HC Deb 08 March 1991 vol 187 cc643-50

Motion made, and Question proposed, That this House do now adjourn.—[Mr. David Davis.]

2.33 pm
Mr. Ken Livingstone (Brent, East)

I ask the House to consider the question of the exchange rate and the particular problems that the country faces as it continues to slide into its second most serious recession since the second world war. It comes close to matching the horrors between 1979 and 1981, when 25 per cent. of Britain's manufacturing capacity went out of business, leaving it permanently weakened in the economic conflicts between nations in the struggle for trade.

No one can deny that the economy is in a full-blown recession—although it took the Government long enough to admit it. The average measure of gross domestic product has fallen by 1.4 per cent. in the third quarter of 1990, according to the latest available figures. Manufacturing output has fallen by 5.6 per cent., since its peak in April 1990. The result is a rapid rise in unemployment—it has risen by 280,000 since the trough in March 1990.

The cause of all that is the high interest rate policy pursued by the Government. Contrary to what we are now being told in the press, the Government are not reducing interest rates. Real interest rates are being maintained. They are reducing interest rates as inflation falls, but the real burden of those rates remains the same. The 2 per cent. reduction in interest rates is purely nominal, as the rate of inflation has fallen by 2 per cent. The same burden remains for British industry and for the average mortgage payer.

I argue strongly for a different approach to our economic problems. The burden of high interest rates is crippling British industry. Every day in the papers we see reports of new casualties—companies that have collapsed under the burden of the financial albatross that they have to carry round their necks, as they struggle to pay off, at inflated rates of interest, debts that they accumulated in previous years.

The financial deficit of industrial and commercial companies, at 6 per cent. of national gross domestic product in the second quarter of last year, and at 5.6 per cent. of GDP in the third quarter, is the worst since records began in 1963. That spells not merely a deep recession, but one whose ramifications will continue for a long time to come.

The domestic recession is being severely worsened by an overvalued exchange rate. When the present Government came to power in 1979, they inherited an essential equilibrium in the balance of payments. In 1979 the current account deficit was 0.3 per cent. of GDP, but by 1990 it had deteriorated to become the most prolonged and serious peacetime balance of payments deficit in United Kingdom history. There were three successive years when current account deficits exceeded 3 per cent. of GDP—1988, 1989 and 1990. That by far exceeded the two previous worst periods of deficit in post-war British history—one arising in 1951 in the aftermath of the Korean war, because of its impact on our balance of payments, and the other between 1973 and 1975, because of the crisis caused by the dramatic increase in the price of oil which followed the Yom Kippur war. The present balance of payments deficit dwarfs those.

If one aggregates the deficits of those years, the immediate post-Korean war deficit was 2.5 per cent. of GDP in 1951, and in 1972–75 it was 7.3 per cent. of GDP. However, the deficit that has set in since 1986 has already aggregated at 11.6 per cent. of GDP and we are clearly still trundling along with a deficit of the order of £12 billion a year in the depths of a recession.

As a schoolboy I grew up watching Ministers in the Harold Macmillan Government explain a succession of stop-go cycles. We were always told that when there is a balance of payments deficit the Government create a domestic recession. Imports stop or are reduced, people buy less, more resources go into exports, a balance of payments surplus results and the Government usually make a manic dash for the next general election before things get worse.

This appalling recession has left us with a balance of payments deficit of £12 billion. When the Government manufacture their mini-boom to try to get through the next general election—I do not know whether it will be this year or next—there will again be a massive increase in the balance of payments deficit. Those figures do not suggest that we shall come out of a recession and into a glowing period of growth in the 1990s but that, after a cosmetic mini-boom in the run-up to the election, there will once again be a long and sustained squeeze. Investment will fall, inflation and unemployment will no doubt once again be out of control and we shall face all the problems that we have experienced in the past.

I draw the House's attention to the Trades Union Congress's submission to the Chancellor in the run-up to Budget considerations. It called for a devaluation of the pound. The Government's strategy is flawed. Speaking as Chancellor in the debate in the House on entry into the exchange rate mechanism, the Prime Minister said: The truth is that the trade gap is the result of domestic demand outstripping supply."—[Official Report, 15 October 1990: Vol. 177, c. 932.] That analysis is wrong. If one examines the decade of the two Prime Ministers, which now stretches to nearly 12 years, it is clear that the trade deficit of 0.3 per cent. of GDP which they inherited has grown to 3 per cent. of GDP. That has not been caused by a massive increase in imports, which still form broadly the same proportion of GDP as they did in 1979. It is the collapse of our ability to export which has created that gap.

The Government's policy of tightening domestic consumption will not help. If we examine what is already happening, we see that exports are collapsing. Over the past few years, exports of goods and services have decreased by 3.3 per cent. between the second and third quarters of 1990. The export of goods has gone down by 3.4 per cent. between the second and third quarters of 1990. Exports of services, which peaked in the third quarter of 1987, have fallen by 11 per cent. since. If the Government's analysis were right, those figures would be the complete reverse and we should now be experiencing the beginnings of export-led growth. Instead, our export market is also collapsing.

There is currently a debate in the financial press. In the past few days, the Financial Times has argued that the slowdown of exports is due to the slowing of world trade. Coming to the Government's rescue, it says that it is not the Government's fault. If we compare the increase in the export of goods and services since the beginning of 1987 when the pound stabilised on the markets at roughly its present rate, the increase in exports by the United Kingdom is 12 per cent. In Holland they rose by 20 per cent., in Italy by 26 per cent., in Germany by 27 per cent. and in France by 28 per cent. Those economies are not suffering the same impact as ours, largely because their exchange rates recognise that they must export. Our exchange rate continues to recognise the Government's priority, which is to benefit the City of London over the industrial base of the nation.

We are facing a ratcheting down of the productive base of the British economy. The Government's primary interest is to support the demands of the City of London and to neglect British industry and they are creating a virtually irreversible decline in our ability to match our European competitors.

We entered the ERM at DM2.95. Everyone in the City of London was happy, as they did nicely out of it, whereas those responsible for manufacturing argued that if we wished to be able to export and have our exports judged to be fairly priced against those of Germany, Japan and France, we should have entered nearer to DM2.60. I believe that that decision—the one decision in the Prime Minister's entire political career which is solely his responsibility—has been a disaster. It locked us into a position in which there is no prospect of sustained, long-term recovery from the recession. I urge a proper debate in the House and in the financial press about the need for a realistic exchange rate.

In our present position, with the progressive loss of markets, we should be thinking of undervaluing the exchange rate. If we consider the great success stories of Japan and West Germany in the post-war period, we see that long periods of growth came out of an undervalued currency which gave those countries a long breathing space in which to reconstruct the economy. In a Britain where we have seen the collapse of so much manufacturing, where we have taken a decade to get back to 1979 levels in manufacturing industry and where we are now seeing that turn down again, the only way forward is to accept that we must have a tremendous increase in exports if we are to close our balance of payments gap.

The only way to close the balance of payments gap is to have an interest rate that serves the needs of industry rather than the interests of finance capital based in the City of London. Until there is a reduction in the exchange rate, we shall have no real reduction in interest rates. We should reduce the exchange rate. I recognise that that would be a matter for discussion with our European partners, although Germany and France can have no interest in having the British economy constantly limping along behind the economies of the rest of Europe. Once the rate had been negotiated to a realistic level, depending on whether we wanted to settle nearer DM2.40 or DM2.60, it would open up the prospect of the Government's being able to make real cuts in interest rates. A real cut of 2 per cent. would immediately make investment in the British economy far more attractive and would immediately open up the prospect of real export-led growth. We should be broadcasting a signal to the world that more than 100 years of economic decline in comparison with our competitors was being turned round because we had taken the decision that we would prioritise our industrial base, not our financial sector.

If one looks at the Conservative Benches—not now, but when they are full—one does not see British industry assembled. One can hardly see an industrialist there any more; one sees the City of London assembled, with accountants, fringe bankers and advertising executives. They do not represent the real economy. Until the House sets a realistic exchange rate that allows British exports to start to build and opens the way to a long period of growth, as we have seen in our major competitors—Germany and Japan—the cycle of boom and bust, which we had in the 1950s and which has now come back to haunt the Government, will haunt whoever governs Britain in the coming decade.

I address my remarks not only to Conservative Members but to Labour Members. We do not want a future Labour Government to repeat the mistakes of the Wilson Administration in 1967, when they defended an unrealistic exchange rate and wasted three years. If the Government do not have the sense and the courage to set a realistic reduction in the exchange rate which will benefit our manufacturing sector, it must be the first priority of an incoming Labour Government. Unless we do that, whoever governs Britain in the 1990s is doomed to fail.

2.47 pm
The Economic Secretary to the Treasury (Mr. John Maples)

I am sure that it will come as no surprise to the hon. Member for Brent, East (Mr. Livingstone) to learn that I do not share his analysis and that I do not agree with him about where the British economy has come from in the past few years and where it is going. No Government will ever be able to abolish the business cycle completely. Ours is not the only economy in recession. The economies of New Zealand, Australia, Canada and the United States are in recession. Industrial production fell recently in France, Italy, Spain and Sweden. All of that cannot be attributed to Britain's joining the exchange rate mechanism at too high a rate.

It is interesting to look back to what the hon. Gentleman said in the debate on the exchange rate mechanism on 23 October 1990, when he pointed out, as he suggested today, that the British economy had been in "relative economic decline" for a long time because successive Governments had failed to take firm measures to arrest that decline. He cited especially the willingness of successive Governments to accept a rate of inflation worse than those of our major competitors. However, when he is now faced with a Government who are prepared to take strong action on the inflation front, he suggests a course of action—devaluation—which would completely undermine any commitment to achieving a rate of inflation comparable with those of our competitors.

The hon. Gentleman also singled out in October and today investment and our record compared with that of our major competitors. He suggested that that was also an underlying cause of decline. In fact, investment growth in the United Kingdom in the 1980s was better than that in Germany, France or Italy, while business investment in the major industrialised countries was bettered only in Japan. Moreover, during that decade the quality of investment improved enormously, as is shown by the rates of return on the profitability of the corporate sector. We believe that the corporation tax reforms contained in the 1984 Budget led to the present circumstances in which investment is undertaken to earn an economic return, rather than just for tax breaks. The net return on capital in 1988 and 1989 was higher than it had been in any year since 1973.

When there is an economic slowdown, some fall in investment is inevitable. Nevertheless, in 1987, 1988 and 1989 there was a 45 per cent. increase in business investment. That enormous increase, which was a part of the boom that was happening then, will mean that we are in good shape to take advantage of the position when we emerge from the recession.

Over the past few years, our investment record has been rather good; so has our manufacturing productivity record. In the 1960s and 1970s, the United Kingdom experienced the slowest manufacturing productivity growth in the European Community, but in the 1980s our productivity grew faster than that of either France or Germany—by 51 per cent., an average of 4.25 per cent. a year. It grew faster than that of any other major industrialised country. I consider the growth in manufacturing productivity and profitability in that decade to be a major achievement.

The hon. Gentleman referred to exports as a share of gross domestic product. It is wrong to conclude that the United Kingdom's export performance has been poor compared with that of other countries, whose export share has often risen in comparison with a much slower growth in GDP. It is better to compare shares of world trade. In manufacturing, the United Kingdom has held its volume share of world trade throughout the 1980s and performance since 1981 has been better than that of any of our major competitors, including Germany, France and Italy. The fall in the export value share of GDP in the 1980s largely reflects a fall in the oil price in 1986, which clearly affects oil producers such as the United Kingdom more than it affects other countries. Value shares represent only one way of looking at export trends; volume shares show a rise in exports, even as a share of GDP, since 1979.

There is no reason to doubt the conclusion that United Kingdom export performance improved a good deal in the 1980s. The main reason for the deficit is the excessive growth in demand during the boom years, which we are now bringing under control. It is clear that the Government's policy is working. The trade deficit is already down from 3 per cent. of GDP in 1989 to 2 per cent. last year, and I shall be extremely surprised if our forecast of a substantial fall in 1991 is not realised.

I do not accept that the United Kingdom has been in relative economic decline under the present Government. The successes of the 1980s will leave us in a very good position to capitalise on them and an essential part of that will be the stability of the value of sterling and maintaining an inflation rate close to that of our European economic partners—which, I think, implies maintaining interest rates close to theirs.

The hon. Gentleman talked about real interest rates. Real interest rates in Gel-many and France are running at about 7 per cent. German interest rates are running at just over 9 per cent., while its inflation rate is about 3 per cent. French interest rates are 10 per cent., and its inflation rate is also 3 per cent. A rate of between 6 and 7 per cent. seems to be the norm. That may be a reflection of the fast growth in Germany or of a world shortage of capital, but we are not seriously out of line. We believe that if we succeed in bringing inflation down to such levels, we shall enjoy the same level of interest rates.

There can be no doubt about the effect of devaluation. We believe that it promotes inflation. Last October, the hon. Gentleman said: a devaluation along the lines that I and many of my colleagues would want … would need to be balanced by measures to protect the poorest members of society from the impact of the inflation that would feed into the system."—[Official Report, 23 October 1990; Vol. 178, c. 256.] The hon. Gentleman realised that that would be a consequence of devaluation. We believe that maintaining a strong pound and bearing down on inflation holds down import prices and reduces the scope of domestic producers to pass on cost increases. A weak pound does exactly the opposite—not only does it promote inflation and devaluation, but the weaker members of society often suffer most from the inflation that follows.

Nor does devaluation guarantee a faster reduction in interest rates. Since last October, when we joined the exchange rate mechanism, we have been able to reduce interest rates by two full percentage points without any significant depreciation in sterling. That has been possible because the markets are coming to recognise our commitment to keep sterling within the ERM bands that have been set for it.

The problem with devaluation is that it inevitably leads to market concern about the next devaluation. If the Government are not prepared to stick to the present bands, why should one assume that they would be prepared to stick to the next set of bands? Devaluation carries a cost in terms of interest rates. The holders of sterling require an interest rate premium—a higher return—to compensate for the risk of further devaluation. We believe that the best prospect for sustainable interest rate reductions is to stick to the discipline imposed by the exchange rate mechanism.

The Government also do not believe that devaluation secures any lasting gains in competitiveness. First, it reduces the pressure for both sides of industry to agree to the steps necessary to control unit costs. Secondly, over time it leads to inflation, which erodes any gains in competitiveness from devaluation. If we look back to the 1970s, we see that during that decade the pound depreciated by a third and competitiveness deteriorated by 20 per cent. because prices and labour costs grew faster in the United Kingdom than in competitor countries. That eroded our competitive position.

The argument that our entry rate into the ERM was too high is not borne out by the facts. The central rate of 2.95 against the deutschmark was close to the average rate during the three to four months preceding entry. It was also close to the average real rate over the last decade. The real rate against all ERM members is close to the average of the last 25 years and is lower than in the 1980s. An interesting article was published in the last edition of the "Treasury Bulletin". It was prepared by Treasury economists who analysed this matter and bears out what I have said.

I do not believe that the assertion that the exchange rate is too high is borne out by the trade figures. Exports are rising. Excluding oil and erratics, they are up 2–5 per cent. over the last year. There has been a rise in manufacturing exports over the same period. In 1989 and 1990, exports rose by 18 per cent. and imports by 9 per cent. In the fourth quarter of 1990, the deficit in manufactures, as a proportion of GDP, was the lowest for five years. The current account deficit is falling and is now only half the peak level reached in the third quarter of 1989. Last year the United Kingdom share of world trade rose for the second year running—all in a period during which sterling has been relatively strong.

If I were wrong about that, and if the hon. Gentleman was right that the exchange rate is so high that it is undermining competitiveness, I do not believe that exports to West Germany would have grown by 17.5 per cent. last year. At that time the hon. Gentleman and others were suggesting that the exchange rate was too high.

That argument does not seem to be true of Spain. ERM entry does not appear to have hurt its exports. Spain had a very high exchange rate—it was at the top of its band —but Spain's manufactured exports continue to grow strongly and it is increasing its market share.

Entry into the exchange rate mechanism has led to a gain in credibility for this country. In the past four years there has been only one realignment of central rates, when the Italians moved early last year to narrow bands. That means that the markets have confidence that ERM members will ensure that they stay within those bands. The stability that that will bring to the pound will enable us to enjoy lower interest rates and lower inflation, along the lines of our European competitors.

What is interesting about the hon. Gentleman's speech is that, apart from attacking our decision to join the exchange rate mechanism and the rate at which we joined it, he has by implication criticised Opposition Front-Bench Members for their support. I understand why he said what he did. The right hon. and learned Member for Monklands, East (Mr. Smith) and his Front-Bench colleagues thought that joining the ERM would serve as a figleaf to cover their lack of any other credible policy to control inflation. Last year, the answer to practically every question put to Opposition Treasury spokesmen was that they would deal with it by joining the exchange rate mechanism. But it is not a soft option, as the hon. Gentleman realises—it is a tough monetary discipline to reduce inflation. The hon. Gentleman is fully aware of that. I suspect that the policies that he would like his party to pursue if it formed a Government—higher public spending, higher borrowing and a reluctance, if not a refusal, to use interest rates as an instrument of monetary policy—would make it impossible to stay within the ERM band at which we joined.

Many Labour Members share the hon. Gentleman's view. Many people have believed for a long time that we should pursue that policy, but the Government do not agree. Opposition Front-Bench spokesmen have adopted it as a disguise for their lack of policy to control inflation. It is not credible in the context of the other policies that they wish to pursue. I suspect that today we heard from the hon. Member for Brent, East the authentic voice of the Labour party, if not of its Front-Bench spokesmen.

The Government's primary objective remains the defeat of inflation. That is why we joined the ERM and why we shall stick to the discipline of the present bands. That was a decisive step which, in time, will help to reduce United Kingdom inflation to the levels of our European competitors. In turn, low inflation will lay the foundation for lower interest rates and a resumption of sustainable growth. Devaluation would undermine that objective and prejudice the long-term benefits which sticking to the ERM discipline offers.

Question put and agreed to.

Adjourned accordingly at Three o'clock.