The neoliberal turn: the Volcker shock, Thatcher and Reagan

Why did a different prescription gain ground over Keynesianism at the end of the 1970s?

After the Second World War Western governments used Keynesian policies: when the economy weakened, they raised spending and cut interest rates to prop up demand. In the 1960s and 1970s economists and policymakers believed they could lower unemployment by accepting somewhat higher inflation, a trade-off called the Phillips curve. By the mid-1970s, however, inflation and unemployment rose together; this was stagflation. The Federal Reserve alternated between loosening when unemployment rose and tightening when prices rose, a "stop-go" policy, and US inflation reached 11 percent in June 1979. When the prevailing Keynesian view seemed unable to explain these contradictory problems after the Nixon shock and the oil shocks, monetarism gained popularity in political circles. 1 2 3

The roots of the alternative went back much further. In The Road to Serfdom (1944) the Austrian-born economist Friedrich Hayek warned of the tyranny that inevitably results from government control of economic decision-making through central planning, and on 10 April 1947, at a conference he organised at the foot of Mont Pèlerin in Switzerland, he gathered scholars intent on defending classical liberalism into the Mont Pelerin Society, which championed the market economy and an open society and looked for ways in which the private sector could take over many functions of government. Margaret Thatcher, who became leader of the British Conservative Party in 1975, is reported to have banged Hayek's The Constitution of Liberty on a table, saying "this is what we believe". Besides Thatcher, Hayek influenced Conservatives such as Keith Joseph, Nigel Lawson and Geoffrey Howe. How the society and the Lippmann colloquium of 1938 before it gave neoliberalism its name is covered in the entry on neoliberalism. 4 5 6

Milton Friedman of the University of Chicago was the most influential opponent of Keynesianism. In A Monetary History of the United States (1963), written with Anna Schwartz, he argued that the Great Depression was caused not by a lack of investment but by a "Great Contraction" of the money supply by the central bank, and he left the dictum that "inflation is always and everywhere a monetary phenomenon". The central bank, he concluded, should not steer the economy by discretion but should follow a rule, increasing the money supply each year by a fixed percentage equal to the growth of output. This body of ideas was monetarism. He argued that pushing unemployment below its "natural rate" would only make inflation accelerate, so that the Phillips-curve trade-off did not hold in the long run, and he predicted what came to be known as stagflation. Friedman received the Nobel Memorial Prize in 1976 and later advised Reagan and Thatcher. 2 7 8

The prescription was first tried as national policy in Chile. When the economy fell into severe crisis under the military regime of Pinochet, who had overthrown Allende's government in the coup of 1973, Friedman travelled to Chile with Arnold Harberger in March 1975, lectured for a week and met Pinochet. In a letter to Pinochet of 21 April he wrote that the only way to end inflation was to reduce drastically the rate of increase of the quantity of money, and that in a Chile where prices were rising 10 to 20 percent a month gradualism was not feasible: the case argued for "shock treatment". The Chicago graduate Sergio de Castro became finance minister in 1975, and the economists who took the regime's economic posts became known as the "Chicago Boys". Their free-market policies later influenced the governments of Reagan and Thatcher. The road to the coup is covered in the event on Chile's Popular Unity government, and the results and assessment of the Chilean experiment in the entry on neoliberalism. 7 9 10

What did Volcker change on 6 October 1979?

In the summer of 1979 President Jimmy Carter, reshuffling his cabinet, moved Federal Reserve chairman G. William Miller to the Treasury and on 25 July nominated Paul Volcker, president of the New York Fed, to succeed him; Volcker took office on 6 August. Prices were then rising at an annual pace of about 9 percent, and the dollar had lost 12 percent of its value against the major currencies since late 1976. At his Senate confirmation hearing Volcker pledged to make fighting inflation his top priority. He believed that in the previous decade the Fed had shown that it placed little weight on price stability, so that the public had come to expect inflation to continue, and that expectation itself pushed prices up. 11 12 1

On the evening of Saturday 6 October 1979 Volcker announced, at an unusual press conference, the results of a Federal Open Market Committee meeting held without notice earlier that day. Until then the Fed had steered money by holding the federal funds rate, the rate at which banks lend to each other overnight, within a narrow range. From now on it would manage the volume of bank reserves supplied to the system instead, to restrain the growth of the money supply directly. When the reserves banks use as the base of their lending are cut, credit becomes harder to get, and the price is that interest rates swing widely in the market. Volcker told reporters that this way "we can get firmer control over the growth in money supply in a shorter period of time", adding that "the other side of the coin" was that the daily market rate "is apt to fluctuate over a wider range than had been the practice in recent years". 12 13 2

Volcker targeted money rather than interest rates for two reasons. With prices rising fast, a nominal rate that looked high could still be a low real rate once inflation was subtracted, so it was hard to know which rate was tight enough. A money target was also a way to signal to the public that this time the Fed was serious. The first attempt faltered: when the Carter administration introduced credit controls in March 1980 the economy dropped sharply, and as unemployment rose the Fed eased again. In late 1980 and early 1981 the Fed tightened once more, letting the federal funds rate approach 20 percent; in June 1981 it reached its peak of 20 percent and the banks' prime rate 21.5 percent. This time Volcker did not back down: "We have set our course to restrain growth in money and credit. We mean to stick with it," he said in 1981. The combination of the rate shock and the money targets is commonly called the Volcker shock. 1 11 12

How heavily did the double-dip recession fall, and on whom?

The US economy turned down twice: a short recession from January to July 1980, and a far deeper one from July 1981 to November 1982. Both times the trigger was tight monetary policy aimed at inflation. In November and December 1982 the national unemployment rate was 10.8 percent, the highest since the Great Depression. The sectors that ran on borrowing fell first. In 1982 goods producers accounted for only 30 percent of employment but suffered 90 percent of the job losses, and by the end of the year residential construction and the auto industry had unemployment rates of 22 and 24 percent. Flint, Michigan, reached 23.4 percent and Rockford, Illinois, 25 percent. 14 1

Volcker's Fed drew the strongest political attacks and most widespread protests in its history. Indebted farmers drove their tractors onto the street outside the Fed's building in Washington and blockaded it; homebuilders who could not build mailed the Fed pieces of lumber, and car dealers stuck with unsold vehicles sent coffins containing their keys. In Congress the attacks came from both parties. "We are destroying the small businessman. We are destroying Middle America. We are destroying the American dream," the conservative Congressman George Hansen said at a 1981 hearing, and Congressman Henry Gonzalez threatened to introduce a bill to impeach Volcker. Volcker held on, arguing that failing to bring down long-run inflation expectations now would bring "more serious economic circumstances over a much longer period of time". 11 12 1

When inflation fell to 5 percent in October 1982 the Fed let the federal funds rate fall to 9 percent, and unemployment came down quickly from its peak at the end of 1982 to 8 percent a year later. Inflation, which had peaked at 14.8 percent in March 1980, fell below 3 percent by 1983, and the double-digit inflation of the 1970s did not return. High rates, however, scarred the financial system. They soared just after the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn–St Germain Act of 1982 had loosened the rules on banks and savings and loans; the savings and loans suffered heavy losses in 1981 and 1982, and 118 of them failed between 1980 and 1983. In 1984 Continental Illinois, the seventh-largest US bank, was brought to the edge of failure and given a $4.5 billion rescue. That story of financial deregulation continues in its own entry. 1 11 14

The shock did not stay in the United States. As the United States and other industrial countries raised rates together, all the G7 countries went through a "double-dip recession", a short one in 1980 and a longer one in 1981–82, and the World Bank called it the "global recession of 1982". The Bank of Canada's rate rose to 21 percent in August 1981. The Volcker shock also caused strong disturbances in the European Monetary System and was deeply criticised in Europe. The heaviest burden fell on the developing countries that had borrowed at floating rates in the 1970s. As American and European rates rose, their debt service grew from $12 billion in 1975 to $66 billion in 1982, and in August 1982 Mexico's finance minister Jesús Silva-Herzog declared that Mexico could no longer service its debt. The debt crisis and structural adjustment that followed are covered in the event on the Third World debt crisis. 14 11 15

How did the Thatcher government fight inflation?

In Britain the Conservatives under Margaret Thatcher defeated James Callaghan's Labour Party in the general election of May 1979, just after the "Winter of Discontent" of 1978–79 in which public-sector workers struck one after another, and Thatcher became Prime Minister on 4 May. Inflation was about 10 percent and some 1.5 million people were unemployed, against about 1 million in 1974 and just over 300,000 in 1964. By "socialism" Thatcher meant government support for inefficient industries, punitive taxation, regulation of the labour market, price controls: everything that interfered with the functioning of the free economy. Under the new government taming inflation displaced high employment as the primary objective of economic policy. The Labour Chancellor Denis Healey, however, had already adopted some monetarist policies, such as reducing public spending and selling off the government's shares in BP. 14 16 6

Chancellor Geoffrey Howe raised interest rates to slow the growth of the money supply and shifted from income tax to indirect taxes, raising value-added tax sharply to 15 percent. In October 1979 exchange controls were abolished, letting capital move abroad freely. The Medium Term Financial Strategy (MTFS), issued with the 1980 budget, set targets for reducing the growth of the money supply over the following years; its publication was one of the measures pressed by the Financial Secretary to the Treasury, Nigel Lawson. As the fiscal and monetary squeeze, combined with the North Sea oil effect, drove up the pound, British goods became dearer in export markets and imports cheaper. Factories, shipyards and coal pits closed one after another, and unemployment passed 2 million by the autumn of 1980. 16 17 18 6 14

Commentators expected Thatcher to make a "U-turn" as Edward Heath's government had, but she told the Conservative conference of 1980: "You turn if you want to. The lady's not for turning." Howe's budget of 10 March 1981 bore her out. In the middle of a recession, with unemployment up by almost a million over the previous twelve months and inflation at about 15 percent, it raised net taxes by £4 billion, leaving income tax allowances unindexed and raising duties on petrol, tobacco and alcohol. The Leader of the Opposition, Michael Foot, called it "a budget to produce over three million unemployed". At the end of March 364 economists sent Thatcher and Howe a statement saying that there was "no basis in economic theory or supporting evidence" for the policy and that it threatened Britain's "social and political stability". Howe argued that cutting the deficit and controlling inflation would let long-term interest rates fall and revive the economy. 16 19 17

Inflation, which had peaked at 22 percent in 1980, fell below 10 percent at the turn of 1982 and to 4 percent by the spring of 1983. The price was unemployment. More than two million manufacturing jobs were lost in the recession of 1979–81, and by 1983 manufacturing output was 30 percent below 1978. Unemployment passed 3 million in January 1982 and stayed there until early 1987; it stood at nearly 20 percent in Northern Ireland and above 15 percent in much of Scotland and Northern England. In April 1981 in Brixton, London, and in July in Toxteth, Liverpool, and elsewhere, riots broke out in which Black youths clashed with the police; discriminatory stop-and-search was blamed along with inner-city deprivation and mass unemployment. Meanwhile, after overshooting many of its money targets, the government revised them upwards in 1982, which some read as an early abandonment of monetarism in the strict sense. 14 16 20 6

How were state-owned homes and companies sold?

One of the Thatcher government's largest policies was the "Right to Buy", which gave tenants of council houses, public housing built and let by local authorities, the right to buy their homes at a large discount. Thatcher believed it would create a "property-owning democracy", and it was enacted in the Housing Act 1980. By 1997 more than 1.7 million dwellings had been sold, and home ownership rose from 55 percent of householders in 1979 to 71 percent in 2003. The new owners were more likely to vote Conservative. But the share of the proceeds used to build new council housing fell towards the end of the 1980s, and social housing shrank from nearly 6.5 million units in 1979 to roughly 2 million in 2017. Critics say the policy compounded the housing shortage for people on low incomes. 16 21

Privatisation started small. The government first sold a small nationalised company, the National Freight Company, to its workers, with a positive response, and after its landslide in the 1983 election it grew bolder and, starting with British Telecom, sold off most of the large utilities that had been in public ownership since the late 1940s. Nigel Lawson, as Energy Secretary and then Chancellor, set the course for the privatisation of gas and electricity and helped privatise British Airways, British Telecom and British Gas. Many people bought shares but sold them at once for a quick profit, so the proportion held by individuals did not rise. Supporters called wider share-ownership and council house sales "popular capitalism"; one critic on the left called privatisation "the biggest electoral bribe in history". On 27 October 1986 the "Big Bang", a sweeping change in the London Stock Exchange's rules, liberalised the financial markets. 16 18 22

The privatisation of British Telecom is described as a landmark moment for neoliberalism and became a model for other countries selling their state utilities. Privatisation became synonymous with Thatcherism and was continued by Tony Blair's Labour government. Thatcher did not, however, discard the welfare state as such. Her biographer Charles Moore writes that she never rejected the wartime foundations of the welfare state in health, social policy or education, and that she aimed instead at abuse of the system, bureaucracy, union militancy and the "dependency culture". Because unemployment benefits swelled, the ratio of public spending to national income did not fall below its 1979 level until 1987, and for most of the 1980s the average tax take was higher than in 1979. 16 6

Why was the miners' strike of 1984–85 a watershed?

Rather than pass one big law as Heath's government had in the 1970s, the Thatcher government cut union power step by step. It made secondary action, strikes in support of disputes at other workplaces, illegal, required a ballot of the membership before a strike, and abolished the "closed shop" in which only union members could be hired. The biggest opponent was the National Union of Mineworkers (NUM), whose strikes of 1972 and 1974 had defeated Heath. The National Coal Board (NCB) received the largest subsidies of any nationalised industry, and by 1984 the annual cost of uneconomic pits had reached £1 billion. Thatcher expected a confrontation and prepared for it: she had at least six months' coal stockpiled, converted some power stations to burn oil, and set up arrangements for moving police from other areas to stop the union's "flying pickets". In 1983 she appointed Ian MacGregor, who had halved the workforce of British Steel in two years, to head the Coal Board. 16 23 24

On 6 March 1984 the Coal Board announced that, to cut subsidies, 20 collieries would close with the loss of 20,000 jobs, and the strike began with a walkout at Cortonwood Colliery in Yorkshire. Arthur Scargill, elected president of the union in 1981 with about 70 percent of the vote, said the government planned to close more than 70 pits. The government denied it, but cabinet papers released in 2014 show that MacGregor wished to close 75 pits over three years. The union did not hold a national strike ballot and instead recognised strikes called area by area. As a result more than a fifth of the miners, especially in Nottinghamshire, worked from the very beginning, and the other major unions were reluctant to give official support. 23 25

The strike was marked by violent clashes between police and pickets. On 18 June 1984 at the Orgreave coking plant near Rotherham about 5,000 miners faced the same number of police; mounted police charged with truncheons drawn, and 51 pickets and 72 police officers were injured. The riot trials of the pickets collapsed when the police evidence was judged unreliable. During the strike 11,291 people were arrested, and at least 9,000 miners were dismissed after arrest even when no charges were brought. Miners' wives and other women set up Women Against Pit Closures to raise money and run communal kitchens. In September 1984 the courts ruled the strike illegal in England and Wales because there had been no national ballot, and the winter passed without power cuts. Worn down by hardship, miners drifted back to work, and on 3 March 1985 the union leadership ended the strike without a deal. More than 26 million working days were lost, the most since the General Strike of 1926. 23 26 16

The defeat discouraged the whole British labour movement for a long time. The number of strikes fell sharply in 1985, and the Wapping dispute of Rupert Murdoch's print workers in 1986 ended in another defeat for the unions. Of the 175 pits working in 1983, closure followed closure; the remnant of the industry was privatised in 1994, and the last deep mine closed in 2015. A European Union inquiry of 1994 named Grimethorpe in South Yorkshire the poorest settlement in the country. Historians differ. Many see Scargill's substitution of flying pickets for a national ballot as the decisive error, while David John Douglass, in a book published by the National Coal Mining Museum for England, points out that the strike was started not by Scargill but by the Yorkshire area invoking its 1981 ballot result. Accounts of Thatcherism judge that the outcome contributed to the resurgence of the power of capital over labour. 23 16 6

How did Reagan change taxes, unions and the budget?

Ronald Reagan, inaugurated on 20 January 1981, said in his inaugural address: "In this present crisis, government is not the solution to our problem; government is the problem." On 28 January he lifted the remaining controls on domestic oil prices. The pillars of his economic policy, Reaganomics, were higher defence spending, slower growth of government spending, cuts in federal income and capital gains taxes, less regulation, and a tighter money supply to reduce inflation. Deregulation of airlines, trucking, railways and banking had, however, begun under Carter, and Reagan's economic adviser William Niskanen wrote that deregulation had the "lowest priority" on Reagan's agenda. 27 3

Reagan made tax cuts his top priority. A cut that the Republicans Representative Jack Kemp and Senator William Roth had failed to pass under Carter went through Congress on 4 August 1981 with the support of conservative Southern Democrats, and Reagan signed the Economic Recovery Tax Act on 13 August. The top income tax rate fell from 70 to 50 percent and the lowest from 14 to 11 percent, and the brackets were indexed to inflation so that rising prices would not push people automatically into higher brackets. The idea behind the cut was supply-side economics: instead of boosting demand, the government should cut taxes and regulation to strengthen incentives to work and invest, so that supply and growth would rise. Its emblem was the Laffer curve, which Arthur Laffer reportedly sketched on a restaurant napkin in 1974, showing that if tax rates are too high, cutting them can actually raise revenue. George H. W. Bush, Reagan's rival for the nomination, had derided this as "voodoo economics". 28 3 29 30

That same month Reagan set a precedent workers would not forget. At 7 a.m. on 3 August 1981 the federal air traffic controllers' union, PATCO, struck for a 32-hour week and higher pay. Strikes by federal employees were prohibited by law. That day Reagan read to reporters the no-strike oath the controllers had signed when they took their jobs and said that those who did not report for work within 48 hours "have forfeited their jobs and will be terminated". Only 1,300 of nearly 13,000 controllers returned; on 5 August the government fired the 11,345 who had not and banned them from federal service for life, and on 22 October the union was decertified. Large private employers such as Phelps Dodge and Hormel then began replacing strikers instead of negotiating, and major strikes and lockouts fell from over 380 in 1970 to under 200 in 1980 and 17 in 1999. Volcker called the strike a "watershed" in the fight against inflation. 31 32

With tax cuts and higher defence spending together, the deficit grew. Defence spending rose from 4.9 percent of GDP in 1980 to 5.8 percent in 1988, and the federal deficit peaked at 6 percent of GDP in 1983. With the Tax Equity and Fiscal Responsibility Act of September 1982 Reagan rolled back much of the corporate tax cut, undoing a third of the 1981 cut. Even so, public debt nearly tripled during his presidency and the United States went from the world's largest international creditor to its largest debtor. The Fed's tight money and the government's expansionary budget together pushed up long-term interest rates and drew in foreign capital, and the dollar rose by about 50 percent against the yen, the mark, the franc and the pound between 1980 and 1985. The budget deficit and the current account deficit moved together from 1981 to the early 1990s, the "twin deficits", and when Congress began to consider protectionist laws, five countries agreed in the Plaza Accord of 22 September 1985 to bring the dollar down. 3 33 34 35

Why did Mitterrand's France go the other way and then turn back?

In the same years France tried the opposite road. On 10 May 1981 François Mitterrand was elected the first Socialist President of the Fifth Republic, and the first left-wing government in 23 years took office. Following the 1972 Common Programme of the Socialist, Communist and Left Radical parties and the "110 Propositions for France", Prime Minister Pierre Mauroy's government nationalised major firms, raised the minimum wage (SMIC) by 10 percent, introduced a 39-hour week, a fifth week of paid holiday and a wealth tax, and extended retirement at 60 and social benefits. It was a Keynesian prescription to revive the economy by supporting demand. But the expansionary budget clashed with the restrictive monetary policy of the Bank of France, and unemployment kept rising. 36 37

Conditions abroad blocked the way. As the Volcker shock sent the dollar lurching, the strong mark and guilder rose within the European Monetary System while weak currencies such as the franc, the lira and the Belgian franc could not follow, and in 1981–83 the EMS went through the worst crisis since its creation. The franc was devalued three times, in October 1981, June 1982 and March 1983. Finance Minister Jacques Delors set ceilings in February 1982 of 3 percent of GDP for the budget deficit and 25 percent for public debt, and the first austerity plan came in June 1982. Inside the government, proposals to take the franc out of the EMS and go it alone arrived every month, but Mitterrand would not isolate France from the European Community. In March 1983 he chose to stay in the EMS and adopted a second austerity plan. This was the "tournant de la rigueur", the turn to austerity. 37 36

With the turn, Jean-Pierre Chevènement and Michel Jobert, the ministers most in favour of leaving the EMS, left the government, and the government closed coal mines and steelworks and encouraged restructuring at Peugeot-Talbot. From 1983 the struggle against inflation came first in Mitterrand's presidency, and apart from two mild reflations in 1984–86 and 1988–90, monetary and fiscal restraint was its essential orientation, although compared with the OECD average French fiscal policy remained relatively expansionary. Mitterrand abandoned his nationalisation programme in favour of austerity and market liberalisation. Priority went to inflation in order to remain competitive in the European Monetary System, and Belgium and Italy, also weak-currency countries, turned to similar austerity at the same time. Delors became President of the European Commission in 1985 and helped design the single market and the euro. 37 36 38

How is the turn interpreted?

Supporters count the conquest of inflation as the first achievement. The Federal Reserve's historians write that the commitment of Volcker and his successors to price stability ensured that the double-digit inflation of the 1970s did not return. Private-sector productivity per hour grew 1.9 percent a year under Reagan, against 1.3 percent in the preceding eight years, and in Britain productivity growth improved greatly relative to other advanced countries in the 1980s. The libertarian Cato Institute judged that on 8 of 10 key variables the economy did better under Reagan than before or after, and Friedman said that Reaganomics had made "good progress" on its four principles of lower marginal tax rates, less regulation, restrained spending and non-inflationary money. Labour's Tony Blair later wrote that Britain "needed the industrial and economic reforms of the Thatcher period". 1 3 16 6

Keynesian critics question both the cost and the explanation. The 364 economists opposed the British budget of 1981, and even those who think Howe's budget worked have called it excessive. Paul Krugman argued that the recovery under Reagan was mainly the result of the business cycle and Volcker's monetary policy, and that Reagan's deficit spending on defence was closer to Keynesian stimulus. Even Martin Feldstein, Reagan's chief economic adviser, called the Laffer-curve claim that tax cuts would raise revenue "the height of supply side hyperbole". Inequality widened: the top 1 percent's share of pre-tax income rose from 9.0 percent in 1979 to 13.8 percent in 1986, and the real hourly wage of production workers stayed below its pre-Reagan level throughout his presidency, continuing a decline that had begun in 1973. 19 17 3

Marxists read the turn as a change in class relations. David Harvey sees 1978–80 as a revolutionary turning point in the world's social and economic history, with Thatcher, elected with a mandate to curb union power, and Reagan, who set out to curb the power of labour, deregulate industry and liberate the powers of finance, among its epicentres. He calls neoliberalism a "class project" of the corporate capitalist class to increase the class power of economic elites. Gérard Duménil and Dominique Lévy likewise hold that the restoration and increase of the power, income and wealth of the upper classes are the primary objectives of neoliberalism. The British cultural theorist Stuart Hall popularised the word "Thatcherism" in "The Great Moving Right Show", written for Marxism Today in 1979, and the political scientist Andrew Gamble summed Thatcherism up as "the free economy and the strong state". These readings, and the experience of Chile and Latin America, are covered in detail in the entry on neoliberalism. 39 10 40 6

The French regulation school arose amid the stagflation of the French economy in the 1970s. Writers such as Michel Aglietta and Robert Boyer hold that capitalism stabilises for a time through a pairing of a "regime of accumulation", which steadies production and distribution, and a "mode of regulation", the laws, institutions and norms that support it, and that when the pairing no longer fits, it falls into crisis and must find new rules. In this frame the Fordism that sustained the postwar golden age, the combination of mass production, wages rising with productivity and full employment, fell into crisis in the 1970s, and in the 1980s flexible production methods called "post-Fordism" emerged in response to a Fordist production that had become rigid and less profitable. In this frame the turn of the 1980s reads as a search for new rules and norms to replace the Fordist regime in crisis; the entry on Fordism follows this further. 41 42