The text of Mr Major’s speech to the American Chamber of Commerce on 27th April 1989.
CHIEF SECRETARY TO THE TREASURY:
I am grateful for this opportunity to address the American Chamber of Commerce. I believe it is true to say that the bilateral links between our two countries have never been stronger, either at a political or a commercial level. At present the US is the largest recipient of UK direct overseas investment and US is the largest direct investor in the UK. These investment flows are very welcome, and are the most tangible sign possible of mutual confidence in our respective economies. We see a similar pattern in visible trade. UK exports to the US, and US exports to the UK, were both around 18 billion dollars in 1988.
Our two countries also share similar convictions about the importance of enterprise, choice, initiative and the need to minimise government controls over industry and commerce and, for that matter, the individual, too. We also agree that the Government has an important role to play in providing a stable background in which industry can operate effectively. The main job is to reduce the current level of inflation and seek to eliminate it in the future. Inflation is the first and most serious problem we face. It undermines business and personal planning. It destabilises industrial relations and it can destroy within a few years the savings of a lifetime. That is why the elimination of inflation must remain the central economic objective. This is why monetary policy has to remain tight to maintain downward pressure on it. And it will remain tight, so inflation should turn down later this year. I know that people dislike the short term discomfort of high interest rates. I understand that. But they are absolutely necessary if we are to avoid the long term pain of an inflationary spiral that would damage our economic competitiveness, our industrial and commercial growth and our individual prospects. We have made it absolutely clear that we are not prepared to take risks with inflation.
Much has changed these last ten years. During the 1980s the UK has grown faster than all other major EC countries, and – if it is not ungracious to say so before this audience – even more rapidly than the US. In the previous two decades the UK was at the bottom of the growth league. Now it is at the top. The same story holds for investment. In the 1980s the growth of total investment here was higher than in any major European country, after being pathetically low in the 60s and 70s. Last year alone the growth of business investment was over 14 per cent and we expect a further 8 per cent this year. Over the past 7 years total investment has grown over twice as fast as total consumption. By contrast, during the 70s, consumption grew over 5 times faster than investment.
This investment is critical and has enabled our industry to improve its productivity considerably. Indeed, the growth of productivity in the UK during the last decade is second only to Japan of all the major industrial countries and manufacturing productivity has grown more rapidly even than in Japan. Recently debate has focused on the trade deficit. For last year the published figures show a current account deficit of 14.5 billion pounds or 3.2 per cent of GDP, although it must be said that these figures certainly overstate its size. The balancing item – which consists of an unknown mixture of unidentified capital inflows and unrecorded net exports – was even larger, at 15 billion pounds, than the total recorded deficit. Nevertheless it is clear that the current account deteriorated significantly between 1987 and 1988. I want to consider three aspects of this: what caused the deficit, whether it poses a threat and how it will be corrected.
Firstly, what caused the deficit?
The main reason for the balance of payments deficit is the dramatic surge in investment I referred to a moment ago. That has not been accompanied by a comparable increase in savings, so UK has had to import capital from abroad. The net capital inflow is the necessary counterpart of the current account deficit. With the world economy becoming increasingly integrated, it is inevitable that there will be differences in patterns of saving and investment in different countries, and hence balance of payments surpluses and deficits.
It is clear that consumer spending in the UK has also been growing rapidly, although, as I have said, at only half the rate of investment. The successful supply side policies of recent years, together with this extra investment, have enabled our economy to increase output substantially. But last year domestic demand from both companies and persons grew even faster than industry’s capacity to meet it. The excess was diverted partly into imports and partly into inflation. This unwelcome resurgence in inflation is a worldwide phenomenon. In response, there has been prompt action to tighten monetary policy around the world, reflecting a common determination to get inflation under control, and keep it under control.
Does the deficit pose a thread?
The forecast we made at the time of the Budget indicated a balance of payments deficit of 14.5 billion pounds, around 3 per cent of GDP.
Given the underlying strength of the economy this is readily financeable. There are three key points which keep the UK deficit in its proper perspective.
First, the UK’s net overseas asset position is extremely strong. Indeed the ratio of our net overseas assets to GNP is by far the largest of any major economy.
Second, the nature of the present deficit is quite different from those the UK faced in the 1970s. In those days, the UK government was borrowing overseas to fund an excessive spending programme. By contrast we are now running a substantial budget surplus of around 3 per cent of GNP. In the three years to March 1990 we will have repaid around one sixth of the outstanding government debt. As a result the public sector is adding to total savings, and not contributing to the deficit in any way.
Thirdly, the most important point to bear in mind when putting the balance of payments deficit in context is its composition. Only about one quarter of the growth in the value of manufactured imports between 1987 and 1988 was accounted for by consumer goods (including cars).
The remainder, fully three quarters, was up of goods for production and investment. The significance of this is that it represents British firms investing both to modernise and increase output. The fact is that we are in the midst of an investment boom that any previous government would have given their eye-teeth for. The short term impact on the balance of payments should be the precursor of long term improvement in productive capacity and efficiency. There is more to the trade gap than video recorders.
In the first quarter of this year the current account deficit was around a fifth lower than the peak registered in the fourth quarter of 1988. The latest figures provide further evidence of the trends I mentioned a moment ago. Goods for production and investment continue to represent the major part of our imports. Indeed imports of consumer goods fell by 1 per cent between the fourth quarter of 1988 and the first quarter of 1989.
I am also glad to see exports performing well as capacity constraints are eased by the rise in investment and the slowdown in domestic demand. Manufactured exports reached their highest ever level in the first quarter of this year, whether measured in value or volume terms. They have increased 13.5 per cent in volume terms since the first quarter of last year. Our exports of consumer goods are doing particularly well.
How will it correct itself?
This illustrates what we have always made clear: that the balance of payments deficit is the result of private sector decisions, and that therefore it is through changes in private sector behaviour that the gap will be closed.
It is now clear that the current level of interest rates is beginning to have the effect we intended. Higher interest rates make saving more attractive and borrowing less so. They will also reduce the growth of consumption to a more manageable level, and in so doing reduce the growth of imports of consumer goods. And the evidence of improvement is gradually accumulating: the housing market has slowed down considerably both in terms of prices and turnover. The decline in turnover is important because many consumer spending decisions (eg buying carpets, curtains, refrigerators) are associated with moving house. Recent statistics on retails sales and M0 can confirm that consumer spending growth is slowing down in response to the tightening of monetary policy against the background of a budget surplus. That is welcome but we must recognise that the process of reducing the deficit will take time. It will not happen overnight.
Of course, the current investment boom, which is adding to the deficit in the short term will, over time, play its part in reducing the deficit. These investments will lead to increased capacity, greater competitiveness and a better export performance, as well as displacing some imports. Either way the new output will help to reduce the balance of payments deficit.
I have no doubt that improved competitiveness is the key to a more prosperous and stable economy. To achieve that, companies must not only invest, not only improve the quality of their goods but also increase their competitiveness by constraining their unit wage costs. Achieving this is an important function of good management and prudent investment. And I must tell managers bluntly that the Government will not permit the depreciation of sterling as a way of artificially improving competitiveness. Such a policy is not sensible. It is not prudent. And it rarely works. it would simply raise import prices and add to inflationary pressures.
It is instructive to look back at experience in the 1970s. In 1974 the UK had a balance of payments deficit of 3.8 per cent of GDP, somewhat higher than last year’s outturn. Over the period 1973-1978 the effective exchange declined by a quarter yet the UK’s competitiveness – measured in terms of relative unit labour costs – did not improve but actually further deteriorated by 5 per cent. I can also assure you that the Government will not attempt to reduce the deficit by protectionist measures such as import controls. We are a very open economy and can only be hurt by a slide into protectionism.
The Government’s role in improving competitiveness is to strengthen economic performance through supply side measures, namely deregulation, privatisation and tax reform. Over the last decade nearly 40 per cent of the state owned commercial sector has been transferred to the private sector since 1979 and a further 20 per cent is in train. The abolition of exchange controls and various other deregulatory measures have all helped to make markets more efficient. The latest White Paper shows the government’s continued commitment to creating an environment in which enterprise can flourish. It lists no less than 120 deregulatory measures achieved in the previous 18 months and specified 80 measures scheduled for the future. And we now have a tax structure which rewards enterprise and initiative, with one of the lowest corporate tax rates in the world.
Business is responding to this invigorating climate. New businesses are being created at an unprecedented rate. New firms are registering for VAT at an average rate of 1,300 a week. These new enterprises will compete for business in home and export markets and will play a part in lowering the deficit.
The Government is playing its part in helping the market to operate more efficiently by improving the flow of information from retailers to manufacturers. From the beginning of June more inflation will be available from Customs and Excise marketing agents about the sort of goods being imported by different companies. This will enable British firms to contact the importing companies to see whether they could compete with those imports. I am sure they can and I hope they will.
Conclusion
To summarise: the trade deficit resulted from excessive growth in domestic demand last year. To combat this, monetary policy has been tightened considerably in the last year (both in the UK and the US). UK fiscal policy is extremely prudent. Higher interest rates will encourage additional savings, discourage borrowing and slow down spending. The private sector will respond to these policies although it would be foolish to expect the deficit to narrow immediately. By their nature these adjustments take time. But they will take place.
What is clear is that the current economic position bears no relation to the balance of payments crises in the 1960s and 1970s. The prophets of doom and gloom should lift their eyes from the history books and look instead at the remarkable transformation that has taken place in the Government’s own finances and on the ground in Britain’s industries.
The productivity and profits of UK companies are at record levels. The number of people in work is at its highest ever level. And we are seeing the longest sustained fall in unemployment since the War. Our current prosperity is based on extremely strong foundations, business is investing to make sure it continues and I have no doubt that it will do so.