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April 10, 2006

364 economists and the 1981 budget: History has confounded both the 364 economists and their Monetarist opponents - this is an important lesson, argues William Coleman

Posted by William Coleman

364 economists famously wrote to The Times to condemn the 1981 budget. Their letter marked the death throes of British Keynesianism, argues Dr William Coleman - Reader in Economics at the Australian National University. But Dr Coleman goes on to argue that history has been little kinder to the Monetarist opponents of "the 364" - Monetarism is now as dead as Keynesianism. This goes to underline the truth of Herbert Butterfield's comment that history is not a struggle between those trying to hasten the onset of the future and those trying to delay it - rather the future will leave the antagonists of today all equally shocked and confounded.

Twenty-five years ago the British economics profession publicly staked its reputation, and lost. The occasion was a letter to The Times, in March 1981, signed by 364 academic economists, that pre-emptorily dismissed the Thatcherite macroeconomic policy of the day. Critically, the signatories were not just one pocket of the profession, but a genuine cross-section of it; embracing the rising stars as well as the fossils, the asses along with the truly formidable. The letter was a mustering of forces. And it failed disastrously. The letter became - in the summary, brutal and accurate judgment of a recent BBC correspondent - "a joke".

Worse, it blackened the name of economists amongst Margaret Thatcher and her coterie. And it did so no less among the keepers of the free-market flame; the twenty-fifth anniversary of this ill-starred letter is presently being observed, with a degree of glee, by the Institute of Economic Affairs. [Were 364 Economists All Wrong? , Phillip Booth ed., Institute of Economic Affairs, 2006]. (The IEA once kindly gave me a platform to defend economics against "anti-economics", but proved cool on putting these ideas into print. I think I understand this reaction better now).

The episode of the 364 raises several questions, but above all a question about the authority of economists. To quote from the letter:

We, who are all present or retired members of the economics staff of British universities, are convinced that,

(i) there is no basis in theory or supporting evidence for the governments belief that by deflating demand they will bring inflation permanently under control and thereby induce an automatic recovery in output and employment;

(ii) present politics will deepen the depression, erode the industrial base of our economy and threaten its social and political stability

(iii) there are alternative policies; and

(iv) the time has come to reject monetarist policies…

This statement's purely credal character ("we … are … convinced"), combined with its show of titles and affiliations, must amount, implicitly, to a claim of authority. But do economists deserve any authority? Or, to be more precise, do they deserve a "rational authority"? That is, do they both know more than lay persons, and can provide rational proofs to those lay persons that they know more?

I believe the answer is, Yes - To some extent. Economists do know more about certain things, and can demonstrate it. They have a good idea about what will soon happen to most macroeconomic variables, and the accuracy of their forecasts bear this out. For, contrary to mythology, the short-term forecasts of economists are fairly good, and certainly better than lay alternatives. Thus the OECD's forecasts of real GDP growth in each of the seven major OECD economies consistently outperform "rule of thumb" forecasts. In a similar way, it has been shown that the predictive accuracy a simple textbook expression for inflation is massively superior to the public's own forecast for inflation. [See Coleman, Economics and Its Enemies, Palgrave Macmillan, 2004 p.204, p. 270].

So; "some" rational authority is deserved by economists. But not, I believe, much rational authority is deserved. Is this because economists do not know any better than laymen? In part it is. Any economist who is not a fraud will find the world surprising. But the greater limitation on economists' rational authority flows, not from any lack of knowledge, but from the difficulty in providing lay persons good evidence of that knowledge. This is because the most convincing proof of anyone's knowledge is the accuracy of their predictions. And, alas, the ceteris paribus propositions that are the stuff of economic theory – and must be the stuff of economic theory – will always be poor material for making predictions. For in the economy, ceteris is never paribus. Unlike physics or biology, economic controlled experiments are rarely possible. And unlike, say, astronomy, economics does not deal with systems that are (by human standards) highly stable. The economist's predicament might be compared to a sighted person attempting to prove - to a blind man - that that they have colour vision. How do they prove it?

One possible remedy for this difficulty in proving superior knowledge is to try to prove something broader, which has as a concomitant a proof of superior knowledge. Thus a sighted person may be able to rationally satisfy a blind man that he posses both self-knowledge and integrity; and these two will be enough to induce the blind person to accept the sighted person's profession of colour vision. This may be the best path to the public's trust for all "knowledge elites"; a combination of integrity, confidence, and marks of their appreciation of their own limitations.

A second response to the difficulty of establishing rational authority is to abandon the whole quest. So instead of economists trying to persuade the public that they know the right policy, economists would try to persuade the public of the right policy. This, historically, has been the choice of the great economists: Ricardo composing letters to the Morning Chronicle, John Stuart Mill writing a best selling Principles of Political Economy, Keynes broadcasting on the BBC, Friedman appearing in his television series.

In retrospect, it was a misfire for the professoriate of 1981 to invoke an arguable authority, rather than focus on directly fighting the battle of ideas. But in doing so they may be guilty of no more than complacency. For it is not clear that the affirmations of the hapless letter to The Times were actually wrong.

For the letter did not object to the Thatcherite microeconomic program. That program (privatisation and labour market reforms) had hardly begun. What the letter objected to was Thatcher's macroeconomic policy, as manifested in the tightening of fiscal policy in 1981 budget.

And were the 364 wrong in objecting to a tightening of fiscal policy? Is a policy of raising taxes in a recession – as the 1981 budget did - sensible? One of the contributors to the IEA's commemorative volume claims that this policy was vindicated by an almost simultaneous recovery in macro aggregates. But a moment's glance at the data reveals there was no almost simultaneous recovery. Real quarterly GDP indicates that the UK remained in the trough of recession until the 4th qtr of 1982. And unemployment kept on rising for three more years. From 5.4 percent in November-January 1979, it had reached 9.4 percent by February-April 1981, and it continued to rise until it reached 12.1 percent by March-May 1984.

But having conceded to the 364 that Thatcher's macro policy may not have been the best, it should be allowed that Thatcher's macro policy was probably not any worse than anything that the 364 could agree upon. It is often a hard thing too decide the rightness or wrongness of any single macro policy move. But the rightness or wrongness does not much matter here. The important thing about the 1981 Budget was not whether it was right or wrong, but in what symbolised. It symbolised the end of Keynesianism.

The significance of this is that in Britain Keynesianism had sunk deeper than anywhere else. In Britain Keynesianism was believed less conditionally, more literally, and more sincerely than anywhere else. In the USA, to illustrate, Keynesianism was stomached only after it was substantially diluted. In France it was conflated with "Planification". In Latin America it was loosely and importunately assimilated with the dirigisme dear to hearts of Raul Presbisch and Economic Commission of Latin America. In almost all countries outside Britain, local idiosyncrasies and fixations left Keynesianism more shallowly rooted than in Britain. Keynesianism had a natural habitat, and that was Great Britain.

Keynesianism was also, of course, a native growth of Great Britain. Keynesianism was, therefore, the gift of British economics to Britain, and the world. It was the mission civilisatrice of British economics that would rid the world of the blight of unemployment. It was almost the point of British economics. It was almost its raison d'etre.

The end of Keynesianism macroeconomic policies therefore amounted to the end of that specialness, and that element of benefaction, that had previously graced British economics. Little wonder, then, that there was amongst British economists a sense on injury, and impulse to protest, when the 1981 Budget signalled the close of Keynesian era. And little wonder that the forlorn letter came on the notepaper of the Faculty of Economics and Politics of the University of Cambridge. And that 54 of the 364 signatories were members of Cambridge University, more than twice the number of the next most represented university.

In 1981 the prestige of British economics was still built on a doctrine whose time had gone. This explains the fiasco of the 364.

But it would be a complete misrepresentation of the episode to portray the 364 as clinging to a badly listing vessel, while their adversaries rode a foam flecked wave of the future. For "monetarism" was just as much a victim of 1981 as Keynesianism. In one point of the letter (point (iv)) the 364 were correct: the time had come to reject monetarist policies, if we take "monetarism" to be the belief that the control of inflation requires making the growth of the money supply an object of policy.

Rarely had a government come to power more convinced of "monetarism" than did Thatcher's in 1979. Rarely had a government been more certain of the need and ability to reduce the growth of money supply. A target for growth "in M3" was duly set: it was to grow between 7 and 11 percent in 1981-2. In the upshot, it grew by 19.5 per cent that year; an outcome that even friends of the government conceded as an embarrassing debacle. Milton Friedman disowned the debacle by assuring the House of Commons Treasury and Civil Service Committee that he "could hardly believe his eyes" when he read how the government proposed to control the money supply. Friedman's own capacity to control money growth was, of course, never put to the test.

The deep frustrations that the Thatcher government had in controlling the money supply beast in those years was the occasion for the atrophy of monetarism over the next decade, and its universal replacement by the mid 1990s by the policy of disregarding the money supply, and instead charging the central bank to move its discount rate up and down in order to meet an inflation target (a policy Friedman has always stringently opposed).

The final demise of monetarisms might be symbolised in a stark two line statement recently issued by the Federal Reserve of the United States of America.

On March 23, 2006, the Board of Governors of the Federal Reserve System will cease publication of the M3 monetary aggregate.

US Federal Reserve, November 10th 2005.

Monetarism is as dead as Keynesianism.

The denouement of the confrontation between Keynesians and Monetarists of 1981 is a reminder of a piece of wisdom articulated by another Cambridge luminary, and contemporary of Keynes, Herbert Butterfield: history does not consist of a struggle between those trying to hasten the onset of the future, and those trying to delay it. The future will leave the antagonists of the present all equally shocked and confounded.

Dr William Coleman is Reader in Economics at the Australian National University and the author of Economics and its Enemies: Two Centuries of Anti-Economics, (Palgrave Macmillan, 2002).

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"Their letter marked the death throws of British Keynesianism"

Shourld be "death throes."


throe (thr) n.

1. A severe pang or spasm of pain, as in childbirth. See Synonyms at pain.
2. throes A condition of agonizing struggle or trouble: a country in the throes of economic collapse.

[Middle English throwe, perhaps alteration of thrawe, from Old English thrawu, genitive of thrah, pain, affliction.]

Source: The American Heritage® Dictionary of the English Language, Fourth Edition.

Posted by: Robert Schwartz at April 11, 2006 02:14 AM

Throws/Throes - Corrected.
Social Affairs Unit

Posted by: Social Affairs Unit at April 11, 2006 10:59 AM

The perceived uselessness of M3 is not evidence of the death of Monetarism (Greenspan commented that it was not a good definition of the money supply).

Posted by: Elliot Fullwood at February 19, 2010 04:56 PM
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