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The Earl of Longford: My Lords, if the previous government were so overwhelmingly successful, why were they treated with such contempt by the electorate?

Lord Mackay of Ardbrecknish: My Lords, that would require a longer answer than your Lordships' patience should endure while I am discussing this Finance Bill. I do not believe for a moment--I do not think that anyone else does--that it was a question of the state of the economy. In some ways the noble Earl might have asked me a more difficult question. The economy was in a good state. I have quoted the noble Earl's noble friend Lord Healey on that point. Perhaps the noble Earl does not agree with the comments of his noble friend Lord Healey. The noble Earl could have asked why, when the economy was in a good state, did the previous government not win the election? Generally if the economy is in a good state the government in office win an election, and if it is in a bad state they lose it. However, the previous two elections have rather stood that theory on its head. However, I shall not be diverted. I have quoted from the Economist and from the noble Lord, Lord Healey. I do not think that anyone disagrees with the proposition that the economy was doing extremely well on 1st May.

I could quote the words of the IMF and the OECD to back my assertion. I noticed that the noble Lord, Lord McIntosh, mentioned some quotations. It is a good job that his noble friend Lord Eatwell, who used to do battle with me on these matters, is not present because he gently reminded me at one stage of the odd time when the IMF and the OECD had made wrong predictions about the economic prospects of government. After that warning I was careful how many times I mentioned the predictions of the IMF and the OECD.

I return to the Budget and the economy. When the Government looked at the books--as it is termed--try as they might, they could find no black hole. Indeed the economy was doing better than the November forecasts in the Red Book produced at that time. In the time between my right honourable friend Kenneth Clarke's Budget to the end of the financial year, borrowing was £3.3 billion less than forecast. Indeed much of the trumpeted speed with which we shall get into balance is due to greater buoyancy of the economy than was forecast by my right honourable friend Kenneth Clarke.

I wonder why we have had these 17 tax rises. Was it because the economy was overheating? If that is the justification--that has been claimed once or twice--why did the tax rises fall so heavily on the corporate sector and not on consumption? If the tax rises were introduced to prevent the economy overheating, they should have fallen on consumption and not on the corporate sector. However, that was not the case. We have heard a great deal, although not today, about rises in spending on health and education. However, none of that is what the Government used to describe--when they criticised us when they were in opposition--as new money. It is money from the reserves and from next year's reserve.

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Every year--but a bit later than this, and in the current year--the Government use the reserves to help those spending programmes that are under pressure. I regret to say they usually had to help the Department of Social Security because we were not good at predicting our spending in the year ahead. We used to be reprimanded quite often, but it was difficult to predict, given the size of the budget and the different factors. However, that was what the reserve was used for. If a programme was under pressure, it went to help.

On this occasion--the Government have trumpeted it loudly--they have allocated half the reserve nine months before the start of the next financial year. They have not changed the control total; it is still within the control total. Therefore, there is no new money. Presumably the Government have a very good crystal ball and can see clearly that in the next financial year there will not be a need for those reserves: that they can live with half the reserve. I do not believe that that is a responsible way forward, but at least we know exactly where the money is coming from. It is not new money. If the Conservative Government had remained in office, nearer the next financial year the chances are that we might have allocated some of those reserves because that has been the pattern of the past few years.

I turn to some specific points in the Budget. I refer, first, to foreign income dividends. The noble Lord, Lord McIntosh of Haringey, did not say much about them; I am not surprised. They are a form of tax relief for British companies with large overseas earnings. The Government said that they were going to abolish them. But when the damage was explained to them--I was going to say that they had cold feet but they did not--they carried on with the legislation. Clause 36 and Schedule 6 to the Bill deal with that. But the clause and the schedule no longer represent government policy. To legislate and then consult is a new concept. I believe that the Government are now persuaded that they cannot undertake what is in the Finance Bill. It is quite remarkable.

I should like to know what they will do. Are we to wait on the next Finance Bill to put matters right? Until that Finance Bill, will they deal with foreign income dividends in the way provided for in Clause 36 and Schedule 6; or will they turn a blind eye to their proposals in the Finance Bill and wait until the next finance legislation to put their mistakes right?

I turn to the other part which I believe important. The Budget claims to help the budget of the Department of Social Security by its welfare-to-work policy. That is fine. As I mentioned earlier, I support anything that can be done to help people back into work, as we were doing. Yet at the same time the Budget endangers the welfare budget by its attack on pensions. The one issue on which I thought we almost had consensus was the importance of our own personal pension provisions, whether through a personal pension or an occupational pension. I know that I am wrong; I have been told that so many times I have to believe it. I am told that the proposals are good for pension funds. It is a doctrine that the noble Lord, Lord McIntosh, has brought before your Lordships' House. I am not sure that too many noble Lords believe him but he keeps on trying.

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The matter has been expounded best by Ms. Dawn Primarolo, the Financial Secretary to the Treasury. On 3rd July at col. 507 of the Official Report she said in another place that it is good for pensions and pensioners, not bad for them. People should understand that the government reforms will benefit pension funds. Will taking £5.4 billion out of pension funds in a year or two's time be good for pensions and pension funds? As I asked the noble Lord, Lord McIntosh, on the last occasion we discussed the issue, if the Government had taken £10.8 billion, would it have been doubly good for them?

Another member of the Government took a different attitude, but before he joined the Government. When the noble Lord, Lord Simon of Highbury, was simply Mr. Simon, chairman of BP, on 1st May he drew the attention of the National Association of Pension Funds to the danger of abolishing tax credits on dividends for pension funds. His remarks were part of a much longer criticism written by John Browne, chief executive of BP. They expressed this simple view: that in the opinion of the board of BP, of which the noble Lord was then chairman, and one of Britain's biggest employers, the plan would be bad for people with occupational pensions and the pensions industry. If I had to choose between Ms. Dawn Primarolo and the noble Lord, Lord Simon of Highbury, I would choose the noble Lord. I suspect that he knows a great deal more about the issue.

Put simply, the position is this. Up to now, when a UK company has paid £100 in dividends, £80 went to the shareholders and £20 to the Treasury. Pension funds were then able to claim that £20 back. They will no longer be able to claim it back. They will therefore not gain £100 but only £80. As in previous debates, a little honesty and integrity is needed, with the Government saying, "Yes, the pensions funds will have a problem, they will have a shortfall, but we need the money and that is the way that we shall go about it". But what is said is that somehow it will be good for pension funds.

The other excuse is that pension funds have big surpluses; that many companies have pension holidays at present. Many do, but not all by any means.

Perhaps I may refer to final salary schemes to which the Government pay such lip service and which are so important for many people. If those schemes do not have surpluses, and when the surpluses are used up, they will then require more contributions from the business, diverting funds from the very investment that the policy was set up to help. The only person who can put money into a money purchase scheme to make up the deficit will be the individual himself or herself. People will have to put more money into their pension funds if they are to achieve the pension they think they need when they retire. Indeed, a 30 year-old who expected at 65 years to have a fund of £270,000 will have his fund reduced to £240,000 by the ACT cuts. He will have to put aside £12 a month for the next 35 years in order to undo that damage. Therefore, I hope that we shall not hear that the policy does not do any damage to pension funds. It does a great deal of damage. For those funds

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which will be brought below the minimum funding requirement, the employers will have to put money in under the 1995 Act in order to make up that difference.

It is a serious matter for pension funds. The Government would do better to be honest about it and say that they believe that pension funds were in a privileged position and they have decided to remove that privilege; and if it means that employers and employees will have either to put more money in or face reduced pensions, they will have to make that decision. That would be more impressive as a reason.

But the policy is supposed to help investments. There is no explanation as to why. I am puzzled why Scottish names have to be changed. Mr. Norman Lamont became "La-mont" and Mrs. Liddell, Chief Financial Secretary is now "Li-ddell". I do not know why Scottish names have to be changed when one enters the Treasury. I am not sure what Brown will be changed to. Mr. Norman Lamont made a reduction from 25 per cent. to 20 per cent. There is no evidence that increased investment arose from that cut. Can the Minister say anything about that in his reply?

I wish to sum up and look at the more general economy briefly. I hope that the noble Lord, Lord Ezra, as he has done with me in the past, will talk a few moments about the impact of sterling on jobs, and the manufacturing industry in this country. This Government have paid much lip service to the manufacturing industry. I do not think that they are doing it any good. They know that themselves. Various remarks are made in what is now to be called either the Red Book or the White Book, depending upon whether one looks at the white cover or the back cover. I could give your Lordships some clear quotes. I am sure noble Lords have read them. The Government say that investment and manufacturing industry will have difficulties over the high value of the pound. Have the Government any intention of doing anything about it; or will they leave the Bank of England to continue putting up interest rates regardless of the consequences for the rest of the economy?

Is it just possible that in the long summer Recess the Government may decide to take Britain back into the exchange rate mechanism? We should be told that, and this is the last opportunity before the Recess to tell us. I hope to receive a clear answer from the Government. I am just a little suspicious that that might be exactly their intention. They will want to make sure that we re-enter at a value of sterling of which they approve. What value do they approve of? And can we have a cast-iron guarantee from the Government that they will certainly not re-enter the ERM between now and the House resuming in October?

12.50 p.m.

Lord Ezra: My Lords, I wish to concentrate on the first two objectives set out by the Government in the Financial Statement and Budget Report issued on 2nd July; namely, promoting economic stability and encouraging long-term investment, to which the noble

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Lord, Lord McIntosh of Haringey, referred in his opening remarks. I reassure the noble Lord, Lord Mackay, that I shall indeed refer to sterling later.

The Government have rightly concluded that the achievement of those two basic objectives is essential if the other objectives set out in the Budget Statement and underlying the Bill under consideration are to be achieved. Those are: modernising the welfare state to encourage work; high-quality public services; protecting the environment; and developing education and health. In view of the importance of the two main objectives, it is worth considering what measures the Government have introduced in the Finance Bill and in other ways in order to achieve them, and what problems lie ahead.

So far as the promotion of economic stability is concerned, the Government have identified the two main issues as keeping inflation and public finances in check. As regards inflation, they have given increased powers of independence to the Bank of England--an approach that we strongly support from these Benches. I have referred to it on many occasions in previous years. We are delighted that the Bank now has that responsibility; it means that decisions in this area will no longer be taken having regard to political consequences.

In the case of fiscal policy, the Government have laid down the golden rule that over the economic cycle they will borrow only to invest and not to fund current expenditure. Again, that is a concept with which we entirely agree. Their stated aim is to keep the public debt, as a proportion of national income, at a stable and prudent level. The Red Book sets out the details by which those desirable objectives are to be achieved. Time will tell whether the measures taken are successful, particularly when changes occur in the economic cycle.

I especially welcome the Government's identification of the need for long-term investment as a priority objective. I have referred to that need many times in previous economic debates; indeed, by my repetition of the subject, I thought I was beginning to bore the noble Lord, Lord Mackay. He has mentioned it to me in the corridors from time to time. I said: "I'll cease to bore you on that, if you cease to bore me on the great and manifold achievements of the Government in running the economy". I do not think that either of us has in fact stopped doing so.

As the Budget Statement makes clear, Britain's ratio of investment to GDP is low by historic and international standards; and in spite of the improvements to the economy to which the noble Lord, Lord Mackay, referred, the gap against other countries has been widening. As recently as 1996 manufacturing investment, which had a particularly bad year then, as a share of GDP fell to its lowest level since records began--a very worrying phenomenon. It is obvious that unless these trends can be corrected there can be no long-term positive prospects for the British economy. I regard the measures introduced in the Budget--which are welcome--to be simply a first step in the process of stimulating investment in the long term; I hope that further Budgets will add to them.

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That is all pretty positive. The Government are basically following the right lines. But, I now turn to what I consider to be the major short-term problem faced by the Government in the management of the economy; namely, the rapid rise in consumption. In previous debates I have drawn attention to the fundamental weakness in the British economy in virtually the whole period since the end of the war--namely, the way in which boom periods have been brought about by substantial increases in consumer spending, alongside continuing weakness in investment, inevitably leading to subsequent recessions. That has been our experience over practically the past 50 years. In these circumstances, when referring to this issue, I call for a rebalancing of policies as between investment and consumption. It is satisfactory that the Government have decided to place so much emphasis on stimulating investment and have taken steps to that end.

However, in the meantime consumption continues to roar ahead. In spite of the previous Government's estimate that it would grow at a rate of 4 per cent. this year (the estimate contained in the previous Red Book) the figures for June show that it is already rising at 5½ per cent. Regrettably, that is very reminiscent of what happened in 1988. I drew attention to the fact in a debate on 5th March which was answered for the Government by the noble Lord, Lord Mackay. The Red Book of that year estimated that consumption would grow at the rate of 4 per cent., a rate identical to that assumed for this year. In the event, in 1988 it rose by 7½ per cent. and was the main factor leading to the subsequent recession.

Returning to the present time, while consumption is rapidly rising, so is consumer credit, which reached a new peak in June. M4, which is the broad money supply indicator, is at its highest level since 1990, when the previous recession set in. There are already gloomy forecasts that we may be heading for another recession. I do not share those views but I fear that there are serious risks ahead unless action is taken.

A worrying consequence of the present situation is the rapid rise in the value of sterling (to which I now turn as I was invited to do by the noble Lord, Lord Mackay), even though there has been a slight levelling off in the past two days. That is undoubtedly already having harmful effects on the engineering sector. I attended a meeting the other day of the Engineering Employers' Federation at which there was shown to be a complete change in all the trends in engineering that were very positive last year--orders at home and abroad, re-equipment, investment and so on were moving up. This year, all those trends are moving the other way, and other parts of manufacturing industry are also suffering. Competitiveness abroad has weakened; but so has the position at home, with imports of manufacturing goods now penetrating the home markets more and more owing to relative cheapness. We were told of German manufacturers who for years had abandoned the British market because of the high costs of the mark now returning. So the situation is serious.

The Government, as a result, face an unfortunate dilemma. They have rightly established a long-term policy, which I fully support, based on financial stability and investment growth, and have taken the first steps

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towards its achievement. But they are confronted with the short-term risk of overheating. That has been spectacularly stimulated by handouts from the demutualised building societies to which reference was made in a Question earlier. Happily, the members of Nationwide, at least for the time being, have resisted the temptation to go the way of the other societies.

The main weapons in constraining the consumer boom are fiscal, through tax, or monetary, through interest rates. Within the limits of their manifesto commitments, the Government introduced a number of fiscal increases in the recent Budget. Many feel that those do not go far enough but I do not believe that they could have gone further in view of the Government's commitments. The only weapon left is that of interest rates. That in turn has had, and will continue to have, the harmful effect of pushing up sterling.

The major issue is how to deal with short-term risk while at the same time keeping on course for the long-term objectives. At this point I should like to turn to consideration of what is likely to happen with the euro. Whatever happens, it is bound to affect us: whether we are in or out, whether it goes ahead with us or without us, it is a factor which we now seriously have to take into account. We must contemplate what is most likely to happen and what our attitude towards it should be.

The present expectation--at any rate in financial markets--is that the single currency will be introduced on schedule in 1999. It is also assumed that it will have a large rather than a restricted membership and is therefore likely to be relatively weak. That is the present expectation, as far as I can glean from careful study of the financial press.

If British policy is to stay out at the initial stage, the likely consequence in those circumstances is for sterling to remain strong and perhaps to become even stronger. In my opinion, a strong sterling alongside a weak euro is a recipe for very serious problems for our economy.

Both the CBI and the TUC recently concluded that Britain should commit to the single currency as long as the conditions were right and there was a prospect of sustainability. I believe that also to be the position of the Government. No doubt that can be confirmed by the noble Lord, Lord McIntosh, when he replies.

The CBI, however, does not consider that entry should be effected at the first wave but at some subsequent date. The TUC considers that all options should be kept open, including first-wave entry. If the Government were to follow the TUC view and declare that all options were open, that could help to reduce speculative currency movements. I therefore believe that there is a great deal in the recommendation of the TUC, subject, of course, to the conditions being right and all the other qualifications. This could bring sterling nearer to an acceptable level, in my opinion. What is an acceptable level? I have always felt that if sterling was quoted at DM 2.50, as opposed to the present DM 3, that would be about right.

It is all the more important, in my opinion, that the Government should keep all options open at this stage, including entry at the first wave, in view of the fact that

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the UK will assume the presidency of the European Union next year, when firm decisions will have to be taken as to who will participate in the single currency.

Let me sum up my opinion. I believe that the Government have been right in their strategic approach to the management of the economy. They have been right to emphasise financial stability and long-term investment as the basis on which to build for the future. Unfortunately, they are faced with the all too familiar phenomenon of a consumer boom. It will require great skill to deal with this problem while at the same time safeguarding the long-term objectives. I hope that this time we shall not be thrown off course.

1.5 p.m.

Lord Simon of Glaisdale: My Lords, in the absence of an opportunity to debate the Consolidated Fund Bill and the appropriation Bill, this is the only opportunity at this time of the year for your Lordships to consider the economy generally. Although we had from both the Minister and the noble Lord, Lord Mackay, a valuable concentration on the Finance Bill and its effects, we have greatly benefited, if I may say so with respect, from the widening of the scope of the debate by the noble Lord, Lord Ezra.

I must begin with an apology in that it is many years since I was concerned directly with a Finance Bill. I feel that all the more strongly when I look at the list of speakers which contains so many experts.

Secondly by way of introduction, I should like to express my gratitude to the noble Lord, Lord McIntosh, not only for his introduction but also for the information which he ensured that I received this morning by breakfast-time. I told him yesterday that one of the points I wanted to raise related to the provisional collection of taxes. That matter is inscribed in detail in the mind of the noble Lord, Lord Cockfield, but most of us do not have that advantage. I am most grateful to the noble Lord, Lord McIntosh, for answering in general the points that I put to him and shall be grateful if he will convey my thanks to whoever wrote the letter. There remain two minor points which I should like to raise but, if I may, I will do so by letter rather than detain your Lordships.

My third point is, I am afraid, a familiar one on these occasions. It is a protest against our having to debate this important measure on the day we rise for the Recess. I am afraid that the Government have had a very bad example set them. After repeated protests last year, we finally had an opportunity to debate the Finance Bill, but it was at very short notice on the Friday when we were to rise for the Whitsun Recess. That is a great waste of parliamentary resources. At a time when the Government are considering deployment of parliamentary resources, I venture to suggest that this is a matter which they should consider.

Your Lordships' House has five former Chancellors, four former Chief Secretaries--I see only one present today and no former Chancellor now--two former Governors of the Bank of England, a chairman of one of the joint stock banks and a number of eminent

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economists, though I think only one is present. There is no other parliamentary chamber in the world which commands such expertise and experience. In my catalogue I forgot to mention the noble Lord, Lord Clark. I also omitted the noble Lord, Lord Cockfield, who has so many multifarious experiences that he cannot be classified. But it is a great waste not to debate this important measure at a more convenient time.

I want to mention three specific points. The first was referred to by previous speakers; namely, interest rates. New Labour is nothing if not a political menagerie. No doubt it is highly attractive to shift onto the Governor of the Bank of England unpopular decisions about rate increases, which seems at the moment to be the favourite method of regulating the economy.

With respect, I draw attention to the immense skill of the previous Chancellor of the Exchequer, Kenneth Clarke, in delicately adjusting the rates and fiscal measures to control the economy. It was a model. I confess that I had not seen that since my own Chancellor when I was in the Treasury. Derick Amory had the same gift, helped in his case by the fact that the economic adviser, Sir Robert Hall, had the same gift of seeing how the economy was moving and making the small adjustments that were required to steady it.

I very much fear that shifting the unpopular decision, which will hit house owners and borrowers, onto the Governor of the Bank of England is bound to cause trouble. In all my adult life I have never known a Bank Governor who has not been a hard money man. There have been three increases in the rate since the present Government came into office. It would surprise me very much if we do not have another. Noble Lords who preceded me emphasised the great damage done to exports if there is too severe an interest rate policy.

These days, there is talk of managing by talking down the sterling rate. That is possible. Perhaps the most likely method is to make noises about joining the European Monetary Union. I am in favour of monetary union and the exchange rate mechanism. Unless they are in place, there will be competitive devaluation, which is a protectionist measure. Perhaps if the Government start talking about Europe, it will be at risk of infuriating the noble Lord, Lord Bruce of Donington, but may be useful in reducing the height of sterling.

The other matter that I wanted to mention is again a general one; namely, the borrowing requirement. When we borrow in order to consume the result, we ask our followers--our children and grandchildren--to pay for our own satisfactions. Naturally, I rate access to justice very high. Nevertheless, if we borrow in order to pay for legal aid, we are asking our children to pay for our litigiousness. It is the same with national health. We are in danger of becoming a nation of hypochondriac litigants. So one is bound to ask: for what purpose is borrowing at the present rate justifiable? The answer must surely be: when the benefit accrues to those who have to repay the debt. So if a bridge is built over which they can go, that is justifiable; if education is improved by borrowing, that is justifiable; but what is not justifiable are the transient satisfactions of our generation.

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The previous Chancellor was very good in reducing the borrowing requirement. But it is still very much too high, on the principles that I have endeavoured to lay before your Lordships. I hope that the noble Lord, when he replies, will be able to tell us something about the borrowing prospect. That seems to me, together with the matter of interest rates, to be the most important matter that we have to face on the long-term view of the economy.

1.17 p.m.

Lord Desai: My Lords, it is a pleasure to follow the noble and learned Lord, Lord Simon of Glaisdale. I agree with him that, when we discuss the Budget, we have only one chance to discuss the Finance Bill. In the previous two years we were able to discuss the Budget speech during the week in which the Chancellor presented the Budget. This year it was not possible because of the overload of business. But I hope that my noble friend can assure us that in future years time will be found within the Budget week to have a discussion on the Budget speech. We can then wait for the Finance Bill, when it comes later.

I very much welcome the debate so far. I am sure that my comments will only follow lines which have already been laid down by previous speakers. First, I welcome the perspective which the Chancellor laid down; namely, that we only borrow for investment purposes--the golden rule--and that we try so far as possible not to borrow for consumption. In the debate introduced last March by the noble Lord, Lord Pym, I remember that I said that in a sense there is now all-party consensus on a certain basic macro-economic framework. That is to be welcomed. We all agree about that and there is not very much to distinguish between us on that question.

But I go further and draw an implication from what my right honourable friend said. At the top of a cycle we should not have any borrowing at all. We should not have a consumption deficit at the top of the cycle. We are at the top of the cycle, as many noble Lords have said, and I should have preferred the Chancellor to have taken much more out of the economy than he did. We know that the PSBR projection in the previous Budget for 1997-98 was an overestimate. The economy has done so well that we will not have a £19 billion PSBR. We will have a £15 billion or £16 billion PSBR. The Chancellor has reduced it by about £9 billion. I would have preferred him to wipe out the entire PSBR in one year. At the top of a cycle you can do it. If you cannot have a zero deficit at the top of a cycle, when can you have it? If he had been able to do that, he would have given the Bank of England reason not to increase interest rates; or rather to anticipate the slowing down of the economy due to fiscal measures, which would have lessened the pressure on the pound.

My right honourable friend has taken a decision. It is a matter of judgment. He could be right. But he does not want to fine tune the economy with fiscal measures. He wants to leave it to monetary policy. I believe that he could have done a one-off balancing this time, especially because the short-run monetary policy measures which the Bank of England can take do not solve the problem of the exchange rate appreciation.

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Therefore, we are left with one instrument short. We have to control the booming economy--a consumption boom--but at the same time we have to take care of the exchange rate appreciation. By not taking enough out of the economy through the Budget my right honourable friend left the field open to the Bank of England to take a rather gloomy view and go on raising interest rates. I fear that we have not seen the last of the increases in interest rates. There will no doubt be many more to come.

Some people have argued in the press--Mr. Gavyn Davies is among them--that the Bank should perhaps go for an overkill; that it should increase interest rates not by quarter percentage points but should go for a one percentage point increase immediately. That would mean a quick dip in the growth rate but a quick recovery as well. If you are not going to take the fiscal road to wiping the deficit out, I would prefer the overkill option. If you go slowly--quarter percentage point by quarter percentage point--you will prolong the agony. We may end up with sterling at about three deutschmarks through much of 1997 and a part of 1998 as well.

I agree with the noble Lord, Lord Ezra, that that will mean that manufacturing growth will slow down, if not become negative. The Red Book--or the Red and White Book as the noble Lord, Lord Mackay of Ardbrecknish, called it--actually anticipates that. It predicts a decline in the growth rate of manufacturing output from 1.5 per cent. in 1997, which by itself is not a very high level of output, to 0.75 per cent. for 1998. This has already been factored in. What we are witnessing now is a two-level change in the British economy. First, investment in the services sector is much stronger than investment in manufacturing. The services sector is more profitable than manufacturing and has been for the past few years. That is a long-term change in the economy. At the same time the strength of the exchange rate is probably going to accelerate this process, at least in the next year or two.

The fact that in the first six months of this year manufacturing exports have stayed up tells me that British exporters are learning to squeeze profits when the pound is strong rather than put the prices up as the pound goes up. How long the profits squeeze can last we do not know. We can only hope that we can go on taking a profits squeeze and go on maintaining an exports growth. However, I fear that what we will have is a slowing down of manufacturing production and we could be facing a growth recession and a considerable slowing down of gross domestic product in the second half of 1998 or the first half of 1999. That will happen because the Bank of England will want to put up interest rates. That will feed the exchange rate.

There is speculation as to whether our making good noises about the euro will have an effect on the pound. Much more important than the noises we make on the euro are the noises the French make on the euro. As the noble Lord, Lord Ezra, mentioned, if this turns out to be a euro with a large initial membership, so that France, Italy, Spain and perhaps Portugal are in as well as the countries of the deutschmark zone, it will be a euro which will be under considerable speculative attack and it will be a euro into which we certainly should not go.

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That will mean that the pound will be as strong next year as it is this year. The right thing for us during the presidency would be to say that the euro should not start on time. We should take a firm view that it is not in anyone's interests to have either a weak euro with many members or a strong euro with few members.

We should not have a situation in which one year's deficit number looms so large that we decide on membership on a 3 per cent. deficit and we judge that the French have managed it very well because they are down to 3.2 per cent. or that the Germans have managed very well, by some degree of fudging, to get it down to 3 per cent. That is not the way economies should be run. When we have the presidency we should say that it is in no one's interest in Europe to start the euro at that date. We should say that countries should be allowed to join only if the deficit goes below 3 per cent. for three years. If we do that there will be a much slower and a much stronger evolutionary process for the euro. We are taking the Maastricht deadlines far too seriously. We are taking them seriously. Not only are the mainland European economies damaging their employment and growth prospects, but we are in danger of starting the euro initially weak. That could be damaging.

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