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It’s worked elsewhere

My recent Times column was on the stagnation of European economic growth rates:

The financial crisis was supposed to have discredited the “Anglo-Saxon” model of economic management as surely as the fall of the Berlin wall discredited communism. Yet last week’s numbers on economic growth show emphatically the opposite. The British economy is up 3.2 per cent in a year, having generated an astonishing 820,000 jobs. We are behaving more like Canada, Australia and America than Europe.

If you think one year is too short, consider that (as David Smith pointed out in the Sunday Times) Britain’s GDP is now 30 per cent higher than it was in 1999, whereas Germany, France and Italy are just 18 per cent, 17 per cent and 3 per cent more prosperous respectively. For all Britain’s huge debt burden, high taxes and chronic problems, we do still seem to be able to grow the economy. Thank heavens we stayed out of the euro.

The performance of the euro economies continues to be dismal. Last week’s news was that France is flatlining, Germany shrinking slightly and Italy back in recession for its third dip. Spanish unemployment is just a tad under 25 per cent. The Greek economy continues to contract; even the Dutch economy is bumping in and out of growth. The eurozone as a whole is flat and teeters on the brink of debilitating deflation. This at a time when the world economy, driven by Asia and Africa, is roaring ahead at a forecast 3.7 per cent this year, according to the International Monetary Fund.

The euro is not primarily to blame for eurosclerosis; there has been plenty wrong with domestic policies in the individual countries, though joining the euro allowed them to conceal their mistakes for a while. But all the lessons point in the same direction: public spending and dirigisme to stimulate growth does not work, while limiting taxes and regulation to unleash growth does.

Patrick Minford and Jiang Wang produced clear evidence a few years ago that “the surest way to increase economic growth is to reduce government spending and taxation”: as figures from the Organisation for Economic Co-operation and Development confirm, a 10 per cent increase in public spending produces a 0.5-1 per cent decrease in growth rates. The encouragement of free enterprise is what has always brought growth, from ancient Phoenicia to modern Mauritius, from Renaissance Italy to Silicon Valley.

Poland’s economy has doubled in size since the fall of communism, while Ukraine’s has stagnated, because Poland made a far more urgent dash in the direction of free markets in labour, capital and trade. Estonia has been the top performing of the former Soviet colonies because Mart Laar, the historian who became prime minister in 1992 at the age of 32, had read only one book on economics, Milton Friedman’s Free to Choose and was in his own words “so ignorant” that he thought flat taxes, privatisation and the abolition of tariffs and subsidies constituted normal policy in the West.

Mr Laar ignored the warnings from most Estonian economists, who told him what he proposed was as “impossible as walking on water”. There’s a common theme here. Germany’s postwar economic miracle happened because Ludwig Erhard abolished rationing and freed up markets in the teeth of expert advice. When the American general Lucius Clay said his experts thought these policies were a bad idea, Erhard replied “so do mine”, and did it anyway. When Sir John Cowperthwaite turned Hong Kong into a low-tax, free-trade enclave in the 1960s, he had to turn a blind eye to the instructions of his LSE-educated masters in London. Indeed, he kept failing to send them data so they could not see what was happening.

A recent analysis by three German economists for the think-tank Politeia looked at the reasons for the economic transformations of Ireland (from 1986), Sweden (1991), New Zealand (1988), Chile (1974) and Brazil (1990), all of which resulted in sustained bursts of rapid economic growth after long spells of stagnation, and concluded that the causes in every case were deregulation of goods and services markets, liberalisation of labour markets, abolition of tariffs or subsidies, privatisation of state enterprises and the encouragement of competition. “Anglo-Saxon” stuff in every case.

Sweden is an interesting case, because many people still think of it as showing an alternative route to prosperity than the Anglo-Saxon one. Nima Sanandaji, a Kurdish-Swede, demonstrated the very opposite in a paper for the Institute for Economic Affairs two years ago. He concluded: “Sweden did not become wealthy through social democracy, big government and a large welfare state. It developed economically by adopting free-market policies in the late 19th century and early 20th century.”

Between 1870 and 1936, when it was a poster boy for Adam Smith, Sweden had the fastest growth rate in the industrialised world and spawned Volvo, Ikea, Ericsson, Tetra Pak and Alfa Laval. Then between 1950 and 1990 it went from having an unusually small state sector to having a very big one. The result was currency devaluation, stagnation and slow growth, culminating in a full-blown economic crisis in 1992 and a rapid fall down the economic league tables. When it then cut taxes, privatised education and liberalised private healthcare in the 1990s, it rediscovered growth and sailed through the financial crisis in pretty good shape.

Entire continents teach the same lesson. South America and now Africa have both confirmed the hypothesis that state-directed commerce leads to stagnation while free enterprise causes rapid growth.

As the economic historian Deirdre McCloskey argues in her forthcoming book Bourgeois Equality, the chief beneficiaries of free enterprise revolutions are the poor. As a result of what she calls “the great enrichment” since 1800, she says “millions more have gas heating, cars, smallpox vaccinations, indoor plumbing, cheap travel, rights for women, lower child mortality, adequate nutrition, taller bodies, doubled life expectancy, schooling for their kids, newspapers, a vote, a shot at university and respect. Never had anything similar happened, not in the glory of Greece or the grandeur of Rome, not in ancient Egypt or medieval China.”

When Mahatma Gandhi was asked what he thought about western civilisation, he said it would be a good idea. Likewise, continental Europe’s approach to free enterprise should be to “give it a try”. How many more years of self-imposed depression must the European continent suffer before its political masters get over their ideological prejudices against Anglo-Saxons and try reading a little Adam Smith, Friedrich Hayek or Milton Friedman?

By Matt Ridley | Tagged:  Rational Opimist  the-times