The Path to Power

TWO MODELS — THE UNITED STATES AND GERMANY

The economic reformers of Central and Eastern Europe naturally sought to study the most successful models of the capitalist system which they intended to recreate. Many of them looked to Britain, particularly in order to learn techniques of privatization, though these have had to be adapted to different circumstances. But it was the examples of the United States and Germany which have had most influence.

There are significant differences between the American and European versions of capitalism. The American traditionally emphasizes the need for limited government, light regulation, low taxes and maximum labour-market flexibility. Its success has been shown above all in the ability to create new jobs, in which it is consistently more successful than Europe. Since the 1960s employment has grown on average by only 0.3 per cent a year in the EEC, compared with 1.8 per cent a year in the USA; moreover, in the US, by contrast with Europe, most of the jobs were created in the private sector. Over 40 per cent of the unemployed in the EC have been out of work for over a year, compared with 10 per cent in the USA.

The European model — in particular the German version — has, however, recently attracted much sympathetic consideration by policy-makers in the American administration who favour an interventionist approach to training, industrial policy and managed trade. It is, therefore, particularly important to understand the weaknesses as well as the undoubted strengths of the European system as exemplified by Germany. For if the world’s greatest example and exponent of liberal capitalism were to turn away from it in either internal or external economic policies that would have momentous implications for the free-enterprise system generally.

West Germany’s emergence as the major European economic power in the post-war years was rightly described as an ‘economic miracle’. A combination of very low inflation and high productivity characterizes the German success. This reflects both the character of the German people and the policies pursued by the German government, particularly in the 1950s and 1960s when the emphasis of the ‘social market’ approach was on ‘market’ rather than ‘social’. The 1970s and 1980s saw something of a reversal in that balance with a growth of state intervention and joint decision-making (Mitbestimmung) by unions and management. There was also a large increase in the tax and regulatory burdens on employers which, it has been suggested, now approach 100 per cent of wages. Although the German economic performance has been impressively consistent, under both these burdens and the shock of a not very well managed enlargement to take in the ex-communist East, some of the characteristics of German capitalism which made for past successes are already leading to serious problems — problems that threaten to get worse. Industrial consensus has degenerated into a more rigid corporatism, which reduces the ability of German industry to adapt flexibly to challenges from Asia and Central Europe. This applies both at the level of individual German companies and in sectors. Significantly, German employers agreed to raise East German wages to West German levels by 1994, which attempt proved deeply damaging — and ultimately practically impossible. But such a decision was only possible in an economy where centralization of wage bargaining was the accepted norm.

Moreover, the German workforce today has the shortest working hours and longest holidays of any country. Asia-Pacific industrial competitors with wage costs per hour a sixth of Germany’s are an increasing challenge. And Germany is relatively more reliant on manufacturing industry than most advanced economies.

It is thus an open question how long present prosperity can last under these conditions. The temptation will grow for Germany to follow France in pressing the European Community in the direction of protectionism. But that would be self-defeating, since protectionism reduces the incentive for efficiency at home while stimulating it overseas.[123] It should be added that this analysis is by no means ‘anti- German’. Indeed, the more corporatist model of capitalism which Germany has come to represent only works as well as it does because of the remarkable qualities of the Germans.

THE TEMPTATION OF ‘STABILITY’

The attraction which the more regulated German model of capitalism offers is not solely the result of Germany’s own impressive economic performance. It also stems from that perpetual desire for security and stability which tempts policy-makers to abandon the risky unpredictability of free markets for the misleading reassurance of planned order. This explains the present tendency to argue for state intervention in industry long after the economic theories justifying it are discredited. It also explains two other current preoccupations — first, the search for a new framework of stable currencies policed by international institutions on the lines of Bretton Woods, and secondly the argument that full-blooded protectionism offers the only hope of withstanding the disruptive competition of new low-cost producers. Each of these viewpoints is advanced by distinguished advocates — in the first case Paul Volcker’s Bretton Woods Commission, in the second Sir James Goldsmith.

The pursuit of exchange-rate stability has done great damage during my political lifetime. Nigel Lawson’s shadowing of the Deutschmark between March 1987 and March 1988 undermined my own Government’s anti- inflation policy. Subsequently, the pursuit of rigid parities within the Exchange Rate Mechanism of the European Monetary System plunged Britain and other European countries into an unnecessarily deep recession. But in any case, as Professor Milton Friedman has pointed out, the experience of pegged exchange rates under the Bretton Woods system devised in 1944, which finally collapsed in 1971, hardly justifies the plaudits it sometimes receives.[124] In fact, it only worked as intended for eight years — from 1959 to 1967 — and even those years were not free from exchange-rate changes. Moreover, the inflation of the 1970s actually began in the last few years of the Bretton Woods system. Its final breakdown reflected both that inflation and the unwillingness of sovereign states to subordinate their interests to an exchange-rate rigidity which transmitted the inflation or deflation of other economies to their own. All experience has shown that attempts to peg exchange rates do not in fact increase stability — or, except in the very short term, confidence; they simply ensure that adjustments take place against a background of economic crisis and political discord. Talk of ‘recreating Bretton Woods’ is nostalgia which we cannot afford — and indeed we cannot even achieve. As Sir Samuel Brittan, a distinguished former supporter of the ERM has recently written: ‘Fixed, but adjustable, (pegged) exchange rates of the Bretton Woods or ERM types are probably no longer a realistic option; and a straight choice has to be made between floating and a full monetary union with partner countries.’ For reasons I advance elsewhere, my choice is firmly for floating rates. Sir Samuel will probably plump for the other option — but we both realize that there is no stopping at the halfway house.

I have more sympathy with the analysis of the international economic scene offered by Sir James Goldsmith.[125] Sir James is right to draw attention to the challenge posed to high-cost, overregulated European industry by foreign competition, which he sees as inevitably leading to falling real wages and soaring unemployment — unless we erect protectionist barriers around the advanced economies of Europe. Research suggests that competition from the emerging markets has indeed begun to depress real wages and in Continental Europe is also raising unemployment.[126] These are real problems with which we must deal.

But the benefits of free trade do not depend upon participating countries having similar cultural or institutional arrangements, nor on their having the same economic potential. The mutual benefit comes from exploiting the comparative advantages enjoyed by different countries. And Sir James probably exaggerates the immediacy and scale of what he calls ‘a completely new type of competition’ from four billion people who are coming into the world economy. The figure of four billion seems to include the entire population of the world outside the developed countries, men, women and children. Not all of these are coming on to the world economy any time soon, and the economic potential of the low-paid workers in China and the former Soviet bloc who are competing with us is very varied.

Of course, the experience of the Asian ‘four tigers’ suggests that some at least of these newly- industrializing countries will enjoy a very rapid rise in industrial skills and living standards. But two consequences will flow from that: they will cease to be low-wage competition, and they will increasingly provide a market for the exports of other nations, including Western nations. Competition will once again work for the benefit of all.

It could be, admittedly, that the West, even while prospering in absolute terms, might fall behind these new competitors in relative terms. That would be no great tragedy; but in any case for several reasons it is unlikely to happen. The most important one is that, the more advanced an economy, the smaller labour costs are