The first Thatcher government of 1979 to 1983 embraced an economic theory called monetarism. The leading proponent was Professor Milton Friedman and it became popular with economists in the 1970s. Basically, monetarists argued that the amount of money in the economy determines economic performance. They blamed an increase in the supply of money for the high inflation and poor economic performance of the 1970s. Key people around Margaret Thatcher like Keith Joseph and Professor Alan Walters became disciples of the Friedman creed.
In this they opposed a rival economic view called Keynesianism that argued demand for goods and services was key to economic success and focussing so much on money supply was incorrect. The Keynesians had dominated government thinking throughout the post-war boom but now the monetarists posed a serious challenge.
So Thatcher, claiming to have embraced monetarism, embarked on a full-throttled policy of mega-austerity and rolling back the state from all areas of life. This helped to turn a recession into something far deeper between 1979 and 1981. In late 1982, with a quarter of British manufacturing gone and a massive slump in investment, Friedman arrived in the UK from his native Chicago keen to disassociate himself from Thatcher.
He’d been busy advising the dictatorship of General Pinochet in Chile on implementing monetarist policy but now turned his attention to Britain. Thatcher’s application of monetarism had been so cack-handed, it was tarnishing the monetarist brand in Washington DC. And that mattered a great deal to Friedman.
Friedman unhappy with Thatcher
Addressing a gloomy audience of British acolytes in the crypt of St John’s church in Smith Square, London, he first reminded everybody what he had meant by monetarism. The relationship between money supply and factors like price levels, unemployment, and interest rates. It had nothing whatsoever to do with the size of government, taxes and spending, and whether industries should be nationalised or not. In other words, all the areas that had fixated Thatcher in her obsessive battle with socialism and the trade unions.
With Keith Joseph and other Tory luminaries sitting before him, he riled his audience by saying that Karl Marx and the leaders of Communist China were also monetarists although on most other things he wouldn’t agree with them. What annoyed Friedman was that the failure of Thatcher’s economic policy was being presented in the media as a failure of monetarist theory.
His message was rather confused and contradictory at times. It sounded very much like a vain attempt to salvage what was becoming increasingly a discredited way of running an economy. Proving that economics really is the dismal science, Friedman lavished praise on Thatcher for reducing the supply of money. But when asked if he thought the resulting sky high unemployment, which was officially 3.5million at the time, was a price worth paying he then accused Thatcher of not reducing the money supply in a “gradual and steady way”.
Like many supply-side economists at the time he also took a swipe at Thatcher’s failure to reduce taxation overall and blamed the recession on that.
Friedman gives Thatcher four out of ten
He gave Thatcher a mere four out of ten for effort. What was holding her back, he claimed, was her own party and the civil service. She was a 19th century liberal heading up a bunch of Tories who didn’t really believe in free markets, he said. They were more interested in an old elite retaining power at all costs. As for the civil service, the blame lay there for inflation in the public sector running at twice the level of the private sector.
Republicans now in control of the White House had looked askance at the progress of monetarism in Britain. Advisers to President Ronald Reagan – an ideological ally of Thatcher – warned him to avoid his British friend’s mistakes. Paul Craig Roberts, a leading American supply side economist, told Reagan to make sure his economic policy didn’t get “Thatcherised”. With Britain in a dire recession, the US administration was keen not to be associated in policy terms with this disaster.
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Tory disenchantment with Friedman
Faced with what appeared to be serious flaws in monetarist theory, senior Tories had been pulling Thatcher away from Friedman since late 1980. That year had seen the recession reach its deepest trough. Chief Secretary to the Treasury John Biffen referred to monetarism as a ‘wayward mistress’ and urged a return to ‘pragmatic Conservatism’. The urban riots that swept Britain during the summer of 1981 helped to reinforce that point of view, as did the catastrophic collapse of manufacturing and Tory political influence across vast swathes of the country.
Biffen had been an apostle of Friedman believing that controlling the money supply was the key to controlling inflation. Yet after nearly 18 months in power, the money supply was still increasing and the economy had been reduced to a basket case. Inflation had also leapt upwards by a third. The strict monetarist answer would have been to hike up interest rates to bring the money supply firmly under control. But senior Tories had an attack of common sense. Wasn’t that just going to deepen the recession even further?
British industry was in distress. Banks were lending to companies struggling to pay back higher interest rates which in turn was boosting the money supply. This wasn’t supposed to happen. And the strengthening pound was crippling the ability of companies to export their way out of trouble. Plus, Keith Joseph may have viewed higher unemployment as a necessary evil when tackling inflation, but it meant the benefits bill was now soaring. And public sector pay rises had been generous in 1980 to the dismay of monetarists.
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Keynesian delight at monetarism in crisis
Keynesians could barely contain their glee at the collapse of monetarism. William Keegan, the respected economics editor at The Observer newspaper, wrote:
It is the lot of the religious fanatic to be branded by the works of his errant disciples.”