§ 7.37 p.m.
§ Lord ORAM rose to move, That the Counter-Inflation (Price Code) Order 1976, laid before the House on 29th July, be approved. The noble Lord said: My Lords, this is an order to approve the radical revision of the Price Code, which came into operation on 1st August, for the period to July of next year.
§ The Government's policies for this second year of the attack on inflation were set out in two White Papers published at the end of June. These outline the strategy by which we shall build on the success achieved in the twelve months since July 1975. We were then facing an annual inflation rate which approached 27 per cent. thanks to the response from the trade union movement, and from millions of ordinary wage and salary earners, that appalling figure has been virtually halved. But the present rate of inflation is still too high and must come down if this country is to maintain its competitive position in the world.
§ My Lords, the Price Code is not the main or the only instrument by which this attack on inflation is to be pressed forward through the next ten months. My right honourable friend the Chancellor 550 of the Exchequer has spoken more fully on several occasions about the economic and monetary policies which were summarised in the White Papers. Public expenditure is being strictly controlled. Most important of all, within the Social Contract, a second year of pay restraint has been recommended by the TUC to their members. Wage earners have shown themselves prepared to moderate their demands so as to hold down industry's costs and leave resources free for new productive investment.
§ It is by the cumulative effect of all these measures that the rate of increase in prices must be halted, rather than by a squeeze on industry's profit margins alone. The Government have made it abundantly clear that we are supporters of the mixed economy. We have no vendetta against profits which are fairly earned and responsibly applied to improving this nation's economic infrastructure and expanding its productive capacity. In the last resort, it is out of profits that the new investment and new jobs we want so badly will come.
The Price Code has therefore been modified, quite deliberately, to halt—and indeed reverse—the erosion of profit margins which would result if blanket price controls were applied too rigorously and insensitively. The purpose of the changes was summarised in the White Paper Modifications to the Price Code which was presented to Parliament by my right honourable friend the Secretary of State for Prices and Consumer Protection. The changes are to
permit British industry to raise the funds that are needed to finance a higher level of activity, to increase employment and to instil the confidence needed to invest for the future".
§ The Price Code is a lengthy document and I do not think your Lordships would thank me for taking you through 153 paragraphs, point by point. I propose to concentrate on the three main ways in which the new Code differs from the Code which preceded it. First, investment. There is general agreement that the priority for the immediate future must be to modernise, re-equip and expand the manufacturing base of British industry so as to be ready to respond to growing demand in export markets. The former Price Code contained a special relief for investing firms. They were free to widen 551 Profit margins, to take account of a proportion of their investment expenditure on plant and machinery. In the new Code, the value of the investment relief has been more than doubled—from 20 per cent. to 50 per cent. of qualifying expenditure. In addition, distributors will qualify for equivalent relief in respect of expenditure on the construction of shops.
§ The new Price Code has also been amended so that its principles approximate more nearly than those of the old Code to the principles of current cost accounting. As Sir Francis Sandilands' Committee has ably demonstrated, the conventions of historic cost accounting are inadequate in a period of rapid inflation. A firm may seem to be pursuing a normal prudent depreciation policy but will nevertheless find when a machine is scrapped that the accumulated depreciation is inadequate to meet its replacement cost. Similarly, when raw material prices are rising, the returns generated from current sales must be sufficient to allow for the replacement of stocks at current prices.
§ The new Price Code moves some way towards recognising the calculation of costs on a replacement cost basis. This is a technical matter, but it is vitally important because all the various Price Code régimes—both the allowable cost rules and the net profit controls—boil down to a calculation of the profit margin that remains when costs have been met. So it is very important that costs should not be understated.
§ Under paragraph 41 of the new Code, firms which have revalued their capital assets for the purpose of their own accounts may calculate depreciation against that value. Alternatively, if they have not undertaken a revaluation the cost of depreciation on a historic cost basis may be marked up by 40 per cent. Firms will also be able to use the latest purchase price for materials when they calculate their current costs. This is in paragraph 55. And they will be free under paragraph 82 to disregard most of the paper profits which arise from stock appreciation, when they see how they stand under the profit ceilings in the Price Code.
§ The former Code had a rule that if costs fell, prices should be reduced proportionately. In many cases, this still applies. But the Government wished 552 to take account also of the criticism that the rule might discourage firms from cutting costs, whether by making a more productive use of their resources or by expanding output and thus spreading overheads more thinly. In paragraphs 29, 30 and 53 the new Code therefore introduces a totally new set of reliefs. In future, this sort of saving in overhead costs may be split fifty-fifty. Half must go to hold prices, but half can be kept to improve profits. Savings in fuel costs over and above the cost per unit of output before 1st August may be kept in full. For labour costs and the cost of raw materials, the approach of the old Code will continue. Any reduction in costs per unit of output must be passed into prices. But we have dropped the old "productivity deduction" under which firms had to absorb an additional slice of any increase in labour costs.
§ The profit margins which firms can aim at under the new Code—by applying these new provisions and others which I have not mentioned—should be significantly more favourable than they would have been if we had allowed the old Code to run on unchanged. That is obvious. What is much less easy—indeed impossible—is to say precisely what difference the order before your Lordships will make to profits and prices. We are dealing with the period up to July 1977, and over that timescale the view taken by the Government's advisers is that the market itself will be the main constraint on the rate at which firms will be able to increase prices on the home market. This is true, in particular, of the distribution sector.
§ The Government have been criticised for the forecast that the effect of the Price Code changes could be to increase the Retail Price Index by about 1 per cent. over 12 months. A lot of people have done a lot of calculations to show that if every firm raised every price to the maximum permitted under the Code then the aggregate effect would be very much more. But that is a completely unreal exercise. There will be all sorts of factors operating on prices over the next year, including both internal and external cost increases. It is the Government's job to give Parliament and the public our best assessment of what will actually happen to the economy over that period, subject to all the uncertainties and constraints of real life. Within these conditions, I must 553 say again that the difference made by Price Code changes is relatively small. One per cent. is not a precise prediction; it is a broad statement to the effect that the Price Code changes in themselves will have little bearing on the aggregate movement of prices in the year ahead. On the other hand, the changes will provide significant headroom for the rebuilding of company profits. We are confident that they will have—indeed have already had—an immediate and positive effect on industrial confidence and on firms' willingness to invest.
§ Since this Government first introduced the investment relief, it has been closely monitored by the Price Commission against actual investment. In the same way, the Commission will keep careful watch on the new reliefs introduced into the new Code. It is essential for public confidence that higher prices claimed under the Price Code should be justified and that reliefs should be applied to their proper objectives.
§ My Lords, I have said that this order covers the period to next July. This debate is not, perhaps, the appropriate place to look beyond that date. It is possible that the present Price Code Order will be the last. In the absence of new legislation, the powers to enforce a Price Code will expire at the end of July 1977, and the Government now have to consider very carefully the form of prices policy which should succeed them. Meanwhile, for the remaining period of the current and second year of pay restraint the Price Code remains an essential buttress to our counter-inflation policies. In its revised form it should offer no obstacle to the rebuilding of industry's profit margins where funds are needed for industrial growth and modernisation. Many criticisms of minor matters in the old Code, and in the procedural requirements, have also been met in this new order, and therefore I hope it now obtain your Lordships' approval. I beg to move.
§ Moved, That the Counter-Inflation (Price Code) Order 1976, laid before the House on 29th July, be approved.—(Lord Oram.)
§ 7.50 p.m.
§ Lord ELTON
My Lords, this seems to be a pretty thick order to introduce into a pretty thin House. I say "thick" because I am told that the volume of 554 explanatory material which accompanies it from official and non-official sources has to be weighed rather than counted in numbers of pages. That is one of the reservations many of us have about the scheme.
Of course one recognises the good intentions of the Government, and that they are trying to achieve the objectives which we hope they will achieve. I rather doubt whether the sweeping benefits which the noble Lord pinned in expectation to this infant Atlas will materialise in regard to the industrial sector. That was the point he made at the beginning of his speech; and towards the end he noted that the effect on the RPI was likely to be marginal. I note the expectation of an increase in profits and the hope that it will contribute to a return of investment confidence, but I cannot help having a nagging doubt in my mind that this conclusion has been arrived at without due consideration of the explosion in minimum lending rate which is now with us, or, indeed, of a number of other costs which have been sprung quite lately upon the sector of the economy to which the noble Lord refers, notably the increase in the National Insurance contribution next July.
In that connection I would say that it is not yet clear to us whether this increase is to be devoted to increasing National Insurance benefits or not. It is widely assumed that it will not be, and indeed that it cannot be since it is really a Treasury device to raise revenue; and I must say in parenthesis that the evasion of the point when it was raised by my right honourable friend in another place by the Under-Secretary of State at column 200 of Monday's Hansard does rather endorse that view. If it is not to be so devoted, could Her Majesty's Government assure us that these will be allowable costs for manufacturers?
I think one ought to give cautious approval where one can, and I can claim no expertise in connection with these very sophisticated accounting methods; but it seems to me that there is an element of commonsense that should be welcomed in the change to replacement cost basis when calculating the value of stocks and their replacement for investment allowances. Whatever answer the noble Lord may have to this query about National Insurance benefits, I wonder whether the 555 Minister accepts that such increases can only be set against net profit margins by distributors, and that the gross profit margin to which they have to work is pegged in a way that may have been acceptable in 1973 but bears little relation to conditions that have evolved since February 1974.
It seems to me that the retailer is rather in the position of somebody exploring a seaside cave when the tide is coming in. That is not a perfect illustration; but the ceiling is pegged and the gross margin is allowed to rise to 110 per cent. of the level of the reference year. However, the emergency rescue clause is triggered only when the retailer's net profit margin has sunk to 80 per cent. of the reference year. As I say, I am somewhat of an ingénu in these matters, but it seems to me very unlikely that you can recover 20 per cent. of net by an increase of 10 per cent. of gross in a time of galloping inflation.
I had intended to remind your Lordships of the remarks made by the Prime Minister recently, but the noble Lord, Lord Oram, has been kind enough to repeat them to us. He said that businesses should be allowed to be profitable. That may be tantamount to a Bishop saying that a layman should be allowed to sin. But we must, I am sure, believe that he intended it. I hope the noble Lord will take that in good part, because it is a matter of great importance. It seems to me that in such a situation as I have outlined, where there is this trap between the gross and the net margin, there is a great danger that the small businessman and indeed the larger retailer is not going to be profitable. For instance, we are told, in anticipation of an eager welcome, that investment allowances will be increased when it comes to building shops.
I wonder whether the noble Lord is aware of how many shopkeepers are clinging desperately to existing premises rather than planning to throw up new ones. There are exceptions, of course, but I hope the noble Lord will consider the position of the retail trade, upon which I have concentrated my remarks during the period of the operation of this order. The noble Lord has told us that it will run perhaps, finally, to next year. That may be the end of the road for this method 556 of trying to control the very dangerous situation in which we are, but I do not think it is likely to be sufficient to wait until the end of that period in order to consider necessary adjustments, not only in the light of existing sliding scales but also in the light of moving those scales themselves in relation to situations which have changed since the Act was passed in 1973.
I should like to raise one other small query with the noble Lord. I noticed in following the proceedings in another place that reference was made to a helpful inquiry made by the chairman of the Carroll group. I noticed that the Under-Secretary of State did not reply to that point. I have failed to achieve any means of discovering whether this has been put right by correspondence without my knowledge and, as the matter will not come before either House again, I would ask the noble Lord whether he would be kind enough to jog the memory of his right honourable friend in another place.
I have made some rather acid comments to a rather empty House, but I hope that your Lordships will see that while we are in sympathy with the aims and some of the methods the Government propose, we do not entertain the sanguine hopes of the noble Lord as to the results.
§ 7.57 p.m.
§ Lord HARMAR-NICHOLLS
My Lords, I think one would admit at once that the Price Code change as regards the depreciation of stocks is a good thing and will be helpful. I do not want to say anything more about the Price Code than to emphasise what my noble friend has said. But I could not sit in silence and still have in mind the points that the noble Lord, Lord Oram, put in presenting the Price Code before he came to the Price Code itself, because if ever we have had an example of giving a little back with one hand and taking much more back with the other hand, we have it here. It may be that I am still looking at this through the eyes of another place, but I do not think we ought to allow the record to stand without some comments to balance what the noble Lord said when he was introducing this order.
What did he say? He said that the Government are bringing in this Price 557 Code change because they believe in a mixed economy. They understand that profits are necessary and they want to support the making of profits so that we can get investment. If that is what the Government believe, why do they not do something about it? Everything they have done since taking Office has been tending to end the mixed economy. It is already 60/40 as regards central control, and if we get what is in the pipeline now the mixed economy will be almost at an end.
As regards profits, the Government should do something about them, because the tax levels at the moment, for any of us who are trying to run businesses with any profits, are such that it is a task which one simply cannot win. Furthermore, it is wrong to suggest that the Price Code changes will be a great advance, when they were thought up and put on paper before we had the increase in interest rates. You cannot borrow money now. You are doing very well if you can negotiate with the bank for 2 per cent. above the base rate, which means 17 per cent. on borrowed money in order to run your business in Germany, the rate is 3½ per cent., in Switzerland it is 2 per cent., in America it is 6½ per cent., and in Japan it is 5½ per cent., and the Government are asking our businessmen, particularly the small ones, to be successful when they are having to pay 17 per cent. in order to get the liquidity to run their businesses.
That is allowed to happen, yet the noble Lord, Lord Oram, speaking as the Government spokesman, says that he believes in people making profits and wants to encourage them. The noble Lord, Lord Oram, is introducing this very small improvement—and I accept that it is an improvement, and I have no doubt that it will have the applause of the whole House in order to get it into operation—but it could not stand alone, taking everything into account.
We have to pay the employment tax of £1,000 million for everybody whom we employ, but we have no return at all. Yet it was suggested that this very tiny, but acceptable, improvement is reflecting the point of view of a Government which believes in profits. I do not think that the Record should be allowed to stand with that unanswered, and that is what I have tried to deal with in these two minutes.
§ 8.2 p.m.
My Lords, I do not think the House would welcome it if I attempted to follow the noble Lord, Lord Harmar-Nicholls, into a wide-ranging debate on the Government's economic policy, since we quite recently had an opportunity for that, but I would make one point. He doubted whether we believed in a mixed economy. I assure him that we do, and the approach of these changes in the Price Code is an illustration of that. Perhaps only a small part of the economy is affected, but it is an indication that we have the investment prospects of the private sector very much in mind, and that is why these changes have been introduced.
I thank the noble Lord, Lord Elton, for at least recognising that we have good intentions in these matters, just as I recognise that he has doubts. I also thank him for the general tone of his comments. Not surprisingly, he raised two important matters which have arisen since the Price Code changes came into effect; namely, the increase in the minimum lending rate, to which he made a brief reference, and the increase in the National Insurance contributions, to which he made a fuller reference. Perhaps I may comment briefly on his point about the minimum lending rate.
We believe that its effects will be relatively marginal, and it is all the more important that companies should be able to generate a substantial proportion of their investment funds from retained profits, which is one of the objectives of the changes in the Price Code. As an illustration of what I have in mind, when I say that I believe that the effects of the increase in interest rates will be relatively marginal, I would point out that in 1975 retained profits accounted for 68 per cent. of the sources of all capital funds, while bank borrowings accounted for only 9 per cent. Moreover, in any, case the new Code gives manufacturing and service companies the option to continue to treat interest charges as allowable costs for Price Code purposes.
§ Lord ELTON
My Lords, may I just intervene? Perhaps I waited too long. The noble Lord said that he thought the minimum lending rates would have a marginal effect. I am wondering what they would have a marginal effect on. Does he 559 mean investment—that it is so low that it will not be reduced, or only marginally affected, or is he talking to the actual area of prices to which the Code is directed?—because I have to tell him that at the latest count retained profits are yielding something like 3 per cent. and there is every prospect of their becoming less, even in spite of this new Code. Therefore I felt, when the noble Lord said that, that with a 15 per cent. minimum lending rate the effects must be more than marginal.
I think that the figures which I gave of retained profits accounting for a major part of capital funds, and of the relatively small proportion that derived from bank borrowings, support my first point, that we expect, and are right to expect, that the effects will be relatively marginal.
May I now turn to the point which the noble Lord made rather more fully about National Insurance contributions? He asked for a certain assurance and I can give it to him. When the Chancellor announced the surcharge, he pointed out that National Insurance contributions are allowable for Price Code purposes, and the specific assurance I can give the noble Lord is that steps will be taken to ensure that the surcharge is allowable in the same way as the basic charges. I believe that that is the assurance he wants. I would also make this point, because it may not be properly appreciated, that the National Insurance surcharge does not come into operation until next April, while the Price Code phase with which we are now dealing ends in July. So that we are talking about a relatively small period. I am not saying that it is unimportant in that period, but there could he an assumption that we are talking about a period of a whole year, which is not the case.
Then the noble Lord, Lord Elton, went on to deal with the difficulties of distributors, and he was quite right in saying that in some respects they are not treated in quite the same way as manufacturing and service industries. But I would point out that many of the measures in this Price Code are designed to help the distributors, not just by an improvement in the safeguard, but also, for example, by the new stock relief, by the fact that investment 560 relief is extended to shops, and by the fact that there is a higher depreciation possible; for example, on commercial vehicles. So it is not a completely blank picture, by any means, although I know from my own experience within the field of distribution that there are anxieties. I acknowledge that entirely. I think I have at least answered the main points which the noble Lord raised, and therefore I hope that the House—
§ Lord ELTON
My Lords, before the noble Lord sits down, he said that he recognises the anxieties, and I am delighted he has done that. But I asked him whether if he did recognise the anxieties, he would seek means of alleviating them in practical terms before the expiry of this order. If that is within his grasp, I think he ought to give that undertaking.
My Lords, how powerful I am in these matters is something that is in some doubt. But I indicated that in the forthcoming year the Government will need to apply their collective thinking to what follows the expiration of this Price Code.
§ Lord ELTON
My Lords, I am sorry to intervene again, but I am talking about what precedes it. Many people may go "bust", to put it crudely, before the Code expires, if it is not adjusted, and if we are right in our expectation of what it will do. If we prove to be right, I hope that the noble Lord will not allow his friends' political pride, or his own, to refuse to look that fact in the face and amend the Code as it goes on.
My Lords, several times since I have been in this House I have declared my own close association with the Co-operative movement, and I can assure the noble Lord, Lord Elton, therefore, that I have an ear to the ground so far as the problems of distributors are concerned; and, naturally, any influence that I can exercise will be on behalf of distributors, because of my own personal interest in that field. I merely say to the noble Lord, I hope he would not expect me to have a dramatic effect on that; but I will do what I can.