In both the United States and Britain the 1980s were a decade of bold economic reform and revival that led to a generation of increasing (if overstated) prosperity. Regrettably, most of the reforms that changed the sluggish 1970s into the economically dynamic 1980s have since been reversed. Reversal of much of the increase in prosperity thus seems inevitable.
The reforms of the 1980s, a reaction against the economically unpleasant 1970s and their ineffectual political leadership, didn’t change everything but they changed a lot. Under two strong leaders, Ronald Reagan and Margaret Thatcher, inflation was conquered, tax systems in both countries were realigned to remove the damaging top marginal rates of tax, state social security and pension systems were put on an actuarially sound basis and financial market practices were restructured to make corporate management more accountable for its actions. Oh, and the Soviet Union collapsed.
By no means all the economic inefficiencies in the system were removed. Some economic problems, such as bloated and inefficient government spending, were not properly addressed. Other problems such as heavy illegal immigration worsened during the decade. Still others, like the permanent near-bankruptcy of the U.S. airline industry and the disappearance of the London merchant banks, were caused by misguided “deregulation” that failed to take account of economic structure and its second order effects. On balance the progress was vast, and was reflected in a substantial improvement in the economic performance of both countries, particularly Britain, where the 1970s decline had gone furthest.
Paul Volcker’s monetary policy of 1979-82 resulted in a peak Federal Funds rate of 19.10 percent, but brought inflation down from 10 percent to 3 percent in four years. Real interest rates remained at close to double digit levels for almost 3 years as the price for achieving this. M2 and M3 money supply were tightly controlled and Volcker ignored the political pressure from both the Jimmy Carter and Reagan administrations, both of which were electorally damaged by the double-dip recession that was an inevitable result of Volcker’s policies.
Volcker’s successor Alan Greenspan has since 1993 followed a very different policy, indeed since 2001 more or less the opposite policy. M3 money supply has been allowed to increase substantially faster than the economy for more than a decade, and real short term interest rates have been kept at a rate below zero for the past 4 years, and show little sign of turning positive any time soon. This has produced successive bubbles in the stock market and the housing market, and is now producing inflation at the consumer level, with October’s Consumer Price Index up 4.3 percent over the preceding 12 months.
Greenspan’s designated successor Ben Bernanke appears even more inflationist, dedicated to inflation targeting by reference to the “core” price indices, a method that can be shown to be more ineffective in controlling inflation than any other policy not followed by the early Weimer Republic. Just in case the investing public might be tempted to enforce monetarist inflation control from the sidelines, the Fed is also going to stop reporting M3 money supply from March next year. Thus the sound policy followed by Volcker has been reversed, and 1979-82’s progress against inflation will shortly prove to have been erased.
In the United States, the Reagan administration eliminated the high rates of up to 70 percent on income tax in 1981, and in 1986 reduced the tax code fairly close to a flat tax, with a top rate of 28 percent. Since then there have been two tax increases, and innumerable lobbyist-driven additions to the tax code. The tax code is now considerably more complex than it was before the 1986 reform and many taxpayers have to calculate their tax on two entirely different bases because of the Alternative Minimum Tax. The 1986 reform’s simplicity and certainty have since 2001 been further eviscerated by the procedure of passing tax reductions that expire in only a few years, making proper tax planning impossible. Naturally, a huge increase in the use of tax shelters and other economically counterproductive schemes has been the result.
In Britain, the extraordinarily high top tax rates of 98 percent levied on investment income were abolished in 1979, and after an economically damaging delay, the top rate of income tax was further reduced to 40 percent in 1988. As a result, Britain’s economic performance has been far superior to that of her EU partners, even though Thatcherite economic policies have in other areas been abandoned. The “stealth” tax rises inserted by Gordon Brown, such as the increases in National Insurance contributions, and the excessive and growing budget deficits in Britain, have already reversed much of Thatcher’s 1988 reform, although it is likely that her initial 1979 reform will be allowed to remain.
In both Britain and the United States, the 1980s saw a stabilization of the social security systems, which had been badly hit by 1970s inflation and negative real interest rates. Thatcher in 1980 removed the earnings link on the basic state pension, allowing Britain to become the only country in Western Europe that is not facing a short term demographic nightmare. In the United States, the Greenspan Commission of 1982 reformed social security, increasing the retirement age to 67 from 2026 and making the United States the first major country to reverse the previous actuarially insane trend towards lower retirement ages.
Again, both countries’ progress is in danger of being lost. In Britain the Pensions Commission headed by Adair Turner last week recommended a return to an earnings linked state pension, with an additional economically damaging 3 percent social security contribution to pay for it. In the United States President Bush’s social security reform plan was dead in the water, while his Medicare drug entitlement introduced in 2003 will drive senior citizen finance even further into hopeless imbalance. In both countries, the progress made by the sensible 1980s reforms has already been eroded, and is in danger of being lost altogether.
A particularly important microeconomic development of the early 1980s was the increase in the accountability of corporate management to its stockholders. Whereas in the 1970s the job of Chief Executive Officer had been regarded as a sinecure for life, the active takeover market of the 1980s, combined with the great expansion of the junk bond market and the leveraged buyout industry, focused the minds of top management squarely on shareholder value, since those without such a focus lost their jobs.
The increased vulnerability of top management was a matter of huge concern to them, and the lobbying resources of corporate America were deployed to remove that vulnerability. Eventually in 1989 the state of Delaware, where most large companies are registered, passed the merger moratorium law by which a 3 year moratorium could be placed on any merger unless the acquirer held 85 percent of the stock. Top management could breathe easy.
Not only did top management breathe easy, it then proceeded to pig out. CEO compensation in large companies, 42 times average worker remuneration in 1980, had already risen beyond 100 times worker remuneration by 1990, but soared during the 1990s to 458 times worker compensation in 2000, and then after a brief dip rose even further, to 520 times worker compensation in 2004. In this case the 1980s reform has been more than fully reversed, so that the position is now far worse than in 1979. At least the 1970s CEO sluggards were only modestly paid, whereas today’s aggressive incompetents, fueled by the last decade’s wave of cheap money, are draining the corporate sector dry without any serious possibility of their removal.
Finally there was the collapse of the Soviet Union and Comecon, instigated during the 1980s but consummated in 1991. Here there is some good news; a number of former Soviet satellites in East Europe have joined the European Union or are close to it. Russia itself and almost all the countries of the former Soviet Union are a very different story. In Russia, the 1990s period of reform was accompanied by low prices for petroleum, Russia’s chief source of foreign exchange. Since 2000 the increasing authoritarianism and state control under Vladimir Putin has been fueled economically by an enormous oil boom.
Something close to free market capitalism, which appeared to have been established by 2000, has been replaced by a state controlled economic development that is edging ever closer to the pre-1991 system of state domination. The Yukos case, where a takeover was reversed without compensation and Yukos Chairman Mikhail Khodorkovsky was sent to Siberia, indicated that private property is no longer secure in Russia, if it ever was.
In most of the non-Russian former Soviet Union, Putin has used Russia’s oil money and remaining influence to reestablish a measure of the former Soviet domination. As an indication of Russia’s new ambitions and strategy in the wider world, Putin is supplying advanced missile technology to the nuclear weapon builders of Iran.
The jury is still out on this one, but if oil prices remain high and Putin or a reliable henchman is elected in 2008 it must be likely that something close to the old Soviet Union will be reestablished. Should that happen, the new Soviet Union will doubtless be deeply hostile to Western and capitalist interests, in a way that even the recalcitrant France is not. The “peace dividend” of the 1990s reduction in Western defense spending will thereupon have to be reversed.
In some areas – trade, immigration, globalization, technology – the changes of the 1980s were only incremental, and good or bad trends already established before that decade have largely continued. In a few areas, notably privatization, modest changes made during the 1980s have remained, although further progress on those fronts has slowed to a halt. Nevertheless, when considered as a whole the reforms of the 1980s were enormously important and have today largely been erased, or in the case of management accountability pushed far in the opposite direction.
A return to the sick economy of the 1970s seems inevitable.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.