Margaret Thatcher: The Authorized Biography (82 page)

Except for the abolition of the Price Commission, key economic measures had to await the Budget. As the days of preparation passed, in addition to his weekly bilateral with the Prime Minister, Geoffrey Howe went more and more often through the door that connects No. 11, the Chancellor’s residence, with No. 10. He had to bring Mrs Thatcher worse and worse news. The consequences of the Callaghan government’s pre-election spree of borrowing and spending, including the cost of wage settlements, were playing havoc with monetary control. On 10 May 1979, Howe informed her that sterling M3, the measure of all coins, notes and bank deposits, now preferred by the Treasury as the best measure of money supply, was growing at an annual rate of 12.8 per cent, above its target range. Given that the government believed and publicly asserted that inflation was caused by excessive growth of the money supply, this was a clear warning of inflation ahead. On 6 June he warned of ‘more bad news (to place alongside the trade figures) to show that our inheritance was much worse than we had appreciated’.
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The money supply growth rate was now 13.1 per cent and would be higher still that month, the figures being ‘right outside even Denis Healey’s target range’. The government’s own target was 7–11 per cent. Howe went on to say that Gordon Richardson, the Governor of the Bank of England, advised a 2 per cent increase in the Minimum Lending Rate (MLR) to 14 per cent. This was bound to put up mortgage rates to 13 per cent. The rise should take effect the following day, Howe insisted, to avoid it becoming involved in the Budget.

Mrs Thatcher was presented, for the first time, with a dilemma which was to trouble her again and again. In those days, before the independence of the Bank of England’s Monetary Policy Committee decreed in 1997, control of interest rates rested, in effect, with the Chancellor, consulting with the Prime Minister. Decisions on putting rates up or down were therefore inevitably political, as well as economic. They were also more noticeable than most such decisions were to become by the end of the
century: because of high inflation, it was hard to give a little touch to the tiller. The quarter-per-cent rate changes familiar in modern times would have been imperceptible then. Rises were often of two, once even of three, percentage points. They placed politicians in the middle of controversies which they disliked, but gave them a power that few at the time would have dreamt of giving up. Mrs Thatcher had an innate distrust of the Bank of England for what she saw as its Keynesian approach, and she was particularly suspicious of Gordon Richardson, the Governor. ‘I just don’t know how you can trust them,’ she said to Adam Ridley.
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And when, that November, a crisis in the funding of government debt in the gilts market precipitated a three-point rise in interest rates, Mrs Thatcher wrote in the margin of a memo about the Bank’s conduct: ‘I must put someone there I can rely on.’
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Richardson was an intellectual who preferred expressing himself in indirect and apparently inconclusive ways which irritated her. He was also a handsome man, but one who did not treat her as if she were an attractive woman – a fatal combination in her eyes: ‘He was feline; she was canine.’
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In her frank way which both delighted and alarmed officials, she looked up one day as John Ashworth, the government’s Chief Scientist, came into her office and said, ‘What do you think of Gordon?’ ‘Gordon who?’ said Ashworth. ‘Oh, you know, that fool who runs the Bank of England.’
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Even though monetarists such as Tim Congdon
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and Hayek himself had already floated the idea of surrendering political control of interest rates, she did not contemplate passing authority to Richardson. Richardson had been Governor under Heath; even before Mrs Thatcher came into office, Gordon Pepper had persuaded her that Richardson had been as ‘guilty as hell’ over the Barber boom.
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Mrs Thatcher longed to make her role as First Lord of the Treasury real as well as titular. She saw interest rates as her main immediate weapon in her war against inflation, and would never cede political power over them. But although no one was stronger than she on the need to beat inflation, no one was more conscious of the effect of high interest rates on what she sometimes referred to as ‘our people’. The most consistent of all threads in the economic history of Margaret Thatcher was her initial objection to interest rate rises whenever they were proposed. She hated the idea that young people on or approaching the housing ladder should be penalized by a Tory government. She was fierce, in theory, about the wickedness of a person or a nation borrowing more than he, she or it could afford, but she
also knew that preventing people from borrowing was a sure way to crush the aspirations which she wished, for reasons of belief and of party politics, to foster.

In early June 1979, the Chancellor and Governor were summoned to her presence. ‘The Prime Minister said she could not accept the Chancellor’s argument on timing,’ her private secretary minuted Howe’s after the meeting, because it left out consideration of the European elections. She said that the increase would have to be on Tuesday (the day of the Budget), and ‘she was doubtful whether a full 2 per cent was needed’ and was worried about mortgage rates. She asked for a reconsideration over the weekend.
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Reverting to Mrs Thatcher on Monday, Howe held fast. He and Richardson took the view that the government must send the right signals. The most basic point of all was that the government had to be able to fund its borrowings in the market: it could not do this if its strategy was disbelieved. It was essential, said Howe, to avoid the ‘subsequent feeling that the change [in interest rates] is insufficient’. He added, ‘given our commitment to monetary targets, our first use of a monetary policy instrument should be effective and unequivocal.’ Lankester wrote on Howe’s note: ‘PM seen and willing to abide by Chancellor’s judgement, albeit very reluctantly.’
²⁵
She made it clear that she thought the increase was mistaken, and would have preferred one of 1.5 per cent.

In doing so, Mrs Thatcher was perfecting a technique she was often to deploy – permitting a decision, but distancing herself from it. When, as night follows day, the rise in the Minimum Lending Rate which she had agreed led to a rise in mortgage rates, Mrs Thatcher decided to be so shocked that she broke her normal habit of writing in the margins of memos received and wrote a full memorandum to Geoffrey Howe herself: ‘I am very worried about the reports in today’s press that mortgage rates may have to go up within a few days. This
must
not
happen. If necessary, there must be a temporary subsidy (as in 1973) from the contingency reserve to keep the rate where it is (11¾ per cent). That rate is
already
too high. Can you consult with Michael Heseltine and the Building Societies forthwith.’
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This subsidy was not, in the end, forthcoming; but the intervention indicated Mrs Thatcher’s unhappiness with the situation, and her readiness, for political reasons, to diverge from the market stringencies, on which, in principle, she insisted. Again and again, the Treasury and various free-market purists urged her to get rid of Mortgage Interest Relief at Source (MIRAS), the tax write-off of mortgage interest, but Mrs Thatcher refused. When rumours got out that MIRAS might be removed, Jim Callaghan challenged her at Prime Minister’s Questions. She did not hesitate:
‘I am delighted to deny it. One’s advisers are not always right, and I often tell them so.’
²⁷

As the first Budget was prepared, Mrs Thatcher quickly came into conflict with the Treasury. At a full-dress meeting with all the Treasury ministers and senior officials she complained that ‘The Treasury approach … was not nearly tough enough’ on public expenditure. She wanted a PSBR of £7.5 billion, rather than the £8.5–10 billion projected. ‘The Prime Minister said that it was essential to get the overall strategy right from the start. This must involve large public expenditure cuts this year leading on to more substantial reductions in later years; a lower growth in the money supply … and lower interest rates.’
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The search for new cuts was agreed, including a reduction of the Rate Support Grant by a further £100 million, a cut in the contingency reserve and a target of £400 million in other savings. Asset sales would raise £1 billion. There would be no adjustment to cash limits,
*
and there would be a cutting of staff costs in the Civil Service.

Mrs Thatcher was less robust, however, about the tax plans: ‘she was extremely perturbed at the prospect of having to increase VAT from 8 per cent to 15. This would mean a sudden jump in the RPI of at least 3 per cent. The result could be catastrophic for the next pay round.’
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As Geoffrey Howe pointed out in his memoirs, Mrs Thatcher was displaying ‘the ambivalence she often showed when the time came to move from the level of high principle and evangelism to practical politics’.
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After considering matters further for a few days, Howe wrote back. His Budget, he knew, would be seen as ‘contractionary’, but that would not matter if it also gave ‘really firm and convincing indications’ of the government’s long-term determination. He wanted to cut income tax from 33 to 30 per cent at the basic rate and from 83 per cent to 60 per cent at the top rate. This could be paid for only by a 15 per cent rate of VAT.

In the constant battle in her own breast between her cautious and radical instincts, Mrs Thatcher now edged towards caution. Was it really wise, she wondered, to try to cut income tax so much, so quickly? ‘She referred in this context to the Budgets of 1952 and 1953. Mr Butler’s first Budget had been a tough one, and it was only in his second Budget that he had introduced major reductions in income tax.’
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But Howe maintained his
position. The PSBR would go way over £8 billion without 15 per cent VAT. ‘What matters’, he wrote, ‘is a comparison between take home pay and prices, and everyone would be securing substantial income tax cuts. Such a package would be presented as giving greater personal choice.’ And he wanted the Budget to mark a decisive departure: ‘this Budget provides our only opportunity to make a radical switch from direct to indirect taxation and thus honour the commitment on which our credibility depends.’
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The two met the following day, and Mrs Thatcher gave her reluctant agreement to the increase in VAT, winning in exchange a decision, for the sake of the Retail Price Index, not to increase the duties on alcohol and tobacco. They also agreed that it was essential for the PSBR to be below £8.5 billion, a slippage from the originally desired £7.5 billion which they would quickly rue. In hindsight, many shared the view that Mrs Thatcher had advanced (though they did not know she had advanced it), criticizing Howe for tax cuts and changes too sudden for the precarious state of the public finances. There was much to be said for this criticism. Against this, though, was the importance of symbol. Howe could see, more clearly than Mrs Thatcher, that a new Conservative government had to signal a new view about what tax was for. It had to emphasize incentive and choice. It even, as Brian Walden had noted before the election, had to suggest the benefits that came from inequality. In a strong moral defence of her economic policies delivered not long after the Budget, Mrs Thatcher justified the cut in the top rate of tax in anti-egalitarian terms: ‘Nations depend for their health, economically, culturally and psychologically, upon the achievements of a comparatively small number of talented and determined people.’
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If her first Budget had not been bold about tax, her later ones would almost certainly have been more cautious still, and the impetus for change would have been lost.

The theme with which Howe introduced his Budget on 12 June 1979 was the decline of Britain. In 1954, he pointed out, Britain’s share of world trade had been the same as that of France and Germany combined. In 1979, a quarter of a century later, the Franco-German share was three times larger than Britain’s. Such a stark admission of decline was a prelude to reversing it. His measures included all the major tax changes that he had wanted. In addition, he changed the basis of calculation for the state pension. In the past, pension increases had been linked to the rise in prices or earnings, ‘whichever is the greater’. Now they were to be linked to prices alone. Since one of the problems of the British economy was the tendency of wages to outstrip prices without compensating improvements in productivity, this change was huge in its long-term effect. So was the decision, announced in the Budget, to begin the staged lifting of exchange controls. For the first
time in a generation, large-scale foreign investment in Britain became a serious proposition, as did new British investment abroad.

Everyone could see the radical change that Howe’s first Budget represented, and it was duly acclaimed or reviled depending on the commentator’s attitude to that radicalism. Cheering news for the government was the annual report by the International Monetary Fund which, since the disaster of 1976, had been making health visits to the British economy as the patient convalesced. Its report in early July praised the restraint on public spending, the tight financial policies and ‘the courageous decision … to act to improve the productivity performance of the UK economy whatever the short-term cost’.
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Less encouraging for Mrs Thatcher was the reaction of Jim Prior. He found the Budget an ‘enormous shock’.
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This may seem strange, given that the chief points of the Budget had been foreshadowed in the election campaign, but Prior admitted in later years that he had been ‘working on the assumption that the rhetoric of opposition would become softened by the experience of government’.
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Besides, because of Mrs Thatcher’s extreme (and, as later events were to show, justified) fear of leaks, there had been no Cabinet discussion of the Budget. Ministers heard its contents only on the morning of the day when it was delivered, by which time protest was too late. Prior, who had earlier got wind of the possible increase in the rate of VAT to 15 per cent, had been to see Mrs Thatcher to lobby against this, and she, who had her own objections to the rise, ‘heard me with sympathy’.
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On the night before the Budget, Prior gave dinner to Moss Evans, the head of the giant Transport and General Workers Union, and told him that he doubted that the rate would go as high as 15 per cent.
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When it did so, Prior lost standing as an interlocutor with the unions, and felt foolish, even misled. He vented his anger by protesting privately at the increases in the RPI which the Budget would cause, and at the policy of encouraging nationalized industries to increase their prices in order to restrain their ‘external financing limits’ (the subsidy they received from central government). These rises, in turn, would push wages higher. For an anti-monetarist like Prior who believed that wage increases, not the quantity of money, caused inflation, the Budget was indeed a great error. For anyone concerned with pay bargaining, it was certainly a high risk.