Free markets aren’t the success we’re led to think

LORD (Adair) Turner once explained when he was still the head of the City’s regulator, the then Financial Services Authority, how in the preceding 30 years global economic thought had been hijacked by free-market dogma. It had become a universally accepted truth that markets, not governments, knew what was best for an economy and therefore the role of governments and regulators was to keep out of the way. But this was not a universal truth. Rather it was the self-confident but ultimately self-serving assertion of mainly American investment banks to further their own business.

It worked not wisely but only too well. The bankers made more and more money, and became more and more confident of their own abilities until they overdid it and blew up the whole system. One might have thought the financial crash, the most extreme drop in living standards and the slowest recovery for 100 years, would have led to a re-think about the economic theories which led us there. It would have been reasonable to challenge the trust in neo-liberal economics and the financial market theory based on it — the efficient market hypothesis, shareholder value and all that.

But that seems not to have happened. There are voices in the wilderness: Paul Woolley at the London School of Economics, Saker Nusseibeh of Hermes and like-minded fund managers in the 300 group — Turner himself. But they have not dented the prevailing orthodoxy.

The US politician Upton Sinclair once said it was difficult to get a man to understand something when his salary depended on not understanding it, so that might explain how the City thinks. But the interesting thing is the way the Left has been cowed by free-market orthodoxy too — to the extent that no one on the Labour benches has yet been willing even to speak out against the latest nonsense promoted by George Osborne — the idea that Govern- ments must aim for a balanced budget every year.

It may be the ideas are so resilient bec ause they chime with an even deeper-seated belief — held particularly among those who were not born at the time — that the British economy was a basket case until Margaret Thatcher came along in 1979. There is almost no challenge to the view that her embrace of the free market transformed our economic prospects.

Now this may be widely believed, but it is not what the figures show.

A couple of academics at the Judge Business School in Cambridge — Ken Coutts and Graham Gudgin — yesterday released a piece of research which demonstrate s the opposite. Their analysis of the data shows the economy performed better before the arrival of Thatcher and neo-liberal economics than it has done since.

They have analysed the statistics in the public records and these show conclusively that the British economy performed significantly better in the three decades up to 1980 when the average annual growth of Gross Domestic Product per head was 2.6%. In the subsequent 27 years to 2007 the equivalent figure was 2.2%, which is a steep decline. Even this looks good, however, compared with the performance since 2007 when per capita GDP has on average declined by 0.2% annually.

The decline in labour productivity is even more marked — running at 2.9% for 30 years before 1980, slumping to 1.8% in the period to 2008, and minus-0.2% since 2008. The average unemployment rate since 1979 at 8.7% has been two-and-a-half times higher than the average for 1950 to 1979.

Not only was growth higher, productivity higher and unemployment and inequality lower before the advent of neo-liberal policies, but the economy as a whole was much less volatile.

Growth tended to come in slow waves rather than sharp spurts. So, in spite of all those transformational policies — from curbing the power of the unions to privatisation, freeing management to manage, mocking the idea of society, cutting the burden of regulation, Big Bang and financial market liberalisation, abolishing exchange controls and lowering taxes on high earners — in spite of all this, growth was still lower and unemployment higher than it was under the old system.

Of course one never knows the counterfactual — what would have happened if she had not come along — because it may be that we would have done even worse. It might be that, without her polic ies the economy would have dropped off a cliff and the growth of the previous three decades would have disappeared. There is no way of telling although it is worth noting that Thatcher’s embrace of the free market had the added tailwind of North Sea oil which began to flow in earnest just as she assumed office. Who knows how much that windfall added to the growth rate down the years and where we would have been without that?

The other major boost was the liberalisation of bank lending — though this began in 1971 — which of course led to the huge surge in consumer spending and similar rises in house prices. But this was powered by a surge in household debt which has ultimately proved unsustainable.

The authors say that the purpose of their research is not to make a party political point. But they do think it is important to understand that in a comp l ex economy such as ours, the “assumption that free markets will generate optimal outputs is shown to be untrue.”

“There is little evidence”, they add, “that liberal market policies taken together improved the trend rate of economic growth even temporarily.”

‘One might have thought the crash would have led to a re-think… But that seems not to have happened’