Exhange Rates, Banking and Thatcherism
Sir Alan Walters speaks to Charles Richardson

Sir Alan Walters was Chief Economics Adviser to the British Prime Minister, Margaret Thatcher, from 1980-84 and again in 1989. He played a prominent part in the controversies of that time, particularly over the issue of Britain’s participation in the European exchange rate mechanism (to which he was strongly opposed), which dominated the last months of Mrs Thatcher’s term. Prior to that he had been an adviser to the World Bank, and a consultant to the governments of Israel, Singapore and Malaysia. Sir Alan has held professorships at the University of London and at Johns Hopkins University, and is a senior fellow of the American Enterprise Institute. He has published widely in academic journals.

Sir Alan has visited Australia on a number of occasions, most recently in May this year. On 6 May he addressed a well-attended Occasional Seminar at the Centre for Independent Studies on ‘Exchange Rate Policy and the Asian Fiasco.’

Before the seminar, I spoke to him about his experiences and his views on the world financial system.

Charles Richardson: Well Sir Alan, welcome to Australia. I think most of the time you must find that people’s eyes glaze over a bit when you talk about the international monetary system, but in the last few months in this part of the world we’ve found that it can be pretty important. What do you think are the lessons we should learn from the Asian crisis?

Alan Walters: There’s one basic lesson, it’s a bit of a bore to say so, but if you’re going to set up a managed exchange rate system for a country, then you had best be absolutely clear that you can run it properly so that you won’t get trapped by it. The big trouble now is that, like any other government, the Asian ones want to have their cake and eat it too. They want pegged exchange rates, but they also want the freedom to operate monetary policy – to save banks, or to save this industry or that industry. And you can’t have it both ways, and you’d better realise that.

CR: They want the advantage of the peg, but they don’t want to wear the discipline that it brings?

AW: That’s right: they don’t want to countenance the discipline that produces. I’m afraid that lesson has been learnt time and time again. To go back no further than Harold Wilson’s disaster when, you’ll recall, he tried to maintain the exchange rate and then, of course, he had to devalue. He went on British television and he said ‘Of course, this doesn’t mean the pound in your pocket is devalued.’ The scandal! And of course it ruined Harold Wilson, and people had very little faith in him thereafter.
But that was the beginning of it. And in those days there was virtually no private capital flowing internationally; it was all concessional capital from governments to governments, with a bit of direct foreign investment. That’s all changed now, with the massive amount of private capital sloshing around – it doesn’t give you much time to make mistakes.

CR: Clearly not. I gather that one thing you’re saying is that although circumstances have changed so much, we’ve still got institutions like the International Monetary Fund that were established to deal with quite a different world. Do you think we can now do without them?

AW: I’ve always thought that both the IMF and the World Bank should be abolished. It’s quite clear that the IMF was set up to provide liquidity for a pegged exchange rate system, pegged on the US dollar and on gold. And those days have gone; I think they went in 1968 or even earlier, but certainly by 1971. But, you know, the golden rule is that international financial institutions never die: they always grow. They’ll always find jobs for the boys.
The World Bank is if anything even worse. It was set up, of course, following the devastation of World War II – it was called the Bank for Reconstruction and Development. I think we should abolish both the IMF and the World Bank, and all these little banks like the Asian Development Bank and the African Bank – their loan portfolios are not a pretty sight.

CR: I can imagine. Do you think there’s any prospect, politically, of abolishing or even curbing those organisations?

AW: No – politicians find them too useful. Secondly, of course, you can say that the IMF serves a useful purpose in providing a supervisory role, almost like a ratings agency; if it’s got the imprimatur of the IMF then it’s a good thing for the private investor and so on. But supposing you admit that – I don’t admit it, but supposing you do – then why do they need loans? Why can’t they just do what Standard & Poor’s do? They say they’ve got an incomparable body of skilled people there – OK, well let them earn their living doing this. You don’t need all the paraphernalia of  loans. In fact the loans are generally quite a small fraction of the total capital flow. However, you have to be careful in places like Africa where many countries are supported by World Bank loans: they’re quite a big item in the government budget.

I think to subsidise loans to induce people to eliminate subsidies is a bit mind-wrenching. The subsidy effectively varies according to how disastrous the borrower is – the borrower who is disastrous has an enormous subsidy. If it’s so-so, it’s a small subsidy. But it always gets a subsidy.

CR: The worse off you are, the more subsidy you get?

AW: Yes.

CR: Well it’s how government works generally, but on a larger scale. A lot of people I think have the impression that the IMF at least has sometimes done good by forcing structural reforms in certain countries– is that right, or is it overrated?

AW: I think it’s quite a bit overrated. We had the IMF into Britain in 1976 when I was there. We had this guy come and lecture us about how there should be a limit on credit expansion, and we said ‘Yes, of course, of course we’ll do that,’ but by the time his backside had disappeared in the direction of Heathrow, we were back to business as usual. I tell it as a joke, but I think it is true. People have done research on this that showed you can’t regard the IMF as a sort of insurance arrangement. You know you might think of it like that, you put money in the pot, and hard luck comes to somebody and we pay them out a grant from the insurance fund. The trouble is that the evidence is that 80% of the rescheduling – which is a good indicator – is done for only 20 countries.

CR: So a number of countries are repeat offenders?

AW: They’re recidivists. So the model of an insurance arrangement doesn’t work. It isn’t consistent with the evidence. I don’t think you could even try to excuse it on those grounds. It’s very difficult to find a positive case for it.

You see, much of it gets captured by this or that pressure group. This is especially so with the World Bank. I was there for a while, and it was dictated, I think by Robert McNamara, that all loans had to have a fertility component – you know, a birth control component. Loans were built up like this, like a Christmas tree: it had to have a birth control component, then a poverty component – there must be something for the poor – you know, all this malarky. You had an operator at the World Bank who would be arranging a loan, the government civil servants they would be dealing with would very likely be ex-World Bank people, and they’d do a deal – ‘we’ve got to provide all this flummery for these guys in Washington so they can swan down to the Capitol and say how splendid they are, and how moral they are.’

With the recent President of the World Bank this hasn’t diminished; on the contrary, it’s grown full measure. You have to have a woman component, you have to have a non-government organisation component, you can imagine what this is like for loan operations. The guy who’s pushing the loan at the World Bank, they’re judged basically by the amount of money they unload – not the quality; quality will be revealed five years later, when they’ll have moved on to better things. That congealing of interests is very important, and provided the quantitative thrust in the McNamara era, which went over into subsequent periods.

CR: How did you first get involved in these public questions? You were more a technical economist by training, weren’t you?

AW: I wasn’t trained at all, really.

CR: But you started in econometrics?

AW: Yes, I started in statistics, but that was an accident really. I’m a son of the working class – my father was a communist, and of course that led me into the opposite camp. I failed the 11+ exam in arithmetic, so I was consigned to a senior school, but I did all right at senior school, and the mathematics master in particular thought I had a mathematical bent. But I left school when I was 15 because my father was still unemployed. Then I worked for two years in factories – a shoe factory and a bolt factory. Then I went into the army, and I was a private in the infantry for four years. Quite an achievement; I was never promoted. When I was coming out of the army I saw my old schoolmaster, and he said ‘What are you going to do?’ I said I’d try to get into a teacher training college – the teaching profession has long holidays – and he said ‘You ought to go to university; they’re taking anyone now.’ This was after the war. I said ‘Well, I’ll try, but what can I do at university?’ He said, ‘What do you know?’ I said, ‘Nothing, I’ve been in the infantry for four years’ – the main thing you do there is stay out of the way.

CR: You avoid getting shot at.

AW: Yes, you stay out of the way. And he said, ‘Well, if you don’t know anything, I suppose the only thing you can do is economics.’ However, I applied to all these universities, and they all turned me down, because I hadn’t got a high school certificate. So I read it externally at London, and as it happens I did statistics – the old B.Sc.(Econ.) – and I got first. Once you get first, you’re home and dried. I never took a higher degree – the only higher degrees I’ve got are honorary ones, I’ve got a few of those – but anyway, from then on it was plain sailing. I got an American Nuffield scholarship, and they all wanted me then. Having been on the scrapheap so long, I was a nugget of gold.

CR: So how did you get involved in government work?

AW: Well I went to Birmingham. I spent about six months in Oxford with Hicks, and I found Hicks a pain in the ass actually – great genius as an economist, but he had no idea about policy. And this is what drove me to policy. You see, Hicks wrote this inaugural lecture for the chair at Oxford, and his inaugural lecture was on the dollar problem. This was 1953. And he together with McDougal and a whole raft of economists said there’d always be a dollar shortage. Why? said Hicks in his lecture, well, because the Americans wouldn’t want anything from Europe, but Europe would want everything from America, therefore there would always be a shortage of dollars. You find it very difficult to believe, but there were whole books written on this.

In any case, by 1954 it was clear that the shortage had turned into glut. You could almost see the Volkswagens. It was rather like the orator in Oceania who was reviling Eastasia and extolling Eurasia. Someone handed him a slip saying the alliances had been reversed. Without taking pause, in the same breath he went onto reviling Eurasia. So it was with the dollar problem. I became interested. I think it was because not many other people were interested in policy. Policy is downplayed in economics; I can never really understand why, because to my view it’s the fun and games of it. It was the only thing that motivated me.

So I got into all sorts of things; I got into transport, really, from econometrics. I was the first to propose congestion pricing, and that goes back to an article I wrote as an undergraduate, actually, in 1953. I used the dynamic analogue model – that’s in the Journal of Industrial Economics for 1953. And I got involved at a personal level with Gilbert Walker, who was a great transport economist, so I drifted into that. There was a lot of econometrics and modelling work. I did a lot of work on production functions and cost functions.

I think it really opened me up to policy, though, when Milton Friedman came to Birmingham in 1954. He came there and he delivered a paper on the theory of the consumption function. I thought, ‘That’s what economics is about.’ It was superb – much better than the monetary stuff he did. It was beautiful, simple, had all the signals – it made an enormous impression on me. I thought Milton was the greatest. So I got into policy then through the work on the consumption function.
On money, I came in much later, in 1958. This is interesting, because in 1959 there was the Radcliffe report. I’d been in America for a year, and I came back and I applied to the Bank of England for a grant whereby one might determine what the quantity of money was – a series on the quantity of money. The Bank of England replied that the quantity of money was of no real concern to anyone and there was no point in studying it. That’s true – I’ve got the letter.

CR: It makes you think that maybe we have made some progress.

AW: I think we’ve made enormous progress in some respects. We’ve slipped back in others.

CR: Tell us about what working for Mrs Thatcher was like.

AW: If you had a tabula rasa, and you could design the best job in the world, you couldn’t do better. I think she’s splendid. She’s the opposite of her image, you know, completely the opposite. She was a kind, considerate person on a personal level; secondly, if you’d got a good argument, you put it up, you’d win her support. She was always susceptible to good arguments. What she couldn’t stand was stuffed shirts saying ‘I think I can say without any fear of contradiction, Prime Minister,’ you know, the Sir Humphrey types – they’re just like that. No, she was great. If you’ve read her memoirs you’d know how close we were –

CR: Yes, she certainly seems to think very highly of you.

AW: I said, ‘What should I do, what are the sort of basics’ and she said, ‘Oh Alan, you know what you ought to do, and you know what you can do best.’ She said, ‘anytime you think it’s serious, then whoever I’m with, come and interrupt me.’ I never used it much, but she gave me considerable leeway. I mean, we had our rows. The first major row, where I thought I couldn’t stand it, or I wouldn’t stand it anyway, was on the 1980-81 budget. She discusses that, if you look at her memoirs, but you don’t get quite the sort of sense of what it was like. But that budget was the foundation of  Thatcherism, everyone agrees about that. Without that we would have never got anywhere.

CR: How do you think history will judge her – do you think Thatcherism was a success?

AW: Oh yes, and how. Not just a success in Britain, but everywhere, I think, if you look at the elements of it – privatisation has gone great guns throughout the world.

CR: Could it have been done without her personal qualities?

AW: No, I don’t think so. You might find other people who would have tried it, but I can’t think of anyone else. You see,what she had was I think fairly unique. She had enormous moral courage. Many people have physical courage, but not many have moral courage. And that was her great strength; she’d do what she believed was right, damn her. I remember the 1981 Budget, when there was a very good chance that they could have thrown her out, you know, they talked about her in the past tense, as if she’d already gone. But then she went into the House of Commons, for the Chancellor to deliver it in the afternoon, she said to me, ‘They may throw me out over this, they’ve all got their knives out behind me – I don’t care about those in front – but you know they won’t be able to say I did the wrong thing.’ And you love her for that.

I think she was greater than Churchill, because she had a much more difficult wicket than Churchill had, in my view. I mean, a woman, in the Conservative Party! They made a special dispensation in the Carlton Club to allow her to walk down the staircase. I regret going in 1989 when I did. I’d have rather hung on there, I would have liked to have stayed.

I saw her the week before last, we had dinner together. Someone said, ‘Do you think in retrospect you’d have done anything differently, much better?’ And we went through it all, we’d have done quite a few things somewhat better – you know, we could have done better on education, and on the social security side, and we could have done the privatisations more efficiently, but fundamentally, no, if we had to do it again we’d do the same thing.

CR: What would you say to people who say that her style was too authoritarian?

AW: I’d say to them, you argue with her. She loves argument. That’s how she got on so well with Gorbachev, you know. She loves argy-bargy.

CR: They did seem to get on very well, didn’t they?

AW: Oh yes, she knew he was a communist, and even though she was a capitalist, they liked arguing. It is true that when I argued with her – the Budget in 1980-81 was a critical one, and later on one or two other things – if you win the argument – and I did win it – she was 100 per cent behind you. Even though she took the opposite position a few hours before. I mean, she was hectoring, yes, but it was all in good part. You’d have a row, and then get together again and she was fine about it, and say ‘well, we know where we are now’. I found her splendid. We agreed about the things she did that were wrong. The worst things she did were to sign the Single European Act in 1985, and to join the Exchange Rate Mechanism in 1990. And she says those were the two worst things she did.

CR: So what do you think of Britain’s future now? Tony Blair is often talked about as her successor; is it Thatcherism with a human face?

AW: Well in many respects it is. I mean the Blair government has only been in office about a year, a long time to go yet, but it’s not destroyed Thatcherism at all, and it’s carried bits of it a little further. On the other hand, Gordon Brown has been, I think, disastrous for some measures, but he has held spending – as he ought to. He’s mucking with taxes far more than he should have done, but these are early days. Blair politically is a superb operator, a model operator – I’ve got great admiration for him. I think this is the greatest achievement of Margaret Thatcher: to take the Labour Party, who were full of nationalisers, Clause Fours and so on, and turn it into a sort of mock Thatcher outfit – which is quite an achievement, really. She moved the whole centre of politics over. When you think what they were like – I mean Michael Foot!

Mind you, Ted Heath was worse. I think the whole thing came out better than I thought it would. You see, I was very reluctant to go back, because I’d been adviser to Heath, and we’d had the most enormous row. I say he fired me – he says I resigned, but I didn’t, he fired me. But Heath was a major disaster in every respect. With the sole exception of  liberating resale price maintenance. That’s the only thing I can think of that he did that was any good. Everything else was a disaster.

CR: So how would you summarise your view of the world financial system now? Where do we go next?

AW: Well the first thing is, I think there’s been an enormous advance in liberalising capital flows. The measure of the advance is that economists start talking about throwing grit in the wheels. I think it’s a success. The thing is, they can’t go back – I mean if they throw the grit in the wheels then capital will just move somewhere else. That’s an enormous step forward. You know they’ve gone back essentially to about the 1890s, when there was pretty much free capital flow. And much of the development then was due to that – railways around the world were financed by London capital. And I think that’s going to be retained.

The EMU is, I think, a political disaster on a massive scale. I think it’s an economic disaster, but that’s small beer compared to the politics of it. You know what it is, it’s pointing directly at the heart of the United States. The development of the Euro is so that France and Germany – but mainly France – can challenge the mighty dollar. It goes back to when De Gaulle, in 1967, complained about the Americans printing little green things, coming over to France, handing over these little bits of paper and taking away French industry. Giscard d’Estaing and the others, they grew up in that environment. I think it’s a disaster, because whatever you say about the Americans, and whatever you say about the World Bank and the IMF and so on, they’ve been pretty damn good custodians of the world monetary system. The dollar system has worked very well, in my view. It’s had its ups and downs and hiccups indeed, but on the whole it’s remained open, and has been the basis of liberalisation. The Americans, if not exactly at the forefront of liberalisation, have always been carried along by it.

I think there are good reasons for optimism there. There are certain boils and carbuncles, if you like, on the international monetary system, like the World Bank and the IMF, but generally we’ve hung on quite well.

CR: You think that the body is basically healthy?

AW: Well, look at the enormous achievements that have been made. It took the ’80s to get rid of inflation, then you’ve seen this enormous expansion in South-East Asia, notwithstanding the present hiccup, the enormous change in Latin America – Chile, Argentina – open markets have done wonders. And we have to pay tribute to those economists – people like Al Harberger, Bela Balassa, Harry Johnson, Ian Little, Deepak Lal – I mean they’ve changed the whole atmosphere of international financial policies. In a way what we did with privatisation was really capitalising on this too. It was essentially part of the same movement to deregulation.
So I’m very optimistic. And what frightens me about Europe is that the European system is anti-free-trade. There’s no doubt that they operate a corporatist system, rather like the fascist systems. It’s worrying. Instead of competition they talk about cooperation all the time. That’s why I’m so pessimistic about Europe. You can point to some progress that has been made, but it’s not their own internal pressures – the pressure there is against liberalisation.

Charles Richardson is Editor of Policy.

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