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the capital allowances given for this essential investment and those for fancy city offices They are both given in precisely the same quantitative amounts.

Service industry, to which the Government were so deeply wedded, rests on the back of manufacturing industry. Financial markets follow industrial success. The service industry is no more use on its own than is the practice of taking in each other's washing. The City of London was created from a successful economy and so was New York. Tokyo and Frankfurt are rising on the strengths of their manufacturing industry. They will pose severe problems to London. The trouble is that through most of this century this country's financial activities have been considered as more important than its industrial operations. That led Winston Churchill to ask that finance be less proud and industry more content. Of course, we need the constraining function of proper financial management. As a country, we have superb accountants, but not many good, and certainly not many adequately- rewarded, engineers. We have the snaffle and the bit--well structured and hand-tooled they are, but where is the bloody horse? The inadequacy of our training and education to provide the motive power for such people is a shaming indictment of our time. The trouble is that the same financial activities have led the rush to London, even of our manufacturing industry. Out of the top 100 companies in Britain, 95 have their headquarters in London. Some years ago I compared that with the city of New York, the financial centre of the United States, where 29 out of the top 100 companies had their headquarters based. Companies such as 3M, Boeing, Ford, IBM and Du Pont are all geographically spread around and give value to the rest of the country. In Germany, companies such as Mercedes, Bauer and Siemens are all provincially based, giving strength to the rest of the country. In Britain, even Scotch Whisky has its headquarters in London. That leads to a centripetal effect and has consequences for our regional policy and activities.

The squeeze on credit, which started 17 or 18 months ago, is painfully slow. Society is different today. More people have capital on which they earn increasing dividends or interest, and they are not so likely to reduce their newly-accustomed standard of living. That was the case for credit controls or tax increases, and that is the case for the restoration of the investment income surcharge. It was absurd to abolish it.

Historically, it existed because it was held that capital was more secure than earned wages--but that is not so true today, when the justification for the surcharge is different. The cost of working has increased and will continue to do so. People are obliged to spend substantial sums of money on travelling to work. It is no longer a case of living just along the road from the mill or the factory. The cost of meals taken at work is also a burden, for today a sandwich often costs as much as a meal did in the past. Working clothes also must be paid for.

None of those expenses is allowable against income tax. That may have been all right when people worked at the factory bench in their old clothes, but not today. There is a real cost involved in the process of earning a living, for which the Inland Revenue does not allow. I appreciate full well the problems of opening the floodgate of the allowances to set off against tax, but in the past it operated

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on the basis that there is a cost involved in earning a living, whereas if one only sits at home and receives dividends or interest, no such cost arises.

The major task confronting the Chancellor of the Exchequer is to ensure that the economy is restored to a non-inflationary trend. He has a task ahead in respect of the balance of payments deficit, and he can be effective only if he does something for manufacturing industry. The level of assistance that it is given will be of supreme importance.

5.41 pm

Sir Peter Hordern (Horsham) : I have followed the right hon. Member for Ashton-under-Lyne (Mr. Sheldon) on many previous occasions, but I do not recollect him advocating before an investment income surcharge. I thought the present problem is one of a shortage of personal savings. I ask the House to consider what the likely impact of an investment income surcharge would be on the propensity of private individuals to save, and I imagine that such a surcharge would not be recommended by members of the Labour Front Bench. I noticed during the speech of the right hon. and learned Member for Monklands, East (Mr. Smith) that he was, as always, short on specifics when it came to taxation. He has some very worthy ambitions in respect of training and education, with which I entirely concur. However, he is not quite so forthcoming in explaining how that extra expenditure will be met. He fails to give sufficient credit to my right hon. Friend the Chancellor of the Exchequer for the measures already taken by the Government and for the vast increase in expenditure that has occurred.

Every potential Labour Government have the problem of paying for the large increase in public expenditure that a Socialist programme necessarily involves. The hon. and learned Gentleman may disagree, but the fact remains that if such expenditure is to be incurred, and if we are to follow the hon. Member for Oldham, West (Mr. Meacher) in thinking that state pensions should increase in line with earnings as well as with prices, large sums of money will inevitably have to be raised by borrowing--which would of necessity mean higher interest rates. That is when the problems invariably begin, with the International Monetary Fund being called in before long.

The right hon. Member for Ashton-under-Lyne spoke of the importance of manufacturing industry, and I do not dissent from that. However, page 53 of the Autumn Statement shows that over the past decade manufacturing productivity in the United Kingdom increased by 5 per cent.--and a conveniently adjacent column reveals that the decade before that recorded the lowest increase in manufacturing output per head. That suggests that, while manufacturing investment is important, one should not ignore the rapid and considerable improvements in manufacturing output per head over the past 10 years, which I hope will continue.

Perhaps it is wrong to draw too much of a distinction between business investment and manufacturing investment. Again, I follow the remarks of the right hon. Member for Ashton-under-Lyne concerning North sea oil.

Labour always keeps very quiet about the way in which this country's overseas assets have been built up over the past 10 years. British business has now invested £90,000 million overseas, which is the largest single amount invested by any country, not excluding Japan or the

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United States. Manufacturing companies such as GKN now produce rather more in the United States than they do in this country, while companies such as Ford, with substantial operations in the rest of the European Community, spread their investment between one country and another. It is unrealistic to suppose that Britain can become the engine room of western Europe or play a large part in world manufacturing capacity.

Mr. Jeremy Hanley (Richmond and Barnes) : Does my right hon. Friend agree that many people think that Britain is the 51st state of America? The reality is that investment by British companies in America is well in excess of investment by American companies in Britain.

Sir Peter Hordern : I agree entirely. It would be perverse always to look backwards and to think of ourselves as an individual nation intent on manufacturing production. That is not the reality of the situation as we move towards the end of the 1990s and the turn of the century. We must follow Adam Smith's adage about the division of labour in manufacturing.

The Opposition naturally picked on some of the more inconvenient parts of the Government's economic record, such as the balance of payments deficit and inflation. Inflation is the single most important issue confronting the Government, whose policy has always been very clear--that it should be tackled by monetary means, which I think is right. However, the figures have not been entirely convenient, and the measure of monetary aggregates has seemed to vary from one year to the next. I do not know the latest fashion, but I notice that little M0 still occupies quite an important place--as does M4, which is the broader measure.

I assumed that after 18 months or two years of expansion and of whatever monetary aggregate was in favour at the time, inflation would follow. Happily, during 1985, when there was a rapid expansion of M4 of about 15 per cent., inflation mercifully fell to little more than 4 per cent. at the time of the 1987 general election. However, I do not so disregard the increase in monetary aggregate as to think that it has no effect. The increase recently in both M0 and M4 is a cause for considerable concern. We cannot continue that way, and if it was not for the fact that bank lending for the latest quarter shows signs of slowing by comparison with the previous quarter--and, as my right hon. Friend the Chancellor said, retail expenditure is decreasing--there would be cause for more alarm than there is. However, I do not believe that monetary policy in the sense of measurement of monetary aggregates is enough. Interest rates must remain the main weapon, but even they are not sufficient to deal with the situation, for we also need to ensure that the exchange rate does not go down too far against other currencies. That is presenting difficulties because in the past year the deutschmark has appreciated by some 16 per cent. against sterling.

Much of our manufacturing industry is devoted to components, and it takes place in different countries in Europe. For example, the other day, I was talking to someone who works for the Ford Motor Company, and he told me that they manufacture the engines for all the Ford 2 litre cars in West Germany. The price of those engines is some 16 per cent. cheaper than it was a year ago. Ford has

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no incentive to keep down wage increases. It knows that it can well afford to pay at least 10 per cent. more because the cost of producing the engines has gone down.

More and more companies which trade within the European Community--as most of them now do--will find that a declining exchange rate makes it more difficult to restrain wage claims than it would be if the exchange rate were kept constant.

Trade with western Europe and the European Community accounts for 51 per cent. of British imports. Therefore, we cannot be oblivious to what the exchange rate should be, nor can we say that we should leave it to the market. We cannot pursue that option.

The 16 per cent. movement in the deutschmark against sterling has meant that Ford can afford to pay more and so can other companies which manufacture and export to the European Community. The public sector regards the private sector as a benchmark for its own wage claims but whereas Ford may be able to pay 10 per cent. more in wages, the public sector certainly cannot. Therefore, I impress upon my right hon. Friend the Chancellor the absolute importance of making it clear to everybody that

Mr. Ronnie Campbell (Blyth Valley) : The hon. Gentleman, as a Member of Parliament working in the public sector, is getting a rise of more than 10 per cent.

Sir Peter Hordern : I am grateful to the hon. Gentleman for his intervention. If we are to be judged by other parts of the public sector in relation to the reports of the Review Body on Top Salaries, we would be regarded as the worst negotiators in the public sector, and I say that without fear of contradiction.

I do not wish to be sidetracked, and I shall return to the question of where the market leads. Some people have the idea that one cannot buck the market but, as I said a moment ago, because Britain has investments of £90,000 million abroad, a finance director of a major company has to study his firm's assets every day, and it is his duty to protect them. Trade and business today consist of finance directors protecting their firms' overseas assets. If sterling were pegged to the deutschmark--as I think it should be--that work would not exist for finance managers.

The market does not force us to have a flexible exchange rate policy. If we had a firm exchange rate policy, aligning sterling with the deutschmark, and took the necessary measures, there would be no need for all the business in the foreign exchange markets that is taking place now. If we are to overcome inflation and to improve the markets, an exchange rate policy is very important.

The right hon. Member for Ashton-under-Lyne was talking about the Labour Government's bad luck when the oil price quintupled. It must be hard for the Opposition to accept this, but the oil reserves in the North sea have been helpful, because they enabled Britain to invest £90,000 million abroad, which gives us a considerable cushion. We can urge people who work in the United States and elsewhere to work harder on our behalf. I see nothing wrong with that. The prospects for economic advance as a result of the recent events in eastern Europe will inconvenience the Opposition even more. The events in eastern Europe are momentous. In 1989 750,000 people moved from the East

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to West Germany--they were ethnic Germans. West Germany was faced with the consequences of an acute shortage of skilled labour, but it is probable that there will now be a considerable increase in production and economic growth in West Germany this year. West Germany's economy grew by 4 per cent. last year. At a press conference on 11 January, Herr Kohl said that it was in the interests of Europe as a whole that the European Community continued to develop as a model of an association of free nations. I think that that commends itself to all hon. Members.

An association of free nations would mean that there would be free movement of people, capital, goods and services within Europe. The European Community plans to make considerable investment by means of loans and grants to the countries of eastern Europe, but if the European Community got rid of the common agricultural policy it would do much more good for the people of eastern Europe. Eastern Europe is primarily an agricultural community, and that would encourage it to increase its production of agricultural produce. It would be able to get higher prices for the goods and increase productivity, and that would do more good than all the money the Community could give. I believe that that should and will happen.

Eastern Europe will resemble America at the beginning of the American industrial revolution, in the 1830s, when there was a similar vast movement of population, because people moved across the Atlantic to the United States. Western Europe will experience a similar increase in economic growth as the United States did at that time.

The future of the British economy is bright because its manufacturing and service industries are enmeshed with the economies of the other countries in the European Community.

I commend my right hon. Friend the Chancellor for all that he is doing. If he keeps a tight control of public expenditure and keeps interest rates high for as long as necessary, which I understand to be his policy, he will have my wholehearted support.

5.57 pm

Mr. A. J. Beith (Berwick-upon-Tweed) : If I could have brought some of my constituents, or some of the people who are now packed like sardines on the Underground, into the Chamber to listen to the Chancellor's opening remarks describing the Government's success, they might have asked sharper questions than many hon. Members tend to ask. They would want to know why, if the economy is such a success, we have such squalid and declining public services. If it is such a success, why are the lowest-paid workers being told that it is irresponsible of them to seek a small share of the success that the country is supposed to be enjoying? If this is success, why have home owners, who have struggled to get on the ladder of home ownership, been so heavily penalised for so long by high interest rates? If this is success, what is failure like? I think that those people would have critical words to say about the measurement of success implicit in the Chancellor's earlier remarks.

The Chancellor could direct our attention to some successes, but in key respects, which affect the lives of ordinary people in Britain, that success is not a reality--the down side is the reality.

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The Autumn Statement refers to the Government's commitment to reduce public expenditure year by year as a proportion of what the nation produces. That policy has not been achieved this year, but it continues to be the Government's policy. When I challenged the Chancellor earlier today, he said that that policy was sustainable because we will have so much growth that the amount of money realised by the declining proportion of national production would be sufficient to maintain and perhaps improve public services. If we do achieve that continual growth, we should expect some improvement in our public services rather than a standstill or even a decline. The doctrine of a perpetual reduction in the proportion of public expenditure is one that various members of the Government clearly find difficult. Whenever an Autumn Statement is presented and the Government issue their various comments and press releases, the next day's papers are confused about whether the Government have said that they are cutting public expenditure and doing very well, or that they are increasing expenditure on important services and doing very well. That, it seems, is not surprising : it is instructive to examine what some Departments have to say.

The Treasury and Civil Service Select Committee examined the pronouncements of the Department of Employment, whose expenditure is being reduced because the Government believe that if fewer people are employed less training will be needed. Nothing could be further from the truth : skill training is desperately needed in the present circumstances. The Department, far from saying in its press statements how successful it has been in cutting public expenditure, tries to pretend that it is increasing that expenditure. Its argument is, "If we compare the figures with those of 1979, it is clear that we are doing very well." The Government's objectives seem to be somewhat confused ; we had better clear that up so that we can get down to establishing what Departments such as the Department of Employment should actually be spending.

Analysis of the figures of other Departments is also instructive. The Department of Transport waxed lyrical about its increased spending on London's public transport, but that has amounted merely to permission for the extension of the Jubilee line : no expenditure has been allowed for the two lines across London which everyone who studies London's transport problem knows to be essential. The Department of Trade and Industry, I note, has cut export promotion and regional expenditure.

Examination of the relative price effect is even more instructive : although the relatively lower inflation rate in the cost of defence materials has meant a gain for the Ministry of Defence, there has been no renegotiation and no clawing back of that money. Conversely, no allowance has been made for the high rate of inflation affecting the commodities that the Department of Health has to buy, and that has had a significant effect on the NHS spending figures. The Government claim to be increasing NHS resources by 5.5 per cent. Let us consider that figure in detail. First, it falls to 4.9 per cent. if cost improvements--the money resulting from savings and income generation within the NHS, about which there is considerable doubt--are excluded. There should be an incentive for those who make such savings to do better than the Government's published overall figures, but that incentive will not be

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there if the cost improvements--some of which seem to have been counted more than once--can only comply directly with those figures.

The Financial Secretary to the Treasury (Mr. Peter Lilley) : Why exclude them?

Mr. Beith : The Financial Secretary to the Treasury is intervening from a sedentary position. I am trying to deal with the arguments as I go along, but if he wishes to speak I will give way.

If the cost of the NHS review and the policies arising from it is excluded- -as seems perfectly sensible in the measurement of overall Health Service expenditure--the real increase is brought down to 3.7 per cent., a figure calculated through the use of the GDP deflator, which is widely considered to be lower than the inflation rate within the NHS. The Department's own figures suggest that the inflation rate in the hospital services is 10.5 per cent., and the rate in the family practitioner services 10.3 per cent. The actual real-terms increase in NHS expenditure may be as low as 1.5 or 2 per cent., a figure that may not be sufficient to account for demographic changes which, as everyone recognises, place additional demands on the service. I am not saying that the Government have not made an extra effort this year to find more funds for the NHS. Nevertheless, they must not claim that the NHS is suddenly in a position greatly to improve the quality of its service by means of the Government's funding, given the background against which the figures are set. As well as the impact of the Autumn Statement on the public services, we must look at what the statement says and at what has happened to the general conduct of the economy since it was issued. The position has certainly not improved overall : we still have high inflation, high interest rates and a large trade deficit. Exports are growing more quickly--which is a welcome sign--and they will benefit from the depreciation of the pound over the past year but, as the hon. Member for Horsham (Sir P. Hordern) pointed out, there is a reverse side to that.

The progress made so far has still not removed the basic danger posed by our large trade deficit. Even one bad set of trade figures can put pressure on sterling, and thus either increase the inflationary pressures in the economy or trigger a further base rate rise. Every time a bad set of trade figures emerges, a waiting game ensues to see whether the Chancellor will have to increase the base rate again to stem a flow from sterling. This week's trade figures, for which we are now waiting, have already prompted nervousness. According to this week's figures, manufacturing output appears to be declining to an alarming and unexpected degree, while the figures for bankruptcies and liquidations again show a high rate of increase. The inflation rate is the worst since 1982. If I wished to hire an exorcist, I would not hire members of the present Government, for the job of an exorcist is to get rid of something once and for all. Year after year, the Government have promised the Treasury and Civil Service Select Committee that in three years' time inflation will be down to 3 per cent., but they have never achieved that objective, which has seemed to recede further as each three-year period has gone by.

There can be no reason to expect the realisation even of the Autumn Statement forecast of a 5.75 per cent. inflation rate, especially in view of the alarming money supply and bank lending figures and the depreciation in sterling. The

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Treasury model predicts that a 5 per cent. fall in sterling will add 4 per cent. to the retail prices index over a four-year period. Sterling has risen slightly since the beginning of the year, but that will not make much difference to a depreciation as large as that of the past 12 months.

The Government are clearly worried about the impact of wage inflation. Inflation in average earnings is now running at over 9.25 per cent. and the prospect of double-figure wage inflation is in sight. The pressure on wages is increased by rising mortgage interest rates. It is no use for the Government to say continually that those rates have nothing to do with inflation and should not be included in the retail prices index ; the fact remains that high mortgage rates and heavy expenditure on buying a home are factors that fuel wage demands, and it is hardly surprising that people ask for larger pay increases to cope with those effects. The Government must recognise the reverse side of their interest rate policy.

There is also the effect of the own-goal inflation referred to by the CBI. Privatisation price increases for water and electricity have been very high : in my constituency, the price of water has increased by more than 18 per cent. this year. Furthermore, waiting to hit the people who are seeking reasonable wage increases to meet those costs is the threat of the poll tax.

When the Agricultural Wages Board for England and Wales meets in the spring, it will have to face the fact that most farm workers will expect to have to pay about £600 a year out of their taxed income that they have never had to pay before. Hitherto they have lived in rent and rate-free accommodation, but now they will have to pay poll tax for themselves and their wives. Will the board ensure that they receive an increase of £600 a year to meet that cost, or will the Government say that it is irresponsible for these workers to be allowed to retain even the low living standards that they have enjoyed for the past year? The Government face a dilemma of their own making because of the impact of the poll tax on that section of the community, but the effect on many other sections will also be powerful.

No one still believes what the Government say about inflation. They say that they want a high pound to prevent import prices from rising, and to force employers to be tough in wage negotiations, but then they let the pound fall and plead with the employers to be tough. As other hon. Members have pointed out, those employers can obtain the benefit of the depreciation in sterling through the prices that they obtain for their goods overseas.

As part of their medium-term financial strategy, the Government say that they intend to bring MO under control, but when MO rises to well above its target range after a year of high interest rates they do not push up interest rates further. Of course, we should all be alarmed if they did, but where does that leave the strategy and the policies that were based on it?

What has happened to the Government's incomes policy? The two aspects of the Government's incomes policy were a high pound and high unemployment. Thankfully, unemployment has fallen, although it may now start to rise again. Those were the two elements by which the Government sought to contain inflation, but

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neither will do so any longer. The Government will have to look elsewhere for a credible framework for an anti -inflation policy. We have argued, as have other hon. Gentlemen who have taken part in the debate, that a better framework for an anti-inflation strategy would be found if Britain joined the exchange rate mechanism of the European monetary system. But we know who we are up against. We are not up against the Chancellor, who has said that he has been in favour of it for a long time. We are up against the Prime Minister's prejudices. The Prime Minister hates the idea of the Government who she heads being inhibited in any way. She adopts exactly the same attitude in her opposition to the previous Chancellor's proposal that there should be a more independent central bank. It was instructive to hear what the Prime Minister said about that. She was opposed to it because she believed that the bank must be under the control of Parliament.

Who here believes that the day-to-day operations of the Bank of England are under the control of Parliament? The Bank of England is under the influence of the Government of the day in a way that cannot be held accountable to Parliament. We do not know what conversations the Chancellor has with the governor, or what was said or to what extent the governor's actions follow from the Chancellor's advice. That is one of the most closely guarded secrets of Government. What is really at stake is the Prime Minister's desire not to be inhibited even from doing things which officially she opposes, such as debauching the currency. She hangs on to the freedom to do things which she says Governments should not do. The Prime Minister's prejudices stand in the way of providing a firm anchor for the anti- inflation policy. Mr. James Hill (Southampton, Test) : The hon. Gentleman suggests that we should join the exchange rate mechanism of the European monetary system. Have not the Government made it clear that we will not join until two major EEC countries have the same rules for exchange controls or the lack of exchange controls that are proposed? Would that not be the right time to join? If the economy is as bad as the hon. Gentleman is suggesting, it would be quite wrong to join the European monetary system with some countries obeying some rules and some countries obeying others.

Mr. Beith : The condition that the hon. Gentleman has advanced is well on the way to being satisfied and would be satisfied pretty quickly if Britain announced that it would join on that condition only. The hon. Gentleman has overlooked another condition, which is that our inflation rate must be close to that of our competitors. On present figures I see no prospect of that. It is the Prime Minister's way of buying as much time as she wants. She will be able to say for a long time that that condition is not satisfied because she knows that she will not meet even her Government's targets for dealing with inflation.

The Government should be seeking that anti-inflationary framework and taking the opportunity that it provides to invest in the long-term health of the economy--in training, education and transport--and to make other structural changes in the British economy that are necessary to drive inflation out of our system. The Government should be looking more closely at opportunities to extend profit-related pay if they want to ensure that the wage bargaining process is informed by

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companies' productivity and profitability. There is a case for a national mechanism so that we can discuss and agree on what would be a reasonable increase for the economy, and a mechanism to ensure that firms which achieve high productivity can pass on that benefit to their employees and their employees can reasonably negotiate for it. There can be no prospect of a giveway Budget this year. The Government must take the opportunity to deal with some of the anomalies such as high-rate mortgage tax relief and the payment of tax relief at the top rate to those least in need of subsidy. The Government should tackle some of the remaining anomalies in the national insurance system and take steps to encourage savings. Those factors must be part of the Chancellor's Budget considerations in the next couple of months.

The Chancellor is the ultimate pragmatist. He is not a monetarist. His evidence to the Select Committee made it clear that he is in no way attached to monetarist theories. Monetarism is out ; the medium-term financial strategy is out ; and the idea of an independent central bank even in Britain, let alone as part of the new European model, is excluded-- if not by the Chancellor, very firmly by the Prime Minister. The EMS is still a long way off. It is surfboarding, but this surfboard has a back- seat driver--the Prime Minister. The Chancellor's pragmatism may be attractive to those who are unhappy with some of the dogma that has dominated recent economic policy, but in the absence of any other anchor for an anti-inflation policy, it gives no prospect that some of the fundamental weaknesses of the British economy will be corrected under the present Government.

6.15 pm

Sir William Clark (Croydon, South) : The hon. Member for Berwick- upon-Tweed (Mr. Beith) spent some time trying to disprove the Government's increase in expenditure on the National Health Service. Suffice it to say that since 1979 expenditure on the National Health Service has increased by about 45 per cent. in real terms and the number of people whom it employs has increased by 77,000. The hon. Gentleman cannot make such accusations when the facts belie what he says.

The hon. Gentleman said that his party's answer was to join the EMS--as though that were the panacea for all our ills. I should like to know how the hon. Gentleman or the right hon. and learned Member for Monklands, East (Mr. Smith) would pay for the policies that they put forward were they ever to form a Government.

The right hon. and learned Member for Monklands, East spent much time discussing our manufacturing industry. Not once did he say that during the 1960s many trade unions were responsible for pricing their members out of jobs. Shipbuilding and steel became uncompetitive. Of course, the manufacturing base will shrink if we do not remain competitive. That is one of the main reasons why we start from a low manufacturing base.

I agree with my right hon. Friend the Member for Worthing (Mr. Higgins) that, having listened to the right hon. and learned Member for Monklands, East, one would think that selective employment tax was coming back, possibly in company with the national insurance surcharge.

I am sure that more than 9 million shareholders will take no comfort from the fact that if the party represented by the right hon. Member for Ashton- under-Lyne (Mr.

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Sheldon) were ever to form a Government, the investment surcharge would be reimposed. He spoke about capital allowances, but they were traded off by reducing corporation tax. We have one of the lowest rates of corporation tax in the Common Market.

Mr. Sheldon : Surely the hon. Gentleman recalls that there was a minimum level before investment surcharge was levied on a person's income tax. It did not start from the first £1 of income tax. The hon. Gentleman must realise that nothing like 9 million people would be affected.

Sir William Clark : I am sure that that will be a comfort to some shareholders. However, I do not think that it will encourage savings.

We could use a straight line 25 per cent. reduction for capital allowances, but I agree with my right hon. Friend the Chancellor that inflation is enemy number one. Last week there was a flurry in the City, the media and the press because of fears that the inflation rate was going up. It is affecting our economy and it is certainly affecting the value of the pound. We take our economic pulse too often and we say what it will be before we have taken it. That is why we get all the flurry. Hon. Members will recall that last week people forecast that inflation would go up to 7.9 per cent. but, in fact, it remained at 7.7 per cent. Indeed, if one discounts the mortgage interest element, it was 6.1 per cent. and there was no change at all.

Opposition Members should pay tribute to the fact that the economy has underlying strength. Over the last 10 years the average family's standard of living, in real terms, has gone up by nearly one third, and the income of the pensioner has gone up by nearly one quarter. That is not a bad record. Of course, it could be better, but the position is much better than it was before 1979. Unemployment is down, the number of jobs is up, growth is up, investment is up, and manufacturing output is 12 per cent. higher than it was in 1979. Consequently, it is wrong to write off our manufacturing base. In fact, the manufacturing base is building up. Take, for example, foreign investment. There has been massive Japanese investment in the motor car industry. Opposition Members should realise that a time element is involved. From the initial stages of setting up a factory it may take two or three years--possibly less--for cars to come off the production line. The fact that we attracted investment last year does not mean that cars will come off the production line in the immediate future, but they will be produced in due course. I am delighted with the remark of my right hon. Friend the Chancellor that public expenditure is under very strict control. When the present Government came to power public expenditure represented 44.5 per cent. of gross domestic product ; this year it will be 39 per cent. Despite the fact that the proportion has gone down, more and more money is being spent on the Health Service, transport and education. The simple reason is that the economy is growing. Opposition Members may shake their heads, but they should look at the facts and the statistics. They will see that, in real terms, more and more money is being spent on those services. Anybody who does not believe that will not believe anything.

Of course, we have a balance of payments problem, and my right hon. Friend the Chancellor admitted it only this afternoon. With hindsight, one sees that it was a mistake to relax interest rates at the beginning of 1988. But if I had known yesterday what I know today I would be a

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millionaire many times over. There is strength in the economy, and our surplus this year will be £12 billion or thereabouts. The statistics show that imports have flattened out and that in the past three months exports have increased by 7 per cent. Of course, we must do better, but there has been an increase in exports. As a result of the budget surplus the Government have been able, over the past three years, to repay some £30,000 million of the national debt. In interest charges alone that has resulted in a saving of about £3 billion to £5 billion per year, which is the equivalent of 2p or 3p in the pound on the standard rate of income tax. That is not just for one year, but for year after year. Such is the achievement of this Government.

Obviously the national debt is a burden, but the burden is being reduced, and I hope that the Treasury team is taking into account the fact that, as the national debt is reduced, problems arise, particularly in relation to the national savings movement. If the national debt were paid off, there would be no national savings and no gilts market. This is something that needs a lot of forward thought. The hon. Member for Berwick-upon-Tweed mentioned savings. I agree with him--this is something that I hope my right hon. Friend will take on board--that, as a result of the Chancellor's policy, those without money who want to spend have to borrow. But the Chancellor has made it far too expensive to borrow and, as a result, consumer demand has come down. Retail spending in December was up slightly, although not as much as in previous years, but I do not think that one can use that for purposes of comparison. One must wait for the January figures because high street sales, which are normally held in January, were brought forward to December. By making borrowing too expensive my right hon. Friend has prevented people from spending.

But an awful lot of people in this country have money and do not need to borrow. Those people are spending. I am thinking in particular of people earnings between £20,000 and £35,000 a year--probably middle-aged people whose children are off their hands and whose mortgages are manageable. Such people have quite a lot of money to spend. My right hon. Friend has introduced personal equity plans, which are an extremely good idea, but to the average person PEPs are not enough of an incentive. Suppose that an average person puts £1,000 into PEPs. He or she is exempt from income tax on dividend. On £1,000 the dividend would be about £60 a year--about 6 per cent. Thus, the tax saving would be £15. What about capital gains tax? In that case, because of the £5,000 exemption limit, no capital gains tax has to be paid anyway.

I am not decrying PEPs altogether, but my right hon. Friend should adopt a more radical approach. He should introduce a system whereby a person could enter into a contractual saving arrangement and have the amount of money involved taken off the amount of his taxable income. That should not be beyond the wit of the Inland Revenue. A person saving, say, £1,000 a year would pay £250 less in tax, but £750 would come out of the consumer spending market. I hope that my right hon. Friend will consider that suggestion.

Many right hon. and hon. Members have said that interest rates are high. The base rate is 15 per cent., and one would be lucky to be able to borrow at 17 or 18 per

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cent. Interest rates are high enough, and I urge my right hon. Friend not to increase them further. The market in the deutschmark and the dollar is fairly stable at the moment, and we all know what a burden interest rates are for industry.

I hope that my right hon. Friend will examine capital gains tax. I realise that since 5 April 1982 we have had indexation and that it has been a great help. But a capital gains tax rate of 40 per cent. is locking up the market. Many people do not and will not change their stocks, and they are locked in. Capital gains tax should at least be reduced to the standard rate, if not abolished.

There is a great move to entice married women back to work, and one pressure that will build up as a consequence is to provide cre ches in the workplace. If one enjoys that perk it has to be entered on a form P11D and the employee is surcharged according to what the perk is worth. That applies to everybody earning more than £8,500 a year and it places a tremendous burden on industry. The figure of £8,500 per annum was fixed in April 1979, but it is time that we allowed employers to provide a cre che without the employee having to pay tax.

At this time of the year, my right hon. Friend the Chancellor receives advice from all quarters. The hon. Member for

Berwick-upon-Tweed said that there must be a reduction in taxation, but I remind hon. Members that the separate treatment of husband and wife for tax purposes will cost the Exchequer about £1.25 billion. If there are to be any tax cuts, I would plead, as I have in the past, that we should concentrate on thresholds. A single man can earn only £53 a week before he starts paying 25p in the pound to the Exchequer and a married man can earn only £84 a week.

This will be my right hon. Friend the Chancellor's first Budget. His forecast was accurate when he said in the last quarter of 1989 that inflation would be about 7.5 per cent. If I were my right hon. Friend, I would ignore some of the siren voices that we have heard from the Opposition Benches suggesting an increase in expenditure here and an increase there. He should keep a tight control on public expenditure and ignore requests for an increase. All my right hon. and hon. Friends will wish my right hon. Friend well in his first Budget.

6.32 pm

Mr. Giles Radice (Durham, North) : I congratulate the right hon. Member for Worthing (Mr. Higgins) on his skilful work in getting all the members of the Treasury and Civil Service Select Committee, with their broad range of views, to agree on a single report. That is a great achievement and it is one which he repeats, with customary skill, at least twice a year. He is not present at the moment, but I am sure that he will be back.

Our report, which is being debated with the motion today, is of considerable value to the House. As my right hon. and learned Friend the Member for Monklands, East (Mr. Smith) said, its importance lies not so much in its conclusions--conclusions go to the heart of the debate about economic policy on which one is unlikely to achieve a consensus--as in the wide range and depth of our investigative hearings and the accuracy and quality of our economic analysis. I want to look at both those points.

The Select Committee procedure allows Members to put questions at length and in depth to the Chancellor and his advisers in a way that is often not possible on the Floor

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of the House, and that gives us a great advantage. For example, at our hearing on 4 December, the Chancellor had to admit that the balance of payments did matter. He also accepted that the deficit was caused not merely by an increase in investment goods but by a surge of consumer goods. That was something that he had not previously admitted on the Floor of the House, but he did so in answer to a series of questions from a number of Members.

The Chancellor revealed as much by his evasions as by his direct replies. We have already heard from the hon. Member for Berwick-upon-Tweed (Mr. Beith) about his neglect of monetarism, but there is also the shift in exchange rate policy. In autumn 1988, the previous Chancellor lectured us about the need for a stronger exchange rate as a counter-inflationary discipline. This December, the present Chancellor was a good deal less emphatic when he said : "It is worthwhile to have a firm exchange rate to bear down on inflation with all the other elements of monetary and fiscal policy as well."

He went on :

"As to the judgment as to what is or is not a firm exchange rate, that is a matter which one has to consider as and when necessary". Now we all know what the Government exchange rate policy is. It is not only the hearings that are valuable ; it is the analysis underlying our report. Thanks mainly to our advisers, the Select Committee's track record has been a good deal better than that of the Treasury. In the spring of 1988, when the then Chancellor was boasting all over the world about the British economic miracle, we warned about the excessive growth in consumer credit, the impact of tax cuts in the Budget and the dangers of overheating. So we have not just spoken with hindsight ; we said it then.

In our April 1988 report, we expressed disappointment about the failure to bring down inflation. We were concerned about the balance of payments. Presciently we said :

"we consider that uncertainties over domestic demand growth and the continuing capacity of the United Kingdom economy to respond, and over the likely growth of the international economy suggest that careful monitoring of the state of the current account will be needed."

We can say that again. We went on :

"Clearly there would be risks if the balance of payments deficit continues to rise."

But the Chancellor said that all was under control.

In view of the Select Committee's relatively good track record, it is well worth considering what we have to say this year about the British economy's prospects. We remain sceptical about the Government's ability to bring down the inflation rate. Commenting on the Treasury's forecast of 3 per cent. inflation by 1992--the hon. Member for Berwick-upon-Tweed said that the Treasury always forecasts 3 per cent. three years ahead--we note that

"Repetition in the face of failure has not added credibility to this forecast."

We underline the significance of the huge current account deficit. As we point out, it has already been responsible for a substantial 10.5 per cent. depreciation, a rise in base rates--the hon. Member for Croydon, South (Sir W. Clark) has already pointed out the impact of that--and a loss of official reserves. It also puts the exchange rate very much at the mercy of market sentiment, as the hon. Member for Horsham (Sir P. Hordern) pointed out.

Like my right hon. and learned Friend the Member for Monklands, East, in his excellent speech, the Committee is

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rightly worried about the supply side. In our report, we note with concern the £17 million deficit in manufacturing and we wonder whether British industry is any longer capable of supplying the range of goods that people want to buy in domestic markets and abroad. Sadly, we have not yet replaced the 20 per cent. of manufacturing capacity that we lost in the deep recession of 1979-82.

We also remain extremely sceptical about the theory put forward by the Government's chief economic adviser that our balance of payments deficit is, in some way, self-correcting. We explicitly warn that the process of adjustment will not be painless. As we say, it could even lead to a recession--a recession induced by high interest rates. The new element in the Select Committee's analysis is our warning about the danger of recession, with all that that could mean for output, investment and employment. To sum up our message in simple terms, we warn about the risk of stagflation--that is, the danger of a relatively high rate of inflation combined with a stagnant economy. That is how the position looks at present.

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