterprise to current managers and employees, at prices well below market values [example: sale of National Freight Corporation assets of 93 million, but sold to employees for 53 million (of which 46 million was put into employee pension funds so it was effectively sold for only 7 million)]. Golden Share a special ownership share retained by the government or sold to a particular buyer (who agrees to certain conditions on their behavior or future sale of their ownership stake), allowing the government to prevent control of the enterprise from falling into unsuitable hands. Often done when privatizing strategic enterprises (e.g., North Sea Oil), where unsuitable hands meant foreign ownership. Impact of Thatcherism on Growth and Income Inequality Economic Growth greatly improved under Thatcher, in comparison to the 1970 s; however, there was also a substantial increase in income inequality (due to shrinking of welfare state, reduced progressivity of tax system, and reduction of union power ). Further, over this period the increase in the value of the Gini-Coefficient was much greater than in other countries with comparable growth rates. For example, from : U.K., U.S., and France all experienced growth in GDP of roughly 28%, but the percentage increases in the value of the Gini-Coefficient were much smaller in France (less than 5%) and U.S. (between 5% and 10%) than in U.K. (over 30%).

4 Multiple Choice Questions: 1. refers to a regime in which the state regulates nearly all aspects of public and private behavior. A. Monetarism B. Socialism C. Totalitarianism D. Communism 2. became known as the Mad Monk because of the impassioned political speeches which he gave throughout Britain in the mid 1970 s extolling the virtues of free enterprise and market based economic systems. A. Milton Friedman B. Keith Joseph C. Friedrich von Hayek D. Margaret Thatcher 3. The Winter of Discontent refers to A. the hyperinflation which occurred in Great Britain in the 1980 s, eliminating the life-savings of many middle class Britons. B. the crash of the London Stock Exchange on 1/14/1989, after which Great Britain entered into an economic recession which would last for all of the 1990 s. C. the large scale labor strife which occurred throughout many sectors of the British economy in D. None of the above answers are correct. 4. In the Road to Serfdom Friedrich von Hayek argued that as central planning replaced individual decision making. A. Socialism would often lead to free markets B. Socialism would often lead to Totalitarianism C. free markets would often lead to Anarchy D. Nationalization would often lead to Privatization 5. One of the arguments in favor of Privatization was that it would provide a boost for productivity. This argument A. focused on eliminating the difficulties with setting wages for employees within a government owned/operated enterprise. B. noted that as a result of privatization, there would be a boost in the number of people who directly had an ownership stake in business enterprises. C. recognized that the sale of nationalized enterprises would boost government revenues, thereby allowing the government to reduce its budget deficits. D. claimed that private enterprises (run by profit maximizing managers) would be more productive than government enterprises (run by bureaucrats with primary motives other than profit).

5 6. Which of the following was NOT one of the four primary causes of Britain s poor economic performance during the 1970 s? A. The tremendous amount of resources devoted to inefficient and economically declining nationalized industries. B. The burdensome and highly progressive tax structure. C. The complete absence of a Social Safety Net. D. Poor labor relations, which lead to numerous strikes. 7. Friedrich von Hayek A. wrote the Road to Serfdom, in which he argued that Socialism would lead to Totalitarianism as central planning replaced individual decision making. B. enacted policies as Prime Minister of Great Britain in the 1960 s which ultimately led to simultaneously high rates of inflation and unemployment in Great Britain in the early to mid 1970 s. C. enacted policies as Prime Minister of Great Britain in the 1990 s which reversed many of the free market reforms which were put in place during Margaret Thatcher s time in office. D. More than one (perhaps all) of the above answers is correct. 8. During the 1970 s the British economy was characterized by A. an inflation rate near 0%, but a high unemployment rate. B. a high inflation rate, but an unemployment rate near 0%. C. an inflation rate and an unemployment rate both near 0%. D. a high inflation rate and a rising unemployment rate. 9. During Margaret Thatcher s time as Prime Minister, the highest marginal tax rate on earned income in Britain A. remained constant at 50%. B. was decreased from 83% to 40%. C. was decreased from 75% to 0% (as a result of all income taxes being eliminated for all workers in the country). D. was increased from 25% to 98%. 10. The British enterprise National Freight Corporation was privatized by employee or management buyout. This technique of privatization is one in which A. the enterprise is sold to current managers and employees, typically at a price well below fair market value. B. the entire enterprise is sold to a single buyer, at terms agreed upon by the buyer and the government. C. shares of stock are sold to the general public, at a price calculated to ensure the sale of all shares. D. ownership of the entire enterprise is given to a foreign government, who then gives shares of stock in the enterprise away to citizens of its own country.

6 11. After Privatization in Great Britain, working days lost to strikes for every 1,000 employees A. increased from 345 in 1979 up to 692 in B. increased from 1,567 in 1979 up to 2,445 in C. decreased from 1,247 in 1979 down to 108 in D. decreased from 98 in 1979 down to 24 in Which of the following was NOT one of the primary policy elements which became known as Thatcherism? A. A comprehensive program of Privatization. B. A rejection of Keynesianism in favor of Monetarism. C. Increasing levels of taxation and making the tax system more progressive. D. Reducing the scope of the welfare state. 13. The Golden Share refers to A. a clause in a CEO s contract specifying that she receive substantial compensation if her employment is terminated for any reason. B. the sale of a government enterprise to current employees at a price well below actual market value. C. the argument that very high marginal tax rates will reduce incentives to work at the high end of the income scale. D. a mechanism which allowed the government to prevent the ownership of an enterprise privatized by initial public offering from falling into unsuitable hands (i.e., foreign ownership ). 14. Which of the following events bolstered patriotism within Great Britain and increased Margaret Thatcher s popularity, allowing her to remain in office as the Prime Minister following the June 1983 general election in the U.K.? A. The success of British athletes in the 1982 Summer Olympics in London. B. The military success of Britain over Argentina in the Falklands War from April 1982 to June C. The government support and ultimate international success of The Beatles (and other popular British entertainers), which enhanced the image of Great Britain throughout the world. D. The complete dismantling of the British army in 1982 by Margaret Thatcher, which successfully allowed the country to realize a peace dividend and devote additional productive resources to welfare programs (thereby increasing welfare benefits for all members of society). 15. can be thought of as a reversal (or undoing) of Nationalization. A. The Economic Calculation Problem B. Privatization C. Contractionary Monetary Policy D. Expansionary Fiscal Policy

7 16. During the time when Margaret Thatcher was in office, Britain experienced A. negative economic growth, along with a decrease in income inequality. B. negative economic growth, along with an increase in income inequality. C. positive economic growth, along with a decrease in income inequality. D. positive economic growth, along with an increase in income inequality. 17. Between 1979 and 1991, the number of Britons who directly owned stock in private enterprises A. remained relatively constant at approximately 16 million. B. increased from approximately 3 million to approximately 11 million. C. decreased from approximately 20 million to zero (as stock ownership was made illegal). D. first increased from approximately 5 million to approximately 20 million by 1983, and then decreased from approximately 20 million in 1983 to approximately 1 million by 1991.

8 Answers to Multiple Choice Questions: 1. C 2. B 3. C 4. B 5. D 6. C 7. A 8. D 9. B 10. A 11. C 12. C 13. D 14. B 15. B 16. D 17. B