Governments pledged to implement `conservative' economic policies took office in Britain and Germany in 1979 and 1980. A special issue of Economic Policy (No. 5, October 1987) examined in detail the `Conservative Revolution' in Britain and Germany as well as in the United States and Switzerland. On December 4, CEPR organized a joint conference in Munich with the IFO Institute for Economic Research to assess and compare the conservative policies in Germany and Britain, using as background the Economic Policy articles of Hellwig and Neumann and of Matthews and Minford. Financial support for the conference was provided by the Anglo-German Foundation for the Study of Industrial Society. In his opening remarks, CEPR Director Richard Portes suggested that the conference should not focus on the current macroeconomic conjuncture but should instead address more fundamental issues. How similar are the assumptions behind recent policies in the two countries, and what were the common elements of their policies? How did results compare, and would the policy shifts prove durable?

German Economic Policies in the 1980s

Martin Hellwig (University of Basel and CEPR) first discussed the analysis contained in his Economic Policy study, written with Manfred Neumann. Chancellor Kohl had come to power when Germany was suffering its greatest postwar crisis of confidence: output was stagnant, the trade balance deteriorating, unemployment rising, and inflation uncomfortably high. The government rightly gave priority to fiscal consolidation in order to bring the growing budget deficit under control. This fiscal contraction boosted private sector confidence to the extent that overall demand was actually stimulated, Hellwig argued. Together, fiscal rectitude by the Federal Government and monetary austerity by the Bundesbank made possible sustained output growth against a background of falling inflation. Since in addition lower deficits `crowd in' private investment in the long run, Hellwig judged Kohl's macroeconomic policy to be a considerable success.
Hellwig did acknowledge that German unemployment remained stubbornly high, but he argued that this was partly because the German labour market remains subject to many distortions which the Kohl government has done little to remove, just as it has not seriously pursued the deregulation of product markets. German unemployment is likely to remain high, at least until favourable demographic changes take effect in the 1990s. He went on to argue that fiscal austerity was also desirable from a supply-side perspective. Reflation in order to reduce unemployment may reduce the incentives to implement painful but necessary structural change. As for pressure to reduce German interest rates, Hellwig argued that they were already low in nominal terms; because it was plausible to believe that business reacts to the nominal interest rate, the high real rate was less relevant.
Hans-Jürgen Krupp (Free University of Berlin) expressed disappointment that much of the discussion in the paper by Hellwig and Neumann had been based on a priori  theorizing, rather than a well articulated empirical model. Specifically, the authors had not presented any evidence to support their controversial view that a cut in government expenditure had actually stimulated growth. Krupp argued that the expansion after 1980 was in fact due to export growth, and hence attributable to US expansion; in addition the recovery was so weak that Germany was ending a cyclical upswing with more unemployed than at its beginning.
Krupp argued that the relatively poor growth performance of the German economy since 1983 should be attributed to overly restrictive fiscal and monetary policies, since most of the supply-side factors had moved in the right direction. Unit labour costs had fallen in recent years, profitability had risen, and the best available evidence suggested that net employment had increased as a result of technological change. Nor did unemployment seem to be the result of a substitution of capital for labour resulting from excessive real wages. Krupp acknowledged that the German economy needed to reallocate resources between sectors and that this process had proceeded too slowly. But in sharp contrast to Hellwig, he argued that these necessary structural changes would be easier to implement in a full employment setting.

Willem Buiter (Yale and CEPR) disagreed with this view, arguing that government should guarantee policies not outcomes. If government guaranteed full employment, for example, workers would have an incentive to maintain restrictive practices in the labour market.
Hans-Werner Sinn (University of Munich) did not accept Hellwig's hypothesis that crowding-out of investment in the 1970s had been followed by crowding-in in the 1980s. Sinn also stressed that unemployment in Germany was not due to high real wages; the share of wages had fallen back to its 1969 level, and the elasticity of substitution between capital and labour was low anyway.
Ernst Helmstädter (University of Münster and Council of Economic Experts) felt that it was misleading to attribute slower growth in Germany to restrictive demand policies. Instead, Germany's spectacular postwar growth could be linked to the advantages of catching up with a technological leader the United States. Since the `catch up' process was now complete, it was almost inevitable that German growth would slow down.
Wolfgang Franz (University of Stuttgart) concurred with Krupp's view that the rise in unemployment could not be explained by supply-side factors. There had been no significant increase either in the generosity of unemployment benefits (as measured by the replacement ratio) or in the degree of mismatch between labour supply and demand. In his own research, Franz had failed to find any evidence that German labour markets had become more sluggish. If one took into account all these supply-side factors, one found that the non-accelerating inflation rate of employment (NAIRU) was only 5%, suggesting that there may be substantial scope for reflation in Germany.
According to Harald Scherf (University of Hamburg), there had been no policy revolution in Germany, no intellectual shift among economists, nor any changes in public attitudes about `fair wages' or in bargaining power. He did, however, detect a new fiscal conservatism in local (Land) governments, which had become net savers. Adam Ridley (Hambros Bank and CEPR) contrasted this picture with the radical changes in Britain: privatization, redistribution, and the establishment of macroeconomic policy credibility. Patrick Minford (University of Liverpool and CEPR) agreed: Germany, he argued, was in the grip of an alliance of large exporting firms and small farmers that frustrated the interests of consumers and the unemployed, supported a crude mercantilism, and pushed up the natural rate of unemployment. Michael Emerson (Commission of the European Communities and CEPR) warned that the German economy might be heading for trouble. 10% of the working-age population were receiving a disability pension (in contrast to only 3.5% in the United States and Britain): this concealed a huge amount of hidden unemployment, and labour force participation rates would almost certainly increase.

The Conservative Revolution in Britain

Patrick Minford summarized his paper written with Kent Matthews and published in Economic Policy No. 5. He reminded the meeting that Mrs Thatcher had inherited a weak economy, whose poor performance might be partly attributed to indiscipline, inefficiency and inflation. Rather than launch an immediate assault on all fronts, Mrs Thatcher picked off her enemies one by one, each victory consolidating her position for the next attack. Only when inflation was clearly under control, for example, could she introduce more radical supply-side reforms. Minford argued that the recession of 1980-1 was not caused by restrictive demand policies but by external and supply-side shocks, although he did concede that subsequently, tight monetary and fiscal policy did have powerful effects in reducing inflation rapidly and holding unemployment above its equilibrium level.
Once serious supply-side policies had been introduced, such as trade union reforms and lower tax rates, they did have a significant effect on productivity growth and on the equilibrium rate of unemployment. In fact, Minford estimated that equilibrium unemployment now stood at about 1.6 million, at least a full million less than actual unemployment. As a result actual unemployment can be expected to fall (albeit gradually), but he did not believe that the government should attempt to accelerate this adjustment through fiscal or monetary expansion this would only reignite inflation. Instead, the economy needed further supply-side measures and deregulation to help markets achieve the transition to lower unemployment.
John Flemming suggested that policy since 1979 had not been `conservative', in the sense of maintaining established institutions, but rather `liberal', as regards markets, competition, free trade and self-help. The shift in demand-side policies and in attitudes to industrial profits had occurred as early as 1976. He pointed out that although inflation had been reduced from about 15% to 5% under Mrs Thatcher, there had been only modest progress since 1983 and unemployment had been much higher, despite the theory which suggested that the announcement of credible policies would reduce inflation without much effect on unemployment.
Flemming wondered what policy changes could have caused the fall in Minford's estimates of the equilibrium rate of unemployment. At first sight, he was inclined to agree with Stephen Nickell's conjecture that this fall stemmed from some model misspecification. The rate of productivity growth had indeed risen, but only back to its 1960s level. Instead of arguing for some specific `Thatcher effect', Flemming preferred to view the 1970s as the aberrant decade. There had been much discussion, both in political circles and in the paper by Matthews and Minford, of the need for greater wage flexibility in Britain; but Flemming had recently formalized Keynes's intuition that such flexibility might be a mixed blessing.
Turning to the microeconomic issues, Flemming questioned Minford's view that the increase in tax revenue could reasonably be attributed to reduced tax rates; a positive supply response from high earners should depress their hourly rate which was not apparent. Financial markets had benefited in many ways from deregulation, particularly the abolition of exchange controls, but the disappearance of the ring fence around the domestic markets meant that the new regulatory regime would extend to the previously freer London euro-markets. The privatization programme was in many respects a success, but some argued that it would not lead to greater competition. As far as the welfare state was concerned, some tension was liable to emerge between the desire to liberalize, while reducing expenditure and marginal tax rates, and protecting the position of the poor. Nevertheless, Flemming concluded, the overall `revolution' was politically safe.
Martin Wolf (Financial Times) felt that the `Thatcher revolution' should be seen as the triumph of the `King and People' over the `Barons' (e.g. local government, nationalized industries and trade unions). Although the policies had succeeded in some of their objectives, such as raising company profitability, he felt that to some extent they had failed to foster greater competition. Adam Ridley disagreed, pointing to the government's reforms of the Stock Exchange, the conveyancing and opticians' monopolies, and public transport. Further, the need to be competitive was now much more keenly felt in the public sector, and this had led to a vastly improved performance. In his view, the broad objectives raising company profitability, improving firms' access to capital, removing controls, and dealing with hidden unemployment had been achieved.
David Stanton (Employment Market Research Unit, Department of Employment) argued that much of the improved productivity performance was directly attributable to the new legislation regarding the trade unions, as well as to the `demonstration effects' of the defeats of the steel and coal workers. Sushil Wadhwani (LSE and CEPR) questioned this interpretation: there was some evidence that much of the improvement in productivity was due only to higher unemployment, and thus might not survive if the level of unemployment ever came down.
What was the long-run British strategy behind exchange rate policy, asked Manfred Wegner (IFO Institute for Economic Research)? Joe Grice (HM Treasury) suggested that the stubbornness of inflation in the UK indicated that macroeconomic policy was still not fully credible, whereas that of Germany was. But if German prospects were poor and disagreement over policy was growing, would policies continue to be consistent and credible? If there was doubt, it might not be sensible to tie sterling to the Deutschmark after all.


Success or Failure?

Opening a panel discussion held to evaluate the performance of the Conservative policies, Richard Layard (LSE and CEPR) said that both the German and the British experiences suggested that fiscal conservatism had failed, because of the accompanying huge rises in unemployment. Austria and Sweden provided good contrasts: they had undergone no fiscal contraction and therefore no rise in unemployment. Moreover, despite record levels of unemployment, wage inflation in the UK showed considerable persistence, almost certainly due to the growth of long-term unemployment, which exerted little downward influence on wages. Half the unemployed in the European Community had been out of work for more than a year, with as many as a quarter of them unemployed for more than three years! The growing number of long-term unemployed may be partly due to the open-ended benefits systems in many European countries, Layard argued, unlike those in the US or Sweden. He was also anxious that the distributional consequences of the `conservative revolution' in the UK should not be neglected: the numbers at or below the Supplementary Benefit level had doubled since 1979, and this now included over 20% of children.
Ernst Helmstädter contrasted Ordnungspolitik, the principles behind supply-side economics, with Prozesspolitik, such as fiscal policy. He stressed the importance of the former in creating a flexible environment for growth according to the Schumpeterian and Hayekian visions of dynamic competition.
Speaking with the benefit of experience in industry, David Stout (Unilever and CEPR) praised the continuity of British government policy in the Thatcher period. Two themes stood out: the belief in market forces and processes, and the establishment of credibility for non-interventionist policies. But it was disturbing that rationalization and increased labour market flexibility had not brought deceleration of real wage growth. In addition, the government's belief in market forces and in the unimportance of externalities was at odds with the view taken by many industrialists. For example, John Flemming had compared British education and industrial training unfavourably with that in Germany. One reason that industry in practice, large firms did not undertake enough training was the fear that their trainees would be poached by rapidly growing small firms: a classic externality. The government should, in Stout's view, now adopt a more pragmatic stance and attempt to deal with such market failures.
Michael Emerson concluded the conference by highlighting some of the contrasts between British and German policies. In agriculture, steel, civil aviation, road transport, financial services and insurance, the UK was generally more market-oriented, and more inclined to remove quotas and restrictions. Only in coal was Britain as protectionist as Germany. Of course, the requirement that regulations be harmonized at the Community level could in practice be protectionist perhaps a true supply-side position would support `competition among rules' across countries, he observed.