Economics: Living with the legacy of neglect

THE Prime Minister really must make up his mind. Does the Government's brand of conservatism break with what Lady Thatcher stood for - or is it a continuation of her traditions, albeit in changed circumstances? Wavering between the two merely reinforces the widespread impression among senior business people that the Government lacks direction.

John Major appeared to have come off the fence in his interview in the Independent last week, when he displayed more concern about manufacturing industry than his predecessors would ever have done. Moreover, his concern was for all the right reasons.

Our manufacturers are our pre- eminent traders. They earned 66 per cent of our foreign currency last year, even though they produce only 24 per cent of national output. This is no surprise. It is easier to export television sets than haircuts, restaurant meals, life assurance premiums or merchant banking.

The point was most vividly expressed by Sir John Harvey-Jones, who argued that we could not pay our way in the world by dressing up in smocks and showing people round Windsor Castle. It would take an extra seven million tourists a year to replace ICI's pounds 2.8bn of exports.

This trading status makes manufacturers rather special in the process of economic growth. Their success determines the amount of foreign currency we can spend, so it also determines the amount of foreign goods we can import.

Since a rising proportion of what we spend at home goes on imports, it follows that if we can afford more imports, we can also afford more home spending. And higher demand at home means more output and jobs in services.

If we fail to compete with overseas producers, we have to damp down spending at home (and hence the growth of all those service businesses that rely on the home market) in order to control our import bill.

When imports get sharply out of line with exports, the gap can only be met by foreigners buying British assets, or holding our IOUs. They soon tire of doing so, and a sterling crisis forces retrenchment and recession. The key indicator of manufacturing success is therefore not the number of jobs in the sector: Japanese factories can employ virtually no-one except supervisors to manage their robots. But the competitiveness of Japanese manufacturers has traditionally allowed spending to expand, so that there have been plenty of jobs in services.

The objective must be to expand our manufacturers' market share both overseas and at home (which saves foreign exchange otherwise spent on imports). And the measure of our failure as a manufacturing nation over the last decade is shown in the graph: we have simply produced less than our rivals.

In his interview, John Major was asked point-blank about the view (put forward by Lady Thatcher and Lord Lawson) that making things was becoming less important. He said: 'I don't agree with it. I didn't agree with it in the Eighties. I was in a minority view in the Eighties.'

In a key passage that repudiated Lord Lawson's insouciance about trade, he said: 'Services are very important . . . but services aren't enough, because services are the first thing you cut - so we need the manufacturing base both as import substitution and as part of the continuing export drive.'

So far, so very good. But the next day, the Prime Minister played down any contrast with Lady Thatcher and Lord Lawson. They had, Mr Major suggested, been misunderstood. They had always been in favour of manufacturing.

Any industrialist who tried to impress on the insensitive Lady Thatcher the folly of her policy between 1979 and 1981 will testify that they were not. Stand up Sir John, Lord Weinstock and a cast of thousands.

The Thatcher Government's record on manufacturing was disastrous. High interest rates - up to 17 per cent in 1979 - were inflicted on the economy in a misbegotten attempt to control a monetary aggregate - sterling M3 - which was growing above its target range.

This excess, far from telling us that inflation was about to accelerate, told us instead that companies were in such parlous trouble that they had to borrow more to pay the interest on their existing debt.

The result of high interest rates was to drive up sterling even though our domestic costs were rising faster than those overseas, fuelled indeed by the further mistake of nearly doubling VAT and stoking up pay claims. Britain's unit labour costs rose by 63 per cent more than those of our trading partners between 1977 and 1981, an unprecedented loss of competitiveness that caused manufacturing output to plunge by a fifth.

Indeed, the proud record of Lord (Geoffrey) Howe is that he managed to destroy more of British manufacturing in two years than Hermann Goering and the Luftwaffe in five. Even Lord Howe, a master of disingenuous understatement, was forced to concede that this policy might at least have been presented better.

He told Channel 4 news on Thursday: 'It certainly did appear from time to time that we were unfriendly towards manufacturing industry, and I think that was a pity. And we tried very hard to rebut that impression.' Lord Howe's regret is as sincere as that of Lewis Carroll's Walrus, sobbing as he gobbled his oysters.

Almost nothing is all bad. The trauma of 1979-81 forced what remained of British manufacturing to change at an unprecedented pace. Indeed, there is a parallel with the post-war experience of the Japanese and the Germans. The recession, in Joseph Schumpeter's phrase, involved creative destruction.

There was a new generation of top managers - the first in which it was normal to have at least one university degree, since it was the first generation to take advantage of the Robbins expansion of higher education in the Sixties. They vastly improved productivity, quality control and delivery times. Restrictive practices died.

The trade union reforms tamed Britain's appalling strike record, and that is an enduring gain. The problems of the late 1980s were not caused by wage push but by an excessive stoking up of demand due to the housing and credit boom. For once, wages followed rather than led. If wage push had been the problem, profit margins would have shrunk, but they rose. This change has improved British companies and the real pay of their employees. It has also attracted more than half of all the Japanese inward direct investment in the European Community in recent years. Although British wage costs are not as low as some, they are a bargain compared with the output that British labour can produce.

But even the catch-up in the late 1980s could not fully compensate for the disaster of the 1979-81 recession, which simply left manufacturing too small to sustain our import needs. That is the underlying reason why we are running an unprecedented trade deficit at the bottom of our longest post-war recession.

Lady Thatcher also stands accused of neglect of the need for trained people in business. She abolished most of the industrial training boards which had, albeit imperfectly, provided much vocational training. We are still training too little, and are still the only major country in western Europe not to pay tuition fees for vocational training.

If you study classics at Oxford, you will get your tuition fees paid and a grant to maintain you if your parents are not well off. If you study engineering for an NVQ certificate, you or your employers will have to pay.

The contrast says it all, and John Major should keep saying it, too. On manufacturing, he is right. And Mrs Thatcher was very, very wrong. Oh yes, she was.