Among the many charges still laid at her feet, the late Baroness Thatcher is often blamed for deliberately increasing unemployment as Prime Minister so as to bring the trade unions to heel.
The truth, however, is somewhat different. The huge rise in unemployment which occurred during her first term in office was in fact the unintended consequence of what one might call blind monetarism.
Her Chancellor Geoffrey Howe, whose background experience was law and not business, embraced the new concept of monetarism wholeheartedly, convinced that the only way to kill inflation was to raise interest rates. So as inflation rose, bank rates in 1979 climbed even higher to contain it. This had two deeply perverse effects.
First, it substantially raised the cost of existing mortgages so that many households simply could not afford the unanticipated cost — which was often more than double that originally entered into. Such households were desperate to see an increase in wages. So inevitably inflation was primarily driven by a wage price spiral — not specifically by any material increase in import prices but by the fuel on the fire of ever-increasing mortgages and the consequent wage-induced business costs. The second effect of forcing the bank rate rise to 17 per cent on November 15, 1979 was that it dramatically raised the value of sterling, on occasion to as much as 2.4 dollars to the pound — some 21 per cent above its purchasing power parity. This was disastrous for exporters.
As co-founder of the Centre for Policy Studies (CPS) with Sir Keith Joseph, I could ensure he was aware of this problem. As an active member of the CBI council, I had been talking to many other concerned industrialists. Sir Emmanuel Kaye, managing director of Lansing Bagnall, a big manufacturer of forklift trucks, asked me if I could arrange a meeting with Keith. The rise in sterling was making it impossible for him to export. It had put up his costs by more than 20 per cent, making his company hugely uncompetitive. Others, like Richard Butler, chairman of the National Farmers Union, were also deeply worried.
I arranged the meeting, showing with a plethora of charts how the overvalued pound was making large sections of British industry uncompetitive. Keith was impressed but told me there was nothing he could do, that we were also a petro-currency and Howe was the man to see. Rising interest rates, he added, were part of his policy of bringing inflation under control.
When I discussed the folly of this approach with Alfred Sherman, the CPS’s policy director, his view was that savers should be protected from inflation by the rise in interest rates. I pointed out that if interest rates remained at that level for long, savers wouldn’t have any dividends — the source of their and pensioners’ wealth — because the companies simply wouldn’t be there to pay them.
As predicted, Lansing Bagnall declined, and was taken over and closed down — an unnecessary industrial tragedy which was to prove just one of thousands.
The feedback I was getting was that Margaret Thatcher instinctively felt that interest rates were far too high, but was unable to convince Howe and the Treasury team. Her intuitive feeling, which, here as in so many things, was justified by events, was not then fully recognised. (Alan Walters, who came back from the US to advise her in 1981, also believed that interest rates had been kept unduly high).
The unemployment caused by industrial bankruptcies, caused in turn by an over-valued pound (the exchange rate rose by more than 33 per cent between 1977 and 1980) was a legacy of Howe’s single-minded approach to the problem; he felt that there was no alternative but the medicine of monetarism. It was neither the fault of Mrs Thatcher nor Sir Keith Joseph, who felt powerless.
Attempting to control inflation through a monetary policy based purely on interest rates sowed the seeds of the decline in British industry over 30 years, throughout which the pound was overvalued most of the time. The American Fed, which has a policy of not only trying to control inflation but sustaining employment, is perhaps a better concept on which to run an economy. Our own monetary policy is now being run on the same lines, in practice if not in theory.
It has been argued that one of Howe’s great successes was to let the pound float and be freely adjusted by market forces. But this is also a myth, as in reality the value of the pound is significantly influenced by the bank rate. If this contributes to keeping the value of sterling well above purchasing parity, then businesses — whose profit margin is seldom much above 10 per cent — inevitably become uncompetitive.
For a trading nation like Britain to ignore the value at which it trades —the value of sterling — can now be seen as an error of the first magnitude. It has decimated our industrial framework, given us a massive imbalance of trade and huge international borrowings, all of which have to be serviced by an ever-increasing burden of general taxation.
Some argue that we should accept that in modern nations manufacturing industry is dead and we should rely on the growth of the service sector. But the UK, with its inventive and entrepreneurial background and extraordinary tradition of scientific innovation, should be perfectly capable of holding its own with Switzerland, Japan or indeed Germany, who have thriving industrial sectors and substantial trade surpluses.
The folly of an economic policy based on interest rates and money supply alone is being increasingly recognised. Sadly, manufacturing capacity cannot be replaced overnight, nor the skills that go with it. But a dawning recognition of the problem, across the political spectrum —catalysed perhaps by the development of cheap shale energy — could, with the pound valued at a sensible level, reactivate our economy and the jobs that go with it.