The Downing Street Years (9 page)

No sooner had we agreed savings for the current year, 1979–80, than the still more difficult task was upon us of planning public expenditure for 1980–81 and subsequent years. In July 1979, when the crucial decisions were being hammered out, we had a series of particularly testing (and testy) Cabinet discussions on the issue. Our goal was what it had been in Opposition, that is to bring public expenditure back to the 1977–8 level in real terms. We hoped to achieve this by 1982–3. But, in spite of the reductions we had made, public expenditure was already threatening to run out of control. That in turn would have serious consequences for the PSBR, and thus for interest rates, in the longer term for taxation, and ultimately for our entire programme.

Nonetheless — or perhaps for that very reason — there was strong opposition from some ministers to the cuts. These were the so-called ‘wets’ who over the next few years took their opposition to our economic
strategy to the very brink of resignation.
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Some argued that the strategy had been overtaken by events; and indeed for those who had not heard that Keynes was dead, the prospect of reducing expenditure and curbing borrowing as we and the world sank into recession was undoubtedly alarming. Others put up a hundred and one reasons why any particular cut was out of the question. Defence, for instance, would not be able to achieve its sacrosanct target of 3 per cent growth a year. Or the DES would not be able to make economies in the time available (in spite of declining pupil numbers.) Or the Department of Employment would have to find money in response to the mounting jobless total. In the light of this opposition, I instructed a small group of key ministers to discuss with departments the proposals for reductions and report back to Cabinet.

Geoffrey Howe was superbly stolid in resisting this pressure. Later in July he set out for colleagues the precise implications of a failure to agree the £6.5 billion reductions he was proposing. He also dispelled some of the misunderstandings. Ministers had to recognize that we were not cutting to the bone, but merely reining in the increases planned by Labour and compensating for other increases that the deepening recession had made almost inevitable.

Labour’s previously announced plans would have increased expenditure in 1979–80 by some 2 to 3 per cent over the level of 1978–9, and in 1980–81 by some 5 per cent, on the transparently erroneous assumption that the economy would grow by between 2 per cent and 3 per cent a year. Not that Labour was unique in this. The Treasury used to produce a fascinating chart, the so-called ‘porcupine’, in which the forecasts of economic growth in successive public spending white papers shot ever upwards, looking a little like porcupine quills, while the actual course of economic growth stubbornly remained on an only gently rising gradient. This was a literally graphic illustration of the overoptimistic assumptions on which past public expenditures plans had been based year after year. I was determined not to add another set of spikes.

In this case, Labour’s plans would have involved expenditure of a further £5 billion in 1980–81 to be financed out of growth that was
not happening. Moreover, this overshoot had been aggravated by a rate of pay increase in the public sector which was forecast to be 18 per cent, and which which would cost another £4.5 billion. To offset these increasing obligations we had to find substantial cuts. We had to make reductions of £6.5 billion in the expenditure plans for 1980–81, just to hold the PSBR in that year down to £9 billion. That figure was in itself too high. But the ‘wets’ continued to oppose the cuts both in Cabinet and in the indecent obscurity of leaks to the
Guardian.

It was not until the end of July that the Cabinet brought itself to take the necessary decisions. The conclusions were extensively leaked. Even so, we decided the wisest course was to wait for the autumn before publishing the full figures in the Autumn Statement. We had made some tough decisions in those first three months. It was, however, only a start.

Over the summer the economic situation worsened. On my return from my first Commonwealth summit in Lusaka in August, Geoffrey Howe presented me with a general survey of the economy which he rightly described as ‘not very cheerful’. Unemployment was likely to begin to rise as the international recession deepened. Inflation was accelerating. Our competitiveness had worsened as a high pound and high wage costs put industry under increasing pressure. We became increasingly worried about the implications of pay rises for unemployment and bankruptcies. I asked that we should collect and circulate examples of excessive pay awards, which priced goods out of the market and destroyed jobs.

In September we again returned to public spending. We not only had to publish the conclusions we had agreed in July, but also our plans for the years up to 1983–4. And that meant more economies. We decided on a renewed drive to cut waste and reduce civil service numbers. We also agreed sharp increases in the price of electricity and gas (which had been artificially held down by Labour) that would come into effect in October 1980. Electricity would rise by 5 per cent, and gas by 10 per cent, over and above inflation.

The 1980–81 Public Expenditure white paper was duly published on 1 November. These public spending plans honoured our pledges to provide more resources for defence, law and order and social security (reflecting the year’s record pensions uprating). They would also hold the public spending total for 1980–81 at the same level as 1979–80. In spite of the fact that this reduction of some £3.5 billion from Labour’s plans was denounced as draconian, it really was not large enough. That was evident not only to me, but also to the financial markets, already concerned about excess monetary growth.

Here, too, we seemed to be running up the ‘Down’ escalator. On 5 November Geoffrey Howe came to see me. The money supply figures were well above target, principally because the PSBR and bank lending were both higher than expected. The PSBR had been affected by one strike which held up payment of telephone bills and by another which had disrupted VAT payments. Companies were borrowing to finance wage settlements they could not afford. Interest rates overseas were on the way up. And the public spending figures had also, as I suspected, proved too high for the markets. A financial crisis threatened. In the days of Denis Healey this would have elicited a fiscal package or ‘mini-budget’. We had no hesitation in rejecting this approach. Higher interest rates or lower public spending, not tinkering with fiscal demand management, were the appropriate response.

On 15 November we accordingly raised Minimum Lending Rate (MLR — the successor to Bank Rate) to 17 per cent. (Measured by the RPI, inflation at this time was running at 17.4 per cent.) Other measures to help fund the PSBR were also announced.

Of course, the Opposition had a field day, attacking our whole strategy as misguided and incompetent. The fact of the matter was not that our strategy was wrong but that we had yet to apply it sufficiently rigorously and get a grip on public spending and borrowing. That in turn was increasing the pressure on the private sector through higher interest rates. Keith Joseph had warned of this in Opposition in his Stockton Lecture in 1976, which was later published as a pamphlet under the title
Monetarism is not Enough
, in which he said:

I knew that we had to break this vicious spiral. We had to make further attempts to curb public spending and borrowing — no matter how difficult — because otherwise private enterprise would have to bear a crushing burden of public sector profligacy. Geoffrey and I accordingly decided that we had no alternative but to seek further spending reductions in 1980–81 and in subsequent years. He brought
forward a paper, first to me and a small group of ministers and then to the full Cabinet, proposing an extra £i billion reduction in 1980 — 81, and £2 billion in each of the following years. From what I had seen of departmental ministers’ fierce defence of their own budgets, I knew that this would provoke trouble. But I also knew that the great majority in the Party were determined to see the strategy succeed. So I sought to take my case to them.

I had already told the Party Conference in Blackpool on 12 October:

Just before the November rise in interest rates, I had used the platform of the Lord Mayor’s Banquet to reaffirm that we would hold to our monetary policy in the fight against inflation:

I now made it clear that we would return to the attack on excessive public spending. The Party Leader’s speeches to the 1922 Committee are an opportunity to appeal directly for support for the Government’s policies. On Thursday 13 December, I told the ‘22 that we needed to ‘have another go at getting expenditure down’ and was well received. A little less than a month later, I agreed to be interviewed by Brian Waiden on
Weekend World
and said of public spending that ‘if we got a billion off, I would be quite pleased’. The atmosphere quickly became more propitious for a renewed drive against overspending.

In Cabinet on 24 January 1980 we returned to a discussion of public expenditure for 1980–81 and the years to 1983–4. Higher oil prices, almost no growth projected in industrialized countries in the coming year, and the steel strike
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adding to the PSBR, formed a sombre background to our deliberations. I knew that these next two years would be crucial. We had to take the required action on inflation and public spending in that time: then as growth resumed, we would again be in a position to move towards lower taxes and lower interest rates. But the ‘wets’ launched a fierce attack on our policy and the theory underlying it. It was argued, for instance, that the PSBR should be allowed to rise during a recession. Our response was that it was a
very different matter when the PSBR started out by being far too high — the legacy of a Labour Government which had doubled the national debt during its period in office. Individual ministers defended their bailiwicks. Jim Prior argued persuasively for a continuation of the special employment measures.
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We agreed but decided that we would have to take another look at the the burgeoning social security budget.

A week later, Cabinet resumed its discussion — and focused closely on social security.
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Both for public spending reasons and in order to deal with the ‘Why Work?’ problem (namely, the disincentive to work created by the small disparity between in-work and out-of-work incomes), we had already agreed to tax short-term social benefits as soon as possible. In the interim we decided to reduce these benefits — unemployment, sickness, injury, maternity and invalidity benefits — by 5 per cent. The so-called earnings related supplement (payable with certain short-term benefits) would be reduced from January 1981, and abolished in January 1982. We also decided to introduce legislation to deal with the vexed question of supplementary benefit for strikers’ families. This was not only expensive to provide; it shifted the balance of power in industrial disputes against employers and responsible union leaders. In future, assessments would assume that £12 a week was provided either from the striker’s own resources, or from union strike pay. We finally agreed a number of disparate savings on housing, on expenditure by the Property Services Agency, and from a rise in prescription charges to £1.

When Geoffrey Howe delivered his second budget on 26 March 1980,
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he was able to announce that we had found over £900 million in further savings in 1980–81 (though part of that was absorbed by an increase in the contingency reserve). Overall, at current prices this was over £5 billion less than Labour had planned to spend. In the circumstances, it was a formidable achievement, but also a fragile one. As the economy sank deeper into recession, there would be fresh demands, some of them difficult to resist, for higher public spending on programmes like social security and the loss-making nationalized
industries. In a paper he wrote for me in June 1979, John Hoskyns had used a memorable phrase about governments ‘trying to pitch [their] tent in the middle of a landslide’. As we moved into the 1980–81 public expenditure round and the forecasts worsened, I could hear the canvas strain and the ground rumble.

The second half of 1979, though dominated by economic policy and by the intense round of diplomatic activity,
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was also a time darkened by terrorism. Barely a fortnight after entering No. 10 I had delivered the address at the Memorial Service for Airey Neave.
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Not long afterwards, IRA terrorists struck another blow which shocked people around the world.

I was at Chequers for the Bank Holiday Monday of 27 August when I learnt of the shocking murder of Lord Mountbatten and, that same day, of eighteen British soldiers. Lord Mountbatten was killed by an explosion on board his boat off the coast at Mullaghmore, County Sligo. Three other members of his party were killed and three injured.

In an even greater defiance of civilized custom, the murder of our soldiers was even more contemptible. Eighteen were killed and five injured in a double explosion triggered by remote controlled devices at Narrow Water, Warrenpoint, near Newry, close to the border with the Republic. The IRA had exploded the first bomb and then waited for those who came by helicopter to rescue their comrades before detonating the second. Among those murdered by the second bomb was the Commanding Officer of the Queen’s Own Highlanders.