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Clear victory for the liberal market policies

Gordon Brown boldly gave away monetary policy to The Bank of England, whose Monetary Policy Committee after a few hitches has done rather well. What did he have left to do, you might well ask? Yes, there's public spending at which he has become quite good at saying the traditional Treasury No; and there are taxes where he has stealthily been doing the bidding of the Inland Revenue, chasing after the IR's bête noire, the self-employed. Soon he will discover that classifying the self-employed as employed is a fool's errand. That can only cause damage to our new-found flexibility; and he will, we must hope, desist in favour of general tax cuts which he can now well afford - some £20 billion of them.

But, no, our Chancellor is most busy with something else- improving our productivity. How, pray, can he do that? The answer is obscure to us - but not to him: he will go on devising more and more devilishly complex tax breaks to encourage us to do things better, to be more high-tech or more hard-working (oops, careful, just so long as the working time inspectors do not catch you at it) or more... whatever.

Unfortunately, it will not help - indeed the contrary. By building layers of complexity upon the relatively neutral lowish-tax regime Nigel Lawson once bequeathed us, he, like his two Conservative predecessors, has somewhat reduced the incentives for our entrepreneurs. Marginal tax rates have risen at various points in our tax system; on higher rate payers with children, on movers selling their houses and suffering a substantial (stamp duty) wealth tax from so doing, on saving for private pensions, on middle class families now eligible for Working Families Tax Credit. The administrative burdens for small businesses have been made massively heavier, for all Tony Blair's protestations about cutting red tape.

Gordon Brown might have looked at Britain and Europe's productivity record; and he might have asked whether the USA's generally low tax rates and relaxed regulative system had anything to do with the American productivity success he so admires. Both would have told him the same story: productivity growth is speeded up when governments stop fiddling and get out of the way.

Continental Europe had much faster productivity growth than we did during the post-war period when we espoused Old Labour and Old Tory socialism while the continent concentrated on rebuilding their economies and their unions co-operated in an environment where growth came before social justice. In 1950 productivity in West Germany and France stood at 79 and 68 per cent of ours respectively; by 1979 they had risen to 127 and 117 percent of ours. These figures are taken from the National Institute's study by Mary O'Mahony and they are for 'total factor productivity' (including capital) in the market (non-government) sector of the economy. Hence productivity in these two countries was growing at 1.6% and 1.9% per annum faster than ours.

But then in 1979 we changed our policies towards market forces. By a peculiar quirk during the 1970s our continental neighbours were shifting in the opposite direction; so that in the past two decades we have got about as close as we are ever likely to in economic affairs to two controlled experiments in the effects of free market policies, one after the other. The results of the first we have seen: the continent overtook us and established a commanding productivity lead. But those of the second are no less remarkable. Since 1979 Ms O'Mahony's figures show that the productivity gap has narrowed markedly, to 115 and 108 percent by 1995. Hence in those 16 years our productivity grew faster by 0.6 and 0.5 percent per annum. As this was a time when productivity growth everywhere slowed down sharply from a typical range of 2-4 per cent per annum to one of 0-2 per cent, this is a big proportionate difference the other way.

People who say  'It all goes to show that the continent's productivity is still better than ours and so we should imitate them still' are missing the point, which is about the effectiveness of policy regimes. These two experiments suggest in a pretty clear way that liberal market policies are the key to faster productivity growth; and today Britain is where they are and the Germany and France is where they are not. Of course the latter two are still ahead; they spent thirty years doing the right things while we went disastrously wrong. But if we project where these productivity relationships will go should present policies continue for another 20 years, then it is a reasonable bet that we will have well overtaken both of them by then.

That judgment is massively reinforced by American experience. You do not have to be a paid-up New Paradigmer to be impressed by the speed-up in US productivity by information technology operating in an entrepreneur-friendly environment: best latest estimates are that labour productivity is growing at 2.5-3% a year. But this omits the remarkable effect on capital productivity of the falling price of computers; this could be boosting profits by up to10% a year, implying up to a 1% a year faster rise in total productivity.

President Clinton has referred to the continent as being on the wrong side of the 'Digital Divide'. The present state of affairs is unsustainable. Bill Jamieson and I have analysed it in a book just out from Politeia (22 Charing Cross Road). Europe must change- or its governments will lose the confidence of its citizens; and then it will change anyway. Tony Blair is right: change is the imperative for us and for Europe. He has been willing - unwisely, for the sake of harmony- to move somewhat, too much, towards the 'social model'; but he has done so while lecturing the continent on its inflexible ways- further change by implication has to come from them.

The European Union as presently constituted does not suit us- but more to the point it does not suit the continent either. It must become flexible, adopt deregulation, and become a free trade area so that approaches to the North American Free Trade Area seem merely logical. 'Politically impossible', I hear you say? That means it is just a matter of time.

Patrick Minford is professor of economics at Cardiff Business School  

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