Thatcher and Reagan

In the period of 1973-1979, there was a growth slowdown signaled by a decrease in terms of trade and productivity. Also, this period was the end of fixed exchange rates in which high money supply led to high inflation. These accompanied by a general sense of economic and political insecurity.
In the case of US, Nixon resigned in 1974 because in 1973 political pressure favoured a 90-day freeze on all profits, interest, and prices in response to high inflation while Nixon’s price controls focused on agricultural export and limited the freeze to 60 days (Hetzel, 2008). His policy became unpopular with the public and businessman, who saw powerful labour unions as preferable to the price board bureaucracy, and they soon thought that the controls were permanent rather than temporary. As a result, the controls produced food shortages which put upward pressure against price. In addition, Nixon also set wage controls in response to high inflation which limit increases to 5.5% however it did not stop inflation and eventually, workers demand higher wages (Hetzel, 2008). Therefore, adding these failure policies with a defeat in Vietnam War and Watergate Scandal actually create the end of Nixon administration.
In the case of UK, labour party led by Jim Callaghan had already lost its majority in the House of Commons when he became Prime Minister in 1976. During his administration in the period of 1978-1979, there was a huge strike by local authority trade unions who demand larger pay raise for their member while the government wanted to control inflation by imposing unpopular policy on the public sector that pay rises must be kept below 5% (BBC, 2009). This strike known as “winter of discontent” forced Callaghan to call the 1979 election and eventually led to his lost.
After this, a period of conservative revival in US and UK led by Ronald Reagan (1981-1989) and Margaret Thatcher (1979-1990) appeared. Shortly, it was stimulated by two reactions as follows: First, there was reaction against welfare-state programs. Both administrations believed that market mechanism that reduces state intervention, emphasises on free market economy and privatizing nationally-owned enterprises, increases entrepreneurialism, and reduces the size of welfare-state will more reach economic prosperity (low unemployment and low inflation) than the government interfere in economy and increase dependency culture (Blackaby, 1999). Second, there was reaction in favour of more robust foreign policy to increase current government’s popularity. In the case of UK, Falklands War took place between UK and Argentine in response to seize Farkland Island in early 1982. Meanwhile, Reagan ordered U.S. forces to invade Grenada and Panama in 1983, leading to confrontation with USSR.
The main component of their economic policies was an adoption of market mechanism which focused on five key elements, as follows:
1. The need of keeping low inflation with tight monetary policy
The reason was because Keynesian approach on demand-side economies failed to stop high inflation at that period so that both Thatcher and Reagan pursue Monetarist approach on supply-side economies in which inflation occurs when money supply growth rate increase faster than real output growth rate (Blackaby, 1999). Therefore, the government must tighten monetary policy to prevent sustained inflation. In the end, both Thatcher and Reagan experienced dramatic decrease in inflation.
Supply-side economies maintain that the whole economy will flourish when business grows and their prosperities “trickle down” throughout the society (Hunt, 2009). In addition, policy should appeal to producers in order to reduce price and thus, make product become more affordable in order to increase economic prosperity.
2. The need of reducing tax rates and social spending
Monetarist believed that the high rate of taxes equates to the cutting of taxes. In addition, maximum benefits are achieved by optimizing the marginal tax rates of those with high incomes and capital investments, who are deemed most likely to increase supply and thus spur growth (Brownlee, 2006). In contrast, Keynesian contends that tax cuts should be used to increase demand instead of supply, and thus should be targeted at cash-strapped, lower-income earners, who are more likely to spend additional income (Bartlett, 2003).
Economic growth can be most effectively created by increasing incentives for people to produce goods and services such as lowering income and capital gain marginal tax rates, and increasing social security and medicare tax rates, and therefore consumers will then benefit from a grater supply of goods and services at lower prices (Niskanen, 2007). Also, many early proponents argued that the size of the economic growth would be significant enough that the increased government revenue from a faster growing economy would be sufficient to compensate completely for the short-term costs of a tax cut, and that tax cuts could cause overall revenue to increase (Bartlett, 2003).
In the case of Thatcher, direct taxes on income were lowered and indirect taxes were increased to amid a recession in 1981. In contrary, during Reagan's tenure, income tax rates dropped from 70% to 28% in 7 years, while social security and medicare taxes increased.
Another component of supply-side economies was reducing the growth of government spending (Niskanen, 2007). In accordance with her less-government intervention views, Thatcher introduced cash limits on public spending and reduced expenditures on social services such as education, housing, and health care (Clark and Dilnot, 2002). Meanwhile, Reagan boosted defence expenditure but restrained domestic spending in social services (Oxford, 2004). During his tenure, defence spending rose from 5.1% to 5.6% of GDP while non-defence fell from 17.1% to 15.6% of GDP and this figure wass contrast to Bush where both defence and non-defence spending increased.
3. The need of privatization and deregulation in the economy
The reason was to improve responsiveness in price signals. Privatization was important because revenue generated by this process allows tax to decrease without increasing budget deficits. However, the effect of privatization was more important in UK than US due to less public ownership in US. During her administration, the government sold most of the large national utilities to private companies. Many people took advantage of share offers, although many sold their shares immediately for a quick profit and therefore the proportion of shares held by individuals did not increase.
There was also evident of deregulation in both countries especially in transport and communications sector, and in financial sectors. In the former sector, the effect was increasing competition and technology change, leading to a decrease in relative costs of travel and phone calls. While in the latter, financial sector reforms not only produced better intermediation but also increased riskiness.
4. The need of reducing importance in trade unions
The reason was to increase labour market flexibility. Thatcher was committed to reducing the power of the trades unions. Several unions of mineworkers launched strikes in response to legislation introduced to curb their power, but these actions eventually collapsed, and gradually Thatcher's reforms reduced the power and influence of the unions. In contrast, the Reagan administration, the air traffic controllers launched a strike for large pay increase and eventually, he destroyed the union. This action had impact on labour relations where it set the stage for more timid labour demands and less excessive in wage growth (Oxford, 2004).
5. The need of free trade
Supply-side economics holds that increased taxation steadily reduces economic trade between economic participants within a nation and that it discourages investment (Case and Fair, 1999). Taxes act as a type of trade barrier or tariff that causes economic participants to revert to less efficient means of satisfying their needs. As such, higher taxation leads to lower levels of specialization and lower economic efficiency. Crucial to the operation of supply-side theory is the expansion of free trade and free movement of capital. It is argued that free capital movement frequently allows an economic expansion. Thus, lowering tax barriers to trade provides the advantages to domestic economy (Case and Fair, 1999).
While Thatcher’s international economic policy imposed the free movement of goods, services, capital, and people, Reagan’s policy was the most protectionist (Reinert et al, 2008). Unlike Thatcher, Reagan imposed more import restraints in steel, semi-conductors, machine tools, and textiles. However, he did attempt to promote global negotiations for more open markets such as bilateral trade arrangements with Israel in early 1980s and Canada in late 1980s (Oxford, 2004).
The criticism of supply-side economics came from those who understand in Laffer curve. Reagan claimed that by cutting upper bracket taxation rates and lowering tax rates on capital gains, national output would increase so much that tax revenues would also increase (Case and Fair, 1999). In the proponent view, Mundell believed that the economic expansion would also mop up excess liquidity and bring inflation back under control. After the tax cuts were implemented, nominal revenues quickly surpassed previous levels (Case and Fair, 1999).

However, excessive tax rates actually reduce potential tax revenues by lowering the incentive to produce. In other words, a rise of taxation rate does not increase tax revenue. In addition, the curve clearly shows that cutting tax rates to the right of the peak rate will increase revenues and cutting tax rates to the left of the peak rate will decrease revenues.
During Reagan administration, there was rapid increase in budget deficits because a rise in government expenditure (military spending) in response to Cold War outweighs a rise in tax revenue, thus IS curve shifted to the right. Meanwhile, the LM curve shifted to the left as the implementation of contraction monetary policy reduced money supply. As a result, interest rate increased.
Using exchange-rate channel, a rise in interest rate will produce capital inflow because domestic interest rate is higher than foreign interest rate, followed by a decrease in demand for foreign exchange and thus USD appreciate. This will lead to a fall in domestic competitiveness because domestic goods are more expensive than foreign goods, followed by US trade deficits. Therefore, Reagan tax policies push both international transaction of Current Account and the Fed budget into deficit and led to increase in public debt.
Pertaining to deployment of Thatcher-Reagan economic policies, Labor governments in both New Zealand and Australia are fully adopted market-oriented reforms. In Australia, the so-called economic rationalism occurs in late 1980s where it encouraged deregulation, privatization, and free market economy, lowered direct taxation, increased indirect taxation, and reduced the size of welfare state (Quiggin, 1997). On the other hand, NZ PM Roger Douglas led this reform in 1984 in which he reduced agricultural subsidies and trade barriers, encouraged privatization of public assets, controlled inflation through supply-side economics, deregulated financial market and removed control on foreign exchange, decreased marginal income tax rate, and forced more concessions on labour unions.
In slight different approach, Clinton and Blair modified the Reagan-Thatcher package with more emphasize on social policies. In the case of Tony Blair, he accepted trade union legislations, privatization and general free-market approach in relation with high economic growth and low unemployment rate. He also increased the taxes but did not increase income tax for high-earners and introduced a minimum wage concept. Moreover, he pursued market-based reforms in the social sectors (education and health) by increasing public spending. One thing should be noted that during his administration, inequality in the bottom half of income distribution decreased because redistributive social policies (minimum wage and tax credits) lower poverty, however inequality at the top increased and this is opposite to what happened during Thatcher administration (LSE, 2009).
In the case of Bill Clinton, he established fiscal diciplines by eliminating budget deficits, keeping interest rate low, and increase private-sector investment (BBC, 2001). He also invested people through education, training, science and research. Clinton also supported ratification of NAFTA which made it cheaper for manufacturing companies to outsource their jobs to different countries, especially Mexico, which then export their products back to US. This policy combined with increase in minimum wage caused a fall in the amount of unskilled jobs in US (Bartlett, 2004). Therefore, Clinton re-established the trend of reducing trade barriers and this is contrast to the protectionist of Reagan.