The economy – and easy credit

From the AK archive: MOST of what little knowledge I have about economics has been gleaned from colleagues and contacts down the years, together with a bit of reading. The result is a strange brew in which the chief ingredient is confusion. I take comfort from the fact that I do not seem to be alone; our policy-makers often seem just as muddled.

I have lived through two distinct eras of official economic management. First, through the fifties to the seventies, there was Keynesian orthodoxy. Then there was Reaganism or its clone Thatcherism. In the first period my guru was the late J. D. Vassie, a leader-writer on the Scotsman. He was a sweet man, much given to uttering economic theorems, and he often turned the editorial conference into a seminar. He died this year.

He was from Bathgate. He was a Labour man of the old school but was not easily able to express this in his leaders. Once when he had written an editorial on housing, the editor of the day (Murray Watson) had not liked it and had placed the Conservative manifesto on Jim’s desk. ”This, Vassie,” he said, ”is our policy on housing.”

The result was that his leaders had a cloudy or occluded quality. Perhaps he should have chosen an academic career because his conversation, by contrast, was didactic in the best sense. The minutes to deadline would tick away unnoticed as he discoursed. To his interest in economics he added a passion for football, and his conversation would mingle both subjects in a delightful way.

He subscribed to four leading truths. The first was that the essential art of attacking football was to draw your opponent and then pass to an unmarked team-mate. The second was that Stafford Cripps should have funded the sterling balances after the war, thus making the pound less vulnerable to external pressures. The third was that the post-war expansion of world trade under the rules of Gatt had been funded by the liquidity created by Eurodollars. Fourthly, he would aver that inflation was caused when the value of money incomes exceeded the value of goods and services produced.

This was the orthodoxy of the day. A central principle of Keynesianism, which after the war had helped the European nations to enjoy sustained economic growth, was that government action could avoid downturns in the business cycle (an unreversed downturn had led to the recession before the war).

A certain amount of inflation, it was accepted, would be the inevitable result of this pump-priming. But as long as prices went up faster than wages this would correct itself in the upswing. What went wrong with Keynesian economic management was that the opposite eventually occurred.

People began to anticipate or discount inflation and pay themselves increases not justified by higher production. (Down the years this has not changed much: in the year to this September wages rose by 7.9% and prices by 3.7%. An optimist might hope the difference reflected gains in efficiency and productivity. A realist in the Vassie mould would fear the worst).

From this habit came Britain’s long obsession with incomes policy (it survives in some manifestoes but is widely discredited). From it, also, flowed the Thatcherite reaction. The belief was that if public spending were cut, state enterprises dismantled and union power broken, then we could escape from stagflation: the market would allocate resources more efficiently than government and create growth. Mrs Thatcher’s certitude, and her gifts of explaining everything in terms of household management, swept all objections aside.

A mature judgment on the Thatcher years must await the historians. But I began to notice during her terms that J. D. Vassie’s explanations of inflation were incomplete if still fundamentally sound. There were other varieties of the disease. If goods or services were in short supply — if there was a lack of economic capacity, for example, or a shortage of land for housing — that would cause prices to rise. (It might also suck in imports, but that’s another story).

But the chief new strain in the virus was easy credit. It was made more virulent by a housing policy which slashed the building programme in the public sector and threw every advantage in the direction of private ownership. In Scotland where there was a low level of home ownership that was no bad thing. In the South of England it is not too much to say that it caused a disaster. As mortgage distress in the south rises to a clamour, Mr Major is having to pay the political penalty for Mrs Thatcher’s mistakes.

The scenario was simple. Banks and building societies fought to lend, often offering 100% mortgages to double-income families. In the south houses were in short supply. Because of green-belt policy new land was not released. Instead of enabling labour mobility (a classic failure of the council-house system, it was alleged), the policy produced severe imbalances in house prices which made things worse: how could someone in the north afford a house in the south? And people in the south could sell a semi and buy a castle in the north.

The system created social inequities by making some people very rich and others very poor. On one side of the coin people borrowed rashly, lumbering themselves with unsustainable commitments. On the other, just as perniciously, the rapid rise in house prices allowed people to release equity from their properties. This they spent freely on consumer durables and leisure, among other things. I remembered enough of my Vassie tutorials to realise that this money was not underpinned by any real increase in the value of the assets: the houses had not changed. It was therefore highly inflationary.

Now the prices have collapsed, the market stagnates. The Government is grappling with ways of alleviating the human misery that has resulted. It is obviously electorally expedient to do so; it is also right, though it is sad that the Government’s compassion does not extend to other impoverished groups.

Because we have accepted the disciplines of the exchange-rate mechanism of the European monetary system, we can no longer fool ourselves. We cannot use resources that do not exist. We cannot pay ourselves more if we have not produced more. We cannot cheat our way back to international competitiveness by devaluing the currency.

If J. D. Vassie were sitting across the table from me now, he would, I suspect, warn us that quite a hard decade was coming. He would probably be right. The Government will get the blame. For myself I blame the banks. They did the daft lending which put the economy into reverse; their competition made the building societies take leave of their normally conservative senses. Scotland didn’t have the disease but it had to take the cure. And the Maxwell fiasco reminds us of the truth of Keynes’s famous dictum. When you owe the bank a thousand, it owns you. When you owe it a million, you own it. Next time the bank manager gets above himself, remember that.