HC Deb 14 March 1989 vol 149 cc293-5

The Government's first 10 years in office have seen a transformation both in the way in which economic policy is conducted, and in the results that have been achieved.

For the first time, economic policy has been set firmly and explicitly in a medium-term context. We have been guided by the basic philosophy that the Government should set a sound medium-term financial framework and leave the private sector free to operate with confidence within it.

The Government came to office with two central objectives—to defeat inflation, and to breathe new life into a moribund economy—and a clear idea of how to achieve those objectives. Inflation is a disease of money; and monetary policy is the cure. The role of fiscal policy is to bring the public accounts into balance and to keep them there, and thus underpin the process of re-establishing sound money.

Strong sustainable growth is achieved, not through any artificial stimulus, but by allowing markets to work again and restoring the enterprise culture; by removing unnecessary restrictions and controls and rolling back the frontiers of the State; by reforming trade union law and promoting all forms of capital ownership; and by reforming and reducing taxation.

The first and most urgent task we faced was to damp down the inflationary fires that had raged in the 1970s, and wrought so much economic and social havoc; and we succeeded. Between 1974 and 1979, inflation had averaged more than 15 per cent. Over the past six years it has averaged 5 per cent.—still not good enough, but a massive improvement.

Once business and industry recognised the fundamental changes that were taking place, they responded to the new economic climate with vigour and confidence. As a result, we have experienced the longest period of strong and steady growth since the war. Output in the United Kingdom has grown faster than in all the other main European nations during the 1980s—a marked contrast to the previous two decades, when we were bottom of the league—and this growth has been based on a dramatic and sustained improvement in productivity.

For the economy as a whole, our productivity growth has been second only to that of Japan among all the major nations during the 1980s, and our productivity growth in manufacturing has exceeded even that of Japan.

In Britain today we have more people in work than ever before in our history; they are better motivated than ever before, and their living standards have improved beyond recognition. But it is not just our economic performance that has been transformed: so have our prospects for the future.

Over the past seven years, investment has grown more than twice as fast as consumption, creating the increased capacity necessary to meet future demand. Total business investment is now a higher proportion of national income than ever before, and its quality has improved immeasurably, too; as has the quality of British management. We have seen a dramatic and long overdue improvement in company profits and a remarkable growth in the total number of businesses, last year at the rate of more than 1,000 a week.

Provided we stand firm in our resolve to get on top of inflation, the prospects before us are excellent. At least on this side of the House, we do stand firm.

A year ago, in the aftermath of the worldwide stock market crash, it looked as if there would be some slowing down from the rapid growth of 1987. In fact that was not to be.

As the House knows, the state of the national income statistics leaves much to be desired, but it now appears that we had in 1988 a second successive year of growth at 4.5 per cent., with unemployment falling by over half a million, to well below the European average. Manufacturing output grew particularly rapidly, by more than 7 per cent., to a level well above the previous peak.

But total spending also grew by getting on for 7 per cent., mainly because of the boom in industrial investment, in itself a welcome event, but also because of continued strong growth in consumer spending. This last was financed to an unprecedented degree by borrowing, overwhelmingly mortgage borrowing.

Invevitably, the rapid growth of total spending led to renewed inflationary pressure. To some extent this was diverted into a sharp rise in imports, and hence into the deficit on the current account of the balance of payments. The published figures put this at £14.5 billion in 1988, although, given the £15 billion positive balancing item—another name for errors and omissions—the true figure:is almost certainly less than this. But whatever the true figure, it is undoubtedly large, and a sharp increase on the deficit recorded in 1987 after seven successive years of surplus. Given sound policies, however, it can readily be financed.

Moreover, unlike previous current account deficits we have known in this country, it reflects not excessive Government borrowing, but rather an upsurge of private investment unmatched by private savings, and this imbalance is something that will in due course correct itself.

The real threat is posed by the increase in inflation itself. Excluding the distorting effect of mortgage interest payments, the RPI rose by 4.5 per cent. last year, much the same as the average over the previous five years, but this underlying rate increased significantly through the year, and now stands at 5.5 per cent.

Moreover, the increase in inflation appears to be a worldwide trend. Taking the seven major industrial nations as a whole, inflation is now at its highest level for three and a half years.

In the United Kingdom, as in a number of other countries, it became clear that it was necessary to tighten monetary policy sharply. That meant raising short-term interest rates, which I duly did, starting last June.

I am, of course, keenly conscious of the difficulties many borrowers, particularly home owners, are now experiencing. But however unwelcome high interest rates may be, they are infinitely preferable to the damage that would be done by high inflation.

There are now increasing signs that the determined action that I have taken is having the desired effect. The housing boom that played such a large part in the events of last year has subsided. Monetary growth has slowed down appreciably, and retail sales, too, seem to have levelled off over the past four months, presaging a gradual recovery in the personal savings ratio.

The outlook for 1989 is for inflation to rise a little further over the next few months, from 7.5 per cent. including mortgage interest payments, to about 8 per cent., before falling back in the second half of the year to 5.5 per cent. in the fourth quarter and perhaps 4.5 per cent. in the second quarter of 1990.

Some slowdown in real growth is inevitable as we get inflation back on to a downward path—indeed, it has almost certainly already begun to happen. Overall growth is forecast to fall from the 4.5 per cent. recorded last year to 2.5 per cent. this year, with growth through the year at 2 per cent.

Domestic demand is forecast to slow down even more markedly. But within this, investment, which is holding up well, is once again forecast to grow faster than consumption. The current account deficit is forecast to remain at the same level as last year.

But the question of just how "soft" or "hard" the so-called landing will be is not in the hands of Government alone. The Government's task is to reduce inflation by acting, through monetary policy, to bring down the growth of national income in money terms. The task of business and industry is to control their pay and other costs. The more successfully they do so, the less costly in terms of output and employment the necessary adjustment will be.

Over the medium term, however, it is clear from our experience over the past 10 years that the policy we are pursuing will bring inflation down, and steady growth will resume. The best contribution the Government can make to this is to carry forward the process of supply side reform, to help make the economy work better. That is the objective of the specific measures to which I shall turn in the second part of my statement.