THE POLITICAL ECONOMY OF FREEDOM — THE MATERIAL AND MORAL BENEFITS OF THE FREE ECONOMY

Introduction

I feel doubly honoured by Mrs Sonia Gandhi in being asked to deliver this lecture in Bangalore, the second I have given in honour of Rajiv Gandhi. His death was not only an incalculable loss to India but also to the wider world in whose councils he was already playing an influential and visionary part.

Both Indira Gandhi and her son Rajiv Gandhi were conscious of the need to promote the development of India's economy in order to give her growing population a brighter prospect of a better life. Mrs Gandhi took an intensely practical interest in India's agriculture, which from the late 1960s underwent what has been called the “Green Revolution” . I well remember how at the 1981 Cancun Summit on North-South issues Mrs Gandhi rejected the notion advanced by some experts that what developing countries needed was assistance with sophisticated projects. Instead, she argued, simpler agricultural equipment was what the country's farmers really needed. But Mrs Gandhi, like her father, was not convinced of the merits of the market.

Rajiv, by contrast, was. His quiet voice and charm concealed an iron will and a passion to get things right so that the people of India could realise their enormous potential. I heard him speak at the UN General Assembly one year. As soon as he began, the auditorium fell quiet as the audience was conscious that a new phase in India's fortunes had begun. His manner was assured and as confident as his powerful message. He never shrank from the call of duty. That is why we remember him not only with admiration but with affection: an affection which we also extend to Sonia and the family.

Rajiv foreshadowed the policy of economic liberalisation which was boldly initiated under Prime Minister Rao and Finance Minister Singh. These reforms are already leading to the transformation and regeneration of India's economy. And the further and faster they go the greater the gains will be.

For many years excessive controls, planning, state ownership, intervention, and taxation held this country back. Now its vast potential is beginning to be realised.

India's Strengths

India sets out on the path towards greater prosperity with many great advantages.

First, her enormous heritage in mathematics and science. Hindu mathematics was undoubtedly the finest intellectual achievement of the sub-continent in medieval times, while later the Muslims brought with them their own strong traditions in astronomy and instrumental technology.

Second, with its many excellent universities and colleges, India has the world's third largest supply of scientists, engineers and technicians. Scientists and technicians are today precisely the people a country must train and reward if it wants to succeed in a world where science and technology are ever more clearly the driving force of economic change. But universities are more than that — they conserve and develop your own culture. Freedom of expression enables them to bring forth those great, unlocking, creative ideas which can move the world.

Third, unlike many other Asian countries, India has a secure democracy, a tradition of good administration, a rule of law and a relatively wide distribution of private property. These things help ensure the stability and confidence that businesses need to flourish. Foreign investors want to be able to count upon them. And India is, alongside other tongues of course, an English speaking country: that is another immeasurable advantage. For English is and will remain the global language for doing business.

Fourth, India is rich in mineral and agricultural resources — coal, iron, oil, wheat, cotton, jute, sugar cane and much more besides. And you have developed the financial services, capital markets and stock exchanges which an advanced economy needs to flourish.

Fifth, there is a spiritual India composed of powerful religious faiths which means that in addition to one's natural desire to achieve a better standard of living for one's own family, your people also have a sense of responsibility to others and a duty to future generations. What makes a man, a family, a community, a nation, is the values by which they live, for values not only inspire policies, they inspire people.

Indeed as Finance Minister Singh said in his 1994/95 Budget speech, India has all the material and human resources to be a front ranking nation in the world.

The Crucial Ingredients

… Enterprise

But great as these advantages are, they will not suffice if the spirit of enterprise is lacking. And that spirit has to be nurtured and developed within what I have called for the purposes of this lecture the “political economy of freedom” . That word “political” is important. For economies do not function in a vacuum.

For many peoples of the world the question is what system of political economy will not only raise the standards of living in the West but create enough wealth to help raise others out of poverty?

Countries are not rich in proportion to their natural resources; if that were so Russia would be the richest country in the world; she has everything, oil, gas, diamonds, platinum, gold, silver, the industrial metals, timber and a rich soil. Countries are rich whose governments have policies which encourage the essential creativity of man who in order to succeed must work with others to produce goods and services which people choose to buy. So Japan, Switzerland, Hong Kong, Taiwan, Singapore and so on have no natural resources but are now among the most prosperous countries in the world.

And how have they achieved this prosperity? Through the market.

There are some commentators who criticise the market. But the market is not the invention of some academic economist. The freedom to buy, sell, and trade is one of the oldest freedoms known to man. Consumers decide what to buy, producers what to make, and competition determines the price.

People will always trade with one another under the most adverse circumstances. They did so even in the Soviet Union in the black markets which spawned today's new mafias. But it is only when the whole political, philosophical, legal and economic framework encourages liberty, rather than suppresses it, that the full benefits of what we call the “market economy” are felt.

As Alexis de Tocqueville put it in the middle of the last century:

“Do you want to test whether a people is given to industry and commerce? Do not sound its ports, or examine the wood from its forests, or the produce of its soil. The spirit of trade will get all these things, and without it, they are useless. Examine whether this people's law gives men the courage to seek prosperity, freedom to follow it up, the sense and habits to find it, and the assurance of reaping the benefit.”

… And a Framework of Law

Note well that de Tocqueville emphasises the importance of a framework of law if markets are to work properly. No market worth the name was ever unfettered. Even in the earliest times there were rules regarding weights and measures, quality and honesty. Similarly, in our own times a successful market economy depends on a framework of law within which it can operate, the law of contract, of private property, laws to safeguard the consumer, to protect health and safety, to break monopolies and promote competition.

Not only a free market, a free society itself requires a rule of law. This is familiar territory to your country and to mine. Long before we had a universal franchise in Britain (not until 1918 — or some would say 1928 when women had the vote on the same basis as men) we would have called ourselves a free people because of the strength of the rule of law.

But the idea is totally new to those so recently freed from communism.

“What do you mean by a rule of law?” they ask when I speak in Moscow or St Petersburg — for they have none. (Nor for that matter is there a rule of law in China.)

“Not the dictats of a Communist Party” I replied, but laws based on custom, or made by a freely elected parliament and administered by an independent judiciary. And all of this based on principles of fairness, equity and of redressing grievances.

Moreover, as the great philosopher Hayek noted “Laws must apply equally to everybody. And that includes the government too, whose actions must be — and be seen to be — subject to those laws” .

This I am afraid leaves my Russian audiences rather puzzled. A rule of law is the thing they lack most of all.

So for free enterprise to flourish, laws have to be clear, comprehensible, and just.

Regulation must be no heavier than is strictly necessary either to protect a genuine public good, like the environment, or to give confidence to consumers, investors, workers and others, that certain basic standards will be met.

Taxation must only be levied in order to meet genuine needs which private citizens, individually or collectively, cannot themselves meet otherwise. That, of course, was de Tocqueville's point when he spoke of: “the assurance of reaping the benefit” .

Role of Government, Strong but Limited

In a free society our overall aim must be limited government. This does not mean weak government. Quite apart from its role of providing a framework of law, government has many functions which cannot effectively be carried out by the private sector, though private enterprise may make a contribution. The state must keep up defence against aggression. It must provide a safety net of benefits to help the really poor. It must ensure a basic infrastructure for transport, energy, water and so on. It has to concern itself with sanitation and health. And it has to ensure that education is provided to give children from all backgrounds a better start in life and the chance to go as far as their talents will take them. Above all it must ensure sound finance and a stable currency.

But the state must be the servant not the master. There must be no drift into paternalism. Paternalism is the enemy of freedom and responsibility. Although it adopts a smiling, human face it is like all kinds of interventionist government: it smothers worthwhile effort; it stifles enterprise; it encourages dependency and it fosters corruption. And by doing so it holds back the wealth creation required in order to pay for hospitals, social benefits, schools, and roads.

… False Arguments

It is quite wrong to say, as some do, that this model — of small government, low taxes, limited regulation, a wide distribution of private property, and a rule of law — is something which only suits wealthy Western countries. It is in large part because countries like the United States adopted that model that they became wealthy. And it is because others did not adopt it that they remained less developed.

Of course, that is not the whole story. There are indeed social, cultural and political reasons why some countries are more enterprising than others. But you have only to look at nations which have been divided and lived under free and unfree systems to see which flourish the more. West Germany or East Germany, before re-unification? South Korea or North Korea? Taiwan and Hong Kong or Communist China? Just reciting the list proves the point.

Transition to a Free Society

But the same can also be seen when a particular country chooses to move from a command economy to free enterprise. Transitions of this sort are never easy. They are particularly difficult when, as with the former Soviet Union, there is no living tradition or recollection of freedom. There are plenty of painful decisions, stresses and disruption of people's lives. And there is also plenty of opportunity for policy makers and businessmen to make mistakes and for crime to flourish. And we know that the longer a country's experience under communism, the harder it is to recover from it.

Apart from that it is the countries which have moved furthest and fastest towards the free economy that have obtained the best results — and even the slow coaches have been better off than they were with state planning and over-regulation.

Let me give a few examples.

In South America, countries which languished under socialism and mercantilism are now attracting investment, breaking into new markets and producing the wealth to improve living conditions — even in spite of the problems of the Mexican peso.

In Central and Eastern Europe, which had a shorter time under communism than the Soviet Union, the countries which were boldest in dismantling communism and broke most cleanly with the communist mentality are doing best.

Poland's recovery owes much to the spirit of the people. Not even the oppression of communism could break either the Roman Catholic Church or the people's faith in it. Nor could it overcome the determination of Poland's farmers to retain their own land. Never under-estimate the character and spirit of a people.

Czechoslovakia, which peacefully divided into two countries by the wishes of both peoples, teaches us the outstanding importance of political leadership. Prime Minister Vaclav Klaus had a clear vision of the free society which he never ceased to propound and for which he gained the understanding and support of the people. He was careful not to under-estimate the difficulties of transition but was confident they could be overcome. His policies were those directed to low inflation, a balanced budget, a fast pace of deregulation and privatisation. He also understood that there are always some people who don't want responsibility, they would rather leave the decisions to someone else, even though that “meant living at a relatively low level of affluence” . But of course they all want the general improvement of services and value for money which comes from a free economy.

But it is, of course, the United States and Japan whose mighty economies demonstrate that success is greatest where the state takes only a comparatively small proportion of the nation's wealth in taxes, much lower than that generally taken in European countries.

Curing the British Disease

Indeed, the recent history of my own country confirms these lessons. Perhaps the greatest obstacles for countries, as for people, to making the changes required to break with failure, lie in the mind. In Britain we comforted ourselves in the sixties and seventies that although we were failing to compete, failing to adapt, and failing to create the wealth needed to raise living standards and improve services, we had a better quality of life than our successful neighbours. But we deceived ourselves. We had in fact just been managing decline — and decline always ends in tears. And we also had a restless, uneasy feeling that we ought to be able to do better.

So the government which I led for eleven and a half years systematically put socialism into reverse. Perhaps that sounds negative. And in my time at No 10 I, like your present most excellent Finance Minister, did get used to saying “no “. “No” to extra public spending. “No” to extra subsidies. And finally three more “nos” to back-door socialism from the European Community. It might be a better description to say that we came out of reverse and then went decisively forward, into first, second, and, eventually top gear. For our objective was positive. It was to re-create that political economy of freedom which had made Britain a great industrial and trading nation in the past, and which could do so again.

So we curbed public spending.

We cut income tax, particularly at the penally discouraging higher rate. I note that Finance Minister Singh has quoted approvingly Professor Kaldor's view that no civilised society should have a maximum marginal rate of income tax higher than 45 per cent. It may interest you to know that when I became Prime Minister the top rate of income tax on earned income was 83 per cent and the basic rate 33 per cent. When I left office, the top rate was down to 40 per cent and the basic rate to 25 per cent. The effect of this on incentives was massively beneficial.

We also removed controls on prices, incomes and dividends.

We abolished exchange controls — in those days that was an almost unheard of revolution. Even one of my City friends said, “goodness me, go steady” . But we went ahead and Britain began to build up huge overseas investments once again.

We cut back the privileges and powers of trade unions, which in recent times had become more powerful than the government. Our aim was to get a better balance in industrial relations; for we understood that excessive union power is not just measured in working days lost, but in restrictive practices retained, in profits squeezed, in investment postponed and in jobs aborted. I knew that if I got those trade union reforms right I would have a majority of trade unionists on my side, for they too had become tired of being pushed around by their own leaders. And a wise politician will never under-estimate the innate common sense of the people.

… Every Man a Capitalist

Most important of all perhaps, we set about privatising state-owned industries.

Let me emphasise that privatisation was not simply an aspect of economic policy. It was part of a broader approach. I believe that private property should be spread as widely as possible, as a bulwark for the liberty and independence of the people, and to enhance a sense of responsibility to future generations. Every man a capitalist was my purpose, privatisation and home ownership were two of our methods.

The object of our whole economic approach was to establish the framework in which freedom in all its aspects could flourish. For economic and political freedom are two sides of the same coin. Economic freedom is real freedom — not just a substitute for it. The ability freely to work, earn, save, give and inherit without being under the suffocating tutelage of the state is vital to a free society. For economics is not a managerial science it is a moral science. Capitalism is, in truth, economic democracy. With capitalism, power is wielded by countless individuals exercising a myriad choices in free markets, not by the state.

By the time I left office the state-owned sector of industry had shrunk by sixty per cent. Equally important, and largely as a result of the wider share ownership schemes which accompanied privatisation, about a quarter of the population owned shares.

Privatisation of loss-making industries absolved the taxpayer from the need to finance them. It was cheaper to provide public money in the short term to settle their financial problems so as to make them viable propositions for private sale than to go on year after year with subsidies. It was also easier to provide substantial sums in redundancy payments to workers whose jobs were fated to disappear, rather than to continue paying them to produce goods that customers did not want to buy. Privatisation allowed the businesses themselves to raise finance in the private sector without the constraints applied by government. The effect on the economy as a whole was also profound. Opening up large industries to competition increased their efficiency. Ending the heavy burden which loss-making firms imposed on the taxpayer allowed us to reduce taxes thereby encouraging new, small businesses, and new jobs.

The effect of these policies in the eighties was precisely what we intended and what our critics thought impossible.

Inflation fell.

Economic growth rates increased.

More businesses started up and expanded.

More jobs were created.

Property and share ownership expanded.

Living standards rose.

Productivity, upon which all the rest ultimately depends, raced ahead, faster than our main competitors.

Had Britain not made these fundamental changes to reverse socialism and apply the principles of the free economy when we did, the country would have been in even worse straits than in 1979. For as the Indian Government rightly recognises, we all have to consider ourselves now, far more than previously, as part of a truly global economy. In such circumstances, attempts to close off our economies from outside influences are even more counter-productive than in the past.

This means that trade protectionism will ultimately fail — although I regret to say that the EU is highly protectionist.

It means that exchange controls will fail.

It means that attempts to spend and borrow one's way out of recession will fail.

By contrast, it means that investment and skilled labour will flow into countries whose governments create the circumstances to attract them. Whether they like it or not, all governments are today players in a giant global competition to provide sound money, low taxes, light regulation, reliable justice, uncorrupt administration and a decent infrastructure. Governments must concern themselves with doing these things — not planning, directing, or subsidising their way to a collectivist nirvana.

The Benefits of Free Trade

Governments must also promote and nurture trade.

It is no accident of history that the great cities grew up on the vigorous trading highways of their age. They drew their riches from the caravan routes, river crossings or natural harbours on which they were situated. For centuries trade, wealth and power went hand in hand, and the most successful trading states were the superpowers of their day.

Trade has also proved the most effective vehicle for spreading prosperity to small and large nations alike. A small nation can still thrive as long as its businesses have access to the larger world market, where they can compete on equal terms with the commercial and political giants. You only have to look at the success of Hong Kong, Taiwan and Singapore to know this to be true.

But, of course, large, populous but economically less developed countries, like India, are equal beneficiaries of open trade. They are able to specialise and develop their natural resources by access to foreign capital.

In the late 1940s, the horrors of the two world wars and the economic misery which had plagued the world in between, led many to believe that there must be some better order through which the nations of the world could conduct their affairs.

On the political side, this manifested itself in the creation of the United Nations, while on the economic front it led to the establishment of the World Bank, the International Monetary Fund and the General Agreement on Tariffs and Trade.

The common factor for those who were members, was a commitment to political and economic freedom which was seen as going hand in hand.

Since the signing of the first GATT accord total world trade in manufactured goods has grown by a multiple of twenty three. This represents the largest growth in history benefiting not only the well established trading economies of the West but also the developing countries, for whom trade is their lifeline to prosperity.

Of great importance to India is that the GATT has now extended its scope beyond manufactured goods to cover services, intellectual property rights and agriculture.

Finally, I am glad that the decision has been made to phase out the Multi-Fibre Agreement on Textiles. This discriminated against many countries, like India, which were unable to take advantage of their lower labour costs. It also, of course, disadvantaged Western consumers — though producers were often keen to keep out competition. I remember how, during questions after a speech I made recently in Aspen, a member of the audience, a clothing manufacturer, protested that we should not open up our Western markets to imported garments. I replied that every country in the world had pulled itself up by selling what its people made. Who were we to deprive others of this chance? How otherwise would the less developed countries earn the money they needed to equip themselves for economic progress?

Ladies and gentlemen, our ultimate objective should be global free trade.

Protection by the West is selfish. Prolonged protection by the less developed countries is folly. And in both cases, though it may get instant plaudits from vested interests, it is self-defeating.

India's Economic Reforms

Since 1991 the policies of Prime Minister Rao and Finance Minister Singh have courageously set about transforming India's economy by sweeping away many of the obstacles to economic advance. They have tackled an enormous problem.

The old bureaucratic system of industrial licensing has largely been dismantled.

Customs duties have been reduced.

Foreign exchange controls have been relaxed.

Financial services are being opened up.

The taxes on foreign companies have been cut.

But there are, I know, still severe difficulties to be overcome. Inflation and borrowing, as British experience shows, always risk rising unless huge efforts are made to keep them down. The reform of labour laws, though a great human problem, will one day have to be tackled and its consequences addressed. People must not be left without hope.

There is also no end to the reasons advanced for not proceeding further and faster with privatisation. These arguments have to be resisted. If taxpayers' money continues to go into inefficient loss-making public sector companies, it will not be available either to pay for bringing proper water supplies to the villages, or to pay for hospitals, or to pay for the infrastructure on which economic growth relies. The greater understanding there is — preferably across the party political lines — about the need to take such action, the greater the chances of securing economic progress.

In particular, it is important to realise that multi-national companies can choose where to invest around the globe and that they always look carefully at the risks they face. Investors will not be prepared to fight through thickets of bureaucracy. They will expect to deal with a straightforward and efficient administration. And if the sanctity of contracts is not honoured, then future investment will be diverted to other countries where it is.

The Social Effects of Free Enterprise

The changes which India is facing as a result of these reforms to open up her economy cannot fail to have profound effects on the country's life at every level. You have a fast growing middle class which is essential to making faster progress. There is an explosive growth in television; and telecommunications will soon follow. Undoubtedly, there will be a great drive to increase basic education for everyone. This will widen the experience of millions and give them access to as yet unknown or unimagined experience. There will also be greater mobility of labour, as old inefficient plants close and new businesses start up in more favourable locations.

But in such circumstances there is always the risk of disorientation. The roots of communities are sometimes torn up. Extended families may lose touch with one another. Vulnerable young people may be subject to unwholesome influences of various kinds.

It is important to guard against these dangers, but also not to fall into the trap of believing that economic freedom inevitably means social irresponsibility. The same ethical values — as opposed to skills — are required in a multi-national business as in subsistence farming. It is, for example, wrong to think that businesses depend on individual entrepreneurship and a spirit of competition alone. They also require the confidence which comes with integrity and the self-sacrifice which promotes cooperation. So moral and religious values really do provide the necessary ballast for political and economic freedom.

India has her own particular philosophy and traditions, developed from different sources over five millennia, to provide an anchor against the turbulence of change. These things must be nurtured even more in our bustling modern world. They have practical value. I have heard it persuasively argued, for example, that the traditions of India's village communities helped to make the imported notion of parliamentary democracy more acceptable. And I am sure that the importance India attaches to the family is crucial to her future. In truth, the modern world has so much to learn from India and from the legacy of her enormously sophisticated and creative civilisation.

India's Influence in the World

In these two lectures I have sought to describe the constituent parts of liberty and to relate them both to India and to the wider world. Countries which pursue liberty at home will naturally wish to uphold it abroad.

When a country has the determination to solve its basic economic problems it gains the influence in world affairs that a country of your size, resources and civilization should command.

That, I know, is the conviction which inspires Finance Minister Singh in the bold programme he has advanced. And perhaps I can quote his words:

“I do not minimise the difficulties that lie ahead on the long and arduous journey on which we have embarked. But as Victor Hugo once said, ‘no power on earth can stop an idea whose time has come’. I suggest … that the emergence of India as a major economic power in the world happens to be one such idea” .

Ladies and gentlemen, that was Rajiv Gandhi's conviction too, and I believe his family will live to see this dream fulfilled.