Commentary (The Times)

Economy: Editorial: “The Chancellor’s Conundrum” ("appears to go on digging the hole still deeper")

Document type: Press
Source: The Times , 11 March 1981 (p15)
Editorial comments:
Importance ranking: Major
Word count:
Themes: Economic policy - theory and process, Monetary policy, Public spending & borrowing, Taxation

The Chancellor’s Conundrum

Sir Geoffrey Howe’s third Budget is something of a conundrum. The tenor of it was that we were nearly at the bottom of the present economic cycle and Britain was now poised to take advantage of recovery. We had, in short, dug the foundations and now was the time to build. That is a proposition which would find wide support. The difficulty with Sir Geoffrey’s Budget is that it appears to go on digging the hole still deeper. The fiscal measures of the Budget amount to a further deflation of £3.3bn which would, other things being equal, promise a further reduction in output and an increase of perhaps 200,000 in unemployment. Other things are, however, never equal in economic policy. On this occasion, considerable importance attaches to non-fiscal measures, to the cut in minimum lending rate, to its effect on the exchange rate, and to other non-fiscal measures the Chancellor may sanction during the year. The Government has impact on the economy over a range of non-fiscal policy; never has that been so important. And here is the conundrum.

The Chancellor claimed success in reducing inflation as a precondition for sustainable growth. He was justified. Pay settlements have begun to show a sense of realism in response to the sharp increase in unemployment. Some good companies have suffered unduly; but many have been able to become leaner and more efficient. Those who advocated a period of restraint as the only way to ease the inflationary pressures have good reason to point to progress. We are, in this area, a long way from the wage anarchy the Government inherited.

Soft years cushioned by North Sea oil

These are the positive achievements of the policy and it would be folly to throw them away in the familiar “Go” reflation for which the Labour Party was clamouring yesterday. To reduce VAT and still further encourage consumption is the kind of crude expansion Milton Friedman has characterized as scattering banknotes from a helicopter. The Chancellor was unreservedly right to raise the excise duties. The Thatcher years have been portrayed as years of harshness, and so they have been for the unemployed and for businesses. But for those in work they have been soft years, with private consumption too much sustained by North Sea oil and public current expenditure at the expense of company profits and investment. Between 1976 and 1981 the rise in private consumption has been at an annual rate of 6.7 per cent of the national income, while fixed investment, the bedrock of future non-inflationary growth, has fallen by 2.3 per cent.

The Chancellor, echoing the Prime Minister’s frequent warning that the country cannot hope to consume more than it produces, was therefore, in our judgment, making a central point when he emphasized the need for all of us to make sacrifices of individual spending power in the short term to help business provide jobs and prosperity in the long term. In this aspect of policy we would only part company with him over the failure to make any adjustment for inflation in the levels of direct taxation. We have had too many consumption-led booms sucking in imports and fuelling further inflation. It is to non-fiscal measures, directly stimulating investment and exports, that we must look for recovery, and it is here that economic judgment on the Budget must be suspended. The Chancellor has cut interest rates which have been strangling industry, but only by 2 percentage points. It does not seem likely that the exchange rate, which he rightly wants reduced, will respond to such a small cut in MLR-indeed sterling rose yesterday after the announcement. What else does he have up his sleeve?

Prudent control of the money supply is certainly required, but that is no longer an adequate prescription for policy. We require further cuts in MLR, a lowering of the exchange rate to reflect or reduce competitiveness, and increased resources for productive investment. No one looking at the economy today could claim that it exhibits overheating. Unemployment is rising sharply, output has been falling and investment in industry is experiencing one of the sharpest downturns since the war. The Government’s difficulty is that it includes public investment in its anathema for “public spending”. That is seriously misleading. There is a fundamental difference between government spending on current consumption and investment in the capital programmes of the public sector. The problems which the Government has faced in cutting its current consumption have forced it, like its predecessors, to concentrate its cuts on the capital side. The effects of this have been dire. In 1974, one fifth of all public spending was capital expenditure; last year, the figure was down to one tenth. The volume of spending on some of the basic parts of the infrastructure of an advanced economy has been slashed.

These cuts have caused double damage to the economy. Services such as telecommunications which are the lifeline of both industry and finance have been strangled to meet financial targets which have nothing to do with the merits of the case. If British Telecoms was free to raise money for all schemes which are profitable, it would not find itself in the ludicrous position where consumers are queuing to pay for services it is unable to provide.

The second kind of harm which has been done is less obvious but even more pernicious. Cuts in public spending on investment are really cuts in demand for things which the private sector provides. The most obvious victim has been the construction industry, which has suffered greatly from cutbacks in all kinds of public investment and was given some modest assistance yesterday. But there have been many more examples, for example in electronics, or in firms which could have directed their surplus capacity to electrifying the railways.

There must surely be some discrimination in regard to the public sector borrowing requirement to protect the essential infrastructure provided by the state. To curtail public investment because the PSBR has been inflated by dole money and by dear money is a recipe for disaster. A public investment programme would have a net cost far less than the amount committed to it, for by cutting unemployment it would reduce that fastest growing and least useful form of public spending - the paying of people to be idle. Nor would increased public investment be inflationary. The factories which produce the goods are under capacity. And where demand would be increased so would the means of satisfying it. Some kinds of expenditure, indeed, could cut inflation by increasing efficiency. There may be many things wrong with British industry but the obsolescence of much of its equipment clearly adds to cost inflation.

Current spending is enemy of revival

All this is emphatically not an argument for the Government letting its spending roar ahead as part of an indiscriminate stimulus of demand. It is Government current spending which is the enemy of revival, not capital spending. And it is current expenditure which is due to increase in 1981-2 while there is a further fall in fixed capital formation.

Public investment must lead the way, for it will provide the vital underpinning to reassure private industry thinking of expanding its output. But the momentum and richness of recovery must be provided by the private sector. A considerably greater flow of credit from the banks to small and medium business is a prime requirement. There is some recognition of the case in the pilot loan guarantee scheme-but will the Chancellor follow through? Who is this Mr Hyde who has grabbed £400m of bank profits?

If Sir Geoffrey now intends to hand over the course of the economy to automatic pilot, guided only by the primitive compass of monetary aggregates, we are destined for a very rough passage indeed. But there are some indications that, in the learning process in which we are all engaged, the navigator has indeed appreciated the crucial difference between recovery led by consumption which could only lead to a recurrence of severe inflation, and recovery led by investment and exports that is the only salvation for Britain. We hope that is where the Chancellor is guiding us.