INTRODUCTION (Hansard, 15 April 1975)

§ The Chancellor of the Exchequer (Mr. Denis Healey)

When I presented my first Budget just over a year ago Britain was simultaneously emerging from two months of three-day working and entering a period in which her own and the world economy were bound to be dominated by the effects of an unprecedented increase in the price of oil. Both the three-day week and the oil crisis created uncertainties about the development of our economy which made prediction dangerous and policy precarious.

A year later many of these uncertainties have diminished. We recovered more quickly than many expected at the time from the consequences of the three-day week, and in the middle quarters of 1974 output was 1 or 2 per cent. above the level of a year earlier. But now that the consequences of the oil crisis can be seen more clearly they provide a formidable setting for British economic policy in the next few years.

In the first place, the increase in the price of oil combined with the increases in the price of food and raw materials which we must import have inflicted a heavy blow on our real income ase a nation. Although through the year as a whole, taking into account the fall in the first two months and the later recovery, our gross domestic product was little changed, the savage lurch in the terms of trade against us between 1973 and 1974 meant that the nation's real income actually fell by about 4 per cent. last year—in effect, it took away 4 pence from every pound we earn.

We entered 1974 with a balance of payments deficit already running at a rate 274 equivalent to 3 per cent. of GNP. But the cost of the oil we imported last year was about £2,900 million more than the year before, and this left us with a current deficit in 1974 of £3,800 million—equivalent to more than 5 per cent. of our GNP. In effect, we were spending 5 per cent. more as a nation than we were producing.

In 1974 we had little difficulty in borrowing sufficient money to cover this enormous deficit on commercial terms, from sources which imposed no policy conditions on their lending. But there is a danger in future that the supply of unconditional funds may prove inadequate to meet our needs. If we are to go on attracting such funds their owners must believe that the value of the money they have placed with us is not threatened by the consequences of our policy actions or inactions.

This brings me to the second consequence of the oil crisis—its impact on inflation in Britain. In February last the Retail Price Index had increased nearly 20 per cent. compared with February 1974. The major source of this inflation for most of last year was the increase in world prices to which oil made such a contribution. But for many months now the prices of most metals and nearly all other industrial materials have tended to fall. The price of most imported foodstuffs except sugar and beef has been fairly stable. The price of crude oil to the United Kingdom has been much the same since mid-1974. So for the last six months or so the main cause of rising prices in Britain has been the scale of wage and salary increases, which were far in excess of what could be justified by the increases in prices and could not possibly be offset by improvements in productivity. Also, whereas last year we were not alone among Western countries in having a very high rate of inflation, there is a risk that this year we shall be out on our own, far above the rest.

§ Mr. Healey

I hope that I do not need to stress the domestic damage which 275 would be caused if inflation continued at this rate. Such inflation redistributes the nation's wealth and income in an arbitrary and anti-social way. It engenders a deep sense of insecurity in all sections of society. It distorts the allocation of resources and makes rational planning of expenditure extremely difficult at every level, for the housewife, for business and industry, and for the Government themselves. If we are almost alone among the industrialised countries with so high a rate of inflation it will have very serious consequences for our trade and payments. Our costs and prices will be tending all the time to rise relative to those of our trading partners. In other words, our international competitiveness will be tening to decline.

Unless we were willing to contemplate a continuing downward drift in our exchange rate which would increase our domestic costs and prices further still, we would find it impossible to prevent our balance of payments from actually deteriorating at a time when we clearly need to improve it substantially.

The third major impact of the oil crisis is one which affects the whole world but which I think we in Britain foresaw more clearly than many of our partners. The fact that the oil-producing countries would be unable at first to spend the enormous additional sums of money they earned meant that the rise in oil prices was bound to reduce world demand. We argued continuously last year that the consuming countries should recognise that the size of the resulting petrodollar surplus would threaten a world slump unless they were prepared to take compensating measures to increase demand. We ourselves did so in July and again in November to the extent which we felt we could afford, given the size of our external deficit and the rate of our domestic inflation. Others were much slower to react. The result is that the exceptional boom between 1972 and 1973 turned rapidly into a world economic recession which is already the most severe since the Thirties.

It is far too rarely recognised, even perhaps by Governments, how long a time lag there must be between fiscal action and its consequences for demand and employment. The main reason why our rate of unemployment in Britain has 276 risen so much less than that of nearly all our competitors is that we took action before the blow hit us. In fact, the effect of the July and November Budgets in stimulating employment in Britain is now being felt. It will add about £1,000 million to demand in the financial year which has just begun. By the same token the full effects of the recent measures of the German and American Governments will not be felt for some time. Nevertheless, they give us real grounds for confidence about the world outlook in 1976, although it is still difficult to be certain how soon world recovery will begin and how fast it will proceed thereafter.

In the early stages of the oil crisis there were also huge uncertainties about the size of the petrodollar surplus that was likely to emerge, and some exceptionally high figures were being quoted of the cumulative size which these surpluses would reach. Those who put about estimates of this size not only took a very pessimistic view of the future course of oil prices and the associated elasticity of demand but also appear to have underestimated the extent to which oil-producing countries would be able to spend their revenues, mainly on imports of goods and services, but also partly on very generous aid to certain countries of the Third World. There is a developing consensus that the cumulative petrodollar surplus will reach its peak a good deal earlier than expected and that the peak itself will be a good deal lower. Many people now believe that a cumulative surplus by 1980 of the order of $ 250 billion in 1974 prices is somewhere near the likely outcome. If this is indeed the case, then the strains on the international monetary system imposed by the petrodollar surplus will be easier to handle. Moreover, the new IMF recycling facility which is already operating, and the OECD Financial Support Fund which we signed last week, will help further to reduce those strains. But for the same reason the consuming countries will have to plan on transferring resources to the producers to pay for their oil faster and on a larger scale than seemed likely to be necessary a year ago.

I have started with this brief account of the impact of the oil crisis on Britain and the world because it establishes the setting within which we must seek to 277 solve our own national economic problems—problems which are at least a generation old, reflected in structural weaknesses which have so far defied the efforts of successive Governments. As I have said on more than one occasion, I do not believe that we are likely to find the solution to these basic structural problems solely through the instruments of fiscal policy. The whole of our post-war experience demonstrates that macroeconomic measures by themselves do not ensure that we have sufficient modern plant and equipment or sufficient workers with the skills needed to maintain our place in a highly competitive world market. They must be accompanied, therefore, by measures which directly affect the tempo and direction of our industrial development. I propose to include in my Budget provision for a number of such measures which at least start on the necessary changes, and will shortly be reinforced by the proposed new instruments of industrial policy.