the lawson doctrine

where did it all go wrong?

Lots of places, of course, in different ways and at different times.  But the British economy, in the period from about 1986 to 1992 is on my mind, partly due to the recent death of the former Chancellor of the Exchequer, Nigel Lawson.

It’s hard to think back to his reputation during the late 80s, of course, misted as the memory is with his various retirement projects of climate change denial, diet books and being Nigella’s dad.  But among a certain kind of economist of a certain age, what Nigel Lawson is famous for is the “Lawson Doctrine”.

This term referred to the current account deficit of the UK during the “Lawson Boom”. At the time, a lot of commentators pointed to this deficit as evidence that the economy was not as good as it seemed in those years of yuppies and wine bars, but Lawson disagreed.  He actually took ownership of it in a speech to the IMF; at the time it was also called the Burns Doctrine after his chief economic advisor, and at the time most people talking about it were happiest to attribute the original whatever-the-opposite-of-an-insight-is to Max Corden.

The central idea was that current account deficits (in general, and specifically the one that was ballooning in the UK) are only a problem if they are accompanied by public sector budget deficits.  If they aren’t, then they must have arisen as a result of private sector firms’ and households’ investment and spending decisions, and consequently they are likely to be, to use the phrase of the time “benign and self-correcting”.

[at this point, I would like to reassure those of my readers who don’t do economics, that nothing from here downwards requires you to know what either a current account deficit or a budget deficit is, let alone to take an opinion on them.  You can mentally substitute “bad economic thing” and “bad economic thing that’s controlled by the government” respectively for the two terms, for the purposes of this post].

“Benign and self-correcting” …

A potted summary of the end of the Lawson Boom (and of Conservative Party economic credibility for two decades after the Black Wednesday currency crisis) would be “it wasn’t”.  The .pdf links above are all to various lectures and papers on the general subject of “don’t fall into the trap of believing in the Lawson Doctrine, don’t recreate the Lawson Doctrine, etc”.

But this itself is interesting.  If the market worked, the Lawson Doctrine would have worked.  The point of the Hayekian economy as information processor is that whenever a private sector transaction happens, information is transmitted through the supply and demand mechanism, and then incorporated into the price mechanism.  If you presume rational expectations, then this mechanism ought to be self-regulating; the price ought to adjust to bring the transactions into equilibrium, so that it shouldn’t be possible to build up deficits which have really bad consequences.

Why wouldn’t that happen?  The Lawson Doctrine does give one out – the government isn’t necessarily subject to conventional budget constraints.  Taxation, borrowing and money creation aren’t transactions in the same straightforward way as buying and selling, so a current account deficit that’s the result of a government-bad-thing could build up without generating the same kind of stabilising feedback. 

But that isn’t what happened in the 1980s.  The thing that happened is precisely that the good kind of deficit, the one that should self-correct, didn’t.  How come?

The exact reasons why the 1980s boom ended so badly would involve the kind of economics I promised three paragraphs ago that I wouldn’t do.  But there’s an easier way to answer the question.  Start by taking seriously the Hayekian model of the market economy as an information processor.  If you do that, the answer is pretty trivial – the self-regulatory mechanism didn’t have enough information processing capability to regulate this problem quickly enough to stop it from getting out of control.

In other words, the Lawson Doctrine failed because the globalised trade and capital markets of the 1980s were not able to transmit enough information at a fast enough rate.  Using the word in its strictest sense – the one which your internet service provider uses in its advertisements – it didn’t have enough bandwidth.

How much bandwidth did the post-Bretton Woods, managed-peg, open capital market of Britain in the 1980s have?  Could you have downloaded a YouTube clip over it? No, no, you’re not getting me as easily as that, I’m not going to give an answer in megabytes per second.  The proof is simply in what happened – we know that it didn’t have enough capacity because it failed in its role as a regulatory system.  If the channel capacity of the price system was X Mbps, then the variety of the underlying economic and financial decisions was some number greater than X.

Economists don’t really think this way.  Largely because the economic debate about information and calculation was won in the 1920s with the “socialist calculation problem”, while the modern theory of information wasn’t invented until Shannon and Wiener published in the 1940s.  “Long and variable lags” could and should have been translated into much more rigorous terms, decades ago.  But we had other things on our minds.