British Economy a Textbook Case

Last month, the British government announced its intention to reduce and simplify tax rates. Henceforth, there will be two personal income tax rates, 25% and 40%. For Americans with personal income tax rates now at 15% and 28%, this may not seem worth much shouting. But for Britons, who faced maximum personal tax rates of 83% less than a decade ago, the new tax rates are one sign of how much has changed. An outsider can only cheer from the sidelines: Great, Britain!

Once widely regarded as the sick man of Europe and as the home of the British disease--welfare statism--Britain has emerged in the past five years as the country with the highest average rate of growth in the 12-nation European Communities. From 1960 to 1980, British real income grew about 40% slower than that of its neighbors. For the past five years, real growth in Britain is 40% faster than the EC average.

The correction was neither easy nor painless. When Margaret Thatcher took office as prime minister in 1979, the inflation rate was above 14%. The next year, inflation rose to nearly 20%. The government was spending large sums, including subsidies to nationalized companies to cover their large losses. Many of these companies had operated at a loss for years. Instead of reducing the loss by increasing productivity and cutting costs, previous governments had financed the companies’ losses with government deficits and by printing money.

The Thatcher government reduced the subsidies and, by lowering money growth, lowered the rate of inflation. The initial effect of the reduced subsidies and slower money growth was higher unemployment. The government stayed with its policies. Unemployment, currently at 9%, is high by past standards but is below the European average and has been falling persistently for nearly two years. Employment has been growing for the past four years at twice the European average. Inflation, at about 3% in 1987, is below the European average.

Firms Denationalized

In the 1970s, British became a synonym for labor unrest, strikes and inefficiency. British Aerospace, British Telecom, British Steel, British Leyland, all showed once again that socialism, whether democratic or totalitarian, is usually a prescription for failure.

Now, most of the socialist industrial program has been abandoned and many of the nationalized firms have been denationalized--sold to private investors who operate profitably.

In one case, a long series of strikes, work stoppages and the failure to eliminate redundant employees had left a history of losses and low productivity. Performance was so poor that the company was worthless. Since no one would buy it, the government gave the company to the workers. Within a few months, productivity increased. Strikes ended, and the company became profitable.

Productivity has increased both in the formerly nationalized industries and in the rest of the economy. Wages have increased with productivity. Real wage increases for the past several years are above the averages for the European Communities or the United States.

Britain’s fiscal position has improved also. The budget had a surplus last year for the first time in 20 years, achieved not by raising taxes but by reducing the growth of spending relative to the growth of the economy. This year’s tax reduction will not be followed by a string of budget deficits. Indeed, a surplus is predicted. Recent budget forecasts in Britain, unlike those in the United States, are cautious and careful, not optimistic and exaggerated. If the growth of spending can be maintained below the growth of output, there will be room for additional tax reduction in 1989 or 1990.

Shortly after Britain voted to move away from socialism, France made the opposite decision. Many firms were nationalized; taxes were raised, and government spending increased. Inflation rose, and economic growth fell. Although the voters’ decision was reversed a few years later, the experiment with socialism was costly. From 1960 to 1980, French real income rose at twice the British rate. Since 1980, British real income has increased at nearly twice the French rate.

Entrenched Skepticism

Britain is not utopia. Large parts of the costly welfare state remain in place. But Britain offers two lessons that we should learn.

First, any attempt to turn the economy in a new direction takes time. Years of vacillating policies had left a residue of entrenched skepticism. Past experience showed frequent alternation between policies to speed up the economy and policies to reduce inflation. These shifts created doubts about the determination of the Thatcher government to maintain its announced course toward a balanced budget and low inflation. Many people had given up hope of a return to stability.

Second, the Thatcher government’s solution was to adopt a medium-term strategy to achieve its objectives gradually and to persist in policies consistent with the medium-term strategy. When the government did not reverse course in the face of rising unemployment and persistent inflation, skepticism began to fade, and the economy began to improve. By maintaining clear direction, the government reduced uncertainty about the future path of the British economy.

The United States is the last of the major economies in the world that does not have a medium-term program for spending, taxes and money. The government budget is an annual battle with no clear commitment to any sustained policy.

The recent appointment of a National Commission on Economic Policy presents an opportunity to do what we have failed to do for years--decide on budget programs and how to finance them. The commission, with members appointed by the President and Congress, is to report next year.

Some Key Questions

The commission should focus on broad questions: How much should we spend, on average, for defense of our interests and our commitments around the world? How much should we spend for income redistribution and other non-defense programs? How can we get more, and better results, from the billions of dollars spent to relieve poverty, improve health care and educate our children? By asking and answering questions of this kind, we will be forced to recognize that it takes a consistent strategy to reduce the growth of government spending relative to income and improve public services while balancing the budget and reducing tax rates.

The key questions for the commission and for Congress are: Why are U.S. policies so variable, so uncertain, so lacking in direction? What must be changed to give Congress and the Administration incentives to improve the process? The British experience suggests that there are major benefits from finding better answers.