Picking Up the Pieces After the Free-Market ‘80s : Economics: Reagan-Thatcher policies torpedoed all financial strictures. The United States and Britain must learn from Germany and Japan.

The Reagan-Thatcher experiment in economics is drawing to its close. As George Bush begs the Japanese for affirmative action for American cars, and as Britain reluctantly prepares to enter a monetary union dominated by Germany, the verdict of history is clear: The ultra-liberal economic policies so popular in the English-speaking world during the last generation do not work as well as the “social market” economics of the former Axis powers.

Both the United States and Britain entered wholeheartedly into the Reagan-Thatcher experiment. Believing that cartels, unions and state intervention were always and everywhere the enemies of growth, policy-makers in London and Washington waged war on these dragons. Ronald Reagan broke the air-traffic controllers’ union; Margaret Thatcher broke a strike by Britain’s powerful coal miners’ union. The “Big Bang” deregulated London’s financial markets; the United States, too, deregulated its financial-service industry. Both leaders preached the virtues of hard work, free enterprises and the private sector.

Now, in both countries, the leaders of the ‘80s have hand-picked successors from within their own parties; and both successors have the difficult task of reversing direction as tactfully as possible. Failure has that effect.

The woes of the English-speaking economies are known around the world. The British were humiliated to learn recently that their economy, once the largest in Europe, has now fallen behind not only West Germany and France, but also Italy. The United States has gone from a creditor to a debtor nation; some of its key industries have a hard time surviving, much less competing; much of its financial system is bankrupt.

Germany and Japan have problems too, but not like this. Theirs are problems of growth. Besides the reconstruction of its new territories in the east, Germany’s principal economic problem today is its strength. The mark is so strong, the German economy so dynamic, that Germany’s European neighbors fear being overwhelmed by it. German policy-makers must learn to balance the needs of their domestic economy with those of their neighbors and partners.

Meanwhile, German workers believe the economy is so strong that they are demanding double-digit wage increases--despite the costs of unification. By U.S. standards, German workers are pampered. Germans work fewer hours, have better benefits--especially health care--and six weeks’ annual paid leave is common. Greed or stupidity could kill the goose that lays these golden eggs but, so far, the system of state-supervised national bargaining between unions and industries has kept German inflation enviably low.

Japan’s problems also come from growth. Japanese goods are of such high quality, and are priced so attractively, that consumers all over the world prefer them to the competition. For this the poor Japanese get attacked on every front--by everybody except consumers, who keep buying. In Japan, where unemployment rarely gets above 2.5%, where inflation in the last year was 3.1%, they define a recession as annual growth of “only” 3%. If the United States could get growth of 3%, politicians would call it a boom.

This is all quite annoying for Yankees and Brits, who grew up thinking their countries were the most advanced. It is even more annoying to our economists, because, in theory, it shouldn’t be.

After all, Thatcherism-Reaganism teaches that protection is bad, and that countries that practice it go straight to the dogs. And if protectionism is bad, planning--even if you call it industrial policy--is worse. Governments don’t pick winners; markets do.

According to theory, countries that protect their markets and employ industrial policy will be filled with incompetent managers, unproductive workers, white-elephant industries and economic stagnation. Why does this sound more like the United States and Britain than Germany and Japan? Why, as the psalmist asks, do the wicked prosper?

Maybe the wicked know something.

For some years, it has been clear to sharp observers that things had gone wrong with the Great Experiment of the ‘80s. The meltdown of the deregulated thrifts and the banks, the climate of scandal and piracy in the financial markets, the continuing fall in real wages and, perhaps most troubling, the continued slow growth in productivity were all indications that something was wrong. The true believers, though, were unshaken. No recession was coming, they said. Then, when it came, they said it would be short. It had hardly arrived before they said it was over. With the recession hanging on and the election in sight, we hear sounds of panic in the temple.

We will now see a new division: between those who accepted Thatcherism because they thought it was a science, and those who believe in it as a religion. We already see that Bush is a scientist, not a priest. Calling on Japan to buy billions of dollars of U.S. auto parts is a radical betrayal of the free-market faith.

Market theory is clear. If U.S. auto parts are better quality at the price than the competition, then the Japanese would be fools not to buy them. By buying more expensive parts from other suppliers, Toyota and Honda would be undermining their competitiveness. This would leave the market free for the clever, U.S. based-companies that got the best deals on parts, whatever the source.

If on the other hand, says market theory, U.S. companies can’t make auto parts that are competitive, then nobody should buy them. Companies that make them, like those in communist countries that make bad products nobody wants, should go under--the sooner the better. Then investors and workers will be free to find more productive ways to use their resources, and we will all be better off.

Nothing could be clearer than this--on the blackboard. It just turns out to be dangerous nonsense in the real world--the world where nations rise and fall and elections are lost and won.

The true believers of the economic world are like people who say that dams are unworkable--water seeks its own level, so it is useless to dam it up. They are right that water seeks its own level--and that markets seek an equilibrium, but wrong to apply these principles in a simplistic way to all the varieties of problems we find in real life.

Some dams are good: They prevent floods, they conserve an important resource; they generate power. On the other hand, some dams are dangerous and stupid. There are good dams and bad dams--and there are good economic policies and bad ones. The art of engineering, and the art of economic policy, lies in deciding which dams and which policies are which.

In retrospect, it is clear that there were, so to speak, too many bad dams in the ‘70s, when the Reagan-Thatcher movement came to power. Like the Army Corps of Engineers, mad builders had tried to dam every creek, every sinkhole. There were dams on earthquake faults, dams on scenic canyons, dams whose benefits were less than their costs.

“Torpedo the dams,” cried the true believers. “Full speed ahead!” Sometimes this was useful, but sometimes the dams turned out to be important. Think of the devastating floods that have washed out the savings and loans, for example.

But what we need now is neither mad bombers, who have never seen a dam they didn’t want to torpedo, nor eager beavers who have never seen a stream they didn’t want to dam. We need to look at what works, draw appropriate conclusions and then set about building for the future. This means learning from places like Germany and Japan, where something, obviously, is working. The United States can’t, and shouldn’t, mindlessly copy policies from overseas. What works in other places may not work as well here. But some of it might, and we can’t afford to ignore the lessons of success.