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leadership of my right hon. Friend the Prime Minister, whose outstanding contribution to the renaissance of Britain over these past 10 years I am proud to have been able to assist.

Several Hon. Members rose --

Mr. Speaker : Will those hon. Members who are not remaining please leave the Chamber quietly?

5.36 pm

Mr. Peter Shore (Bethnal Green and Stepney) : The House listened with close attention to what the right hon. Member for Blaby (Mr. Lawson) had to say. He was frank. There were no obfuscations, no skating over the reality of his disagreements and the reality of his disappointment that he felt obliged to resign his high post. As he said, he did not lightly give up being Chancellor of the Exchequer, nor was it an outcome that he sought.

Furthermore, the right hon. Gentleman focused upon what I believe was the major and continuing source of disagreement between himself and the Prime Minister in economic policy--that is, the relative weight that they have given and continue to give to the use of exchange rate policy in the general mix of Government policy and counter-inflation strategy.

The right hon. Gentleman has not in the past sought, or conducted himself in a way that encouraged, the affection of the House. But, if I may say to him, those of us who have disagreed with him most strongly have always respected his intellectual ability and his great intellectual candour. We have not always enjoyed it, but we have respected it. He has done himself no harm at all on either side of the House in what he has had to say in his very frank speech today. The right hon. Gentleman's resignation last Thursday raised for all of us three serious issues of economic policy. First is the question of the authority over economic policy of the Chancellor of the Exchequer in relation to the Prime Minister and to her advisers. Second is the question of the Government's policy towards joining the exchange rate mechanism of the EMS. Third is the question--the most important of all--of the continued and massive deterioration in our economic prospects and what the Government intend to do about it. The first issue has inevitably received much attention in the debate, and no doubt will continue to do so after the right hon. Gentleman's speech. I say "inevitably" because it was the right hon. Gentleman who, in his resignation letter, put clearly, as he saw them, his reasons for going. Having listened to the right hon. Gentleman, surely no hon. Member can doubt that for the best part of the past 18 months he has had major disagreements with the Prime Minister on both interest rate and exchange rate policy.

Not only were there major disagreements, but they were made highly visible by comments both from the Prime Minister and her former economic adviser, Sir Alan Walters. When the Prime Minister told Mr. Brian Walden in a television interview on Sunday :

"I fully backed and supported the Chancellor somehow Nigel had made up his mind that he was going",

she was being exceptionally economical with the truth. Today's debate would never have been staged if the Prime Minister had really wanted to keep the right hon. Member for Blaby as her Chancellor. Without further ado, she would have sacked her part-time adviser. She did not do so, and she continued to refuse to do so even when she

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knew for certain that to retain Sir Alan would mean the departure of the Chancellor of the Exchequer. Faced with the choice of backing or sacking the right hon. Gentleman, the Prime Minister simply waited for his resignation. Sir Alan Walters's resignation settled nothing. It simply removed the surface manifestation of disagreements between the Prime Minister, her former Chancellor and her present Deputy Prime Minister.

The result is confusion and uncertainty, or, to use the words of the right hon. Member for Chingford (Mr. Tebbit) only yesterday, "an appalling muddle" about the real thrust of Government policy and in particular their attitude to joining the exchange rate mechanism of the European monetary system. It is no good the new Chancellor making statements, partly propagandistic and partly designed to reassure people, that there is no real change in Government policy, because the nation knows that two different policies were pursued in parallel, the consequences of which we are all aware of today.

The problem that the Government must face is the result of their long-term mismanagement of the British economy. They have presided over years of under-investment, high and costly unemployment, squandering of North sea oil reserves and, in the past three years, the growth of excessive purchasing power swollen by a falling savings ratio, a massive increase in personal borrowing and large cuts in taxation. That excess purchasing power has been reflected in both rising inflation and a horrific current account deficit.

That is the economic background against which proposals for joining the ERM must be judged. The argument about joining the ERM in the next two or three years is now largely academic. Whether or not the Prime Minister's condition that other European countries free the movement of capital is met, and whether or not United Kingdom inflation comes down from its present rate of 7.6 per cent. to the Community average, we are in no position to join so long as our vast current account deficit pertains.

Our £20 billion deficit on current account this year is almost 5 per cent. of our gross domestic product and the largest deficit that any major country has experienced since the end of the second world war. At its peak, the American deficit was less than 3.5 per cent. of GDP and its gradual diminution required several massive devaluations of the dollar before noticeable progress could be made. Today, no one has the faintest idea what the level of sterling should be in relation to the deutschmark and other European currencies. I am aware that many other conditions would need to be satisfied before Britain could contemplate membership of the ERM. My right hon. Friend the Leader of the Opposition and my right hon. and learned Friend the shadow Chancellor of the Exchequer frequently refer to the need for adequate swap arrangements between the central banks, for a co- ordinated growth strategy throughout the European Community and for enhanced regional support. All those points are important, as is the ending of exchange controls in European Community countries, but it is inconceivable that we should enter the ERM and fix our exchange rate while our huge deficit remains and we have literally no idea what the rate should be.

Mr. Beith : Will the right hon. Gentleman give way?

Mr. Shore : No, not for the moment.

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If we were so foolish as to join the ERM before the problem of our deficit were resolved, we should be forced to make successive adjustments in the rate--with all the ill will that that would create--or to suffer the penalties of rising unemployment and lower output, as we became increasingly uncompetitive.

Mr. Beith : I had formed the impression that the right hon. and learned Member for Monklands, East (Mr. Smith) would join the ERM now if his four conditions were met. Is that not the right hon. Gentleman's view?

Mr. Shore : I am simply drawing attention to the problem of fixing a current, practicable and sustainable rate for sterling. It cannot be done now, given the horrendous size of our current account deficit.

Our long and far from happy experience of fixed exchange rates between 1945 and 1972 in the International Monetary Fund system should also counsel caution. Two problems were repeatedly experienced. First, there were large, short-term speculative movements, with the constant danger of exhausting our reserves. Secondly, there was medium-term loss of competitiveness, due to our slower rate of growth of productivity and our tendency to higher inflation than many of our major competitors. The result was strong pressure on us throughout that period to maintain an uncompetitive rate for sterling long after we should have devalued. That forced successive Governments in the post-war period to engage in stop-go policies and made the United Kingdom growth rate unsatisfactory compared with other, faster- moving, competitor economies. There can be no real stability in exchange rates while there are large differences in productivity and inflation between member countries. Large differences remain today between ourselves and both Germany and France. Furthermore, as the case for periodic realignments in exchange rates becomes ever stronger, the pressure for adjustments falls on the weaker currencies and is hardly felt by the stronger ones. That lack of symmetry in the adjustment process exerts deflationary pressure on all weaker economies in fixed exchange rate systems.

The ERM, which has been the focus of much of the debate, is no exception. Those who claim the virtues of the ERM should look at the performance of the economies of the member states. Unemployment in France has remained virtually static for the past four years and was running at 10 per cent., or 2.6 million men and women, in May this year. During the same four-year period, unemployment in Italy has risen from 9.2 per cent. to 10.7 per cent., reaching a total of nearly 2.9 million people. Unemployment of 10 per cent. in the Netherlands and Belgium has shown only a marginal improvement in the past four years.

Those figures of 10 per cent.-plus unemployment in major European economies within the ERM compare with 6.8 per cent. unemployment in May 1989 in the United Kingdom. Most of us believe that that is still much too high, but it is well below the levels of our European neighbours.

The only country in Europe that has seen a near return to full employment and a substantial decrease in the numbers of unemployed in the past four years is Germany, where the unemployment rate was only 5.9 per cent. in May 1989. Far from achieving convergence since the

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formation of the ERM in 1979, the German trade surplus with other EC countries has massively increased in terms of both money and import-export ratios.

Our experience of fixed exchange rates in the IMF--which was far from the happy one that some seem to recall--took place against a background of strong controls over the movement of capital from the United Kingdom into the outside world. We no longer have those controls ; we no longer have any exchange controls. The cost of maintaining a fixed rate for sterling is bound to be much more onerous in the future than it has been in the past.

Mr. Giles Radice (Durham, North) : My right hon. Friend has not mentioned the way in which the inflation rates of the countries that he has named have come together. I should have thought that, if we are to discuss the convergence of the economies of those countries, we should consider that factor.

Mr. Shore : It is one of the mix of matters that should concern all who wish to see a balanced, effective and successful macro-economic policy ; but to posit the overriding importance of counter-inflation against our other major interests--growth in the economy, and the provision of jobs--is far more a Conservative philosophy than one that has commended itself to Opposition Members. All those matters need to be debated and evaluated seriously before any decision is made to return to a fixed exchange rate system.

In my view--I address this remark particularly to the right hon. Member for Blaby--it would be both dangerous and wrong for Britain to make its decision about joining the exchange rate mechanism not on economic grounds, but as a political act--either as a gesture to demonstrate our European bona fides or, still more disastrous, as a prelude to the full-blown economic and monetary union described in stages 2 and 3 of the Delors report. We must judge such issues in the economic interests of our people, not simply as part of a madcap rush towards federalism in western Europe.

5.51 pm

Mr. John Townend (Bridlington) : I am surprised that the Opposition decided to have a second Supply day to debate the economy within seven days of the first. Nothing in the economy has changed since last week : it is as strong as it was then, and has the same troublesome but, I hope, short-term problems. The only difference is that we have a new Chancellor of the Exchequer. I congratulate my right hon. Friend on his new appointment, and wish him every success in his post. He has come in at a difficult time, but his background as a banker and former Chief Secretary to the Treasury will provide him with invaluable experience, and I am sure that he will fill the position with distinction.

Like my hon. Friends--and, indeed, many Opposition Members--I think that the former Chancellor, my right hon. Friend the Member for Blaby (Mr. Lawson), will go down in history as a great reformer. The country will, I believe, benefit greatly over the years from his reforms, particularly his reform of company taxation and the part that he played in creating the enterprise economy by reducing direct taxation dramatically and encouraging the talented in every sphere to work in this country. I find it odd that the Opposition, who were so critical of the former

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Chancellor last week, are now turning him into their hero, although both my right hon. Friend the Prime Minister and the new Chancellor have said that there will be no change of policy, and that the Government's priority will continue to be the defeat of inflation. If any justifiable criticism could be made of the previous Chancellor and his policies, it would be that the Government, having brought inflation down to its lowest level for decades, have allowed it to rise again. It is easy to be wise after the event, and I think that, understandably, the former Chancellor underestimated the extent to which the economy was overheating in the first half of 1988. To be fair, I must point out that the statistics on which he and the Bank of England must work could be much better, as has been pointed out several times by the Treasury Select Committee.

Most people, I think, agree in retrospect that monetary conditions in the first half of 1988 were too lax, and that it was a mistake to try to shadow the deutschmark at a level of DM3 to the pound when market pressures were forcing the pound up.

Mr. John Butcher (Coventry, South-West) : Did my hon. Friend hear the former Chancellor say that he recommended according the Bank of England similar status to that of the German Bundesbank, and that the Bundesbank had enjoyed constitutional independence and been both a brake on inflation and a prudent guardian of the money supply in the Federal Republic, thus providing the benefits that we have seen in that country? Will my hon. Friend say a little more about what may be the ex-Chancellor's final legacy to the House, in that he has moved us in the same direction--I hope inexorably?

Mr. Townend : I noted what the former Chancellor said with great interest, and have made a note to refer to it later in my speech. To shadow the deutschmark, the Chancellor reduced interest rates several times, and I think that that error played a major part in the overheating of the economy. If it had not been made, our trade deficit would now be lower, as would inflation, and interest rates would not have been able to rise so much. Taking that into account, I find it strange that so many hon. Members on both sides of the House are so enthusiastic about joining the exchange rate mechanism. When my right hon. Friend the Member for Blaby was shadowing the deutschmark, the United Kingdom was a de facto member of the ERM, and we are now paying a heavy price for that.

Mr. Bell : The hon. Gentleman is quite right : at that time we were a de facto member of the ERM. That was the entire policy, although it certainly was not elaborated by the Treasury.

The hon. Gentleman has criticised the former Chancellor for shadowing the deutschmark. The real reason why the economy went into disequilibrium was not that, however, but the fact that the right hon. Gentleman reduced income tax so much that he put £6,000 million into the economy.

Mr. Townend : There is another reason, which I shall come to in a minute.

If there was a disagreement between the former Chancellor and the Prime Minister at that time--as many commentators have said--time has proved that, once again, the Prime Minister was right. It is not often that I

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agree with the right hon. Member for Bethnal Green and Stepney (Mr. Shore), but I thought that he made some relevant points. We are not yet fully aware of the strain that will be put on the system when the other members of the ERM abolish exchange controls.

I also find it strange that those on the Opposition Front Bench are so keen to join a mechanism that depends on the dictate of the Bundesbank. Let me now deal with the point made by my hon. Friend the Member for Coventry, South-West (Mr. Butcher). I thought that one of the ex-Chancellor's most significant statements today was his suggestion that he had advanced to the Prime Minister proposals to make the Bank of England independent and more like the Bundesbank. That may indeed be one of his great legacies : an independent Bank of England would give us even less reason to join the ERM and experience the discipline of the Bundesbank.

I hope that my right hon. Friend the new Chancellor will not slavishly follow an exchange rate policy, and increase interest rates to a level that will force us into a major recession. Interest rates are very high at present, and, while I accept that such rates are necessary, they are bearing down very hard on the small businesses that are the seedcorn of our future success.

The hon. Member for Middlesbrough (Mr. Bell) referred to the shadowing of the deutschmark. Although the shadowing of the deutschmark, and the low interest rates that went with it, was partly responsible for the upsurge in inflation, the seeds of the inflation that we are now having to deal with were sown in 1986, when the Chancellor of the Exchequer stopped targeting broad money. I accept all the difficulties that in measuring broad money, but the argument in its favour was put cogently by William Rees-Mogg in a press article yesterday. His argument was most convincing. Whatever the problems of measuring broad money may be--and I accept that there are problems--may I ask the new Chancellor not to ignore it.

The trade deficit is too high for comfort. However, it is not mirrored, as is the case with most trade deficits, by a budget deficit. The deficit is caused by the private sector spending too much, running down savings too much and borrowing too much. Over time, the trade deficit should right itself, but the position will improve more quickly if we improve the supply side of the economy. The major cause of the trade deficit is said to be the decline in our manufacturing base. The figures for the motor car industry show that there is a deficit of £6 billion, so the point is well made. We must ask ourselves why the United Kingdom ceased to be a car exporting country in surplus and became a car importing country in deficit. The answer is that we did not make the right cars at the right price and of the right quality, with the right after-sales service that the market wanted. Without doubt, a large part of the blame for that lies at the door of the Opposition paymasters, the trade unions.

Mr. Austin Mitchell (Great Grimsby) : Does it not have any connection with the fact that one quarter of our manufacturing capacity and 28 per cent. of our manufacturing jobs were closed down between 1979 and 1983?

Mr. Townend : That has nothing to do with the car industry. Just look back to the 1970s--to the disruption in the car industry. At open-air meetings, there were no secret

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ballots, and out the workers went on unofficial strike. Just look at the restrictive practices, the go-slows, the refusal to accept new technology. Management was unable to manage and the industry was dominated by militant shop stewards.

We should cast our minds back to what happened to the Rootes family business, a fine British motor car firm that tried to stand up to crypto- Communist, Left-wing shop stewards. A strike at Acton went on for week after week. The company was financially crippled and had to sell out to Chrysler in America. British Leyland would have gone broke had it not been for the millions of pounds of taxpayers' money that were poured into it. In some factories, quality control managers were ordered to limit the number of cars that they sent back for poor quality because there would have been a strike if more than a certain number had gone back. Those cars went to the customer. That is what destroyed the British car industry.

This Government, under the Prime Minister, have dealt with those problems. We have stopped the rot by reforming industrial legislation and by bringing the trade unions within the law. We have severely restricted picketing, blacking and sympathy strikes. The British motor car industry is beginning to rise like a phoenix from the ashes. Investment is pouring in, but sadly much of it is Japanese. Beggars, however, cannot be choosers. The Opposition's friends destroyed the industry ; we need help to rebuild it. Nissan will be producing 400,000 cars within five years, Toyota 200,000 cars and Honda 200,000 cars. In the mid-1990s, that will have a significant effect on our balance of trade. We shall reduce our imports and we shall reconquer the European car market.

All of us agree that British industry must keep down unit costs. Is it not tragic, when we have this balance of trade deficit, that the engineers are demanding a reduction in the working week to 35 hours and threatening to go on strike? If they win, that will increase our unit labour costs, at a time when we cannot afford to do so. If the Opposition want to be considered able to form a responsible alternative Government, they should tell the engineers to settle and condemn their ridiculous action.

A reduction in the working week at this time would do more damage than at any other time in the last 10 years. The labour market is very tight. If we reduced the working week, we should reduce the number of hours of skilled labour that are available. That would lead to inflationary pressures on the skilled work force. The reason for the shortage of skilled workers is the decline in

apprenticeships--again partly due to the ridiculous attitude during the last 10 years of the unions that have forced up apprentices' wages. The only place where there has been an increase in apprenticeships is the electrical industry. The union leaders have been sensible. They have decided to reform apprenticeships by reducing the length of apprenticeships and the level of pay. Therefore, apprenticeships in the electrical industry are now expanding.

I wish the new Chancellor every success. It is quite clear that it is business as usual, that there will be no let-up in the Government's determination to solve the short-term economic problems. My hon. Friends and I are fully behind the Chancellor and the Prime Minister.

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6.6 pm

Mr. A. J. Beith (Berwick-upon-Tweed) : I wish the Chancellor well and welcome him to his new job, to which he brings particular qualities, relevant experience and the courtesy that we have all come to expect from him. It is a very odd course of career that has brought him to the job at this time. If I were in the furniture removing business, I would get to know him well. His effects must have been careering up and down Whitehall at an alarming rate. As I heard the cheers of his hon. Friends, I thought that they ought to press him to their bosom while they still can, before he is moved on to something else.

If, for example, the new Foreign Secretary is thought after a week or two to have gone native--there is a considerable risk of that, after his previous experience at the Foreign Office--the Prime Minister would be on the phone to the Chancellor, saying, "John, I need you back in the Foreign Office." It may be that the new Home Secretary will be moved yet again to another post to fill the gap that the Prime Minister creates by her manner of conducting business.

Mr. Harry Ewing (Falkirk, East) : The Chancellor has had as many job changes as the party of the hon. Member for Berwick-upon-Tweed (Mr. Beith) has had name changes.

Mr. Beith : I am very happy with my party's name. The hon. Gentleman must be careful what he says. It is all coming out this afternoon. We now see the differences on the Government side over the European monetary system. It is impossible for Ministers to say that the policy remains unchanged after the clear assertion of the former Chancellor, the right hon. Member for Blaby (Mr. Lawson), that he believes that we should join the European monetary system in the shortest possible time. We have heard his successor pronounce a formula that is closer to the Prime Minister's words, one that we understand will have to be interpreted in the light of her words, which means that it will take an unconscionably long time to join the European monetary system.

We have also heard from the right hon. Member for Monklands, East (Mr. Smith) a clear declaration that, if certain terms can be met--which are a little far-fetched because they rely on the Germans embarking on a policy of reflation, which seems unlikely, at best--the Labour party would take us into the EMS immediately. However, in last week's debate, senior Labour party members made pronouncements in terms that were very close to those of the Prime Minister. They could usefully hold a little seminar at which the Prime Minister, the right hon. Member for Bethnal Green and Stepney (Mr. Shore) and others could gather together to extend the list of conditions that would have to be satisfied before they could support entry into the EMS. Between them they could produce volumes of conditions. All of them represent delicate compromises by means of which each of the parties can refer to the EMS, because both parties are divided as to whether we should enter the EMS.

The Chancellor's speech was thin on certain of the major issues on which answers are currently sought. It did not give any clear guidance about the Government's monetary policy. The Chancellor spoke of a broad range of indicators. He did not tell us whether he places his faith in M0 or whether we are to have a new indicator of broad

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money. He did not tell us whether movements in the money supply or movements in the exchange rate will determine the level of interest rates.

He was still unclear what he meant by his preference for a strong pound, and how far he would go to secure it. We know that he will spend our reserves to secure it, as that was clearly done on Friday, but how far will he raise interest rates to "buck the market" and keep the pound at the level he prefers? That remains unclear, and his speech added nothing to our knowledge.

The Chancellor's words about the European monetary system demonstrate vividly that the Prime Minister's prejudices are still determining that issue. The Prime Minister is like the heroine of one of those old black-and -white films, who is always waiting to get on the train that is about to leave. The guard blows his whistle and still she will not get on board. We sit in the cinema wondering whether she will board the train or remain on the platform locked in an embrace. The Prime Minister is embracing her prejudices, her belief in national sovereignty and her conviction that, however little power we exercise, we must preserve the illusion of sovereignty. So she never boards the train.

Mr. Butcher : I should like to put to the hon. Gentleman the same question I asked my right hon. Friend the Prime Minister this afternoon. The SLD is in favour of almost immediate membership of the exchange rate mechanism. If we did so with a margin of 7 per cent. between German and British interest rates, and if British borrowers bypassed with impunity the domestic constraints and borrowed from Frankfurt, would that not increase the money supply and add to domestic inflation? When would the hon. Gentleman suggest we join the exchange rate mechanism--now, under those circumstances?

Mr. Beith : Borrowers are quite free to borrow in Frankfurt now. The former Chancellor quite rightly removed exchange controls and capital controls. One disincentive to borrowing abroad is uncertainty about the exchange rate, and clearly that is a changing situation. Clearly, the basis on which we would enter the exchange rate mechanism and the terms of the currency at the moment of our entry are bound to be influenced by such issues. The Conservative party is supposed to be in favour of liberal exchange rates and a free regime in which people can borrow freely in any part of Europe. I believe that any security or framework for our currency requires us to join the European monetary system as soon as we reasonably can. What other respite is being offered to those who now have to face a £900-a-year increase on a £30,000 mortgage as a result of the interest rate increases since March? What respite is offered to all the other victims of high interest rates?

There can be no serious prospect of lower interest rates, unless some alternative to present policy is found. Only one element of that alternative is membership of the exchange rate mechanism. There have to be other components. There has to be a tight fiscal policy, but that should not be achieved by further cuts in the very public expenditure which is necessary to turn round our balance of payments deficit. We should not start cutting expenditure on training, research and the infrastructure, which are most in need of additional expenditure. The new

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Chancellor, as a former Chief Secretary, was familiar with that exercise. He was so recently in that office that I was tempted to use his former title.

If we launch into public expenditure cuts in those areas, we shall never get the trade deficit sorted out. It must therefore be achieved by other means. We have suggested increases in national insurance contributions, a commitment not to make tax cuts in the next Budget and the abandonment of the 20p in the pound tax pledge. I did not hear anything from the new Chancellor about whether he still holds to that pledge, and whether that policy is unchanged.

We want incentives for saving, and we have suggested changes in funding policy all designed to accompany membership of the exchange rate mechanism. We certainly would not argue that that by itself would solve our economic problems. The Chancellor was building a straw man, erecting a whole structure around the idea that there are those who believe that membership of the exchange rate mechanism would sort out all our problems.

As it is, there is no framework, no rule and no discipline now governing British economic policy. We are not in the exchange rate mechanism and we are clearly not joining it ; we do not have in independent central bank ; and the right hon. Member for Blaby implied that we must have one or the other if anti-inflation policy is to be credible. It would be interesting to hear whether the study of central bank independence to which he referred has been taken any further or whether it found its way into the Prime Minister's or Sir Alan Walters's wastepaper basket ; and if so, for what reason. Perhaps it is to be a new source of dispute. Is it an unchanged commitment which will be continued by the new Chancellor, or will it surge forward at some point as the issue on which he resigns when he discovers that it is the subject of tittle-tattle and unwarranted things all got up by the press?

There is no clear framework within which British economic policy operates-- it is not the EMS, the independent central bank, broad money or narrow money ; and it is certainly not the exchange rate. If monetarism cannot be worked by the present Government, I cannot conceive of any Government that could make it work. If a strict monetary policy tied to M0 cannot be made to work by this Government, with the authoritarian power that is exercised by the Prime Minister and that certainly was not exercised in America by President Reagan, I suspect that the experiment has been carried out and that we have demonstrated that there is no political structure short of absolute dictatorship in which pure monetarism can be applied.

We now have the economic management of a touch on the tiller, but the Chancellor will find that two different hands are reaching for the tiller. If he is not careful, the new Chancellor will find that another hand is there before his.

The right hon. Member for Blaby stated in his resignation letter : "The successful conduct of economic policy is possible only if there is--and is seen to be--full agreement between the Prime Minister and the Chancellor of the Exchequer."

How will that ever be secured other than by subservience? How did the Prime Minister manage to contrive that what the former Chancellor wanted as his price for staying happened as soon as he had got out of the door? That is the unanswered question about the details of last week. How could she have received and accepted the very

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resignation which had been sought the moment that the former Chancellor had departed? Did she try to dissuade Sir Alan Walters from resigning? We never found out.

The former Trade Secretary, the right hon. Member for Chingford (Mr. Tebbit), dwelt on how dangerous it was for a captain to appear semi- detached from the team, and said that, had Lord Whitelaw still been in the Government, he would have warned the Prime Minister that she was in danger of having to choose between her adviser and the Chancellor. The Prime Minister said that the Chancellor was unassailable. What Chancellor is unassailable if his chosen exchange rate policy is publicly challenged by the Prime Minister's adviser? What Chancellor is unassailable if the Government's stated conditions for entering the European monetary system are extended every time the Prime Minister opens her mouth, and particularly every time she appears on television? The longer that interview had continued, the more conditions she could have produced to prevent our entering the exchange rate mechanism.

It is all part of a wider issue. As the right hon. Member for Blaby pointed out, it is the tip of an iceberg. The Prime Minister's dispute with the former Chancellor, her hectoring of our European partners and her behaviour at the Commonwealth conference are all of a piece. It all rests on the belief that she alone is right and everyone else is out of step. It is no basis for running Commonwealth, Europe or Cabinet, and it comes home most particularly in Cabinet government. It means that nothing the Chancellor could say today can claim much credibility. Indeed, if his stature grows in office, his future will be shortened.

The whole character of British government under the Prime Minister has become autocratic, centralised and patronising. Power is concentrated as never before. Cabinet government has gone the way of local government. The Prime Minister has no time for it, and the people of this country are the victims.

Liberal Democrats are determined to secure for this country a system of government in which no future Prime Minister can exercise such unchallenged power.

6.19 pm

Sir Ian Gilmour (Chesham and Amersham) : The hon. Member for Berwick -upon-Tweed (Mr. Beith) envisaged a seminar to be attended by the Prime Minister, Labour Members and himself. That is an enticing thought. I do not like seminars, but I should like to be present at that one.

There seemed to be something of a black hole in the policy that the hon. Member for Berwick-upon-Tweed outlined, but he made some interesting remarks about the European monetary system. I shall not talk about that, neither shall I talk about Sir Alan Walters. There was even more of a black hole in the critical speech made by the right hon. and learned Member for Monklands, East (Mr. Smith). Although his name was not mentioned, there was the all-pervasive presence of one man throughout the speeches that the right hon. and learned Gentleman made last week and today--Mr. Walter Mondale, to whom I shall return shortly.

I congratulate my right hon. Friend the Chancellor of his new high office, in which we all know that he will perform exceedingly well. He has a difficult task ahead, for two reasons. First, as was confirmed this afternoon, his predecessor is a man of massive intellectual distinction, knowledge and ability and, secondly, because the legacy

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that my right hon. Friend has inherited is not as he would wish. He made a good start today with a most pugnacious and partisan speech. Although there was not a black hole in his policy, there was a small gap in it, with which I should like to deal in a moment.

My right hon. Friend mentioned the balance of payments, although not in as much detail as I should have wished, and said that it would come down in line with inflation. The key question is whether by using a single weapon the balance of payments problem and inflation can be conquered. That is not only interesting but it is the key factor in whether we shall have a Conservative Government after 1992.

The Government have never exactly explained how interest rates are meant to cure inflation--certainly not through controlling the money supply, as the hon. Member for Berwick-upon-Tweed suggested. I do not think that anyone believes that that now happens. But as my right hon. Friend the Chancellor seemed to suggest, they work by cutting demand, so unemployment rises and wage claims are reduced. There is pressure on companies not to accede to wage claims, and therefore inflation falls as companies' profit margins, particularly on exports, are squeezed. Clearly, that is not the only way of cutting demand and it has obvious disadvantages, which I shall mention only briefly as the House is well aware of them.

The first disadvantage of using interest rates is that they have an immediate effect on the retail price index and therefore increase inflation. It is a perfectly respectable argument to say that mortgage interest rates should not be included in the RPI, but the fact is that increases in mortgages increase housing costs and will have an effect on wage claims later this year.

The second disadvantage is that high interest rates have an uncertain effect over an uncertain period. The Government have been using the interest-rate weapon with increasing strength for a year, but it is still unclear when, whether, where and by how much the economy is slowing down.

The third disadvantage is injustice. As my right hon. Friend the Chancellor freely conceded, people who have bought houses, or who are trying to do so, are, through no fault of their own, suffering grievously. High interest rates have equally important, if not more important, effects on industrial investment, which has only recently recovered, and therefore have serious implications for our future. The fourth disadvantage of high interest rates is their perverse effect on the balance of payments. Squeezing export margins not only makes it difficult for exporters to export but sometimes makes it almost impossible. After a year of the medicine that we have been enjoying--if that is the right word--the last quarter was the worst for the balance of payments in our history. Although the last month was slightly less discouraging than the preceding two, the last quarter has been disastrous.

Everyone now seems to agree that a sharp fall in demand is necessary. As the policy of high interest rates has the considerable disadvantages that I have mentioned, the onus is surely heavy on the Government to prove that no other weapon could or should be used. Until now, that onus of proof has not come anywhere near being discharged. Indeed, it has hardly been attempted.

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In his speech last week, when he was interrupted by the hon. Member for Berwick-upon-Tweed, my right hon. Friend the Member for Blaby (Mr. Lawson) dismissed out of hand the use of fiscal measures to reduce demand, curb inflation and help the balance of payments. If I understood my right hon. Friend the Chancellor correctly, he said the same this afternoon. He said that we should use all practical levers, but then said that the key lever is monetary policy. He said nothing about using fiscal policy.

As it is now widely agreed that the tax cuts in the 1988 Budget were too high, surely this is the time to rectify that mistake. The Government's objective is to cut demand, and tax rates do that far better than high interest rates, because they are far fairer and do not hit investment but cut consumption.

The Labour party is unable to recommend that obvious expedient--to some extent, the same applies to the Liberal Democrats, if that is the right name--because of its electoral unpopularity. We all know what happened to Walter Mondale--he has never been heard of or seen since he fought the 1984 election on a tax-increasing policy. Mr. Bush got himself into quite a lot of trouble by following the reverse of that example in 1988. The Government are not prepared to implement such a policy, because they have made such a fetish of tax cuts. We all welcome tax cuts and have done very well from them, but surely it is wholly erroneous to think that taxes should never increase. Surely the only proper way to proceed is to cut taxes when one can and raise them when one must. Surely this near-crisis is one of the occasions when taxes should be raised.

Dr. John Marek (Wrexham) : The right hon. Gentleman should be careful about what taxes he is talking about. He must remember that the Government have increased taxes as a proportion of gross domestic product, whereas they were about 4 or 5 per cent. lower under the last Labour Administration.

Sir Ian Gilmour : I apologise if I did not make myself clear. I was talking about direct taxes, which I think was implicit when I mentioned the tax cuts in 1988.

I believe that income tax should be increased and that the ceiling on national insurance contributions should be removed. That is one point about which I am in agreement with the Social and Liberal Democratic party. If taxes are not increased, it will be difficult to solve the current problem.

Another expedient that is derided by many hon. Members on this side of the House--it certainly has great disadvantages, but I do not believe that it would be right entirely to rule it out--is some sort of credit controls. As my right hon. Friend the Member for Blaby said in his Mansion house speech, they would be very leaky and there would be massive evasion, but would there be so much evasion that they would not be worth having? There is considerable income tax evasion, but no one has suggested that we should not have income tax. The Government have not made the case in practice-- that is important, because so far the medicine has not worked very well-- and neither have they argued it properly in theory, for using only high interest rates, which have considerable disadvantages. I hope that they will think again. The enormous advantage of raising direct taxes and using direct control of credit is that the reduction in domestic demand would, so far as possible, be

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concentrated on personal consumption, which is where it is needed. With lower interest rates and ultimately a lower real rate of exchange, industrial investment and international competitiveness would be better sustained. After we have turned what my right hon. Friend the Member for Blaby suggested will be an awkward corner, there will be a reasonable chance of achieving at a later stage sustained non-inflationary growth. There will be a real chance that the Conservative party will win the next general election. 6.30 pm

Mr. Doug Hoyle (Warrington, North) : The hon. Member for Bridlington (Mr. Townend) suggested that, because we were courteous and polite to the right hon. Member for Blaby (Mr. Lawson), we accepted the Government's economic policies. That is untrue. It has been said repeatedly that it is business as usual. I shudder to think about that, because it means that we shall have a £20 billion deficit by the end of the year. The former Chancellor suggested that that did not matter and neither did the fact that we will have a manufacturing deficit of £17.5 billion. Far from being a success story, the economic record of the Government since 1979 has been one of failure. Under this Government, the increase in expenditure on manufactured goods has been three times greater than the increase in what has been spent on the production of manufactured goods. That is a way to disaster.

Since the Government took office in 1979, there has been a 20 to 25 per cent. destruction of manufacturing industry and we are paying a heavy price for that now. The growth in output since 1979 shows that this country is 17th out of the 18 OECD countries. That is far from being a success--it is a failure. If the Government continue to claim it as a success, I would not like to see what they regard as a failure.

Last year the former Chancellor spent billions of pounds trying to keep the pound below DM3. This year he has spent billions of pounds trying to keep it above DM3. Clearly, both policies cannot be right. To continue with that policy would be akin to economic madness. The consequences of attempting to keep the pound at a level that cannot be sustained were pointed out by my right hon. Friend the Member for Bethnal Green and Stepney (Mr. Shore) when he said that successive Governments--including previous Labour Governments- -have paid a heavy price for trying to keep the currency at a level that one cannot protect. It would be better to allow it to float downwards. The right hon. Member for Chesham and Amersham (Sir I. Gilmour) referred to high interest rates attracting hot money into the country. That hot money would quickly leave when interest rates came down. High interest rates mean mortgages that people cannot afford and that is under a Government who talk about a property-owning democracy. People will have to give up their homes because they cannot afford them and young couples cannot even think about buying. Even more disturbing is the cut that will take place in investment in manufacturing industry. Already we are investing less than our competitors such as France, Italy or West Germany. The Confederation of British Industry predicts that the cut will occur in 1990. As a consequence of that cut we will be less competitive and there will be a rise in unemployment.

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