Economy: "The economic perils of thinking for the moment" (case for a long-term stabilization plan) ["Rules rule: OK?"]
|Source:||The Times , 14 September 1978|
|Editorial comments:||This speech prefigured the Medium-Term Financial Strategy (MTFS) announced in the 1980 budget.|
|Themes:||Economy (general discussions), Public spending and borrowing, Taxation, Monetary policy|
The economic perils of thinking for the moment
Nothing could better illustrate the triviality of the Wilson-Callaghan-Healey approach to politics in general and economic policy in particular than the question the Prime Minister chose to put to the nation in his now notorious non-election broadcast. “Let’s think for the moment”, he intoned, “of the great domestic issues that the country faces now and ask ourselves whether a general election now would make them any better this winter.”
It is this obsession with the short-term that has been the bugbear of economic policy- making in Britain in recent years, and emancipation from it is the sine qua non of economic success. It is in large measures this obsession, too, that has led the present govern-mention, along with a number of its predecessors, to erect wage control as the central pillar of economic policy, and to tailor all its other policies to the presumed needs of wage control.
Surely by now we have learned the hard way that nothing is attained without a price, and in particular that the long-term costs of formal incomes policies in practice invariably exceed any short-term benefits that may flow from them. As even Sir Ronald McIntosh , a long-standing advocate of incomes policies, ruefully conceded in his speech on retiring as Director-General of NEDC a few months ago:
over the years incomes policies have not on balance brought any net benefit to this country and may indeed - through their effect on industrial relations and incentives - have done more harm than good.
The time has come for a wholly new approach to economic policy in Britain. And the overriding need is for a long-term stabilization programme to defeat inflation, recreate business confidence, and provide a favourable climate for economic growth.
At the heart of such a programme must lie a firm commitment to a steady and gradual reduction in the rate of growth of the money supply, until it is consistent with our best guess at the potentially sustainable real rate of economic growth. Only in this way can inflation be wrung out of the system.
But this alone is not enough. In theory, there is no direct connexion between monetary and fiscal policy; in theory, any Budget deficit can be made compatible with a given rate of monetary growth. In practice, however, there is a very close and indeed crucial connexion. For as the events of this summer underlined, an excessive Budget deficit destroys confidence and puts the Government gratuitously at the mercy of the financial markets, with the inevitable consequence of a financial crisis which has to be fended off by a sharp rise in interest rates and all the usual paraphernalia of a credit squeeze.
And this in turn not merely undoes the supposed expansionary effect of the large Budget deficit which created the problem in the first place: it also bears down inexorably with special severity on the private sector. All this, moreover. assumes that governments do not succumb to the ever-present temptation to try to avoid this unpleasant consequence of a large Budget deficit by financing it through an inflation of the money supply instead.
Thus an equally important part of the long-term stabilization plan has to be a reduction in the present Budget deficit to well below this year's forecast level of £8,500m. Indeed, something operationally and psychologically akin to the old balanced- Budget discipline needs to be restored: the secret of practical economic success, as overseas experience confirms, is the acceptance of known rules. Rules rule: OK?
It is this basic truth that lies at the root of the failure of the fine-tuning demand management approach to economic policy. For quite apart from anything else, We simply do not have the know- ledge to fine tune sensibly-nor do we possess sufficiently precise and sensitive controls. The fundamental point, which the fine tuners have never understood is that, at bottom, economics is about markets, and markets cannot be fine tuned. All that happens if a government attempts to fine tune - whether by fiscal or monetary means - is that it forfeits the very real gains to business confidence that derives from a known long-term stabilization programme.
Nor, incidentally, is there any reason to fear that any significant reduction in the Budget deficit, achieved - as it must be - by trimming back public expenditure, will lead to massive unemployment. As the London Business School recently pointed out, between the third quarter of 1976 and the third quarter of 1977, the Budget deficit (as measured by the Public Sector Borrowing Requirement) was cut by an unprecedented £5,000m (taking the quarterly figures at an annual rate); Mr Wynne Godley, the eminent oboist and neo-Keynesian leader of the new Cambridge school of economists, predicted in a letter to The Times in September, 1976, that a cut of this magnitude would add “perhaps a million to unemployment in 1978”. In the event, unemployment rose by roughly 100,000 - substantially less than when the Budget deficit was soaring through the roof. The proof of the pudding is in the eating.
But just as a coherent long-term approach to the demand side of the economy is required, in place of the frenetic fine-tuning to which industry has had to become accustomed, so, too, on the supply side - where so many of our difficulties lie - a similar transformation is long overdue.
One of the most widely held myths of our time is that an imperfection of the market- and the market is undoubtedly riddled with imperfections is in itself a justification for government intervention. The truth is that, for intervention to be justified, it must be demonstrated that the imperfections of government action are less serious than the imperfection of the market that the intervention in question is intended to correct. And this is not an easy condition to satisfy.
Even with the best of intentions, governments can get things wrong - and when they do, there is no self-correcting mechanism as there is, to a greater or lesser extent, in the case of market failure: indeed, the admission of error is usually the hardest course of all for any government. And, of course, they do not always have the best of intentions. Government intervention of this kind, in the real world, is invariably guided by the crudest of political pressures, and it is all too easy for the laws of marginal cost pricing to be suspended in marginal seats.
Thus the overriding need on the supply side is to replace the gamut of discretionary government interventions designed to meet one short-term crisis after another, which merely treat (or mis-treat) the symptoms of our economic debility, with a really significant reduction in personal taxation, at all levels, in order to recreate the incentive to take risks, to acquire skills, to expand and, above all quite simply, the incentive to work.
This can be done, provided the will is there. In part, a substantial reduction in income tax at all levels can be financed by a shift of more of the burden of taxation on to spending: in recent years, thanks largely to the non-indexation of our tax system, the shift has been in the opposite direction. In part it can be financed, by the growing bonus of the yield of Petroleum Revenue Tax and oil royalties. But given she need to accompany this reduction in income tax with the equally necessary reduction, in the Budget deficit, it will also be necessary to hold back public expenditure.
However, this must be put into perspective. In the first place, public expenditure was cut substantially last year (1977-78), partly at the behest of the IMF and partly, it would seem, through inadvertence; and with this cut came a sharp reduction in the Budget deficit. Regrettably, the present Government has decided to budget this year (1978-79) for a 6 per cent, or £4.000m, increase in public expenditure in real terms - which, of course, is the sole reason for the expected £3,000m rise in the Budget deficit. Had last year’s level been held in real terms, there would not have been any need for any further economies in the overall figure (although there would still have been a crying need for changes within that total).
And in the second place. it should never be forgotten that the level of public services in the long run directly and inescapably depends on the wealth of the economy as a whole; and any economic policy designed to improve the conditions for wealth creation will imply, at the end of the day, a higher - not a lower - level of public services.
We have here, therefore, the essential elements of a coherent long-term approach to both the demand side and the supply side of the economy, and one that differs sharply from the discredited short-term expedients of the present administration. Sooner or later, when even Mr Callaghan can run away no longer, it will be put to the British people.
The author is Conservative MP for Blaby.