Bang!: A History of Britain in the 1980s (11 page)

In contrast to Healey’s multifaceted approach, the claim that control of growth in the money supply should be the central preoccupation of government allowed the Thatcher administration to
dismantle complex mechanisms whose combined effect was an increasingly corporatist state. For monetarism offered simplicity. There would be no need to appease the trade unions
because, with the abolition of an incomes policy, they would not be asked to frame pay norms across the economy. This was a crucial consideration. If a Labour administration had come
unstuck trying to operate an anti-inflationary strategy based upon agreeing wage restraint with their nominal allies in the trade union movement, there was clearly even less chance of their
cooperating with a Tory-led incomes policy. In short, that option did not exist, even if Thatcher had believed in it in principle – which she did not. If monetarism and the control of
inflation came to be elevated to an all-consuming obsession in the first years of the new Conservative administration, it was for reasons that made perfect sense in the light of Thatcher’s
interpretation of what had gone wrong in the previous decade. To her and her monetarist friends, inflation did not accompany national decline, it hastened it. An incomes policy aimed at reducing
price rises through persuading union members to take wage increases close to or below the inflation rate – in other words to reduce in real terms their standard of living – was doomed
to fail. There was no personal incentive to agree to such a cut in living standards, and the effort to enforce it naturally led to strikes for higher pay, which, when successful, only further
priced British jobs out of the international market, thereby fostering stagflation. Thus, counter-intuitively, tough incomes policies actually encouraged union militancy and ever higher wage
demands. Monetarism offered a way out of government engagement with this vicious circle. Furthermore, if inflation could be controlled by strict monetary policy, there was no requirement to depress
prices artificially through subsidies to certain, favoured (usually nationalized) industries. This would leave the free market to determine the price at which producers sold to consumers. And over
time, taxation could fall in order to let the market operate more freely, rather than tax rates having to be periodically hiked and lowered in a continuous, and disrupting, cycle of demand
management.

That was the theory. The practice was more complicated. Even if inflation was caused by lax control of growth in the money supply, how was that growth to be accurately measured? After all, if it
could not be properly measured, government could not know whether it had set appropriate targets. Finding a convincing measure for the money sloshing around in the British economy proved no less
difficult than assessing whether controlling demand needed the Chancellor’s touch on the accelerator or the brake. Was a narrow definition of money, like Sterling M0 (cash), the best measure?
Or would a broader measure, like Sterling M3 (cash and bank deposits) or Sterling M4 (cash and bank deposits and building society deposits), be more appropriate? Even monetarist economists –
in fact, especially monetarist economists – could not agree. The broader the category, the more difficult it was for government to control. Sir Geoffrey Howe, who was by training a lawyer,
not an economist, used his prerogative as Chancellor to pronounce that the correct measure was Sterling M3. Later, he was not so sure.

Having decided what indicator of money supply growth to watch, the next question was how that growth might be controlled. High interest rates were the obvious tool by which credit, and thus the
money supply, could be made more expensive. Howe’s policy was to raise interest rates at the same time as he implemented a separate strand of the Tories’ agenda – the bringing
down of the government’s own reliance on credit to fund state investment programmes, by reducing the public sector borrowing requirement (PSBR). The British electorate did not wait long to
discover the extent of the new administration’s determination to place the war against inflation above other considerations. In June 1979, the month after the election, Howe stood at the
dispatch box in the House of Commons to deliver his first budget speech.

He did so at the very moment when it was clear that inflation was again rising back into double digits. Partly, this was for reasons beyond Whitehall’s control. The price of oil rose
threefold between the beginning of 1978 and the end of 1979. Given that the North Sea rigs were in the process of making Britain self-sufficient, the high price of oil meant large petroleum tax
receipts for the Treasury. But it was bad news for British industry and for the cost of living. The re-emergence of inflationary pressure was not purely down to the soaring cost of energy, however.
It was also a consequence of political decisions taken during the last months of the Callaghan government. With the approach of a general election, Healey had begun relaxing the tough spending
constraints he had previously imposed. The concession of high pay awards to end the Winter of Discontent began to feed through. And Howe had been bequeathed a ticking time bomb by his
predecessor’s establishment of the Clegg commission on public sector pay. Thatcher had been panicked on the election campaign trail into promising to honour Clegg’s recommendations. The
pay awards transpired to be high, inflationary and a significant drain on the public purse just when the Treasury was trying to find savings. The pledge, however, could not be rescinded.

Most of all, Sir Geoffrey Howe’s 1979 budget demonstrated the contradiction at the heart of the Tories’ economic policy. On the one hand, the PSBR could only be reduced by cutting
government spending: what the government spent had to cease greatly exceeding what the government raised in revenues. Thus, at least until such time as spending came down significantly, taxes ought
to have remained high. Yet the Conservatives had won the election as the defenders of free enterprise. They were the party that wanted to remove the fiscal shackles from the private sector, freeing
it to expand and create jobs. With the first signs of a recession already on the horizon, hard-pressed employers pleaded for a lighter tax burden. Indeed,
bringing down
taxation had been at the heart of the Tories’ election campaign. Yet if Howe was to honour the fiscal pledges, he risked upsetting the borrowing targets – and these Thatcher considered
intrinsically linked to bringing down inflation. Compounding this problem was the Chancellor’s determination to remove other impediments to the free flow of money, such as exchange controls
and limits on what banks could lend. Such liberalizations were consistent with the desire to free up the market. They were not consistent with keeping a tight control on credit and the money
supply.

Howe’s first budget was thus not a consistent policy aimed single-mindedly – as the purest monetarists might have hoped – at attacking the factors that were swelling the money
supply. In order to balance the competing demands of curtailing Sterling M3 and encouraging faster economic growth, Howe was forced to push up the cost of credit and to cut public spending even
more than if he had been able to leave the tax burden and the armoury of financial controls untouched. This was to compensate for reduced government receipts and the money supply-increasing impact
of liberalizations of market regulations. In this way, what British industry gained in lighter taxes it paid for in higher interest rates. This, in turn, pushed up the value of sterling to levels
that priced all but the most competitive exports out of the international market. By trying to solve one problem, the Chancellor had created another one.

The monetarist measures were clearly set out. Howe announced he was setting a money supply target of 7 to 11 per cent growth (from its current rate of 13 per cent). The Bank of England’s
minimum lending rate would rise from 12 to 14 per cent. The PSBR would be cut from 5.5 to 4.5 per cent of national output (measured as GDP). The reduction would be achieved by making about £4
billion of cuts to public spending. The greatest long-term saving came from linking state pensions to price rises. Previously they had been index-linked to whichever of price or wage increases was
the higher. Howe’s announcement of the switch was interrupted by a furious Labour MP shouting ‘That is treasonable!’
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It was
unquestionably a fundamental departure from precedent, with huge consequences for an ageing population. With wages rapidly outpacing prices during the eighties, the cost to the Exchequer of pegging
pensions to wages would have been astronomical. The result was relative impoverishment for those dependent solely on the state pension for their income in old age. Nevertheless, it was a switch
that successive governments of neither main party found the money to reverse until 2010.

Alongside the squeeze came the incentives. Top rate income tax – to be paid by all those earning over £25,000 a year – was cut from 83 to 60 per cent. This brought
Britain’s upper-rate taxation to the same level as that in France, although the burden on affluent Britons remained heavier than that
placed on wealthy Germans (56 per
cent) or in the United States (50 per cent). The cut was met with indignant gasps from the opposition benches, but it could be defended as a revenue-raising measure since it made tax avoidance less
attractive and encouraged the diaspora of tax exiles to relocate back to Britain (in consequence, far more revenue was raised through a reduced top tax rate during the 1980s than had been squeezed
from the rich in the 1970s). Initially more significant in absolute revenue terms was Howe’s announcement that the basic rate of income tax would be cut from 33 to 30 per cent. Reducing the
tax grab from pay packets automatically made employees wealthier, thereby encouraging them to make less extravagant wage claims. But the scale of the cut risked widening the budget deficit,
necessitating more government borrowing and loosening the monetarist squeeze. To claw back this deficit, Howe massively increased indirect taxes. VAT, which had been at 8 per cent (with a 12.5 per
cent marginal upper rate), was raised to a new single rate of 15 per cent. During the election campaign, Howe had denied Labour claims that he would double VAT, and the vast scale of this increase,
only a month after the polling stations closed, demonstrated that his denials had been true only as measured against the detail rather than the spirit of the accusation. Unfortunately, the debate
about the VAT rise concerned more than the Chancellor’s personal probity. Borrowing might be inflationary, but so was a huge VAT surcharge on the cost of many everyday goods. The result added
upward pressure to the retail price index, which by July had again passed 15 per cent.

While the struggle to control inflation would prove long and hard, the abolition of exchange controls was secured in an instant. In 1979, Britain had the most stringent exchange controls of any
major industrial nation. There were limits on how much foreign investment income could be reinvested abroad. There were restrictions on how much money British citizens could take on holiday or
emigrate with. These controls to stop money crossing borders had been introduced as an emergency measure at the outset of the Second World War. But while the threat from the Third Reich had
disappeared within six years, the perceived need to protect the British currency had remained throughout the following four decades. The continuation of such controls demonstrated the
Treasury’s persistent fear of a currency collapse if the free movement of capital was permitted. Not only that, exchange controls provided the government with a means of cajoling British
capital holders into investing at home rather than seeking potentially higher returns abroad. It was an active form of financial protectionism and, like import controls or tariff barriers, it was
double-edged, for, equally, the controls acted to restrict foreign investment in Britain.

In the space of time it took Howe to make his Commons statement, all exchange controls were dramatically abolished on 23 October 1979, a date
that marked the United
Kingdom’s re-emergence as a principal driver of the process of globalization. The effects were immediate and impacted upon everyday decisions taken by holidaymakers and small-scale investors
as well as by banks and major City institutions. For the first time in forty years, Britons were suddenly allowed to open bank accounts in foreign currencies, to buy property abroad without
restriction, or to buy overseas shares, gold bullion and commodity futures without limit.

To the Labour opposition it was, in the words of Denis Healey, the shadow Chancellor, ‘one more reckless, precipitate and doctrinaire action which the government will regret no sooner than
those who go bankrupt as a result’.
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Howe’s decision (backed, rather than encouraged, by Thatcher) was partly of a piece with Conservative
thinking on the liberalization of markets. It was also made expedient by the specific circumstances of the moment. Rapidly expanding North Sea oil revenues were dramatically strengthening the value
of sterling. This reduced the risk that removing exchange controls would cause the pound’s value to go into free fall. Indeed, where the fear of a massive withdrawal of money and a currency
collapse had frightened off previous Chancellors who had pondered relaxing exchange controls, suddenly anything that eased the upward pressure on sterling’s value seemed a positive outcome.
Ending exchange controls did cause capital to exit the country, but far from being a disaster that was a bonus, for without this outflow the balance of payments would have been in even greater
surplus because of North Sea oil. That surplus would have pushed the value of sterling so high that British exports would have been rendered wholly uncompetitive in the world market. Even as it
was, the combination of anti-inflationary high interest rates and the petro-currency component that North Sea oil brought to sterling was to do immense damage to Britain as an industrial trading
nation. Much as successive Labour Party leaders and their Treasury spokesmen lamented this state of affairs, the reality was that throughout the eighties Labour remained committed to reintroducing
exchange controls – a policy that, by sending sterling higher still, would have destroyed yet more of British manufacturing’s export market and the jobs that went with it.