How EEC membership drove Margaret Thatcher’s reforms

Nauro Campos, Fabrizio Coricelli

After 1945, the economies of the six founding members of the European Union grew faster than the UK's economy. Margaret Thatcher’s reforms in the mid-1980s have been credited with reversing this relative decline. This column argues that there is little empirical support for this explanation, and that a more credible turning point was around 1970 when the UK finally began the process of joining the European Economic Community.

On 23 June 2016, 52% of British voters decided to make the UK the first country ever to leave the European Union. This disillusionment with the EU seems to have been fuelled partly by the notion that the European integration project has failed to deliver and distribute the economic benefits it promised. New historical research on the drivers of the relative post-war economic performance of the UK throws light on this matter.

The relative economic decline of the UK (Bean and Crafts 1996) is a central theme in British economic history. After 1945, the six founding members of the European Economic Community (EEC), which later became the EU, grew faster than the UK (we refer to these countries – Belgium, France, Germany, Italy, Luxemburg, and the Netherlands – as the EU6). This relative decline in the UK stopped, however. The conventional explanation for this is the far-reaching structural reforms implemented by Margaret Thatcher in the mid-1980s (Walters 1986). After thorough scrutiny (Bean and Symons 1989, Layard and Nickell 1989, Card and Freeman 2004), this view remains popular (Minford 2015).

We ask whether econometric evidence provides support for this perspective, and find that it does not. We then examine an alternative hypothesis: the turning point occurred instead around 1970, when the UK finally began the process of joining the EEC. We find that this latter explanation has strong empirical support.

Our intuition is that UK’s accession to the EEC signalled the pre-eminence of business groups that preferred to compete in the high-tech common European market over those that favoured the Commonwealth markets driven by comparative advantage. These pro-Europe business groups later became key supporters of Mrs Thatcher’s reforms. Without their support, we argue, Mrs Thatcher’s reforms would not have been nearly as effective, and perhaps not even designed or implemented.

The great British reversal: Stylised facts

What we call the “great British reversal” refers to the fact that the relative economic decline of the UK compared to other leading European countries accelerated immediately after WW2, but suddenly halted. This is shown in Figure 1, which displays per capita GDP levels from 1850 to 2015 for the UK and the average for the five EU founding members excluding Luxemburg (EU5). It highlights that:

The UK has a higher per capita income from 1850 until about 1970

The gap in per capita GDP increases during both World Wars

The reconstruction period after WW2 (the return to the pre-war steady-state path) has been completed by 1950

During 1945-1970, growth rates in the EU5 are higher than in the UK

The level of GDP per capita in the UK since 2000 is higher than the EU5 average

Figure 1 GDP per capita of the UK and the EU founding members excluding Luxembourg (1850 to 2015)

Notes: US dollars 2010 PPP. EU5 refers to Belgium, France, Germany, Italy, and Netherlands.

Source: Authors’ own calculation using data from Bergeaud et al. (2016).

Per capita GDP trends in the UK and EU5 after 1945 are quite different (Crafts 2012). Using data from 1945 (the last year of the WW2) to 1973 (the year the UK joined the EEC), we can make a linear extrapolation and create a counterfactual forecast of GDP per capita 30 years into the future from that point. We find that, by 2000, GDP per capita would have been approximately 18% lower in the UK than the EU5 average. If UK GDP growth was driven by Thatcherite reforms, we would expect econometric support for turning points around the time they were implemented (1983 or 1986), or when Mrs Thatcher’s government was formed (1979).

In a recent analysis, we assess these hypotheses using standard structural break econometric frameworks (Campos and Coricelli 2017). We test for structural breaks in the run-up to EU accession, as well as during the years Mrs Thatcher held office. We used the Chow, Zivot-Andrews and Bai-Perron frameworks on per capita GDP and total factor productivity (TFP) data for both individual UK and EU6 countries series, and their ratios.

Our main finding for per capita GDP, and even more strongly for total factor productivity (TFP), was that 1969 was the main turning point. This was the year Charles de Gaulle resigned, and hence the year in which the UK successfully applied to join the EEC. (This was the third attempt – de Gaulle vetoed applications in 1961 and 1967).

Figure 2 shows the ratio of TFP for the three countries that joined the EU in 1973 (UK, Denmark and Ireland) to the EU6 founding members between 1950 and 2011. We subjected these TFP ratios to the same structural break estimation exercise and same range of robustness checks (Campos and Coricelli 2017). The conclusions are even stronger than for per capita GDP. They suggest a structural break in 1969, which dominates the 1979, 1983, 1986 or 1990 alternatives. Although the turning point for productivity in Ireland is the introduction of the single market (O'Rourke 2016), for Denmark and UK this clearly happens earlier.

Figure 2 Total factor productivity, 1950-2011 (1973 enlargement country ratios compared to EU6)

Note: 2005 = 1; PWT8.

Source: Campos and Coricelli (2017).

A new political economy explanation

These results provide new evidence that the great British reversal was driven by membership of the European Economic Community, not Mrs Thatcher’s structural reforms. These two explanations may, however, be complementary.

These reforms were implemented in the second term of the Thatcher government. Her June 1983 general election victory was the most decisive since Labour’s victory in 1945. The main reforms that defined her second term covered labour, product, financial market liberalisation, privatisation and openness to foreign investment (Card and Freeman 2004, Oulton 2016).

Our main finding was that the 1969 turning point is more powerful than structural breaks at the launch of Mrs Thatcher’s programme of structural reforms in 1983 or 1986. Our earlier Vox column on this topic discusses the determinants of the UK decision to join the EU (Campos and Coricelli 2015), while here we focus on its implications by providing new statistical evidence on the effects of European integration on UK economic performance, compared to Mrs Thatcher’s reforms. Hence our study combines the empirical identification of structural breaks with an analysis of how and why the benefits from EEC – and later, EU – membership changed over time (Campos et al. 2016, Crafts forthcoming). The UK’s per capita GDP relative to the EU founding members declined steadily from 1945 to around 1970, and became relatively stable after that. If the UK joined the EEC to stop its relative economic decline, it worked. It also laid the ground for future improvements in relative economic performance with the introduction of the single market.

The success of Mrs Thatcher’s reforms required EEC membership. These structural reforms were not implemented in a vacuum. They could not have existed without the powerful support of British entrepreneurs (Grossman and Helpman 2001), who benefited from a larger, deeper and more innovative market (contrast the EEC at the time with EFTA and the Commonwealth). These entrepreneurs also realised that to be competitive they would need access to deeper capital and labour markets supported by a set of common standards, rules and regulations (Baldwin 2016, Mulabdic et al. forthcoming). Without support from such powerful constituencies, Mrs Thatcher’s reforms would not have been implemented as they did, and certainly would not have been as successful.

This explanation draws parallels with the French experience in the immediate post-war period (Adams 1989). Between 1945 and 1957, there was a conflict of interest between powerful groups of French entrepreneurs, some of whom were against, and some in favour of, further European economic integration. The interests of those against were associated mostly with the former French colonies, though they lost influence in the run-up to the Treaty of Rome and found themselves locked into the European integration project even after de Gaulle was elected president in 1958 (Moravcsik 2012). At that point, they could redirect but not reverse the process.

Mrs Thatcher’s reforms were important and, together with the Single Market, have a role in the great reversal in British relative economic performance. Yet our results and interpretation suggest that EEC membership signalled the arrival of pro-Europe constituencies to UK politics and policymaking. Without the support from them, Mrs Thatcher’s reforms would have been very different.

The Thatcherite reforms have been the dominant explanation for the change in the UK’s relative performance during this time. An unfortunate consequence has been that this explanation has crowded out economic research on these constituencies. Bean and Crafts (1996) argued this: “We also anticipate that much more will eventually be written on the implications for growth of the interplay between government and producer interests.” Unfortunately, their call was not heeded.

European integration

UK economic performance is complex and has many causes. Yet European integration has so far been dismissed as a potential explanatory factor of the UK’s post-war reversal of economic performance. We argue it should not. If European integration played a key role in the economic performance of one of its most reluctant partners (George 1994), we suggest that it can also work elsewhere (and probably anywhere). Future research could investigate whether, and how, EU membership has helped elsewhere, and the role domestic interest groups and business associations played in this process.

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