What The EU Could Learn From Margaret Thatcher

Includes: EU, EWU, FXB, FXE
by: Mike the PhD

As the European Union lurches from one crisis to the next, making the continent as a whole appear to be the proverbial sick man of the global economy, it is worth looking for past national overhauls that might serve as a template for future EU success. Great Britain is an excellent overhaul template, and it owes much of its prosperity over the last two decades to Margaret Thatcher, who passed away earlier this week.

Margaret Thatcher is widely regarded as the British counterpart to America's Ronald Reagan, and thanks to the policies she championed, the U.K. is a far more vibrant and successful country today, even with the ongoing recession in the EU, than it was at the best of times in the 1970s. However, Thatcher's policies were controversial because while they increased average incomes and national prosperity in the medium term, they also increased inequality undoubtedly leading to resentment among those who did not benefit as much from her policies.

In particular, Thatcher stood for three economic policies first and foremost:

1. More flexible labor markets with less power for unions

2. Less government intervention in the economy

3. A tight lid on inflation

Prior to Thatcher taking office in 1979, the U.K. was relying heavily on state intervention and strong labor protection to drive its economy. The country was suffering through inflation rates that approached nearly 25%, and the U.K., the birthplace of the industrial revolution and modern economics, had been forced to take an IMF loan in 1977. In 1979, state owned enterprises accounted for 10% of the economy versus 2% today. Most of these state owned firms were unprofitable, and long union strikes were the norm. All was clearly not well in the U.K.

Upon taking office Thatcher, like Paul Volker in America, raised interest rates (the Bank of England was not an independent body at the time), slashed government spending, and went to war with unions. The result was a deep recession where unemployment rose to more than 11%.

However, the short term pain associated with economic confusion surrounding all of the removing of red tape, regulation, and labor rules led to a more prosperous Great Britain in the longer run. Intuitively it makes sense that after major changes to any complex system, (and a national economy certainly qualifies as complex), it takes awhile before the system adjusts to the changes and starts to function properly again.

A good analogy might be a person who had a broken leg which has set improperly. The result of the bone setting improperly would be the person limping around with limited mobility. The proper course of action here would be to re-break the leg and then have it set properly in a cast. It takes a while after the cast has been put on before the person's leg is healed, but in the longer run, the individual will be better off having a properly healed leg.

So it was with Britain.

The following graph shows the British GDP relative to France. As the graph shows, U.K. GDP fell to its lowest point around 1982, and thereafter began to recover consistently through the mid 2000s with only a shallow recession in the late 1980s. GDP growth was even more impressive averaging 4% per year throughout the 1980s versus an anemic 1.5% throughout the 1970s.

In the end, Thatcher broke the power of unions in the U.K., and created an economy based much less on the state and much more on the free markets. By the time Tony Blair took power in 1997 after close to 20 years of Conservative party leadership, the Labour Party had dropped its support of nationalizing industry and accepted most of Thatcher's ideals including the power of the free market.

The point here is that, like the EU of today, Britain was once a place where regulations, state owned enterprises, inflexible labor rules, and general social malaise all caused perpetual economic problems. The U.K. was able to get out of this situation by making significant changes to the system and enduring the pain those changes caused. The changes were controversial then and they are still controversial today. Union members don't like losing bargaining power. Managers and workers at nationalized firms don't like having the firms privatized and made more efficient through layoffs, cutbacks, etc. Citizens don't like having tax codes enforced, free government benefits taken away, and wealth transfers dropped. But all of those things lead to greater economic inefficiency. Taking them away will mean short term pain, but eventually, in two years or ten, the economy will emerge stronger for it.

Unfortunately, to date Europe seems to have talked a lot about these ideas, but accomplished little. Much of Greece's economy is still run by state owned firms. The Italians and French still have incredibly inflexible labor markets that make it nearly impossible to fire anyone no matter how bad a job they do. The Cypriots still seem to be trying to cling to the cash invested in the country by wealthy Russians, and the Germans seem insistent on preventing the creation of a single set of rules for all European banks.

From the outside at least, it still looks like Europe has a long way to go, but if they are smart, EU leaders should be looking at the reforms put in place by Thatcher, and trying to emulate them for the future regardless of the uproar those reforms would undoubtedly cause. In the end, Europe as a whole would be made better off by such reforms.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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