There is No Alternative (20 page)

Is my example simplistic and far-fetched? Try putting that question to anyone who grew up in the Soviet Union. Gorbachev, apparently, struggling to solve precisely this problem, once asked Thatcher how she made sure the British people got enough food. She didn't, she told him tartly.
Prices
did. By extension, anything that distorts the information conveyed by prices is harmful to the market's functioning and leads, sooner or later, to oversupply of things that people do not want and shortages of the things they do want—as Soviet planners discovered. “It was a shame,” recalled Gorbachev in 2001, “and I continue to say that it was a shame, that during the final years under Brezhnev, we were planning to create a commission headed by the secretary of the Central Committee, [Ivan] Kapitonov, to solve the problem of women's pantyhose. Imagine a country that flies into space, launches Sputniks, creates such a defense system, and it can't resolve the problem of women's pantyhose. There's no toothpaste, no soap powder, not the basic necessities of life. It was incredible and humiliating to work in such a government.”
⁹⁷

The free market is a simple concept, and the empirical evidence that it provides goods and services more efficiently than a command economy is about as strong as we can hope to have in the social sciences. Command economies everywhere have resulted in waste, shortages, poverty, and immiseration. That is why the great command economies of the twentieth century collapsed and the free-market economies are still here. Of course, the free market is a model, and like all models, it can only be approximated in reality. But it can be approximated to greater and lesser degrees, and those degrees matter. A freer market, Thatcher believed, is almost always a better one.

Despite the manifest failure of any number of command economy experiments, the concept of a free market continues to arouse
great suspicion. Many people who are in no doubt that they favor freedom of religion, free speech, free assembly and free elections feel no such instincts about free markets. Likewise, many people who claim to believe in free markets think that free markets are fine for the widgets they talk about in the textbooks, but not for food, water, medicine, energy, or, indeed, jobs. After all, they think, you can't trust that essential goods will be provided by impersonal market forces. No, the government had best step in to make sure there's enough of those to go around. But if you accept the argument that free markets work better than ones that are not free, then logically, the essential goods are the ones you least want the government allocating by decree. The more you need the commodity in question, the more you must hope it is being produced and sold in the most efficient way possible.

No one in his right mind believes free markets will function smoothly with no government intervention at all. Even the most enthusiastic free-marketer willingly concedes that governments must make and enforce the laws that permit a free market to operate: You may not sell your widgets at gunpoint, for example, and if you promise to deliver fifty widgets on the first of January, you must do just that—you must not take your customer's money and decamp for the Caymans. No one believes you should be allowed to buy or sell anything; not even the late, great Milton Friedman would have said that parents should be allowed to sell their children's eyeballs to the highest bidders. To prevent people from doing these things, you must have a legal system; to have a legal system, you must raise taxes. Enthusiasts of free markets accept this but believe that government intervention should be the exception, not the rule. The government's role, in other words, should be confined to the smallest possible sphere.

Yes, but how small is the “smallest possible sphere”? Those on the Left side of the spectrum often ask this in a sly, knowing way, as if the question is basically unanswerable and the optimal size of
government thus a matter of taste. In fact, the question is not unanswerable at all, and the answer is quite precise.

The answer is 14 percent of GDP.
⁹⁸

From a commitment to free markets, Thatcher believed, certain policies followed logically: monetarism; financial deregulation; reducing controls on prices, wages, and exchange rates; lowering taxation; reducing government spending; privatization; and curtailing the power of trade unions to set wages that did not reflect market demand for labor. These were the policies Thatcher put in place, with varying degrees of success.

Let us look first at monetarism because this is where Thatcher's critics usually start. Those who are inclined to sneer when they say the name
Thatcher
are likewise inclined to pronounce the word
monetarism
much as they would the words
pervert
or
pathogen.
Often the criticism reflects a conflation of monetarism with the rest of Thatcher's policies and personality. In fact, monetarism was only one component of Thatcherism, and not the most significant one. But because it is so widely held to be
the
defining Thatcherite dogma, it warrants our attention.

So what is monetarism, really?

The story begins with the Phillips Curve. If you took Economics 101 as an undergraduate, you may remember it. In 1958, the economist A. W. Phillips described a relationship between inflation and unemployment. Simply put, he argued that when unemployment falls, workers interpret this, correctly, as a sign that there is now a greater demand for what they are selling—labor. They therefore increase the price of labor by demanding higher wages. Employers then pass on the cost of these higher wages to the consumers in the form of higher prices
.
Rising prices, inflation—same thing. The Phillips Curve implied that you could have low inflation or low unemployment, but not both. It also implied that there was a reasonably simple cure for unemployment: Create inflation.

It is not hard to create inflation. All you need to do is increase the quantity of money in an economy, otherwise known as the money supply. The value of money, like the value of any other commodity, depends upon the relationship between the supply of that commodity and the demand for it. If the supply of money increases, its value will diminish. That is the very meaning of inflation.

A government can pursue an
expansionary
policy—which often leads to inflation—in one of two ways. It can control the supply of money directly, through what is called monetary policy. For example, it can lower interest rates. This increases aggregate expenditure, because when interest rates are low, people save less and spend more. Investors invest more, because they can get cheap loans.

Alternatively, it can use fiscal policy: By taxing less, or by spending more, the government directly increases aggregate expenditure, leading to an increase in output. The use of fiscal policy to combat unemployment is commonly associated with the economist John Maynard Keynes—this is broadly what is meant by the term “Keynesian economics”—and until the late 1960s, Keynesian policies were held to be the state of the art. No one likes inflation, but the assumption underpinning an expansionary policy is that at times of unusually high unemployment, a controlled rise in the inflation rate is a reasonable tradeoff for getting people back to work.

Controlled
is the operative word.

The state of the industrialized world in the 1970s led to a crisis of faith in the Phillips Curve. Stagflation—high rates of inflation
and
unemployment—forced economists to develop a competing idea: the
natural
rate of unemployment. If unemployment fell below this natural rate, they speculated, prices would not rise in a stable and proportionate way. Instead, inflation would gallop.
⁹⁹

Now why would that happen?

In 1975, the economist Milton Friedman famously proposed this answer: At any given time, constraints placed upon the economy's efficiency create barriers to full employment. These constraints include, for example, the degree to which it is easy to relocate to find work, the degree to which the price of labor is artificially elevated (by, for example, mandatory minimum wages or collective wage bargaining), and the degree to which options other than working—such as collecting unemployment benefits—seem attractive. If these constraints are not lifted, then no matter how high the rate of inflation, unemployment cannot be completely eliminated.

Now suppose, said Friedman, that despite these constraints, the government, seeking to reduce unemployment below the natural rate, accepts the logic of the Phillips Curve and pursues an expansionary policy. This pushes up prices. Real wages fall, leading firms to increase their demand for labor, which is now cheaper. Employment rises. In the short run, the policy seems to work. Happy employees enter the marketplace; the government wins the election.

The problem, said Friedman, is this: The workers agreed to supply their labor at Wage W assuming that prices would remain stable. But the workers aren't stupid: They notice that prices are rising, and they notice that the real value of Wage W is falling. They expect that this trend will continue. They demand higher wages. When labor becomes more expensive, employers buy less
of it. Unemployment returns to its previous level. You have therefore raised inflation and gained nothing.

Now the government, which unlike the workers
is
stupid, again pursues an inflationary policy to correct unemployment. The workers respond by demanding higher wages still. This cycle continues, each time more rapidly. Voilà, skyrocketing inflation, and still no commensurate rise in employment.

If you accept this analysis, you will conclude that policymakers cannot attempt to choose between high unemployment and high inflation. Instead, they should steer the economy toward a growth rate such that prices remain stable, and accept the level of unemployment consistent with this. This target is called the Non-Accelerating Inflation Rate of Unemployment, or NAIRU.
¹⁰⁰
To treat unemployment, the government should fix the underlying problem—the structural flaws in the economy that are increasing the NAIRU. Over the long run, argued Friedman, unemployment simply
cannot
be cured by pushing up the inflation rate, so there is no point in trying. What's more, by stimulating runaway inflation, the government will serve only to raise the overall level of misery.

During the 1970s, this argument looked extremely persuasive. Britain was suffering from acute stagflation. Thatcher's predecessors—both Labour and Conservative—had attempted to control inflation through fiscal policy and by implementing wage and price controls.
¹⁰¹
These efforts had failed. Moreover, wage and price controls were ideologically abhorrent to free-market economists. Thus did Thatcher determine

It is important to stress that Thatcher viewed inflation not only as a problem, but, like socialism, an
evil.
And if inflation is evil, skyrocketing inflation is more evil still. But why was inflation so wrong? First, because it punishes the thrifty: If inflation is rising unpredictably, it is pointless to save. If you have not saved, to whom will you turn in your needy old age? You will turn to the government. Inflation, Thatcher believed, thereby encouraged citizens to adopt a dependent, infantilized posture toward the state.

Moreover, inflation distorts price signals. If the cost of goods and services rises quickly and unpredictably, the information conveyed by prices becomes gibberish. Who can plan or invest when they have simply no idea what things will cost in a year's time or ten? The price mechanism is the key to the free market. If prices fail to convey meaningful information, the market will not function efficiently. This is why monetarism, for Thatcher, devolved from a commitment to free markets. Just as contract law is necessary to ensure the smooth functioning of the free market, so, she held, was the control of inflation.

If you believe, as Thatcher did, that free markets are morally ennobling, you must of necessity view inflation as no mere macroeconomic problem: It is, in fact, a
moral
problem. Thus did Thatcher describe inflation as an “insidious moral evil to whose defeat everything must be subordinated.” In her famous “The Lady's Not for Turning” speech, she called the defeat of inflation her “prime economic objective”:

Contractionary economic policies appealed intuitively to Thatcher, for they seemed consonant with a key Methodist value:
thrift.
The Keynesian idea that a government could make an economy grow by spending more money seemed to her not only contrary to common sense, but a serpent-in-the-garden species of temptation. That way lay the wickedness of profligacy. “For many years,” she said,