Inflation is De-capitalizing British Industry.
Leith, August 8 1974
Argument over Mr. Healey's second quarterly budget is likely to continue in one form or another until the run-up, if this government survives, to his third in the late autumn. This new Labour invention, the quarterly budget, epitomizes the frantic escalation of intervention to which Labour has committed itself. No sooner has one budget been introduced than Mr. Healey is discussing its successor apparently designed to counteract the unanticipated effects of its predecessor. In other words, the economy, the business community, the public, are being turned into a kind of punchball – inflation, deflation, reflation, higher taxes, something off, expand, contract – until we are completely punchdrunk.
While this non-stop performance is going on, British industry – and the jobs and the social services that depend on it – is in danger of bleeding to death from loss of profits.
[Footnote: National Income and Expenditure 1963–73, HMSO, 1974; Economic Trends. “The Real crisis now facing Britain's industry”, A. J. Merrett and Allen Sykes, The Financial Times, September 30th 1974: “Profitability of British Manufacturing Industry”, M. Panic and R.E. Close, Lloyds Bank Review, July, 1973.]
And I mean this without exaggeration. In my Upminster speech I used the word “debilitated” and meant it. Here I am spelling out why I used that word to describe the condition of much of British industry.
Socialist politicians tend to welcome any business failure as evidence of the weakness of the free enterprise system. It is not such evidence. The fact is that ever since the war industry has been debilitated by well-meant but damaging political policies.
[Footnote: Economics and Economic Policy in Britain, 1946–66, T.W. Hutchison, Allen & Unwin, 1968.]
It has no reserves with which to cope with inflation and with the mischief of Mr. Healey and Mr. Benn.
Three decades of almost continuous inflation and erratic government intervention have so debilitated British industry that large sections of it could soon come near to collapse unless something is done to remedy the harm. I say this with full awareness of the seriousness of what I am saying. Things are worse than most of us in Parliament realize, worse even than many people inside industry itself fully grasp, or if they understand it are prepared to state publicly, or if they have said it, have not been given a hearing.[end p1] [end p2]
The profit haemorrhage
Profitability has declined to such an extent that some firms can no longer replenish their working capital, to accumulate the additional working capital needed to finance operations in face of rising prices let alone to finance new investment. Many firms are finding it increasingly difficult to meet their obligations. Few can raise new capital in the money markets as they did in the past, because they do not produce the profits needed to service it.
A substantial part of manufacturing industry will soon as a result of debilitation by government policies and union attitudes over a long period, intensified by inflation and by the unprecedentedly damaging policies of the present government, be in serious difficulties through lack of profitability. Unless something is done soon significant numbers of basically sound companies will, for these reasons find it difficult to continue trading.
The next government – whether or not it is Conservative – will need to enable industry to improve its profit position if grave danger to employment, the social services and the fabric of our society is to be avoided.
Why have we only now woken up to this state of affairs? There are several answers. Companies do not like to publicize their own difficulties; politicians and business experts do not like to cry wolf.
But the main answer is that inflation has not only helped to undermine profitability but has also masked the process for some time. We were inebriated by inflation.
But first let me outline the facts. Over the past 12 years or so as I have said, profits have suffered a catastrophic decline. The profitability of all private sector companies fell by over half in less than 10 years. From the late 1960's, even nominal profits have begun to fall in spite of substantial new investment over the past dozen years.
[Footnote: Company net-of-tax profits have dropped by 42.5 per cent. in money terms during 1973 and are now running at around 37 per cent. of their 1963 level despite an increase in real fixed investment during this period of over 50 per cent. These comparisons are before correcting for changing money values.]
Taxing non-existent profits
These published figures are bad enough. But they understate the decline in profits. You will all realize that £100 today is worth only half of what it was in the mid-1960s. So an apparently stable rate of profit means decline. But that is not all. For our tax laws do not recognise the existence of inflation. On the contrary, they regard an increase in the money value of stocks held as profit to be taxed, though in fact companies do not benefit from this increase. On the other hand, the tax authorities allow firms to offset depreciation of their assets against tax only on the basis of historic cost, although we know very well that a new machine will now cost two or three times what the old one did. In other words, profits in company accounts are inflated three times over – as revenue; by revaluing stocks, and by understating true depreciation.
[Footnote: Merrett and Sykes, op. cit.]
This means that firms are paying tax on profits which do not really exist. It also means that they may be paying dividends on profits [end p3] that do not exist either.
As I have said, on average the rate of profit has fallen by over half in 10 years. This is the average figure. By and large some fields of business have done better than average and some worse. Manufacturing industry has on the whole done worse, particularly the metal industries which have to re-equip often: it is not only that machines wear out, but technology advances.
A NEDO study last September summed up the situation in the engineering industries, the heart of British economy.
[Footnote: Inflation and Company Accounts in Mechanical Engineering, September, 1973.]
It reviewed inflation in relation to accounting, and re-examined company accounts for the period 1966 to 1971. After adjusting for the changed value of money, it discovered that firms which on the face of it had made good earnings and ploughed much of them back into the firm, had in fact scarcely made any profit at all. When stock appreciation and the real replacement cost of their fixed assets were taken into account, they had gained little, some were even running down their net worth.
Most of the companies concerned have continued paying dividends of sorts on their paper profits. But if they were not making real profits, or certainly not enough to cover dividends, where were the dividends coming from? The NEDO study comes to the conclusion that a substantial number of engineering companies have been simply running down their business in order to meet current outgoings, interest on loans and dividend and other obligations. They are not keeping enough in the kitty to re-equip themselves. In many cases they are now short of working capital. As current prices rise further or their cash receipts fall, for any reason, they face serious liquidity problems, which could prove fatal for some, unless the situation is mended soon.
You may say that it is illegal to pay dividends out of capital; directors have been tried and imprisoned for this in the past. True, but that was in the bad old days when money retained its value for decades. Today the law obliges firms to pay tax out of capital on paper profits; it cannot easily forbid paying dividends out of the same paper profits. A change in our tax laws to recognise inflation, the declining real value of money, is now well overdue.
Capital not for borrowing
If firms cannot meet their investment needs out of their own resources, and in many cases not even their working capital needs, where will they find their capital? Until recently, a sound firm could raise all the capital it needed in London through the merchant banks and the Stock Exchange. London is the world's capital market. But now our manufacturing firms, however technically sound and well managed, cannot raise capital any longer, if government and unions do not permit them to earn the profits needed to service it.
When money loses its value at the rate of 10, 12, 15 or 20 per cent per year, when banks pay 12 per cent. interest and charge 15, who will lend money – his own, or his depositors' – to firms which at best make a few per cent. profit and may well soon be making losses?[end p4]
Here then are the facts. Before I come to the implications for all of us, let me deal with the causes. Why should British industry, which still leads the world technically in many fields and has been profitable for most of modern history, now suffer reduced profitability? Let me list some of the causes that have brought industry nearly to its knees.
Inflation, the arch-destroyer, has inexorably sapped the vitality of industry, forcing up the scale of working capital required, squeezing profit between price control and soaring costs, undermining the one area of certainty and stability on which business and most other plans depend.
[Footnote: “Inflation and Declining Profits”, Colin Clark, Lloyds Bank Review, October, 1974.]
Taxes required to finance increased government expenditure have placed additional costs on industry for many years past,
[Footnote: The Power To Destroy: A Study of the British Tax System, L. R. Myddelton, Johnson Publications, 1969.]
rates, corporation tax – and that which it replaced – national insurance contributions, and a host of subsidiary levies, direct and indirect. Profits of industry have not only to help finance the social services, and defence and much else, but also help support loss-making nationalized industries and industries receiving subsidies. Now I am not arguing here about the principle of the mixed economy, but about the mix. The lean kine have eaten the fat kine and grown even hungrier as a result. There are few fat kine left.
Another cause of debilitation is dear money. The rate of interest has risen spectacularly, partly to offset the decline in the value of money, partly because central and local government have been taking such a large share of savings available. Local authorities now take up a substantial proportion of short, medium and long-term credit available through the Stock Exchange, money market and banks. They can always find the money needed to pay going interest rates – however high, they adjust income to meet expenditure. This both forces up interest rates to industry and leaves them less credits. So, in effect, town halls, community centres and swimming baths are built at the expense of industrial development.
Wage increases have soared far beyond productivity increases. Increases in wages are in themselves good, provided they do not cause price increases. But there has been a widespread lack of co-operation in increasing productivity by the use of new machinery and techniques. So wage increases have far outstripped productivity increases, prices have soared and profits have been squeezed.
[Footnote: Financial Statistics, Interest Tables, HMSO.]
Incessant policy changes by governments, though undertaken with the best intentions, have undermined industry's ability to plan ahead, improve its efficiency as much as it would have desired, and even to meet commitments. “Stop-go” has made good management difficult. Over the past 25 years government policy on investment incentives, etc. has changed 16 times! Instead of concentrating on the market and on serving it, management is forced to devote much of its time to coping with government gyrations. All these burdens and uncertainties have prevented proper forward planning, and forced industry to live increasingly from hand to mouth, rather as government now does. You can insure against acts of God, but not against acts of government, though the latter are becoming more cataclysmic. [end p5]
For much of the period industry has been subject to price controls, formal and informal.
[Footnote: Hutchinson, op. cit.]
While prices and profit margins have been severely constrained, costs have remorselessly risen, not least by government action.
Lastly, the seventh lean cow to eat up our wealth producers for most of the post-war period – the £ sterling has been over-valued, as a result of efforts to keep the economy running at a high level by over-expanding demand. This has made it harder for British industry to export and even to compete with imports into this country.
All these difficulties for industry were created as a result of economic policies which were well-intentioned but harmful in their effects. It is not enough to take one's share of the responsibility: the lessons must be learned and urgently applied.
The vendetta against profits
But still worse, and less excusable, there has been a whole range of difficulties created by the anti-profit, anti-private industry climate which has prevailed in parts of government, media, universities and trade unions. So the private sector has been on the defensive. “Profit should not be a dirty word”, Mr. Healey told a business audience recently.
[Footnote: CBI annual dinner, Hilton Hotel, May 14th, 1974.]
When I hear him tell a Labour or union audience this, I shall believe in his change of heart. For if profit is a dirty word in many circles, who made it so?
[Footnote: Socialism and Nationalization, op. cit.]
In those countries which are our successful competitors, the prestige of industry – ownership and management – is high. Industrialists and managers are recognized as the real creators of wealth, as the men on whose shoulders the whole economy is carried, whose efforts provide employment, find the taxes to pay for schools, defence, welfare, whose dividends underpin pensions, insurance policies, and savings. In Britain a large proportion of political and intellectual opinion-formers is convinced that we can dispense with profits. Socialist governments are torn between trying to weaken the private sector, so that they can take it over, and trying to make it work in the meantime to support the economy.
No wonder that their utterances and actions alike are so self-contradictory, and that industry suffers.
Conflicting purposes of trades union
Trade unions suffer from the same politico-economic split personality. As economic men, they want private firms to be healthy and profitable, to be able to afford good wages and conditions for their workers. But as political animals they want to fight capitalism, bash the bourgeoisie, usher in state capitalism, even though they know that the state is a bad employer, which over-mans, underpays, uses the public sector as an economic regulator, and generally depends on Treasury hand-outs for improvement in wages.[end p6]
Industry's hostile environment
And then, to add insult to injury, after all the difficulties placed in industry's way, politicians and press have the cheek to chide industry for its poor performance. People who could not tell a lathe from a lawnmower, and have never carried the responsibilities of management, never tire of telling British management off for its alleged inefficiency.
I would not dream of claiming that all is well in British industry, or that it ever will be perfect. But by and large, the quality of British industrial management, initiative and design are highly thought of in the industrialized world.
Indeed, considering all the obstacles placed in its way by government and unions, British industry has done remarkably well and deserves combined congratulation and commiseration – not blame.
The fact of the matter is that we politicians have over-estimated the ability of government to do good by intervention. We politicians have been guilty of hubris: it is British industry on which nemesis has been visited. We have no right to tell the industrialists: “Find you own way out”, while we are standing on their lifeline. We must get off it.
Even Socialists need profits
I know that Socialists and Trade Unionists may be in two minds over this prescription. If difficulties they have helped to create make it easier to take firms or whole industries over, why not welcome the difficulties as doing this good work? But they had better look before they leap.
[Footnote: British Capitalism, Workers and the Profit Squeeze, A. Glyn and R. B. Sutcliffe, Penguin Books, 1972.]
It is one thing to take over profitable firms, man them with loyal self-confident Socialist proteges, and hope for the best. But what do you do if nationalization in whatever form or by any other name has the effect of making losses? Where will you find the money to subsidize these new flocks of lame ducks?
And if some of the firms collapse in the meantime, if some of the profitable private sector vanishes, there will be a shortage not only of jobs and much else but also tax revenue. The government – unless it raises other taxes – will have difficulty in honouring properly its huge existing commitments, to the NHS, to education, to the pensioners, to defence, let alone have the funds for wholesale rescue. Moreover, a substantial part of industrial and other equities are held by institutions – pension funds, insurance companies, small investors through unit trusts. One study suggests that 85 per cent. of all families are to a greater or lesser extent dependant on the yield of securities.
[Footnote: Based on a Stock Exchange Study of 1966.]
What would happen if there were wholesale failures of companies in which such institutions have invested? This is no distant prospect.
Already some firms are having to make good the shortfall of pensionfund investments out of profits or capital, just at a time when profits are at their weakest and working capital under pressure. True, local authorities and nationalized corporations can make up their employees and staff pension-fund shortfall out of higher rates and [end p7] taxes. But as profits fall, where will additional taxes and rates come from?
Liquidity crisis looming
When you go round and see factories working, boards meeting, you find it hard to believe that there is a crisis just round the corner. But do not be deceived. The liquidity crisis is on us. One firm after another will go to the banks for loans to top up working capital, but loans will add to costs and cannot be unlimited.
[Footnote: ‘… we are sick and tired of the queue of Rolls-Royces one can see every day outside the Dept. of Industry: begging bowls of their passengers at the ready’, Mr. Kilroy-Silk, Col. 1753. Hansard, 12/7/74.]
Once some companies begin to falter, the effects could be incalculable.
One is reminded of a house being eaten away by termites: one moment it looks as it has always done, the next it has collapsed.
It is against this background that Mr. Healey's second quarterly budget – his July budget – must be assessed. I appreciate his dilemma. If he inflates a little – let us use plain English rather than talking about reflation, giving back, etc., – it will temporarily halt the deterioration. But at what cost? The shot in the arm – and what an apt simile – will get the blood flowing faster, but then the haemorrhage, the loss of profits, will go on faster too. Pep pills are no cure for haemorrhage.
Needs for increased profitability
Successive governments – Tory and Labour – with the aid of the unions, and the encouragement of the media, have helped undermine British industry – with the best of intentions, of course. Now Healey and Benn wish to give it the coup de grace. Even a strong economy might not be able to afford a Healey or a Benn, but we certainly cannot afford them now after three decades of debilitation.
There is no easy way out, we need urgent measures to increase profitability and to help bring home the facts to the public, all the public. At present, pronouncements by Mr. Benn – but on behalf of the whole Labour leadership and Labour policy – have encouraged workers to believe that they have nothing to lose from their firm's difficulties, only to gain – if the firm stumbles, government will take them over. Let Mr. Healey and Mr. Wilson say publicly what they know privately: that at a time like this, if industries fall the government will be in no position to catch them, it already has its hands full. Let them tell the unions to stop throwing stones, because they live in the same glass-houses as their employers.
Unless the next government – whether it be Conservative or not-enable industry substantially to improve its profit position, it will do serious damage to employment, social services and the fabric of British society.
Leith, August 8, 1974[end p8]