When Margaret Thatcher rose to power in 1979, Britain was an economic basket case. How did she turn things around? James McKeigue reports.
What did she do?
When Margaret Thatcher came to power in 1979, Britain was heavily indebted, the economy was stagnant, inflation was rampant (averaging 13% that year), and the country had just endured a winter of crippling strike action. Thatcher wasted no time.
To encourage entrepreneurship, she cut the top level of income tax from 83% to 60%, raising value added tax (VAT, a consumption tax) from 8% to 15% to compensate. She also tried to improve the government’s fiscal position by cutting government spending, and raised interest rates as high as 17% to rein in inflation.
Were these policies a success?
Not immediately. Raising VAT drove inflation as high as 21%. Yet despite pleas from within her own party to change course, Thatcher repeatedly said “there is no alternative”. Her stubbornness paid off. From 1982, inflation slid into single figures. Despite the protests of 364 economists who wrote an open letter to The Times in 1981 decrying that year’s budget, the government’s fiscal position also improved during her tenure.
By 1988, her second chancellor, Nigel Lawson, had managed to balance Britain’s books (ie, record a budget surplus) for the first time since the 1960s. Overall, Britain’s total debt-to-GDP ratio fell from 46% in 1979 to 32% in 1991. Between 1980 and 2010, Britain’s GDP per head (national wealth per person) outgrew the rest of the G7, where previously it had lagged behind.
But it’s worth noting that despite her reputation for tax and spending cuts, Thatcher never managed significantly to reduce the size of the government’s tax take from the 40% of GDP she inherited in 1979.
How did she rein in the unions?
In 1979, Britain had lost 29 million working days to strike action. At first, Thatcher avoided outright conflict with the unions, but worked on a strategy to constrain the power of union bosses. By 1984, with emergency coal stocks in place, she felt ready to take on the powerful National Union of Mineworkers, and announced a plan to shut down the country’s most unprofitable mines.
The resulting strike was one of the most bitter episodes in Britain’s post-war social history (in the same year, unemployment hit a peak of 12%), but Thatcher’s victory drastically shrunk the role of the unions in the British economy. By 1990, the number of working days lost to strike action had fallen to less than 500,000. Privatisation was another key part of opening up the labour market.
Starting in 1981 a string of famous names – including British Telecom, British Steel, British Petroleum, British Airways – were sold to investors. British Gas famously ran its “Tell Sid” campaign to encourage first-time private investors to take part. In 1979 only 7% of the British population owned shares, whereas by 1990 it was 25%. Overall, almost a million jobs were moved from the public to the private sector.
What about the financial sector?
In 1986, the ‘Big Bang’ reforms opened up the City to competition. Fixed commissions were abolished, outside ownership of City firms was allowed for the first time, and building societies were allowed to compete with banks for deposits and mortgage business. These changes helped London become the world’s top financial centre and a huge source of tax receipts.
The housing market was opened up via the “right-to-buy” scheme, which saw more than a million state-owned houses sold to tenants, pushing home ownership up to more than 70%. While some argue that today’s financial crisis has its roots in the ‘Big Bang’ reforms, as Philip Booth notes in City AM, “in many respects she increased regulation of the financial sector” – bank deposit insurance was introduced in 1979, and the sale of investment and insurance products regulated from 1986.
What about Europe?
Thatcher was in favour of the idea of a trading bloc. She presided over Britain’s entry to the European single market but won a rebate for Britain’s contributions to the European Union with the refrain “I want my money back”. But despite acquiescing
to Britain’s entry to the Exchange Rate Mechanism, she became suspicious of the European project, and was a eurosceptic by the end of her tenure. She also understood the problems that would give rise to today’s crisis.
In the second part of her 1995 autobiography, The Path to Power, she noted that the Germans would be worried about a “weakening of their anti-inflation policies” if they had to share a currency with the “poorer countries”, who would be as uncomfortable about “losing their ability to compete on the basis of a currency that reflected their economic performance”. As Joe Weisenthal and Rob Wile put it on BusinessInsider.com, she “nail[ed] why the euro would be such a disaster”.
A financial innovator
British index-linked bonds owe their existence largely to Margaret Thatcher. As Matthew C Klein notes on Bloomberg.com, in 1979 she and her ministers wanted to establish the government’s commitment to stable inflation and compensate bond investors for rising prices. So they came up with a bond that had its coupon and final capital repayment linked to the retail prices index (RPI) rate of inflation.
As the issuer, the government would suffer if inflation remained high (thanks to rising interest payments on these bonds) and benefit as inflation fell. ‘Linkers’ were great news for savers and pensioners worried about inflation, and also imposed some much-needed discipline over government borrowing. Their arrival was “unambiguously positive”.