Mr Chairman, ladies and Gentlemen.
It is a great honour to be asked to address this distinguished audience—and a great pleasure also to be back in New York which never ceases to astonish, delight, intimidate, inspire, elevate, and widen one's horizon's.
Mr Chairman, New York remains the economic and financial capital of the world's greatest military power, the world's greatest defender of liberty and, despite your real but short-term difficulties, the world's greatest economic power. So this is the right place to discuss the future direction of economic policy and, following the great victory of Desert Storm, the right place to discuss the economic aspects of President Bush 's “New World Order” .
Inflation and the Economy
It is also the right time to do so.
For, after a decade of rising prosperity, both our countries are suffering from a recession that has been more prolonged than some expected.I am delighted to hear that some economists are forecasting a speedy recovery—and even some central bankers have been detected smiling in private. But many of the businessmen I meet are more cautious.
Recovery will, of course, come—and with it revived investment and higher living standards. Let us hope it will match the long period of growth of the 1980s. But there is bound to be another recession in the course of time.
For the trade cycle is a permanent fact of economic life, which politicians can ameliorate by sensible policies, or aggravate by foolish ones, but which they can't abolish altogether.
It should be the aim of a prudent government to improve the nation's general economic performance at all stages of the cycle by removing obstacles to enterprise and mobility.
In that way, growth will be more sustainable, the inevitable setbacks less painful, and inflation less of a temptation to short-sighted administrations. [end p1]
What government should not do is attempt to compensate for the trade cycle by fiscal and monetary manipulation.
This policy has been likened to bringing out “sunshades in October” , either stimulating the economy when recovery is already under way, or pushing an incipient recession even deeper.
The facts of financial life make this a hopelessly hit-or-miss affair. A central bank inevitably has difficulties in controlling money supply growth, principally in predicting the demand for money. This is extremely difficult to achieve in the very short term. But over a period of three or six months—and certainly on an annual basis—it is much easier and, indeed, can be done.
So there is a strong case, as Milton Friedman has long argued, for a regular and predictable increase in the money supply calculated on a long-term basis.
And there is no case at all for any attempt at “fine tuning” .
What, then is the proper role of government in a free enterprise economy?
Government has the fundamental duty to provide a sound financial framework by controlling monetary growth in pursuit of a currency which holds its value.
It must control its budget deficit so as not to build up debt for future generations. And it must do so mainly by controlling its expenditure.
These are not truths of merely temporary application. They go to the root of government's fundamental tasks at all times and in all places.
As soon as politicians, economists or bankers devise ways to try to circumvent them—the trouble begins. It is no good departing from financial orthodoxy when political pressures mount. That is precisely the time you must stick to it.
If you tolerate a little inflation, it quickly leads to a lot of inflation.
As with any addictive drug, increasing the doses is required to achieve the same results.
If you ease up in the battle to curb public spending and allow government budget deficits to rise, you put an unnecessary interest burden on business borrowers and starve the wealth-creating industries. [end p2]
Or if your response to increased public spending is to put up taxes, you lose out even sooner, as talent departs, investment is postponed and hard work discouraged.
Britain in the 1980s
Britain was a perfect demonstration of that lesson.
For most of the post War period the British economy had been in relative decline. Some argued that this was inevitable, that it reflected fundamental weaknesses in British society or even the British character.
Government intervention was therefore regarded as the answer to these alleged weaknesses.
It only slowly dawned on people that the exact opposite diagnosis was the correct one. Government was doing too much, and the wrong things.
It was stoking up the money supply and therefore inflation in order to prop up companies that otherwise would have priced themselves out of the market. And when inflation took hold, it then intervened ad hoc to fix specific costs and prices and to bail out particular companies.
Whitehall—not the British people—was to blame for the resulting stagflation.
We had to reverse all that.
We provided a sound financial framework to beat inflation.
We cut back government borrowing.
But in the words of my friend and colleague, Keith Joseph, contained in a lecture at that time, we realised that “monetarism is not enough” .
So we also set out to create a framework favourable to enterprise: We cut penal rates of income tax and the tax on companies and we abolished some taxes altogether. We slashed burdensome regulations to encourage small businesses, the seedcorn of economic growth. We restored the balance in law both between trade unions and employers, and between unions and their members. [end p3]
We embarked on a vigorous programme of privatisation—forty-four major businesses so far—spreading ownership of capital and property ever more widely.
These policies were dramatically successful. The performance of the British economy was transformed.
And in spite of the difficulties of our present recession, the great gains made in the 1980s are not being lost. Britain now has a soundly based free enterprise economy.
Experience—The Name We Give To Our Mistakes.
But how, if we learned those lessons in the 1980s, did we allow the renewed inflation—which prompted this recession—to occur?
Why was money supply allowed to grow too rapidly?
Part of the explanation lies in the general response of all Western countries to the collapse of the Stock Market in late 1987.
Some people were talking of a Great Depression on the scale of the 1930s. It seemed imperative that all Western countries should respond by making sure that the financial market and the banking system were not short of liquidity. And we did.
But though this may have contributed something to the inflationary pressures we have seen, I do not believe it accounts for them fully.
For the real explanation, we must go back to first principles. We must rethink the basis of coordination of policies within the G-7 -and especially the coordination of exchange rate intervention.
With the Louvre and Plaza Agreements in the mid-1980s, we sought to put the objective of greater stability of international exchange rates above that of the control of inflation.
In Britain, we compounded this error when in 1987–88 we tried to shadow the deutschmark. Again the objective of a stable exchange rate was pursued at the expense of monetary discipline.
These policies led to falls in interest rates to artificial and unsustainable levels, which in turn prompted excessive monetary and credit growth. That produced the inflation with which we are all too familiar, and which is the underlying cause of the present [end p4] recession.
“Experience,” said Oscar Wilde, “is the name we give to our mistakes.”
And the conclusion to be drawn from our experience in both the 1970s and the 1980s is that governments should commit themselves to price stability—which can only be achieved by reduced monetary growth—and leave it to companies and individuals in the marketplace to calculate the various other risks in the business of wealth creation.
Targeting exchange rate injects excessive monetary pressure when central bankers “guesstimate” the wrong rate and, like fine-tuning, can produce wild swings towards inflation or deflation when the rate is either undervalued or over-valued” as East Germany is currently discovering.
When that happens, the “Stability” that makes fixed exchange rates superficially attractive to businessmen is either abandoned in dramatic devaluation or maintained at the cost of far more damaging instabilities like rapid inflation and higher interest rates. In the ERM Britain is fortunate to have a margin of six per cent to accommodate variations in the exchange rate.
In general, however, I recall the words of Karl Otto Pöhl, former governor of the Bundesbank: “Interest rates should be set according to domestic monetary conditions and the exchange rate should be left to go where it will” .
To which I will add: if you fix the exchange rate, then interest rates and domestic monetary conditions go where they will.
And finance ministers are left like innocent bystanders at the scene of an accident. [end p5]
Let me now attempt to draw from the economic experience of the past fifteen years four broad lessons. They are:——
1). An economy will work best when it is built on a framework of clear and predictable rules on which individuals and companies can depend when making their own plans.
2). Government's primary economic task is to frame and enforce such rules. Its own discretionary interventions should be kept to a minimum.
3). Within such rules individuals, families, companies, and other social organisations should be free to pursue success at the risk of failure. And—
4). Although governments will sometimes break the first three rules, public opinion should as far as possible make them ashamed of doing so and eager to return to observing them.
But do not the same rules—or something very like them—apply also to the “New World Order” envisaged by President Bush in the after math of America's two great victories in the Cold War and the Gulf War?
For make no mistake: America now has a unique, even awesome, responsibility. It alone occupies the position of the three wartime allies in 1944 and 1945 when the blueprints for the great international institutions like the GATT, the IMF, the World Bank, and the U.N. were laid down. It will be an American President and Congress who will have the dominant voice in drawing up any new blueprints.
Some of those institutions are flourishing—notably the U.N. now that the automatic Soviet veto has been removed. Some, like the International Atomic Energy Agency, will need strengthening to take on a greater role in combatting nuclear proliferation to “rogue” states.
And some face the challenges of new organisations—like the GATT facing the erosion of free trade as regional economic blocs attempt to assert their identities.
And what is true for organisations is also true for the rules of world order laid down in 1945.
One of those rules—that states should not commit unprovoked aggression against other states—has just been triumphantly [end p6] vindicated by President Bush's successful liberation of Kuwait. So triumphantly, indeed, that it is unlikely to be challenged in any clear-cut way for some considerable time to come.
But should there perhaps be new—and more ambitious—rules in the future? Must we continue to turn a blind eye to utterly appalling violations of human rights provided that they are confined within a country? Even if those violations send thousands of people like the Kurds fleeing into neighboring states as refugees, destabilising those neighbours in the process?
And if we are to have such wider rules—which would surely be a step towards a more civilised world—who is to enforce them? And under what authority?
Then there is the erosion of existing rules—principally in the field of trade and economics. Can GATT be given a new lease of life? Does it need strengthening?
Or the support of new organisations committed firmly to free trade? And if so, what?
And perhaps the biggest question of all: will the American people be prepared to undertake the role of Atlas holding up this new world order? Or, as in the 1920s, will the ingratitude of the rest of the world persuade them to retreat into a hemispheric economic isolationism?
Let me answer that last question at once!
I believe that the American people will be prepared to accept this burden of world leadership and to act as the international community's enforcer of last resort—but only if the United States can rely on the support of its allies, not only in ad hoc military coalitions but in a wider alliance encompassing trade and economic relations as well as the occasional rare military action.
I think you know I am not a Marxist! So I do not think that economics determines everything. But I do believe that you cannot have political and diplomatic unity in a West that is bitterly divided over trade and economic relations.
Let us remember that the world order established in 1945 was [end p7] sustained on the basis of Western economic cooperation. The West's military alliance and post-war prosperity could never have been achieved without, first, the Marshall Plan, and, later, the growth of trade within the orderly framework of rules provided by the GATT, the IMF and the World Bank.
However, that picture has to be qualified. Since the mid-1970s the volume of trade has continued to grow—but at a slower rate in relation to total world output than before. This is in part, because there has been a growth in covert forms of protection.
Our current challenge is to prevent the world slipping back into protection and instead to give a new momentum to freer trade.
How is this to be done?
We must honour the rules of the GATT and, where possible, widen their application.
We must ensure that the problems over agriculture, services and intellectual property rights—but above all agriculture—are resolved. And that the Uruguay Round is thereby salvaged.
For there is a harsh rule of politics to which international bodies are not immune. If things are not going forward, then they are going backwards. At present in trade they are going backwards.
Other moves toward free trade—provided these conform to GATT rules—should therefore be encouraged.
I welcome the creation of a US-Canada free trade area and the prospect of its extension to Mexico. These reforms should strengthen the economies of your two neighbours and hold down the cost of living for Americans.
It is vital, however, that these should not be steps towards a world of three protectionist blocks built around the US, the European Community and Japan. There are those in Europe who regard the prospect of two such blocs, engaging in managed trade with a new European Superstate, with apparent equanimity and even enthusiasm.
I am not among them.
Nor, I believe, should anyone who has at heart the interests of America or the West as a whole. For it would undermine the sense of Western solidarity under American leadership which is the only sure foundation of any [end p8] new world order built to last.
So these new blocks must be steps not towards protectionism but towards a world of freer trade.
When the Uruguay Round has been successfully completed therefore—and that will require the full cooperation of the European Community—we must take the next step towards wider economic integration.
We must begin to lay the foundations of an Atlantic Economic Community—embracing Europe (namely the European Economic Community, EFTA and the new democratic states of Eastern Europe) on the one hand and North America on the other.
This proposal has all the merits which are attached to any extension of free trade—greater economic efficiency leading to greater wealth, benefiting all those taking part. But it has two other important advantages, as well.
Given the liberal economic tradition of the US, Britain and several European Community countries, and given the fierce commitment to free market economics of the former communist states—such a block would be imbued with the philosophy of free trade.
And because it would account for no less than fifty-eight per cent of world GNP, other trading blocks and potential trading blocks would have to follow its lead in such matters. It would give the GATT real clout—halting and reversing the drift towards a world of protectionist blocks.
The second advantage is that, by moving in this direction, it would strengthen the vital ties of defence and culture which link America and Europe, and which the drift to protectionism and trade wars threatens to undermine.
It would, in effect, be the economic underpinning of NATO—and make a great deal more sense than the various half-baked schemes for giving a defence identity to the European Community.
This proposal is only the beginning of what would be a very long road. It certainly needs close and detailed study.
We would need to lay out very carefully the steps to merging a European Single Market and a North American Free Trade Area and what mechanisms would be required to settle disputes over obstacles to trade. No one with experience of negotiating the Single Market in Europe would pretend that will be easy.
We would need also to work out transitional arrangements for [end p9] some industries, particularly steel, agriculture and some services.
But none of those need be insuperable obstacles. I hope that in the months ahead a group could be formed to look at all these matters with a view to a practical time-table for such a scheme.
Because, to repeat the political law I quoted above: if things are not going forward, then they are going backwards. And in matters of free trade they are going backwards. [end p10]
But I am encouraged, Mr. Chairman, by remembering the role that America and Britain played at the end of the Second World War at Bretton Woods in laying earlier foundations for the Free World's economy. Our countries were both closely involved in setting up the IMF, the IBRD, the OECD and, of course, the GATT.
Like NATO, these international institutions have stood the tests of time and stress. Like NATO, they have always depended on trust nd on common goals. And no matter how many institutions you create—or how elaborate their acronyms—if they do not have such a basis they will not long endure.
One such basis is provided by the special relationship between the United States and Britain. Our shared commitment to free enterprise capitalism, to free trade and to liberal democracy—will be tested in many ways in the years ahead.
So let us now resolve that the triumph of these Western values should not be some transient phenomenon.
Let us hold fast to the truths by which we set our compass.
And let us extend a helping hand to those who follow us on the glorious trail to a freer and more peaceful world.