By Martin Wolf Published: December 3 2009 22:09 | Last updated: December 3 2009 22:09

Margaret Thatcher became prime minister of the UK on May 4 1979 and remained in office for more than 11 years. Her government reshaped the politics of the UK and, after the election of Ronald Reagan as president of the US in 1980, these two reshaped the world. But, in the aftermath of the biggest financial crisis since the 1930s, one that centred upon the US and UK, where the world’s two leading financial centres are located, what is left of the Thatcher revolution? Mrs (now Lady) Thatcher entered office determined to reverse a national decline marked by high inflation, slow growth and trade union militancy. Her government emphasised monetary control, deregulation, particularly of the financial sector, flexible labour markets, and privatisation. The post-1997 Labour government did not overthrow these policies but built upon them. Labour increased public spending but not hugely: in 2007-08, expenditure was below where it had been under Mrs Thatcher until 1988-89. Labour also abandoned active fiscal policy, adopted inflation targeting, introduced central bank independence and welcomed the vigour of the financial sector. The world has now changed. The state has been forced to rescue the financial sector from implosion. Macroeconomic stability has vanished: in the third quarter of 2009, UK gross domestic product was 10 per cent below where it would have been if the trend from 1991 (annual growth of 3 per cent) had continued after the beginning of 2008. A huge fiscal deficit has also emerged: current spending for this financial year was forecast in the March 2009 Budget to be 3 per cent higher than had been forecast a year earlier, but the forecast of nominal GDP was 9 per cent lower and of current revenue 18 per cent lower. This last debacle largely explains the deficits experienced and forecast. Gone, it seems, is the rapid growth and high profitability of the financial sector. Gone, too, must be the assumption that governments should merely get out of the way of markets. So how much is left of the belief that these reforms durably strengthened the UK economy? First, even with the recession, UK GDP has grown far more than that of the big continental European countries or Japan. Between the first quarter of 1991 and the third quarter of 2009, UK GDP rose by 48 per cent, against 35 per cent in France, 22 per cent in Germany, 19 per cent in Italy and 16 per cent in Japan. Within the group of seven leading high-income countries, only the US and Canada outperformed the UK, with GDP increases of 63 per cent and 60 per cent, respectively. Second, a part of this performance will surely prove a mirage. But, unless UK trend growth falls below the rates seen in the UK’s European peers and Japan between 1991 and the beginning of this crisis (1.1 per cent in Japan, 1.5 per cent in Germany and Italy, and 2.1 per cent in France), or the performance of the latter improves significantly (which seems unlikely), the UK will retain a good part of the advantage it won during the expansion. The era of reforms was definitely not a waste. Third, stabilisation clearly did not go far enough. In particular, before the crisis, fiscal indebtedness – net debt to GDP at about 40 per cent – and running deficits were too high to give the country the room for manoeuvre it needed. This has painful implications. There is a risk that the UK now confronts 20 lean years – 10 to get deficits back under control and another 10 to lower debt levels back to where they started. Finally, if such a painful outcome is to be avoided, the alternatives must be a disastrous inflationary default or a resurgence of growth. The faster the growth, the more manageable the fiscal crisis will be. The path of least resistance on growth would be the desperate hope that a wave of loose monetary policies across the globe would allow a resurgent, but largely unreformed, financial sector to refloat the UK economy. That would be dangerous, economically (because unstable) and fiscally (because potentially costly). The UK can barely afford to insure its current financial sector, let alone one even bigger. The solution must be found elsewhere: in a growth-oriented policy that encourages emergence of a more diversified economy. This should be done not by suppressing markets, but by supporting and guiding them. Fiscal cutbacks must not fall on activities likely to support growth – infrastructure and research and development. Both savings and investment will need to rise. Immigration policy should seek those most able to contribute. In view of the household indebtedness, attention should go to activities that serve world markets. The Thatcher and post-Thatcher eras were not wasted. But the UK became complacent in the fat years about where markets were taking the economy and so about the true fiscal position. Overheated financial markets are a dangerous economic guide, as Keynes once argued; and fiscal positions should also be judged with great caution. What is needed now from the politicians is a focus on growth. That is the only palatable way to manage the shock.