Who Dares Wins

by Dominic Sandbrook

  A few moments after Howe’s appointment had been announced, he had a call from his Labour predecessor, Denis Healey, who wanted to pass on some tips about the 11 Downing Street kitchen and to wish him ‘the best of luck on the bed of nails’. Having guided the British economy through the chaos of the mid-1970s, Healey knew better than anybody how sharp those nails were. And when the new Chancellor arrived at the Treasury, his new officials handed him a document that made extremely depressing reading.

  To put it bluntly, the outlook was terrible. Thanks partly to the revolution that had broken out in Iran at the end of 1978, the world economy was tipping into recession. On top of that, Britain had serious problems of its own. Driven by people’s anxiety that their earnings were being eroded by inflation, pay settlements were running at about 14 per cent a year, with prices rising at 11 per cent. With growth trickling to a halt, unemployment was certain to rise. Company profits were very poor, productivity was awful and international competitiveness was deteriorating all the time. ‘Lying behind these trends’, the Treasury briefing said sadly, ‘is a long history of industrial inertia, inefficiency and lack of innovation’. And with the exception of North Sea oil, ‘the prospects for the rest of the economy, particularly manufacturing, are extremely worrying’.14

  As Howe settled into life at Number 11, the bad news poured in. One particular concern was inflation. Having peaked at almost 27 per cent in August 1975, it had fallen during the Callaghan years but was now rising again, thanks largely to the explosion in public pay after the Winter of Discontent. As for public spending, the Cabinet Secretary, Sir John Hunt, reported that the new government had a ‘dreadful inheritance’. The Callaghan government had planned on the basis that the economy would continue to grow and inflation would continue to fall. But now both assumptions looked wildly over-optimistic, leaving Howe staring at a hole in the public finances before he had even started. Originally, Labour had forecast a budget deficit – then known as ‘the public sector borrowing requirement’, or PSBR – of about £8½ billion in the next financial year. But with pay settlements running out of control, the Treasury now expected it to be more than £10 billion. So if Howe wanted to reduce taxes, as he had promised in the campaign, he would have to make deep spending cuts.15

  These were merely the most immediate issues. Underpinning everything else, from the dire inflation figures to the woes of Britain’s exporters, was a pervasive crisis of confidence. In Whitehall, there was a sense that, with Britain doomed to decline, no government could do anything but stagger from crisis to crisis. The last ten years, wrote The Times’s economics editor, David Blake, in December 1979, had ‘produced a fundamental change in the attitude of most ordinary people and policy-makers’, which meant that ‘belief in the inevitability of prosperity [had] disappeared from Britain’. This was what Mrs Thatcher had been elected to fix. Yet when John Hoskyns listed the various problems – ‘trade union obstruction, inflationary expectations, the tendency of the best talent to keep away from manufacturing industry, fiscal distortions, high interest rates, an overvalued pound, stop-go economic management, the low status of engineers, poor industrial design, the anti-enterprise culture’ – he wondered whether economic decline was ‘like the weather, simply beyond human intervention’. The biggest problem of all, he wrote, was that ‘sense of futility, the feeling that nothing in Britain was ever going to change’.16

  As if all this were not bad enough, Howe’s job was complicated by two things over which he had no control. The first was a commission on public sector pay, chaired by the industrial relations expert Professor Hugh Clegg, which was due to report in August. In reality, Clegg had been handed a blank cheque by the Callaghan government to buy off public sector workers after the Winter of Discontent. Since their pay had been squeezed for the last three years, everybody knew Clegg was bound to recommend hefty rises. In her heart of hearts, Mrs Thatcher hated everything about it; but with the election looming, she had reluctantly promised to honour Clegg’s recommendations. This was great news for the public sector workers, but far from ideal for the new Chancellor. On 1 August, Clegg filled in the cheque with all the munificence Howe had feared, with some workers getting as much as 26 per cent. In just twelve months the government’s wage bill went up by almost a quarter. For a Chancellor desperate to show his mettle against inflation it was a dreadful start.17

  The more serious issue, though, was the much-discussed black gold in the North Sea. Since the discovery of the Ekofisk field in 1969, the oil companies had spent a fortune on platforms, pipelines and shipyards, transforming the economy of north-eastern Scotland. By the time Mrs Thatcher came to power, some 20,000 men were already working on twenty platforms in unimaginably cold, grim and dangerous conditions. The rewards were enormous. By 1980 Britain was practically self-sufficient in oil. A year later, it became the first major Western oil exporter. As luck would have it, this happened at the very moment when the price was surging, because of the revolution in Iran. So by the middle of 1983, with the North Sea platforms pumping out 2 million barrels a day, the Treasury was banking almost £8 billion annually in oil revenue. By 1985 it was making £12 billion, which was just under a tenth of Britain’s total tax revenue. So, by a fluke of timing, Mrs Thatcher was the political equivalent of a lottery millionaire. As one of Callaghan’s old aides put it, she and Howe were ‘inheriting a bonanza’.18

  Yet as every lottery winner invariably finds, there is always a downside. Yes, Britain was now shielded from balance of payments crises and the prospect of another oil shock. The problem, though, was that the pound had become a petro-currency, which made it immensely desirable. Indeed, on Howe’s first day as Chancellor, the Governor of the Bank of England, Gordon Richardson, greeted him with a grimly prescient warning. Ever since the IMF bailout, Richardson wrote, sterling had been under ‘upward pressure’ on the exchange markets. To put it simply, North Sea oil made the pound an excellent investment. Until the last months of 1977 the Bank had held sterling below $1.77, but by the time Howe took office it had reached $2.07, and further rises seemed inevitable.

  The good news was that a strong pound helped to get inflation down. The bad news was that a strong pound was terrible for British manufacturers, because it made their products very expensive abroad. With every fraction of a cent that the pound rose in value, Britain’s exporters lost more customers. So why not intervene in the markets to reduce the value of the pound? Alas, Richardson explained, it was not that simple. Experience had shown that when the Bank tried to intervene, investors worked out what they were doing and reacted accordingly, so they found themselves ‘encouraging rather than reducing pressure’. In short, there was ‘very little scope’ for action. They just had to hope that the pound stopped rising. For if it went as high as, say, $2.30, or even, God forbid, $2.40, then British manufacturers would be facing an economic holocaust.19

  So what was the plan?

  Although Mrs Thatcher’s manifesto had been remarkably cautious, her basic approach was well established. A good starting point is a summary prepared by Howe’s officials after the election, entitled ‘The Government’s Economic Strategy’. ‘The facts of Britain’s post-war economic decline,’ it began, ‘are well-known … We have slipped further and further behind our competitors in terms of living standards and the quality of public services.’ The authors singled out inflation, ‘which damages competitiveness, causes divisive social pressures, and creates uncertainty about the future’. But instead of adopting an incomes policy, ‘which deals only with a symptom of the disease’, Mrs Thatcher was committed to ‘control of the money supply’, using monetary targets to bring inflation down. Elsewhere, the government would encourage free enterprise by ‘cutting back the role of the State’ and ‘promoting small businesses’ – which meant reducing taxes as much as possible. Finally, they would not shrink from ‘difficult decisions’ on public spending. That meant cutting the Callaghan government’s spending commitments, which had been based on an ‘over-optim
istic view’ of the economy.20

  The fact that this document gave so much attention to inflation was no accident. To many commentators at the turn of the 1980s, inflation was more than just another economic problem. It was a chronic condition, a cancer remorselessly eating away at salaries, savings and living standards, eroding individual ambition and social unity. As Mrs Thatcher explained, it was ‘one of the greatest threats to liberty – to all our freedoms … the freedom to save, to find a job, to do better for our families’. And after she had won the election, her ministers took every opportunity to remind their listeners of the scale of the challenge. ‘So long as it persists,’ Howe told the Commons in 1980:

  economic stability and prosperity will continue to elude us. So long as it persists, social coherence will also elude us … The violence of the picket lines and last winter’s examples of hospital patients denied supplies, and of the dead denied burial, would have been unthinkable 20 years ago. They reflect the social disintegration caused by inflation. That is one of the reasons why the conquest of inflation is so important.21

  Nobody was under any illusions, though, that beating inflation would be easy. For decades, successive governments had promised to stop the surge in prices, yet with every fresh offensive the rate of increase seemed to quicken. Under Churchill, Eden and Macmillan inflation had been 3½ per cent. Under Wilson in the 1960s it had been 4½ per cent. Under Heath it had been 9 per cent, and after 1974 it had been 15½ per cent. And quite apart from its impact on ordinary people – especially pensioners, people dependent on their savings and those not represented by a union – inflation seemed to demolish the economic wisdom of the post-war years.

  For a quarter of a century, governments had worshipped at the altar of the economist John Maynard Keynes, whose disciples argued that the priority must be to fight unemployment by borrowing and spending to maintain demand. But as inflation mounted, Keynesianism began to look like the gospel of a bygone age. In September 1976 Callaghan had explicitly told his party conference that the Keynesians’ cosy world, ‘where full employment would be guaranteed by a stroke of the Chancellor’s pen’, was gone forever. ‘We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting Government spending,’ Callaghan said. ‘I tell you in all candour that that option no longer exists.’ The speech had been written by his son-in-law, The Times’s economics editor, Peter Jay. But the fact that it was delivered by a man nicknamed ‘the Keeper of the Cloth Cap’ made it all the more striking.22

  So if Keynesianism was dead, by what lodestar would governments chart their course? The Conservatives’ answer was an economic doctrine that had first become fashionable across the Atlantic, and had been taken up in the early 1970s by an eclectic assortment of free-market economists, think-tanks and columnists. This was monetarism, associated above all with the Chicago professor Milton Friedman. The basic outline was simple enough. As Friedman saw it, by borrowing and spending to keep unemployment down, Western governments had inadvertently sent inflation through the roof, throwing the economy off course and putting hundreds of thousands out of work. Instead of getting worked up about unemployment, they should focus on the one thing they could genuinely control, which was inflation. The government’s job, Friedman argued, was to set clear monetary targets, which would stop the money supply from growing too quickly. If inflation did get out of hand, the only solution was to squeeze the money supply: for example, by slashing spending or raising interest rates. This would be very painful, of course, and people would lose their jobs. But, in the long run, it would be worth it.23

  Monetarism has not, by and large, had a very good press. As early as 1977, the Guardian’s Peter Jenkins was pouring scorn on the ‘false disciples’ and ‘ill-founded dogma’ of the ‘money religion’, and this kind of language has endured ever since. Sir Ian Gilmour’s book Dancing with Dogma (1992), for example, portrays monetarism as Mrs Thatcher’s Marxism, a crackpot pseudo-science espoused by fools and fanatics. Even Howe admitted that his arrival in office was painted as ‘the start of an era of uncoupled dogma and unprecedented lunacy’. But as he pointed out, it was actually Labour that introduced monetarism to British economic policy, not the Conservatives. The Bank of England had quietly adopted money supply targets as far back as 1973, while Harold Wilson’s Policy Unit had urged ‘a stricter monetarist approach to government finances’ after his return to office a year later. Indeed, the first Chancellor to publish a money supply target was not Howe but Denis Healey, in the summer of 1976. It was Healey who first talked about controlling sterling. It was Healey who started cutting taxes and spending. It was even Healey who abandoned Keynesianism by concentrating on inflation rather than unemployment.24

  It is true that there were differences. Healey’s monetarism was driven by reluctant pragmatism rather than burning conviction. He was operating within a more rigid financial system, and he was still employing an informal incomes policy. Even so, the fact is that monetarism, in the words of the Labour MP Austin Mitchell, had been ‘introduced and house-trained by Labour, ready for the Conservatives to turn it into the only instrument of policy’. But it suited neither side to admit it. The Conservatives preferred to portray their predecessors as feckless spendthrifts, while Labour painted Howe and his allies as fanatical ideologues. ‘What one calls virtue,’ remarked The Times’s David Wood in 1982, ‘the other damns as sin.’ But as the realists on both sides knew, there was more than enough sin to go around.25

  The problem, though, was that like all economic theories, monetarism was less straightforward than it looked. As Howe’s friend Nigel Lawson explained, it was based on two simple ideas: first, that changes in the money supply determined inflation; second, that governments could control the money supply. But both propositions were hotly disputed. Even if the money supply did determine inflation, monetarists did not agree how to measure it. (The government’s preferred yardstick was sterling M3, ‘broad money’, which included cash, bank deposits and various funds and securities.) As for controlling it, some economists thought the government should manage the monetary base directly, setting targets for the banks’ reserves at the Bank of England. Others thought the government should concentrate on its own budget, bringing inflation down by cutting public borrowing. And still others preferred the blunt instrument of interest rates, reducing the demand for money by making it punitively expensive to borrow.

  As Nicholas Garland recognized, there was more continuity between Denis Healey and Sir Geoffrey Howe than either admitted – not least in the challenges they had to face (Daily Telegraph, 16 November 1979).

  By the turn of the 1980s, these arguments had reached theological heights of obscurity, comparable to the quarrels about the divine nature of Christ in the late Roman Empire. In the newspapers, columnists hammered out long essays about the nature and meaning of the money supply. In Whitehall seminars and think-tank briefings, politicians and civil servants contemplated the differences between M0, M1, M2 and M3, the virtues of Monetary Base Control and the problems of the Medium Term Financial Strategy. Given the sheer complexity of the issues, it is a safe bet that not all of them really knew what they were talking about. (‘This is the bit I have never understood,’ says Private Eye’s Denis Thatcher, ‘and strictly between ourselves, Bill, I don’t think Howe does either.’fn3) It is an equally safe bet that most ordinary people were bored and baffled by the entire business. In an episode of Yes Minister, there is a lovely exchange between Nigel Hawthorne’s Sir Humphrey Appleby and the banking boss Sir Desmond Glazebrook, who confides that he buys the Financial Times but never reads it. ‘Can’t understand it. Full of economic theory,’ Sir Desmond says. ‘It took me thirty years to understand Keynes’s economics. And when I just caught on, everyone started getting hooked on these monetarist ideas. You know, I Want To Be Free by Milton Shulman.’fn426

  For all the talk of doctrines and dogma, monetarism was less a blueprint than a never-ending argument. But in oppos
ition, at least, it had some compelling attractions. It offered a clear, moralistic narrative about what had gone wrong. It chimed with a growing national feeling that the government had lost its way, taxes were too heavy and inflation was too high. It allowed the Conservatives to push the union leaders into the shadows, because it eliminated any need for incomes policies. Above all, monetarism seemed to be something new, creating an impression of radical momentum and promising a clean break with the failures of the past.

  And given monetarism’s optimistic vision of a nation transformed, if only its leaders chose the path of righteousness, it is no wonder some observers saw it as a kind of religion. It is telling that in the weeks after the election, some of Mrs Thatcher’s key ministers talked not of changing policies but of changing Britain’s entire political culture. What was needed, wrote Lawson on 18 July, was ‘a sustained campaign to educate the public about the economic facts of life’. Thirteen days later, the Treasury’s summary of the government’s economic strategy declared that ‘the Government intend to change, and change radically, the framework of expectations that forms the key to individual behaviour’. In their own minds, Mrs Thatcher and her allies were missionaries, embarking on a crusade of national conversion. For as the Chief Missionary told the Sunday Times in May 1981: ‘Economics are the method; the object is to change the heart and soul.’27