LAST WEEK I started to rebut the widespread belief that Britain is living beyond its means as a nation. Although we now manufacture rather few consumer products, our balance of payments deficit is smaller in relation to national income than its average of the past 20 years. This is no mean achievement considering that our European trading partners are mired in recession, while Britain is enjoying a consumer boom.
So where has Britain’s prosperity come from? And why is everyone so sceptical about it? The answer to both questions is the same. From the late 19th century onwards, Britain fell into a steady economic decline relative to the rest of the world. But this decline was reversed abruptly in the early 1990s.
To see the scale and significance of this historic transformation consider a famous example. In June 1979, one month after Margaret Thatcher became Prime Minister, Sir Nicholas Henderson, the British Ambassador to Paris, sent a telegram describing how Britain was perceived in Europe: “Our economic decline in relation to our European partners has been so marked that today we are not only no longer a world power, but we are not in the first rank even as a European one.” He supported his message with a table which showed how Britain’s GDP per head had fallen to 46 per cent below the German level and 41 per cent below that of France.
Almost nobody in Britain — maybe not even Mrs Thatcher — believed that the economic decline could be reversed. Yet it has been. In less than a generation, Britain has overtaken Italy, France and even Germany in terms of per capita income. And this summer, the European Commission declared that Britain’s GDP per head was higher than in any other EU country, apart from tiny Luxemburg.
Since the new trend has been running for only a decade, while the old one lasted 100 years, it is hardly surprising that most Britons still assume that the nation is in relative decline. Only people under 20, who became economically aware from the mid-1990s onwards, can readily believe what Gordon Brown keeps repeating: that Britain is one of the most successful economies in the world today. Yet this is, quite simply, a statistical fact.
How, then, did Britain reverse its century-long decline? Britain’s economic renaissance was not just a triumph of Thatcherism, nor was it simply attributable to the skill of the Bank of England or to Mr Brown’s monetary reforms. Rather, Britain’s unexpected good fortune was due to the confluence of three separate events.
The first is familiar enough. The trade union reforms, deregulation and privatisation of the Thatcher era created a truly competitive market economy in Britain for the first time in the 20th century, while most continental nations embarked on exactly the opposite course. This gave Britain a big advantage over its European neighbours. But Thatcherism on its own was not enough, as became all too apparent in the boom and bust of 1988-92.
There was a second reason for Britain’s revival, without which the Thatcherite reforms would never have had a proper chance to work. This was a macroeconomic revolution triggered, ironically, by the very event which discredited Tory economic management once and for all. The ejection of the pound from the European exchange rate mechanism on Black Wednesday — September 16, 1992 — freed Britain from a century of servitude to quasi-religious dogmas about “defending” the value of the pound.
For almost a century up to that momentous day, which The Times immediately relabelled White Wednesday, the British Government’s supreme economic objective was always to “defend” the pound against some arbitrary standard of value, whether gold, the dollar, the German mark or some arcane monetarist measure of the money supply. This obsession with defending or stabilising sterling replaced the management of demand in the British economy as the top priority of the Treasury and the Bank of England.
Only when all efforts to defend the pound were finally abandoned that day, could Britain move towards a rational policy for managing economic growth — and it did not take long for the Treasury to devise a sensible demand management policy under Norman Lamont. After the 1992 intellectual revolution, Mr Brown’s codification of the new macroeconomic policy in 1997, when he transferred control of interest rates to the Bank of England, was only a small, though significant, technocratic advance.
The really significant feature of the macroeconomic revolution which followed White Wednesday was its symbiotic relationship with the Thatcher reforms of the 1980s. It was only when the micro and macro reforms started to act simultaneously from the mid-1990s onwards, that their combined benefits became clear. Without the anti-union legislation and deregulation of the 1980s, low interest rates would simply have created inflation, as in the 1960s and 1970s. Without expansionary demand management, labour market reforms and the pruning of inefficient industries would only have created unemployment, as it did in the 1980s and is doing again in the eurozone today.
From the mid-1990s onwards, by contrast, Britain combined a competitive, deregulated economy with an activist monetary policy. As a result, the country suddenly discovered that it was possible to maintain both full employment and low inflation, both rapid growth and ruthless efficiency at the same time. Because this is a formula which has eluded most other countries, especially after Europe seemed to unlearn all the lessons of national demand management when it launched the single currency project, Britain has forged ahead in relative terms during the past ten years.
But to complete the explanation of Britain’s unaccustomed prosperity, we have to consider a third longterm trend: the way that globalisation, technological change and the emergence of a single European financial market have all played to Britain’s comparative advantage in knowledge-based services. As a result of technological progress and Asian competition, the goods which Britain has never been good at making and has had to buy from the rest of the world — mainly mass produced manufactures, ranging from toys and clothes to computers and cars — are getting dramatically cheaper in the world market. The things that Britain has always had an advantage in selling to the world — financial services, scientific research, education, entertainment and so on — are rising in price. Because of this shift in relative prices, the British people have effectively enjoyed a large pay increase without having to work any harder.
This “pay rise” has been the most mysterious feature of Britain’s economic renaissance because, for technical reasons, official statistics cannot pick it up until many years after the event. But a simple example suggests how it works. An international lawyer earning £200,000 today probably works no harder than did his counterpart 15 years ago, when he might have earned half that amount, even adjusted for inflation. According to the official statistics, his productivity has not increased at all. But the contribution to Britain’s economy from his foreign income, his taxes and his consumer spending has doubled nonetheless.
Like three separate tributaries flowing together to create a powerful river, these three currents of economic change have combined to transform Britain’s economic performance and reverse a century of economic decline. How long will this river of prosperity keep flowing? What future disturbances might dam it up? Could Britain’s newfound fortune be dissipated in a slough of self-satisfaction or might it swell into a destructive flood of greed? The tides of history move in a baffling manner and Britain’s economic renaissance may prove much briefer than its century of relative decline. But for the present, Britain’s prosperity is no illusion.
Join the Debate at comment@thetimes.co.uk
