but by a revolt within the Conservative Party. She was forced to step
down in late 1990. Thatcher remained bitter toward those who removed
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her from power. The insult still rankled in September 1992 when, shortly
after Britain's humiliating forced withdrawal from the European Community's
Exchange Rate Mechanism, I was at a dinner with her and her husband,
Denis Thatcher. Denis, filled with hopes of a restoration, told the
story of a London taxi driver's remark following the financial debacle:
"Governor, I expect to see you back at Number Ten within the month." It
was not to be.
The Conservative Party under Prime Minister John Major was still in
power two years later when the premature death of John Smith vaulted his
deputies, Gordon Brown and Tony Blair, to the leadership of the Labour
Party. Shortly after, in the fall of 1994, Brown and Blair trekked into my office
at the Federal Reserve. As we exchanged greetings, it appeared to me
that Brown was the senior person. Blair stayed in the background while
Brown did most of the talking about a "new" Labour. Gone were the socialist
tenets of postwar Labour leaders like Michael Foot and Arthur Scargill,
the fiery leader of the miners' union. Brown espoused globalization and
free markets and did not seem interested in reversing much of what
Thatcher had changed in Britain. The fact that he and Blair had arrived on
the doorstep of a renowned defender of capitalism (namely, me) solidified
my impressions.
In office from 1997 forward, Tony Blair and Gordon Brown, heads of a
rejuvenated and far more centrist Labour Party, accepted Thatcher's profoundly
important structural changes to British product and labor markets.
In fact Brown, the chancellor of the exchequer for a record number of
years, appeared to revel in Britain's remarkable surge of economic flexibility.
(Brown encouraged my proselytizing to our G7 colleagues about the
importance of flexibility to economic stability.) What socialism was left in
twenty-first-century Britain was much reduced. Fabian socialism was still
reflected in Britain's social safety net but, from my perspective, in its most
diluted form. Britain's success with the free-market thrust of Thatcher and
"New Labour" suggests that their GDP-enhancing reforms are likely to persevere
through the next generation.
Britain's evolution from the ossified economy of the years immediately
following World War II to one of the most open economies in the world
is reflected in the intellectual journey of Gordon Brown, who described his
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industrywide unions and wage negotiation at a national level. In Germany
labor representation on supervisory boards became mandatory. Large businesses
and large unions controlled the economy. Large so-called universal
banks were encouraged to invest in; and lend to, major corporate enterprises.
This ethos of bigness had its roots in late-nineteenth-century economic
cartelization that was fostered in part by the needs of the military.
In the decades immediately following World War II, creative destruction
in Europe was largely "creative." Most of the "destruction" of what
would have been obsolescent facilities after the war had been done by the
bombing during it. The stress of the capitalist process and the need for an
economic safety net through the 1970s were minimal. German business
expanded rapidly even in the face of formidable regulatory and cultural
constraints.
By the late 1970s, however, the German economic miracle was fading.
West Germany had largely worked through the backlog of reconstruction
demand that so buoyed its economy. Demand was easing off and economic
growth slowed. Creative destruction—the need for painful economic
changes and redeployment of economic resources—largely dormant since
the war, reemerged. Much of the economic infrastructure that had been
put in place in the 1950s was edging toward obsolescence. Companies and
their employees began to feel the strain.
The labor laws enacted to protect jobs shortly after the war had little
bite in a period of unexpectedly huge demand for labor. In the years of
rapid economic growth employers were under pressure to hire enough
workers to meet burgeoning demand. They rarely considered the new statutory
costs of discharging workers since the chances of incurring them
seemed remote. Now the balance was changing as the postwar rebuilding
approached completion. The cost of firing workers soon made employers
reluctant to hire. In West Germany, the unemployment rate soared from a
low of 0.4 percent in 1970 to nearly 7 percent by 1985 and over 9 percent
in 2005. A global cyclical upturn fostered German export-led growth that
brought the unemployment rate down to 6.4 percent by the spring of 2007.
The longer-term structural problems, however—high unemployment and
shortfalls in productivity—have yet to be adequately addressed. The costs
of discharging workers have been a major deterrent to hiring.
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More generally, the OECD identifies high business taxes on employee
compensation and generous unemployment benefits as also contributing
to a level of unemployment in Western Europe that significantly exceeds
that of the United States. According to the IMF, labor productivity in the
EU-15* in 2005 was only 83 percent of that of the United States, down
from over 90 percent in 1995. Currently, no member's labor productivity
level exceeds that of the United States. The IMF attributes the growing
shortfall relative to the United States "to the slower take-up of new technologies,
particularly rapid advances in information and communications
technology (ICT)/' owing to lagging ICT investment in finance and retail
and wholesale trade. The IMF suggests that this implies a need for Europe
to reduce its barriers to competition.
The crowning blow to West Germany's earlier economic growth performance
was the fateful decision that as part of the unification of East and
West Germany, East German mark-denominated assets and liabilities would
be converted into West German deutsche marks on a one-to-one basis. As
the levels of East German productivity prior to unification were discovered
to have been far below those of West Germany, it was feared that East German
industry would be wholly uncompetitive and would collapse into
bankruptcy. But failure to convert one to one would have caused a massive
stampede of the productive workforce from East to West, then-chancellor
Helmut Kohl argued, probably correctly. Either way, East German industry
would have to be subsidized by the Federal Republic to survive. In addition,
the East gained access to the generous West German social safety net, which
has since required a transfer of about 4 percent or more of German GDP to
support retirees and the unemployed in the East.
As standards of living in East Germany eventually caught up to those
in the West, Chancellor Kohl concluded that the economic difficulties
would be resolved and the drain on West German taxpayers would come
to an end. Kohl thought the adjustment might take five to ten years. Karl
Otto Pohl, the very effective president of the Deutsche Bundesbank, West
Germany's central bank, told me and others in the days leading up to unifi
*European Union member countries prior to the expansion of 2004.
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cation that he feared the consequences to Germany would be severe. His
judgment proved prescient.
The French are somewhat special in that their sense of civility and history
very consciously guides their economy. Most French reject market
competition, the very basis on which capitalist economies function. It is
viewed as uncivil, or the "law of the jungle," in the words of Balladur. Yet
they protect the institutions of capitalism—the rule of law and especially
property rights—as well as any other developed nation.
The intellectual conflict plays out in the day-by-day functioning of the
economy. The French publicly eschew the economic liberalism of open
markets and globalization. In 2005, then-president Jacques Chirac boldly
stated that "ultra-liberalism is as great a menace as communism in its day."
Yet France has a whole host of world-class companies that compete very
effectively on the world scene (and gain four-fifths of their profits from
abroad). France, with Germany, led the way into the European Union's
economic free-trading zone, which celebrated its fiftieth anniversary in
March 2007. (To be sure, the motives were less economic and more a step
toward political integration of the Continent, which had seen the devastation
of two world wars in a third of a century.) Nonetheless, the failure of
a new European constitution to be approved in a referendum in France
(and elsewhere) has stayed the process of integration.
Although union representation in the French private sector is relatively
low, national collective-bargaining agreements bind all employees whether
unionized or not. Unions therefore wield considerable power in the marketplace,
and especially in government. In France as in Germany, regulations
fostered by unions to protect jobs by making it costly to discharge
employees have curbed hiring, with the effect that unemployment has
been significantly higher than in economies where the cost of discharging
workers is low, as in the United States.
The loading-up of employment costs on business (especially retirement
costs) periodically induces French governments in desperation to initiate
modest reforms, only to be thwarted by opposition marches on the Champs-
Elysees, a tactic that has brought many a French government to grief.
It is difficult not to be gloomy about France's economic prospects. In
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world rankings of income per capita, France has fallen from eleventh in
1980 to eighteenth in 2005, according to IMF data. The unemployment
rate in the early 1970s averaged 2.5 percent. Since the late 1980s, it has
ranged between 8 percent and 12 percent.* Yet the French people's sense
of freedom and nationalism is so pervasive that when pushed to the edge,
they seem to regroup and productively engage the global community. I
suspect there will be more of the same now that Nicolas Sarkozy has been
elected president. From my perspective, he offers hope. To be sure, in public
he has been staunchly protectionist. But in my conversations with him
as finance minister in 2004, he exhibited admiration for the United States'
economic model of flexibility. World-competitive markets will drive him in
that direction in any event. Culture and economic well-being are destined
to clash.
Italy harbors many of the same problems as France and in many respects
has the same outlook. Rome has been at the center of civilization for more
than two millennia. Like France, Italy has had its ups and its downs, but it
struggles forward. Adopting the euro in 1999 immediately gained Italy the
economic power of a strong currency (the lira had to decline in value continually
to maintain Italy's global competitiveness), lower interest rates,
and low inflation. But its culture of fiscal extravagance did not abate with its
new currency. Without the safety valve of periodic depreciations, the Italian
economy has lagged. Talk of Italy's returning to the lira (and devaluations)
is mostly talk. The problem of how and when Italy could be converted back
to the lira is hugely formidable and extremely costly. Looking into that
abyss and not liking what is there will eventually force Italian governments
to engage in the reform whose need is obvious to both Italians and their
global partners.
But history and a culture of civility will not in themselves sustain the
economy of the euro area, or the European Union more generally. The European
leaders' March 2000 meeting in Lisbon recognized that the European
economic model was in need of a competitive fix. They launched
what came to be known as the Lisbon Agenda, which set a fully innovative
and competitive Europe as a ten-year goal. To date, progress has fallen far
*In April 2007, the rate was 8.2 percent.
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short of that laudable goal. Some catch-up is required. In the last year or so;
Europe has exhibited signs of cyclical growth driven by a booming world
economy. But for reasons I outline in chapter 25, the pace of world growth
will slow, and unless they are addressed, the euro area's culture-driven
structural economic problems will remain.*
Japan is probably the most culturally uniform society of the major industrial
powers. Its immigration laws generally discourage anyone of other
than Japanese origin, and it encourages conformity. It is a very civil society,
which eschews creative destruction. The Japanese frown upon the large
turnover of jobs and the frequent discharging of workers associated with
the elimination or evolution of obsolescent companies. Nonetheless, from
the end of World War II to 1989, Japan succeeded in developing one of the
world's most successful capitalist economies. Postwar rebuilding absorbed
all of the labor force—very few employees were discharged and Japan became
famous for its embrace of lifetime employment. Similarly, poorly run
companies were bailed out by rising demand. By 1989, the value world investors
placed on the land on which the Imperial Palace resides was said to
be equal to the value of all the real estate in California. I remember thinking
at the time how bizarre these values were.
Japan in recent years has had to struggle back from the stock-market
and real estate crash of 1990. Japanese banks became heavily invested in
loans backed by real estate as collateral, as real estate prices soared. When
the turn came and prices cascaded downward, the collateral became inadequate.
