The Battle of ideas for the World Economy
Features and Impact on Thatcherism in the UK
Term Paper (Advanced seminar) 2012 25 Pages
Table of Contents
2. The Battle of Ideas
2.1 Keynes’ Economy
2.1.1 Keynes’ Success
2.1.2 Keynes’ Fall
2.2 The Rise of Monetarism
2.2.1 Hayek’s Road to Serfdom
2.2.2 Hayek’s Theories Unpopular
2.2.3 Hayek’s Breakthrough
3. Thatcher’s Ideology
3.1 Thatcher’s Monetary Policies
3.2 Problems and Successes
4. Britain after Margaret Thatcher
5. Conclusion – the Battle of Ideas decided?
Representative political institutions cannot alone guarantee our liberties. It is economic liberty that nourishes the enterprise of those whose hard work and imagination ultimately determine the conditions in which we live. It is economic liberty that makes possible a free press. It is economic liberty that has enabled the modern democratic state to provide a decent minimum of welfare for the citizen, while leaving him free to choose when, where, and how he will make his own contribution to the economic life of the country. If the economic life of the country is dominated by the state, few of these things, are true.
Margaret Thatcher, the Winston Churchill Memorial Lecture,
This citation is taken from a speech Margaret Thatcher held in Luxembourg on October 18th 1979. It clearly illustrates the attitude of Britain’s first female prime minister towards economics. When Thatcher came into power, she strived for the establishment of a free market economy without too much government intervention. She was greatly influenced by Friedrich August von Hayek, who is considered to be one of the most influential liberal theorists of the 20th century. His work was a major source for arguments against socialist social and economic orders and significantly influenced the politics of various countries. Ludwig Erhard’s planning of Germany’s post-war economy and Ronald Reagan’s neo-liberal reforms in the 1980’s are just two examples.
The intellectual counterpart of Hayek was the British economist John Maynard Keynes. According to him, market economies could not function on their own. In the face of the growing danger from the Soviet Union he came up with a concept to maintain the capitalist economic system together with an advocated use of fiscal and monetary measures to mitigate the adverse effects of economic depression and recession. His ideas, known as Keynesianism, had greatly influenced Great Britain’s post-war economy. In the course of the emergence of this mixed economy, large parts of the country’s heavy-, energy-, and transport industry became nationalized. However, the experiment soon demonstrated its weaknesses. During the 1970s, many of the giant state-owned plants were losing money and the attempts of the government to maintain full employment were swallowing enormous amounts of money. This resulted in high energy-prices and an increased inflation rate.
This paper is to illustrate the battle for the world economy between the intellectual rivals John Maynard Keynes and Friedrich von Hayek and their influence on the economic policies of Margaret Thatcher. Therefore, I am first going to shed some light on the theories of the two famous economists and their achievements. In a second part, the paper is going to elaborate on the question why Thatcher decided to enforce new economic policies in Britain in spite of contrary opinions of her opponents in the cabinet.
2. The Battle of Ideas
In order to understand Margaret Thatcher’s ideology and her approach to economics, we have to unroll the battle of ideas between Friedrich von Hayek, who felt that meddling in the economy was a threat to freedom, and John Maynard Keynes, who supported the allied government to plan their wartime economy.
This battle, that in face of the current economic crisis, seems to have gained new importance, began after World War I. The great depression that affected all advanced countries like The US, Canada, Scandinavian countries, England, Germany, Belgium, the Netherlands, and France, originally drew one’s attention to the problems and advantages of political organization. In 1929 the unemployment rate in England added up to 10.4% and reached 22.1% in 1932. By that time, Germany laid down in ruins and was burdened with unbearable war reparations according to the treaty of Versailles. People were disillusioned and they feared the emerging economic order in the east where the economic theories of Karl Marx had inspired the Russian Revolution, which overthrew the old system and made private property a criminal act .
Faced with this unpromising situation, Keynes and Hayek developed ideas on how to establish a new economic order able to overcome the crisis. Keynes wrote “The Economic Consequences of the Peace” in which he described that the reparations, Germany was burdened with, were out of proportion and that they had “very destructive social, political and economic consequences” .
It was also during that time when Hayek decided to dedicate his life to economics. He enrolled at the University of Vienna and joined a discussion circle of the libertarian called Ludwig von Mises who believed that “markets work; governments don’t” . Hayek’s work was greatly influenced by Von Mises’ ideas.
2.1 Keynes’ Economy
John Maynard Keynes was born on June 5th, 1883 in Cambridge, Great Britain. He attented the private school Eton and studied Philosophy, History and Mathematics at the King’s College in Cambridge. His father was a lecturer at the University of Cambridge and his mother was one of the first female students there. Later, she even became Mayor of Cambridge. Keynes had a brilliant curriculum vitae: he was lecturer and fellow at King’s College; editor of the Economic Journal; advisor of the Treasury; chairman of the “National Mutual Life Assurance Society” and the “Independent Investment Trust”; finally, he became a Lord, Baron Keynes of Tilton, and member of the House of Lords. Keynes also published many books and articles which made him very popular. His first book Economic Consequences of the Peace made him famous and The General Theory of Employment, Interest and Money was his main work.
In his works, Keynes wanted to explain depression and high unemployment in order to avoid them in the future . In the beginning of the 20th century, Keynes and other economists faced these two enemies of economics and society and realized that the classical economic theory did not work anymore. The basis of the ‘old’ idea was that economy was always in equilibrium: there is always full-employment; demand and supply are equal. If, nevertheless, consumers felt uncertain about the future and decided to save more money, consumption would fall, enterprises would be forced to reduce their production of goods and consequently either to dismiss some of their workers or to reduce wages. Thus, many people would be without jobs and the argument of full-employment would be worthless. Economists of the classic theory tried to explain the high unemployment of the 20th century by claiming that there was no involuntary unemployment but employees who voluntarily had chosen to be without work because they did not want to agree on the sinking wages.
However, the USA and Europe faced a great depression and high unemployment in 1929. Moreover, there was a crash of the Stock Exchange at the Wall Street on 24th of October, 1929. It obviously seemed to be a failure to reduce wages in order to prevent high unemployment because by doing this the demand for goods decreased as well. In spring 1930, Keynes realized that this depression was going to become the biggest world wide economic crisis and that the classic theory as well as the economists of that time could not manage these problems because this theory only worked if there was full employment. Thus, he asked for “active and determined politics.”
Keynes’ developed a theory on how depression and high unemployment could be resisted. In his General Theory, the state was no longer an auditor but an actor; the state had to intervene in times of depression. Keynes demanded that the state had to oppose these problems by supporting the demand through additional state expenses. If the state did not have enough money, it had to be borrowed. It is obvious that many people of that time thought Keynes was from the Left or even a socialist because he asked for an active role of the state. Willke (2002, p.23), however, explains that Keynes was a liberal, who was interested in solving the problem of high unemployment; who did not want just to wait until everything became stable somehow.
2.1.1 Keynes’ Success
I believe myself to be writing a book on economic theory which will largely revolutionize—not, I suppose, at once but in the course of the next ten years—the way the world thinks about economic problems.
In a way John Maynard Keynes should be right after all although his ideas were unpopular at first. In 1930, Keynes published his book A Treatise on Money in which he explained his hypothesis that saving money was not always a wise decision and that it could even have devastating consequences for the economy in times of depression and lack of demand. In 1936, Keynes’ General Theory was published.
It challenged the earlier neo-classical economic paradigm, which had held the position that the market would reach a full employment equilibrium provided it was free from government interference. The book declares demand, not supply, to be the key variable governing the overall level of economic activity.
However, his books were not popular at first. He introduced his theories in a very complicated and incomprehensible way. According to Willke (2002, p.19) he also chose a perspective that was completely different to those of contemporary economists. Supporters of the Classic Theory claimed that Keynes’ ideas were not new or simply wrong and that the state must not get more active than it already was. People from the Left said Keynes tried to save capitalism with reforms and state interventions.
Nevertheless, Keynes’ theories finally broke through because the US government decided to act according to his ideas. All of a sudden, the high unemployment disappeared because the state created new jobs by increasing their war expenses. This seemed to work out well for the entire economy: Keynes became the initiator of the New Economics; also in Great Britain. One of the main consequences of his ideas was the conviction that “economics and society were no longer victims of the devastating cycle of boom and bust because the state now had instruments on how to stable the economic process.” Keynes not only supplied an explanation for the staggering of output and employment but also found some measures on how to omit an economic crisis and depression. Although his theory had some weak points, it worked out well in practice. The fact that the classic ideas failed was an advantage to make a start into a new economic era – the New Economics.
 Thatcher (1979), Winston Churchill Memorial Lecture, para. 10.
 Geppert (2002), Thatchers konservative Revolution, p. 152 ff..
 Dadkhah (2009), The Evolution of Macroeconomic Theory and Policy, p.213.
 Dadkhah (2009), p.6
 Yergin (2002), The Commanding Heights. The Battle for the World Economy, p. 21
 Yergin (2002), p. 21.
 Willke, G. (2002): John Maynard Keynes, p. 15.
 Ibid., pp. 183-184.
 Ibid., p. 13.
 Morgan, B. (1978): Monetarists and Keynesians, p. 14.
 Willke (2002), p. 33.
 Ibid., p. 32.
 Ibid., p. 14.
 Ibid., p. 19.
 Ibid., p. 15.
 From Keynes’s letter of January 1, 1935 to George Bernard Shaw, cited in Dadkhah (2009), p.15.
 Willke (2002), p. 19.
 Ibid., pp. 140-141.
 Dadkhah (2009), p. 16.
 Willke (2002) p. 143.