The World Economy
Mr Chairman, Ladies and Gentlemen, when I received an invitation to speak to your Institute, I was of course tempted first to talk to you about a subject which here in Victoria is taken very seriously—cricket. But you are likely to know more about that than I do. Many of you actually play the game and rightly abhor the pavilion pundits. So it is perhaps not cricket. Then after a little thought I suspected that you probably expected me to expound on the key role of private enterprise in a free economy. But this would be preaching to the converted.
Most of you know far more about the virtues and the vicissitudes of free private enterprise than I do. I have the most profound respect and admiration for businessmen, large or small, who take the risks and organise the production of our wealth in such variety and profusion. They deserve to prosper.
But in my role of politician and in my capacity as Prime Minister, I must frequently take a larger view. Of course the state of the national economy of the United Kingdom is a recurring preoccupation of virtually all Ministers and in particular the Prime Minister and the Treasury. But the national economy is often quite crucially affected by [end p1] what happens in the rest of the world. In Australia, as in Britain, you are buffeted by international events and volatile markets. Healthy, steady, persistent growth of the world economy is important to us all. So I will ask you to share my reflections on the state and prospects of the world economy.
It is easy for economists, in the middle of one of the deepest recessions for many years, to be despondent about the prospects for the world economy. Cataclysmic prophesies, doom and gloom, certainly provide a supply of sensational headlines for which there is such a ready market. But any reflective observer should take a somewhat more calm, and certainly much longer, view of history and future prospects.
The last three decades have witnessed the most remarkable expansion of wealth in the history of man. The Western industrialised economies achieved an average income per head in 1980 that was two-and-a-half times bigger than in 1950. This is an average growth rate of about 3.2%; for thirty years. Even more interesting is the composition of this average. Much of the high figure was due to the performance of the miracle economies of Japan, Germany and France. Over these thirty years, Germany and France increased their income four-and-a-half-fold and Japan increased almost ten-fold. [end p2]
Perhaps even more remarkable to you here in Australia is the great success of certain newly industrialised countries in East Asia and the Pacific. They have created rapidly growing prosperous economies out of unpromising or even desperate beginnings. The most astonishing example is that of the Crown Colony of Hong Kong. Without any base of resources, only a rocky island and a tiny peninsula, lacking even the water needed to sustain a population frequently augmented by droves of impoverished refugees, Hong Kong has managed to produce growth rates equivalent to those of Japan. Its income per head is now about the same as that of countries in Southern Europe. Yet Hong Kong is not an isolated example. Taiwan, the Republic of Korea, Singapore, and to a lesser extent Malaysia and Thailand, all show evidence of vigorous and sustained growth and prosperity.
One of the common characteristics of all these countries is that they encourage free enterprise in the private sector. These miracles were not the result of some grandiose state plan; they were the aggregate of hundreds of thousands of individuals and firms each trying, and superbly succeeding, to improve his lot.
These countries have been bastions of stability when some of their neighbours were going through the turmoils of war and revolution. The newly industrialised countries were not tempted into [end p3] the paths of revolution and war. Their inhabitants were too busy creating wealth. Their main challenge and opportunities were to be found in the market place and not in gun or bomb. Our most distinguished economist this century, Lord Keynes, put this idea forcibly when he wrote the General Theory:
“Dangerous human proclivities can be canalised into comparatively harmless channels by the existence of opportunities for money making and private wealth which, if they cannot be satisfied in this way, may find their outlet in cruelty, the reckless pursuit of personal power and authority, and other forms of self-aggrandisement. It is better that a man should tyrannize over his bank balance than over his fellow citizens.”
I believe therefore that both in Europe, in the Americas and in South East Asia, and if I may presume to say so, in Australasia, the free enterprise systems create their own forms of stability. When most of the inhabitants have a stake in the system, with their own house, their own car and their own savings, and with the prospects of opportunities to improve their lot, it is doubtful if such people will be tempted to become revolutionary zealots. Such countries are an object lesson to other states that have embraced the various forms of planned and controlled economies. [end p4]
So can we conclude that the free enterprise system is alive, well and growing rapidly in Europe, South East Asia, South Asia, America and other parts of the non-Communist world? Some of you may have your doubts. The rate of growth of the world economy during the decade of the 1970s was much lower than in the 1950s and 60s. Even in those miracle economies Japan and Germany, the rate of growth was halved.
Before we follow our statisticians and economists, as they busily extrapolate these downward trends, we must ask what happened in the 1970s to cause this slowing down of growth. There is no doubt that many factors were at work to explain the decline. But one was dominant. That was the enormous impact of the increase in the price of oil in 1973 and again in 1979.
The increase in the price of oil was dramatic and very large. The decision of OPEC rendered obsolete much of the capital equipment of the western world, including plant, vehicles and buildings which had been designed for cheap energy. The world was faced with the problem of refitting and redesigning its equipment to take account of the soaring price of energy. And as you all know from your experience in industry, redesigning and refitting is expensive. It also takes a long time. [end p5] I believe that we have not yet fully adjusted to the first rise in oil prices in 1973/74. And it will be many years, perhaps even another decade, before the world has fully adjusted to the rise in 1979.
We can learn a great deal about the way in which different countries reacted to these increases in the cost of energy. Some tried to pretend that the increase had never happened; by subsidising the domestic price of oil. This policy of shielding the consumer from reality was politically popular—and so it continues to be practised in many countries. But the costs are immense. Such a policy perpetuates distortions, delays adjustments. It destroys the incentive to economise in oil, keeps up imports and soon results in adverse balances of payments. Other imports have to be reduced to close the gap and that begins the demand for import quotas and higher tariff barriers. But as this year's World Bank Development Report has pointed out, the countries which pursued policies of free enterprise and open markets adjusted much more rapidly than those which sheltered behind high tariff walls.
Protection and Free Trade
Yet calls for more protection are loud in every land. It is so easy to raise tariff barriers. It is so difficult to demolish them. [end p6]
Yet I remain optimistic. One of the main grounds for optimism is that manufacturing industry and indeed many extractive industries, have become truly international. It would be a form of commercial suicide to build tariffs against such a process. Secondly, technology is changing very rapidly. The chip is the basis for a new technological revolution which will transform communication and manufacturing. We need to keep an open window on the world's technology. Thirdly,—and I believe most important—the massive increase in foreign travel has demonstrated to many people that free trade enormously expands our choice and improves our material standards. A visit to Hong Kong or Singapore leaves an indelible impression of the virtues of freedom. I do not think that there are likely to be many votes for a siege economy.
Increased freedom of trade is only one of the preconditions for an expanding world economy. The other main requirement is that public confidence in the value of money should be restored. We must stop, or at least reduce drastically the inflation which afflicts virtually all countries of the world.
The rate of inflation in the industrialised western world in the first half of the 1960s was only about 3%;. From 1965 the great acceleration of world inflation began and we have no convincing sign that it is yet slowing down. Today, and in the middle of a sharp world recession, the underlying rate of world inflation is still well over 10%;. [end p7]
Of course the two great oil shocks were a considerable contributory factor in generating more inflation. Many Governments tried to spend their way out of problems of adjustment, and alas all they did was to add yet another turn to the inflationary spiral. But everything can't be blamed on oil. The inflation long pre-dated the oil shock. It all began in the mid-1960s with the fiscal and monetary expansion of President Johnson 's “great society” in the United States. (And in Britain we contributed our share: the Government launched its “go for growth” policy with the National Plan and its attendant expansionist measures.) The great expansion of dollars which was generated by President Johnson 's policy, culminated in the formal demise of the gold standard in 1971. Shortly after, the world inflation accelerated alarmingly.
Like the tariff, the inflation rate is easier to increase than to bring down. Yet Governments have decided that, painful and protracted though it may be, the fight against inflation must be won. As we saw at the OECD meetings this summer, there was wide agreement that, in order to bring inflation under control, there must be a long term reduction in the rate of growth of the money supply and that budgetary policies should try to contain or reduce deficits. Indeed, the OECD recommendations were remarkably similar to our own medium term financial strategy which we adopted more than two years ago. [end p8]
We all know that it is going to take a long time to bring the rate of inflation down to the levels which were customary some twenty years ago. It is unfortunate that we have to do this at the same time as world economies are adjusting to those increases in the price of oil. It was inevitable that the adjustments would be associated with a world rise in unemployment.
Yet I am relieved to see that almost all Governments have decided that this time we must grasp the nettle of inflation. We cannot spend our way out of trouble; if we try to do so we would end up with all the characteristic dislocation and ever higher unemployment of an economy in a state of super-inflation.
The great inflation inevitably brought about in 1971 the breakdown of the system of fixed exchange rates which had provided the firm background for the expansion of international trade and capital flows. Floating exchange rates have exhibited greater volatility than most of us expected. Nevertheless floating exchange rates did enable us to adjust to the two great oil shocks. Furthermore in the 1970s trade expanded relative to the expansion of production at roughly the same rate as before. There is no evidence that floating rates inhibited the international flows of capital. They continued to increase during the 1970s. Indeed, the great triumph of the world banking system, the recycling of the oil surpluses, was achieved under this floating rate regime with an ease which greatly surprised the world's economies. [end p9]
Of course fixed rates of exchange, provided they are really fixed, have many advantages. They would automatically guarantee that a country could not inflate in the long run at a rate greater than, or much less than, its trading partners. Central banks and finance ministers would have to adjust their policies so that the fixed exchange rate was upheld. In the medium and long term monetary policy would be out of the hand of the politicians; the money supply would be determined quasi automatically.
This system has many of the characteristics of the old gold standard which ensured stability of monetary policy and of the price level for virtually a century.
But nostalgia for a distant past should not cloud our judgement of today's realities. Although it may make sense for a small country to link its rate of inflation firmly to that of one of its big trading partners, it is very unlikely that any major economy will be willing to suffer the considerable strain and upheaval that a fixed exchange rate would involve.
However, this does not mean that Governments will have no role in influencing exchange rates. They may decide to limit the variations, or to carry out smoothing operations. Some may even go towards the sort of regional linking of currencies that we see in the EMS. [end p10] But it is unlikely that any Government or major economy will be willing to sacrifice its domestic policy in order to defend a fixed parity. I think it may be properly claimed that today, with the enormous size of the international capital market, no Government can afford to accumulate sufficient reserves to defend the exchange rate against a determined attack from a financial world that is convinced the currency must fall. So, float we must.
I wish I could end this talk by sharing with you my forecasts of the future state of the world economy. But you must forgive me. I make no predictions. I do not believe that there are any so-called general laws of history which will enable us confidently to say what the future will hold. This, no doubt, was in Sam Goldwyn 's mind when he said “Never prophesy, especially about the future.”
Nevertheless, you would want me to say a word about recent events.
We have been witnessing days of world-wide uncertainty in financial markets. Stock exchanges in New York, London, Paris, Dusseldorf, Tokyo and Toronto have all been affected. There has naturally been great concern and a desire to understand the full significance of what is happening.
The main source of this uncertainty has been developments in the U.S. and the attempts of the markets to assess what they mean for the world economy. [end p11] Concern about the future of interest rates has been a large part of this, because the world is one vast capital market. But there have been other elements too: the implications for growth and for prospects in each country.
All this illustrates the importance to each one of us of the success of the United States fight against inflation. The U.K. entirely supports that fight, and welcomes the further measures just announced by President Reagan. We applaud his determination to reduce the U.S. budget deficit. We see success in reducing that deficit as of great importance in making possible lower U.S. interest rates consistent with reducing inflation.
In the U.S. and elsewhere there have been uncertainties about the impact of these measures. The uncertainty has led to big fluctuations in stock markets. There were large initial falls, but also substantial recoveries.
What has happened in the London markets must be seen in this world-wide context. There, as elsewhere, there has been fear of the impact of higher interest rates because the trend generally has been upwards. But the underlying position in the U.K. economy has not changed. [end p12] U.K. industry has the benefits of an important improvement in productivity, a much better trend in pay increases, and also the recent fall in the exchange rate from the high level at the beginning of 1981. And we shall adhere to the policy of reducing inflation, containing public spending and securing a sound monetary framework for resuming growth.
Yet I would leave you with this reflection The trend towards freedom in most countries of the West has been one of the most encouraging signs of the Seventies. And throughout the world there is a new determination to defeat the evil of escalating inflation. For these reasons I believe there is a chance that, granted peace, the remaining years of the Eighties will continue that long run of prosperity which has so enriched our lives since World War II. Such peace and prosperity are not inevitable. They need to be earned by constant vigilance and the tireless defence of individual liberty. As defenders of freedom, you Australians have a reputation second to none. I am sure, Mr Chairman, that you will never yield that proud record.