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A look at the economic and social impact of Mrs Thatcher’s economic policies.

  Summary of Thatcher’s Economic policies

• Belief in desirability of free markets over government intervention. E.g. pursuing policies of privatisation and deregulation.
• Pursuit of supply side policies to increase efficiency and productivity.
• Reducing power of trades unions and increased labour market flexibility.
• Financial deregulation, e.g. building societies becoming profit making banks.
• Reducing higher rates of marginal income tax to increase incentives to work.
• Ending state subsidies for major manufacturing companies.
• Encouraging home ownership and share ownership.
• Targeting money supply and monetarist policies to reduce inflation of late 1979. Monetarism was effectively abandoned by 1984.

The Economic Impact of Margaret Thatcher

Recession of 1981

When Mrs Thatcher came to power, she sought to

• Reduce inflation running at over 20% in 1979
• Reduce budget deficit.
• Increase efficiency of economy
• Reduce power of Trades Unions

On coming to power, the Conservatives followed a policy of Monetarism – seeking to control the Money Supply in order to control inflation. This involved higher interest rates, and higher taxes. This did reduce inflation from over 20% to 5%, but at the cost of a deep recession and unemployment rising to over 3 million.

In 1981, 365 economists signed a letter to the Times newspaper arguing the government should reverse its economic policy and seek an end to the recession. This caused Mrs Thatcher to make her famous speech to the Conservative party conference of 1981.

“To those waiting with bated breath for that favourite media catchphrase, the U-turn, I have only one thing to say: You turn if you want to. The lady’s not for turning! (BBC)

It was great politics, but the economic cost was a significant decline in GDP and unemployment staying at nearly 3 million until the mid 1980s.

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The amount of UK retail sales increased by 2.5% in the 12 months from September 2011 to September 2012.

This measure includes the amount (quantity) of goods in all retailing, seasonally adjusted. The amount spent (value of goods) increased by 3.2%

Annual store price inflation was estimated to be 0.7 %.

This suggests that the UK retail sector is relatively strong compared to other components of the economy. These figures gives hope for better GDP statistics in future quarters. Combined with falling unemployment, it suggests that the double dip recession may soon come to an end.

However, it also shows the continued price squeeze in retail shops. Shops have been able to boost sales through keeping prices and profit margins low. Retail sales may also have been helped by low interest rates, which have eased the burden for consumers with mortgages.

The headline CPI inflation of 2.2% is being driven by other factors, such as transport and energy prices.

Despite the increased retail sales volume, many big retail shops are still struggling with a report by  PricewaterhouseCoopers and the Local Data Company suggesting that, since the demise of JJB Sports, 32 shops per day are closing per day.

Household Goods

UK household goods retail sales are more volatile.

Many household goods, (white goods such as fridges and freezers, electronic goods e.t.c. are considered income elastic. A small fall in income causes a bigger % fall in demand. Therefore, in a period of falling incomes, people will delay buying.

In a recession, people can cut back on non-essential items, such as a new cooker. However, when the economy recovers, people who delayed buying take the opportunity to buy. Therefore, these non-essential ‘luxury’ goods, tend to be more volatile. If the economy recovers, you would expect to see a big increase in demand for these household goods.

Related

• Economic Growth
• Inflation

What are the key issues affecting the UK economy over the next few years?

Recession and Recovery

The biggest problem facing the UK economy is the lack of economic recovery. After a fall in GDP of 6% in 2008/09, the economy briefly recovered, but the recent double dip recession of 2012 has left the UK in a longer economic downturn than the Great Depression. A key factor over the next few years  is whether the UK economy can return to a normal rate of economic growth  or whether we may become stuck in a Japanese style period of economic stagnation.

If the UK economy can return to its long run trend rate of economic growth (2.5% and over), we can expect to see a fall in demand deficient unemployment and start to reduce the growing numbers of the long-term unemployed. A return to economic growth would improve government tax revenues and help reduce the budget deficit and stabilise the countries long-term debt. Economic growth would also give firms and consumers the opportunity to reduce their debt overhang from the previous credit crunch.

If the UK economy fails to recover, we will see a continued fall in living standards, persistently high unemployment and it will prove very difficult to reduce the government’s debt to GDP ratio.

Economic growth is a key factor in determining other problems such as unemployment, debt and the banking sector.

 Issues affecting economic growth

• Will the Eurozone crisis deepen, leading to a fall in UK exports to our main trading partner? – The EU has also re-entered recession, and has poor prospects of recovery given their current fiscal and monetary policies.
• Will the government commit to further austerity and job cuts in the public sector or will it change policy and be willing to finance substantial sums in public sector infrastructure? There is likely to be a fudge with small scale investment, and overall small reductions in public spending as they stick with their deficit reduction plans.
• Supply Side Miracle? Rather belatedly the government have become more concerned with economic growth. However, rather than tackle the issue of aggregate demand, they are pinning their hopes on supply side reforms – Tax cuts to boost incentives. Reducing planning restrictions to encourage people to build conservatories. However, governments often over-estimate the potential of minor supply side policies to overcome a fundamental lack of aggregate demand. (see role of supply side policies in recession)
• Housing Market. Further falls in house prices would weaken consumer wealth and lead to lower spending.
• Consumer confidence. After reaching an all time low, how will this recover?

Government Debt / Deficit

The Euro debt crisis has focused attention on the UK’s rapid growth in debt since 2008. The government responded by saying that deficit reduction was the highest economic priority. However, even relatively mild austerity policies contributed to a double dip recession. This second recession meant tax revenues have been less than expected and the government is in danger of missing their deficit reduction targets. Some economists even say that the austerity measures have been self-defeating.

Markets seem to be willing to keep buying UK debt, with UK bond yields falling to less than 2% (10 year bonds). But, still there is concern over the level of debt, giving the government less room for fiscal expansion.

More on UK national debt

Monetary Policy / Inflation

Despite the length of the recession, inflation has often been stubbornly over the government’s target of 2%. With fiscal policy limited by the government’s attempt to reduce the deficit, there is greater pressure on monetary policy to provide an economic stimulus.

UK CPI inflation – mostly above target of 2% – but still pressure to pursue expansionary monetary policy

So far the MPC have been willing to tolerate  inflation above target. They have also been willing to pursue unconventional monetary policy – Quantitative easing. However, if the economy continues to stagnate, the MPC will face a further difficult choice of how much to use monetary policy as a tool to promote growth. Should the MPC worry about the inflationary potential of further rounds of quantitative easing or should they be most concerned about recession and unemployment?

Unemployment

UK unemployment has risen to over 8% since the recession started. This is still less than the European average. It is also lower than previous recessions, when unemployment rose at a faster rate. This suggests the UK labour market is fairly flexible. (It is also much harder to get benefits). However, the rise in unemployment to 2.6 million is still of great concern; in particular the rise in numbers of long-term unemployment. The Institute for Public Policy Research stated that the number of people out of work for more than a year – is up to 904,000 in the latest figures.

Long-term unemployment is damaging to those involved – both financially and emotionally. Unemployment also increases the danger of social division and social problems.

UK Unemployment in the last three recessions.

 UK Current Account deficit

Less important than other objectives, the UK current account is still a rough guide to economic pressures. Last month, there was a drop in imports and rise in exports. A growing current account deficit may be a cause for concern showing a decline in UK competitiveness. But, it depends how it is financed. (Is a current account deficit a problem)

Other Issues

• Banking Sector – If banks make further losses in double dip recession and Eurozone crisis, there could be need for bailouts.
• Total UK Debt level of private + public debt. UK one of most indebted countries.
• Exchange rate – how will the Pound fare?
• Consumer confidence
• Savings ratio
• Housing market

Readers Question:

1. critically examine the effectiveness of monetary policy.

2. what factors do you think limit the effectiveness of monetary policy.

Previously, I have written an essay – what determines the effectiveness of monetary policy

In brief, the aim of monetary policy is to target low inflation (CPI = 2% +/-1). But, also to maintain a steady rate of economic growth. In recent months it has been difficult for the Bank of England to achieve both these objectives. This is because we have had cost push inflation (rising oil, food prices). The cost push inflation causes rising prices and falling economic growth. Therefore, even though inflation has increased to over 4%, the Bank don’t want to increase interest rates because the economy is already slowing down. Therefore, they have left interest rates the same and have been unable to keep inflation on target.

However, in period 1997-2007, monetary policy effectively kept economic growth and inflation stable. This was because cost push inflation was low and the independent Bank of England was successful in preventing growth exceeding the long run trend rate.

However, in the great moderation, despite low inflation, there were imbalances in the economy – such as rising house prices and boom in credit. This shows limit of monetary policy in preventing credit bubble.

2007-2011

Between 2007 and 2011, monetary policy became much more difficult. This was because of:

Cost push inflation and recession. In 2008 and 2011, the UK experienced a rise in CPI inflation to over 5%. (see: cost push inflation) Yet, at the same time, economic growth was very low or negative. This present the Bank of England with a difficulty. On the one hand, inflation is above their target so they should consider raising interest rates. However, with a depressed economy, the economy needs the opposite.

Liquidity Trap In 2008, the economy was in a liquidity trap. Cutting interest rates to zero, failed to boost spending and economic growth. Therefore, the Bank of England were forced to pursue quantitative easing.

Related

• Tight Monetary policy
• UK Monetary Policy

At the moment, an important economic and political question is when and how to tackle the government’s public sector debt. It is currently over £800bn (56%) but growing very rapidly.

D.Cameron has been making a case that the government debt poses a threat to recovery and it should be tackled with a high priority. He makes the following points.

High levels of government debt could cause the UK to lose its triple A rating status. A downgrade in  status would make it more difficult for the UK to borrow. It would increase the cost of borrowing and possibly force interest rates up. This would hamper a recovery.

Gordon Brown is making a case that the most important thing is an economic recovery. Tackling the budget deficit too early, could stamp out a recovery and push the UK back into recession.

Both are making valid points. It is a concern that UK debt is forecast to grow to 100% of GDP. When debt gets so large it could create problems of financial crowding out (higher interest rates) and possibly inflation, and depereciation of sterling.

However, in a fragile recovery, the last thing you want to do it is to be increasing taxes and cutting government spending, as this will reduce aggregate demand and push the economy back into recession.

Conclusion – So What Should We do?

Personally, I feel that:

The Dangers of borrowing in the short / medium term are often exaggerated. The bond market is not panicking at the level of government debt. Interest rates are bonds are still quite low (true, this has been helped by quantitative easing and purchase of gilts by Bank of England). But, this level of government borrowing is not unprecedented. Other countries have similar or worse, levels of debt. The UK has had much higher levels of debt in the past.

This does not mean borrowing is a good thing and it should not be tackled. Clearly this kind of debt level has to be reduced in the long term. Markets will need assurance that the debt is temporary.

But, I feel the immediate priority is an economy recovery. It is only through economic recovery that we will see a recovery in tax receipts and fall in unemployment (which will of course help reduce budget deficit).

I see little threat of inflation. But, if the economy does recover strongly, it makes sense to tighten fiscal policy (higher taxes) first before monetary policy (higher interest rates)

Related

• How much can government borrow?