The Downing Street Years (16 page)

The Middle East continued to occupy my attention throughout the rest of 1980. At the European Council in Venice on 12 and 13 June the heads of government discussed Israel and the Palestinian question. The key issue was whether the Community governments were to call for the PLO to be ‘associated with’ the Middle East peace talks, or to ‘participate in’ them: I was very much against the latter course, for as long as the PLO did not reject terrorism. In fact, the final communiqué reflected what seemed to me the right balance: it reaffirmed the right of all the states in the region — including Israel — to existence
and security, but also demanded justice for all peoples, which implied recognition of of the Palestinians’ right to self-determination. So, of course, it pleased no one.

Then the Middle East focus shifted again. In September 1980 Iraq attacked Iran and we were once again in the throes of a new crisis, with potentially dangerous political and economic implications for western interests. Saddam Hussein had decided that the chaos in Iran provided him with a good opportunity to renounce the 1975 Algiers Settlement of the two countries’ disputed claims to the Shatt-al-Arab waterway and seize it by force.

Shortly after the outbreak of the war Peter Carrington came over to Chequers to discuss the situation with me. I was chiefly concerned to prevent the conflict spreading down the Gulf and involving the vulnerable oil-rich Gulf States, which had traditionally close links with Britain. I told Peter that I did not share the common view that the Iranians would quickly be beaten. They were fanatical fighters and had an effective airforce with which they could attack oil installations. I was right: by the end of the year and after initial successes, the Iraqis became bogged down and the war threatened both the stability of the Gulf and western shipping. But by this time we had put in the Armilla Patrol to protect our ships.

As I looked back on the international scene that Christmas of 1980 at Chequers, I reflected that the successes of British foreign policy had helped us through a particularly dark and difficult time in domestic, and particularly economic, affairs. But as in economic matters so in foreign affairs I knew that we were only starting the course. Tackling Britain’s Community budget problem was only the first step to reforming the Community’s finances. Bringing Rhodesia to legal independence was but a prelude to addressing the problem of South Africa. The West’s response to the Soviet invasion of Afghanistan would have to be a fundamental rethinking of our relations with the communist bloc and this had barely begun. The renewed instability in the Gulf as a result of Iraq’s attack on Iran would ultimately require a new commitment by the western powers to the security of the region. All these issues were to dominate British foreign policy in the years ahead.

CHAPTER IV

In the years since the war British politics had focused, above all, on the debate about the proper role of the state in the operation of the economy. By 1979 and perhaps earlier, optimism about the beneficent effects of government intervention had largely disappeared. This change of attitude, for which I had long worked and argued, meant that many people who had not previously been Conservative supporters were now prepared to give our approach at least the benefit of the doubt. But I knew that this entirely justified lack of faith in the wisdom of the state must be matched by a renewed confidence in the creative capacity of enterprise.

A sort of cynical disdain, often disguised as black humour, had come to characterize many people’s attitude to industry and unions. We all enjoyed the film
I’m All Right, Jack
, but the problem was no laughing matter.

British goods will only be attractive if they can compete with the best on offer from other countries, in respect of quality, reliability and price, or some combination of the three, and the truth is that too often British industrial products were uncompetitive. This was not simply because the strong pound was making it difficult to sell abroad, but because our industrial reputation had steadily been eroded. In the end reputation reflects reality. Nothing less than changing that reality — fundamentally and for the better — would do.

In spite of what might seem the more immediate and pressing problems of strikes, price competitiveness and international recession, the root of Britain’s industrial problem was low productivity. British living standards were lower than those of our principal competitors and the number of well-paid and reasonably secure jobs was smaller
because we produced less per person than they did. Some twenty-five years earlier our productivity was the highest in western Europe; by 1979 it was among the lowest. The overmanning resulting from trade union restrictive practices was concealed unemployment; and beyond a certain point — certainly beyond the point we had reached in 1979 — overmanning would bring down businesses and destroy existing jobs, and abort those which otherwise could have flourished. Outdated capacity and old jobs have to go to make the most of new opportunities. Yet the paradox which neither British trade unions nor the socialists were prepared to accept was that an increase in productivity is likely, initially, to reduce the number of jobs before creating the wealth that sustains new ones. Time and again we were asked when plants and companies closed, ‘where will the new jobs come from?’ As the months went by, we could point to the expansion of self-employment and to industrial successes in aerospace, chemicals and North Sea oil. Increasingly we could also look to foreign investment, for example in electronics and cars. But the fact is that in a market economy government does not — and cannot — know where jobs will come from: if it did know, all those interventionist policies for ‘picking winners’ and ‘backing success’ would not have picked losers and compounded failure.

Because our analysis of what was wrong with Britain’s industrial performance centred on low productivity and its causes — rather than on levels of pay — incomes policy had no place in our economic strategy. I was determined that the Government should not become enmeshed, as previous Labour and Conservative administrations had been, in the obscure intricacies of ‘norms’, ‘going rates’ and ‘special cases’. Of course, pay rises at this time were far too high in large parts of British industry where profits were small or nonexistent, investment was inadequate, or market prospects looked poor. Judged by relative labour costs, our level of competitiveness in 1980 was some 40 to 50 per cent worse than in 1978: and around three-fifths of this was due to UK unit labour costs increasing at a faster rate than those abroad, with only two-fifths the result of exchange rate appreciation. There was little, if anything, we could do to influence the exchange rate, without allowing inflation to rise still further and faster. But there was a great deal which trade union negotiators had it in their power to do if they wished to prevent their own members and others being priced out of jobs; and as the scale of union irresponsibility grew apparent, talk of the need for a pay policy began to be heard.

So it was important that from the very beginning — even before we had realized the extent of the pay explosion which was under way — I
stood firm against suggestions of pay policies. Some senior colleagues supported a return to incomes policy: shortly after we took office Jim Prior argued for early talks with the TUC and CBI about pay. We had already had vigorous disagreements on the issue in Opposition.
The Right Approach to the Economy
had gone further than I would have liked in proposing a ‘forum’ for discussion between employers and unions of the pay implications of government economic policy. A far weaker reference had been included in the 1979 manifesto. I had now come to feel that all such talk was at best irrelevant and at worst misguided.

Of course, it is of great importance that all those involved in wage bargaining should know and understand the economic framework in which they are operating and the facts of life confronting their particular business. Within a given money supply (provided that the government sticks to it), the more taken out in higher pay, the less available for investment, and the smaller the number of jobs.

Some people offered what they thought of as the ‘German model’. We were all conscious of Germany’s economic success. Indeed, we had helped create the conditions for it after the war by introducing competition and restructuring their trade unions. There were those in Britain who went further than this and said that we should copy the German corporatist tendency of making national economic decisions in consultation with business organizations and trade union leaders. However, what might work for Germany would not necessarily work for us. The German experience of hyperinflation between the wars meant that nearly everyone there was deeply conscious of the need to keep inflation down, even at the expense of a short-term rise in unemployment. German trade unions were also far more responsible than ours, and of course the German character is different, less individualistic and more regimented. So the ‘German model’ was inappropriate for Britain.

In any case, we already had the National Economic Development Council (NEDC) in which ministers, employers and trade unionists met from time to time. And so I was quite sure that we should not proceed further with the idea of a new ‘forum’. In fact, I felt that we should do all that we could to reinforce the contrary view: the whole approach based on prices and incomes controls should be swept away. The Government would set the framework, but it was for businesses and workforces to make their own choices, and to face the consequences of their actions, good and bad. In the private sector rates of pay must be determined by what businesses could afford, depending on their profitability and productivity. In the public sector also affordability
was the key — in this case meaning the scale of the burden it was right to ask the taxpayer and ratepayer to bear. Given that government was the ultimate owner and banker, however, the mechanism by which these disciplines could be made effective was bound to be less clear and direct than in the private sector.

The income tax cuts in our 1979 budget were intended to give more incentives to work. But the budget of 1980 was still more directly focused on improving our underlying economic performance. Towards the end of February Geoffrey Howe came to see me to discuss the shape of it. We were agreed entirely about the monetary and fiscal position: we would continue with the present money supply targets, which were still not being met, and keep the PSBR at the same level as the previous year.

However, I was more concerned about his tax proposals. There was no doubt about the difficulties industry was facing. Very high pay awards had left firms short of cash, though oil companies were in a better position due to the oil price rise. There was, therefore, a strong argument for a budget which helped business. On the other hand, I certainly did not want to see personal incentives diminished. It was going to be difficult to get the balance right. In any case, there was also a question of the precise means to help industry. My instinct was to go for a lower PSBR and so bring down interest rates. But many in industry wanted us to cut the National Insurance Surcharge (NIS) — a tax introduced by Labour, which had substantially raised business costs. Geoffrey had also been pressing from the previous December for a package of capital tax cuts and reliefs.

In the end we settled on a ‘budget for business’, but only by fairly modest and inexpensive measures. Geoffrey Howe’s second budget on 26 March 1980 helped small businesses through enterprise zones,
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gave tax relief to encourage the investment of venture capital, and introduced building allowances for small workshops.

As regards income tax, personal allowances generally were raised in line with inflation. But the lower rate band of 25 per cent, which we had inherited from the Labour Party and which complicated the tax system, was abolished. To balance this we raised the thresholds of the higher rate bands by about seven percentage points less than inflation. The budget also announced difficult and unpopular measures on prescription charges and social security benefits.

However, the most important aspect of the 1980 budget related to monetary policy rather than taxation. We announced in the budget our Medium Term Financial Strategy (quickly known as the MTFS), which was to remain at the heart of our economic policies throughout the period of their success and which was only relegated in importance in those final years, when Nigel Lawson’s imprudence had already begun to steer us to disaster. A little historical irony is provided by the fact that Nigel himself, as Financial Secretary, signed the Financial Statement and Budget Report (FSBR), or ‘Red Book’, in which the MTFS first burst on an astonished world, that he had contributed much to its preparation and that he was its most brilliant and committed exponent.