The success or failure of all governments turns very largely on their achievements on the economy. Of course, political leaders have many other matters in mind when elected. They can set a new style. They can tackle sleaze. They can reorganise the constitution. They can change spending priorities. They can make rousing speeches to their party conferences. In the end, however, it is success or failure on the economy which is likely to be the pre-eminent factor in the electorate’s mind when judging the record of any government’s tenure of office. To fail there undermines everything.

It might be thought, therefore, that making sure that the economy performed well would be the top priority. Claims that it was each political party’s intention to make sure that it was used to feature strongly in election manifestos. Now that so many policies have failed, and so many promises have been broken, politicians of all parties are more cautious, and electoral commitments are much more muted. Meanwhile, however, Britain’s poor economic performance has continued. At least since the end of World War II, and arguably for much longer than this, the British economy has achieved relatively worse results that that of any other country in the developed world. Over the half century since 1945, our growth rate, at 2.3%, has been less than two thirds of the world average of about 3.5%. Our inflation rate has been 2.0% higher than the OECD mean throughout the period. Our level of investment, still the lowest in Europe, has been far below the world average, 17.7% compared to 22.4% for the last thirty years. The September 1996 Labour Force Survey showed that we had nearly 5m able and willing to work but with no job - nearly two and a half times the number registered unemployed at the time. In 1945, we were the richest country in the world per head of the population, after the United States and Sweden. Now we barely scrape into the top twenty. In 1950 25% of world manufactured exports were British. Now, including oil, our total share of world trade is less than 5%.

Why has this happened? Is there any good reason why we can look forward to doing any better in future? Unfortunately, unless there is a radical change of policy, it appears that the social, institutional and ideological factors responsible for our past failings are all too likely to continue to operate at least as forcefully, if not more so. This is indeed a dismal prospect. Consider some of the symptoms. Almost none of those responsible for running the country, either in Parliament or elsewhere, have any practical experience of the business world. They have never been involved in manufacturing or international trading. They have never exported anything. Nor have almost any of their friends or associates, who tend to come from the media, the academic world and the professions. Interestingly, too, few of our senior politicians have any formal background in economics, although academic economists in general have served Britain so poorly in policy terms for a long period that this may not be such a disadvantage. The advice they have given has at best been discordant, and a good deal of it has been downright counter-productive. Much of it has been too rarefied and abstract to have been of practical use. Too many economists and journalists have been fervent advocates of monetarist doctrines, which greatly suited the ideological prejudices of a large part of the British establishment, but which has done nothing to improve Britain’s long term growth performance. Again, the gap between those in the academic world of economics and the practical world of business is astonishingly wide, reflecting the same malaise as with politicians. Their ignorance is the best explained and most articulate in the world. Having failed to understand the real dynamics of production and economic growth, they have become far better at accounting for what is wrong than producing workable policies to cure the economy’s deficient performance. Usually their explanations constitute long lists of people held to be responsible - always others - such as the unions, overpaid workers, scroungers, restrictive practices, bad managers incapable of seeing investment opportunities, or company directors paying out excessive dividends.

Hardly surprisingly, in these circumstances, with few reliable signposts to guide them, political fashion on economic issues has lurched from one solution to another, none of which has worked well in practice. The collectivism of the immediate post war period, punctuated by crises mostly caused by over-commitment of available resources, gave way to the more free market approach of the Conservatives between 1951 and 1964, where bursts of growth were interspersed with long stagnant periods as part of the Stop-Go syndrome. Harold Wilson’s "white hot technological revolution", to be carried into effect by the National Plan, established in 1964, collapsed into the 1967 devaluation as policies of retrenchment reverted back to type. Edward Heath’s Selsdon Man approach, no longer a soft touch for lame ducks, came to grief with boom and bust and the miner’s strike. His other solution, hitching ourselves to Europe’s faster growth, went the same way as the fast growth in the Common Market disappeared, while the direct costs of membership via the CAP and our contribution to the Community budget, proved a heavy additional and debilitating burden, not a boost.

The 1974 to 1979 Labour government did no better, as monetarism closed its grip on Denis Healey. The early Thatcher years saw a bloodletting of British industry, to which Parliament was largely acquiescent, followed by a fragile boom, as North Sea oil was frittered away on an import bonanza, followed by another boom and bust at the end of the 1980s. Membership of the Exchange Rate Mechanism, accepted by almost everyone in 1990 as the solution to Britain’s problems, led straight to the deep recession at the beginning of the 1990s, followed by our ejection from the ERM in September 1992, as George Soros saved the nation from its own folly. The slow recovery since then is now cumulating into another unsustainable consumer boom, unsupported by adequate industrial investment to underpin a consistent and substantial growth trend. Meanwhile, the huge opportunities presented by North Sea oil have steadily continued to be wasted.

Throughout this long saga of relative decline, official optimism has reigned supreme, as it does now, although the policies currently being pursued on the economy cannot solve Britain’s real problems. Higher interest rates and a grossly over-valued pound are bound to lead to further faltering growth, rising unemployment, more fiscal problems and probably rising inflation too, as money tightens its grip and its burden. Why are such policies pursued, when their record over decades has been so poor? Much of the reason has to do with the power of banking and finance in Britain as against commerce and manufacturing. In particular, since the City is regarded as Britain’s one major commercial success, and the rest of the economy as its whingeing and ineffectual poor relation, it is to City people that governments of all persuasions turn for advice. Much flows from the bias this advice contains.

There have been profound consequences from the attitudes and policies advocated and implemented by politicians, economists and the City, reinforced by the clubs, the educational systems, the associations and the web of social contacts which they share. Their impact has been to build up a concatenation of social attitudes deeply disparaging and damaging to the business world outside the City. No-one familiar with Britain can fail to miss the symptoms. Few of our most able graduates go into industry, and, if they do, most of them go into research rather than mainstream management. Being in trade is regarded as socially inferior to almost any other way of earning a living - in the media, the professions, academic life - even politics. Technical and commercial studies at universities are regarded as second rate options. From top to bottom, there is a subtle but pervasive perception in Britain that being in business is less respectable than it is in almost any other country, and being involved in the messy business of manufacturing even more so.

Yet only successful businesses make the economy grow, not other activities. If, by a combination of economic policies and social attitudes, in Britain we have bled talent out of business, especially manufacturing, and into every other way of making a living except making and selling things, we have set ourselves up to fail. This is why our economic performance is so poor. Our most talented people are not employed in the activities which matter most. Because, in consequence, we cannot compete successfully in the world, our economy has grown much more slowly than the average. The syndrome is self reinforcing, for the less successful business is, the less attractive it becomes. All the other economic difficulties under which we have laboured flow from this.

When World War II finished, Britain appeared to be much better placed than subsequent history showed us to be. Since 1945, as a result of our inability to manage our economy successfully, we have done worse than any other developed country in terms of growth, and the results have been extremely damaging in every direction.

First, and most obviously, the British people have foregone increases in their standard of living which self evidently they would have preferred to enjoy. The results of Britain’s relatively slow growth have, however, been much more pervasive than this. Our position in the world, and our power and influence in it, has declined hugely over the last fifty years, and with it our capacity to control events in our favour. Our ability to keep all our potential workforce in employment has been severely undermined. This would make little sense at any time, but makes even less in a period when demographic changes are inexorably increasing the numbers of people who are above retirement age in relation to those still capable of working. Few people, too, believe that high unemployment has no connection with increasing alienation and crime, partly as a result of the widening distribution of income for which unemployment is mainly responsible. Slow growth has also had other unwelcome effects. It is largely responsible for the higher rates of inflation from which we have suffered compared with other developed countries, and the growing burden of debit. Defensiveness replaces dynamism. A culture of cuts undermines betterment.

Why has Britain done so badly, and in particular, why has our growth rate been so much lower than that of other countries? If this major question can be answered, it then becomes much easier to see what might be done to counteract the influences which have damaged us so much in the past, and to design fresh policies which would work better to rebuild the economic strength of the nation. Far too much of the discussion about the British economy’s deficiencies concentrates on the symptoms of decline, such as excessive pay claims, bad industrial relations, over-high taxation, bad management and ineffective state intervention, each of which has been treated as if it was a fundamental cause. Too often they are treated as moral issues instead of practical failures, for there is a simple and wholly convincing answer to the key question on growth, which, once understood, makes much of the history of the post World War II period easy to explain. It is the failure of the British establishment to understand and appreciate, either intuitively or directly, the processes which generate the production of increased real wealth which have been the country’s undoing.

Economic growth, and especially high rates of growth, are the product of particular types of investment, mostly to be found in manufacturing, but also in some parts of the service sector. This type of investment consists of plant, machinery and tooling, usually combined with changed working practices, capable of producing goods and services at much lower cost than previously. It thus has the potential to increase substantially the productivity of those operating it. Given the right conditions, it also has the scope for being very profitable. In addition, it has two more key characteristics. First, the returns on investment of this type are not only high both to those who invest in it and those who operate it, they are also rapid. Second, the output from this type of investment tends to lend itself to international trading

Most investment of this type is not tied to any great extent to one locality rather than another. The machinery and tooling required is readily available on world markets, as are the raw materials to be processed. Production facilities can, therefore, within broad limits, be sited almost anywhere. In practice, however, there are tight competitive constraints on where they will flourish. They will be located in those places which provide three key interlocking advantages. The first is that they will tend to be found where local costs are low compared to elsewhere in the world, including wage costs adjusted for productivity. The second is that they need good management, and will therefore be more likely to be successful in an environment where the best available talent is concentrated on running them. The third is that they will have a big advantage if they are sited in countries with ready access to world markets, so that economies of scale can be reaped from rapidly rising order books from international trading.

Once established, fast growth tends to reinforce itself. High profits and plentiful opportunities generate the wherewithal for more waves of investment, leading to better products and services in a cumulatively favourable spiral. Rapid productivity growth tends to contain inflationary pressures, even if the economy is expanding strongly, helping to make pricing even more competitive. High profits enable expanding businesses to attract the best available talent, thus improving the quality of management. They also provide the resources for effective sales forces, and well organised product servicing and back up. As more and more of the economy takes the form of businesses with these characteristics, so the growth rate rises.

A tour d’horizon of world economic history since 1945 shows how easily this account of the key characteristics of economic growth explains the relative success of different countries at varying periods. The enormous rates of growth achieved in Western Europe, excluding Britain, after World War II were the product of a combination of artificially low exchange rates, particularly in Germany, and far better opportunities in business than in most other careers available, following the discrediting of so many other activities as a consequence of the war. Much the same happened in Japan. Other Pacific rim countries have more recently launched themselves into the same growth spiral, starting initially with low wages and relatively unsophisticated manufacturing operations, but now rapidly approaching Western wage levels and standards of living. As one successful wave of investment and adjustment to new business opportunities has succeeded another, they have graduated up the skill scale. They have moved from the labour intensive output where they began, to capital intensive production, and then, in the most advanced cases, to innovation achievable only with the most tightly focused managerial and skill orientated approach to developing and marketing new state of the art products and services.

Britain, and the USA for much of the period since World War II, have not followed this pattern. This is why their growth rates lagged. Their exchange rates were too high to make them obvious locations for setting up sufficient internationally mobile production plants. Particularly in Britain, the necessary pro-business culture never existed. Our political leaders were complacent, prone to shoulder over-heavy burdens particularly in defence, and inclined to take industry for granted, or to treat it as a milch cow, rather than to boost it and build it as the engine of growth. So in the restless drive to innovate and grow, we were left behind, clinging more and more desperately to a declining sense of superiority which had less and less relationship to reality.

Economic history also shows, however, that even impressive initial success does not always guarantee a high growth rate in future. If the conditions necessary to sustain high rates of growth slip away, the performance of the economy will deteriorate quickly. The most obvious example of this happening has been the experience of most of the Western European economies, whose growth rates have slowed up enormously since the 1970s. The countries currently making up the European Union had an average growth rate of 4.7% per annum during the period from 1950 to 1973. Since then, the average growth rate has been 2.2%. Why did this happen? What occurred which suddenly made most of Western Europe an unattractive place for easily mobile investment opportunities?

This is a critically important question, but the most plausible answer makes uncomfortable reading for those responsible for EU policy development, and their supporters. By far the most convincing explanation of this slow down has been the series of policies pursued in the EU to lock the currencies of the constituent economies together, first in the Snake and then subsequently in the Exchange Rate Mechanism. Driven by the political goal of the "ever closer union" set out in the preamble to the Treaty of Rome, which was claimed to require monetary union as the agent of political cohesion, the case for exchange rate flexibility, to enable each country in the Community to remain equally competitive, was brushed aside.

The problem was that Germany’s powerful industries provided it with more competitive exports and a lower inflation rate than the other countries. Germany’s competitors could only contain the balance of payment problems which then accrued by deflating their economies, slowing their growth rates, depressing investment, and undermining the cumulative growth process. As two thirds of Germany’s exports went to other EU countries, Germany was in turn adversely affected by falling exports, and thus suffered from the same problems of falling output. The slow down in growth and investment across the EU in turn made the whole of the Union progressively less competitive. The EU’s share of world trade fell as its exports lost attractiveness in world markets, while import competition became more difficult for Member States to contain.

The result has been slow growth and high unemployment, which, in turn, have steadily undermined the prestige and political clout of industry to the benefit of bankers and politicians, leading to the widespread but completely irrational conviction that more deflation, Maastricht style, will cure Europe’s economic problems. Thus the attempt to build political union by fixing European exchange rates in relation to each other as a prelude to "one currency" slowed the EU’s growth, for realities change even if exchange rates cannot do so, and the less competitive economies which should have devalued to maintain their growth instead had to deflate to maintain their exchange rates. Italy and France grew much more slowly than before, and when the ERM eschewed any adjustment after 1989, it became difficult for France and impossible for Italy to maintain the fixed rates. Italy was forced out in the summer of 1992. A few weeks later, so was Britain, after a damaging two years in which the British economy, locked in depression by high interest rates, lost 1.5m jobs.

Another telling case is that of Japan, whose legendary growth rate throughout the 1950s and 1960s gave way to a weaker performance in the 1970s and 1980s, and to stagnation in the 1990s. There is no doubt that the rise in the value of the yen was largely responsible. This could have been avoided if the Japanese had allowed their economy to be opened up to imports, thus avoiding the chronic balance of payments surpluses, which in the end up drove the value of the yen. The result was that Japan became no longer an attractive location for mobile investment, which much preferred to be sited in places where costs were far lower. Indeed, a large proportion of Japan’s own investment moved offshore to locations where costs were a great deal less than in Japan itself, while much of the still enormous Japanese surpluses had to be recycled as investment abroad, particularly in the USA. This allowed America to finance its huge appetite for Japanese imports, although the Treasury bonds and other assets purchased by the Japanese lost much of their value in yen when the American deficit forced the dollar/yen exchange rate down almost 40% between 1985 and 1992.

The solution to Britain’s problems of low growth, and all that goes with it, is to create the conditions where high and rapid return investment finds a natural place here rather than elsewhere. This, critically, is what policy makers in Britain have consistently failed to do. Our competitors started with undervalued currencies, making exports from their industries profitable and boosting an export sector whose competitiveness was continually enhanced by heavy investment and the economies of scale achievable by penetrating foreign markets. We, on the contrary, have always had an overvalued currency, at least since the end of World War II, making it impossible for our manufacturing base to prosper. The transition from fixed to floating rates in the early 1970s did provide us with a new opportunity, but we frustrated it throughout the next quarter century by keeping the pound high in a vain attempt to offset the inflationary consequences of slow growth.

What are the chances of changes now being achieved? Much will turn on the extent to which those who form and influence economic policy in Britain can be persuaded to understand what needs to be done. What might these prospects be?

Seen from a rational standpoint, it seems odd that the financial community should be a major obstacle to improving Britain’s economic lot. The City is not totally insulated from the rest of the economy. If Britain’s growth rate falters, this inevitably weakens an important part of the financial base from which the City has to operate. Look at the rise of Japanese banks, starting from a low base only a few decades ago, and see how significant to their success was the strengthening of the domestic economy from which they sprung. Furthermore, it ought to be in the City’s interest to cater well for the financial requirements of those closest to it, and to share the aspirations and determination of those depending on the British economy to make it perform well.

The reality, however, is very different. The short term benefits of those with primarily financial concerns have overwhelmed their long term community of interest with everyone else in the economy. The City view, exemplified by the Bank of England, has always been to favour high rates of interest, the lowest possible rate of inflation, a restrictive monetary policy and a high pound. Partly this has been a matter of immediate self interest, but it has always been buttressed by indifference or lack of knowledge or interest in the rest of the economy. The huge international involvement of the City leaves it comparatively unaffected by the domestic economy’s performance. Most City people have almost no contact with manufacturing, or even with much of the service sector, other than as consumers, and have therefore little idea of the conditions which make industrial or commercial businesses perform well or badly. They are only too well aware, on the other hand, of the fact that, on average, people working in the City make far more money than those in most other parts of the economy. This can hardly fail to nurture a feeling of superiority for their activities, and relative contempt for those who in fact have to earn a living mostly in much more difficult and demanding circumstances.

The City is another country, which is why it is possible for the conditions which most people working there favour, out of self interest or as a result of the social pressures brought to bear upon them by their peers, are exactly the opposite to those which the rest of the economy needs to make it prosper. The City’s preference is for zero inflation and dear money. In particular, its attitude to the strength of sterling is critical. The kind of tight monetary and high interest rate policy which the City favours tends to push up the value of sterling to a much higher level than is in the economy’s overall interest. City people then enjoy opportunities to buy foreign assets cheaply, as well as gaining the benefit of cheap imports and holidays abroad. Most neither understand nor care much about what an overvalued pound does to Britain’s trading position, and to manufacturing in particular.

This is why relying on advice from those working in the City, to the exclusion of everyone else, is liable to be so disastrous. People with financial backgrounds tend to fear inflation unduly, little recognising that their own enormous salaries and bonuses are much more obvious signs of rising costs than the much more modest wage increases prevalent elsewhere. Almost all believe, against all the evidence to the contrary, that if the value of sterling falls, inflation will rise, adding justification to policies which keep the pound high. Their penchant invariably is to favour raising interest rates to deflate the economy whenever there is any sign of over-heating, rather than to change the way the economy is run to increase output. The more power the City has, and in particular the more independence the Bank of England, the City’s mouthpiece, has on controlling the money supply and setting interest rates, the more devastating the results will be for the rest of the economy.

The Conservative Party might also be thought naturally to favour nurturing a successful economy. It can have been of no comfort to the vast majority of Conservative voters to see Britain’s influence in the world steadily sliding down the scale to near insignificance, as a direct result of the economy’s poor performance. The business classes in Britain are natural allies of the Conservative Party, and their ill treatment under successive Tory administrations has undermined the support of an important Tory constituency. The strong one nation Tory tradition has been appalled by the hardships and divisions brought upon the nation by high unemployment. A rather different strand of Conservative thinking is increasingly fed up with rising crime and violence, which all those close to the problems agree is partly caused by unemployment and the alienation caused by exclusion from a mainstream contribution to society, particularly in the form of lack of work, for hundreds of thousands of young people.

Yet again, however, other instincts and proclivities have dominated the Conservative Party’s thinking and attitudes, driving them away from policies which might have remedied such clear deficiencies in our economic management. Part of the problem, as with so many other sections of Britain’s leadership, is that nearly all those running the Conservative Party have little direct experience or even contact with the real economy. Many are still from the privileged rentier section of society, with much closer relationships with finance than manufacturing. Others have been more concerned with social and industrial discipline, and breaking the power of labour rather than empowering it to create the consensual and co-operative working relationships which the whole world has found is the true solution to industrial success. Much of the policy pursued so vigorously by the Tory government, particularly during the early years after 1979, is only explicable when the backgrounds of those responsible are borne in mind.

No doubt there were problems with over-mighty unions in the 1970s, mainly because the cake was not growing, so people struggled to increase their share. Yet there are other ways of coming to a tolerable social compact between capital and labour than the visceral anti-union policies and attitudes which became the Tory staple diet. As was shown in many countries in Europe during the decades after the war, much the most efficacious solution was high economic growth, which the Tory policies post 1979 never achieved for any length of time. Significantly, during the 1950s and 1960s across most of Western Europe, rising output almost every year generated a wage bargaining climate of moderation, the maintenance of which was clearly in everyone’s interest, thus keeping inflation at bay for nearly all the period. In Britain, on the contrary, appeals for wage restraint to reduce costs never on their own, without changes in macro-economic policies, had a chance of producing the promised big increases in subsequent output. When trade unionists loyally accepted low wage increases, to no avail, it is hardly surprising that disillusionment set in, and a harder and much more disruptive wage relations climate was the result.

Unquestionably, some industries in Britain were poorly managed in 1979. Those that now remain may, on average, be in better shape than those which existed eighteen years ago. Yet the cost in lost output and opportunities in the meantime from deindustrialisation in Britain has been enormous. British manufacturing output is still hardly any higher than it was in 1973, during the three day week. Average efficiency in manufacturing may have improved, but only at the expense of eliminating vast swathes of industrial output which are now located elsewhere in the world. Britain now manufacturers almost no domestic appliances or office equipment, and has virtually no indigenous computer hardware or even toy manufacturers left. It is simply untrue that there is no way of improving manufacturing efficiency other than to close down almost everything which is not either exceptionally efficient, or in niche businesses, or production which is not subject to international competition in order to survive. Practically every other country in the world has succeeded, where we have failed, which is why our industrial base has shrunk further and faster than that of any other developed country.

The long Conservative administration from 1979 to 1997, despite all the social divisions it engendered, did nothing to improve Britain’s long term economic performance. The cumulative increase in the Gross Domestic Product over the whole of these eighteen years was only 2.0% per annum - worse than the average since World War II despite the oil. The monetarist philosophy, which the 1979 government embraced with such enthusiasm, was riddled with intellectual contradictions and failed both in Britain and in many other countries to produce the economic results it promised. It is easy to explain why. Its appeal was never one of practicality. It was the ideology behind monetarism which so ingratiated it to its supporters, providing, as it did, a spurious justification for policies close to the most selfish side of the Tory philosophy. Unfortunately, on balance, they did only damage to the real economy, upon which the fortunes of the country ultimately depends.

The record between 1979 and 1997 speaks for itself. There were two depressions and two credit explosions, sucking in imports with sudden boosts to demand to which a diminished British industry was unable to respond. The result was a miserable growth rate, a huge increase in unemployment, and a marked deterioration in the fiscal balance. The legacy left to the new Labour administration is not a booming, soundly based economy, but one in the throes of an unsustainable credit expansion, with the danger of a third industrial bloodletting as it breaks.

The Labour Party, too, has an enormous interest in running the economy successfully. It represents the mass of the people, for whom growth and secure jobs are much more critical than for the privileged few. Like every other party, it depends on rising living standards for electoral success, but it also has particular items on its agenda for whose achievement a sharp increase in the growth rate provides the only realistic approach. Unemployment is a central issue for the Labour Party, which does not share the more selfish part of the Conservative Party’s lack of concern for those not winning in the economic race. The only way to reduce unemployment is to increase the growth rate, to create enough new jobs to keep everyone who wants to work gainfully employed. Securing increased resources for the public sector, to pay for many of Labour’s cherished projects from better health care to improved educational opportunities, again depends on better growth performance, given the constraints of the tax system. So does reducing inequality in society, providing everyone with reasonable opportunities in life, and increasing the scope for all the regions of the country to share in rising prosperity. After eighteen years of opposition, and a five year rearguard action before that, Labour must now show that it can deliver the rapid increase in living standards and the economic growth which Britain has long been denied.

The Labour Party, however, like the Tories, conspicuously lacks a well articulated and convincing economic programme. Unquestionably, New Labour’s drive for financial respectability, seen as an electoral asset for the general election, has been partly responsible. The danger, however, is that public relations have become dominant over effective prescriptions. Policies have been developed to avoid frightening investors. We have espoused orthodoxy, rejected spending commitments, tied the government’s hands on taxation, and passed the responsibility for monetary policy to the Bank of England. As a result, there is no clear agenda for increasing demand, investment and output. There is no realistic strategy for making British industry more competitive, so that it can recapture some of the 50% of the home market it has already lost, let alone increasing exports, to enable the economy to sustain a much higher level of demand without running into balance of payments constraints. Great store is put on supply side improvements, such as better education and training, but supply does not produce its own demand, and there is no evidence that these policies on their own will produce anything other than a better qualified dole queue.

Instead, like the Tories, Labour has put its faith in the City and the monetarist remedies it always puts forward, although these are the same orthodoxies which ruined the last two Labour administrations. The advisors to the Bank of England on interest rate policy do not include a single person with manufacturing experience. All the stress in policy is on providing "stability", although the huge gain in strength of the pound, and the rapid increase in interest rates since the election have produced anything but stable conditions. The Bank of England, as always, is obsessed with the fear of inflation, although the current rate of inflation is very low by historical standards, and almost certainly below the level which could be combined with the rapid growth which is urgently needed. The notion that low nominal rates of inflation are essential for investment growth is simply untrue. There is no statistical or logical evidence for this connection. Unquestionably, the conditions which do produce increases in investment, especially of the high return and rapid pay off variety which is the key to fast economic growth, are rising demand for output which can be produced at a profit. There seems to be no recognition at all of this among those most closely responsible for formulating Labour’s economic policies, and the results are likely to be as depressing and unnecessary as those between 1964 and 1970, and between 1974 and 1979. Nor is there any recognition of the fact that after two decades of dear money and a continuously overvalued exchange rate, both have to be thrown into reverse before the damage can be made good.

The dangers facing the Labour government elected in 1997 are the same as those which were the undoing of the last two Labour administrations. Poor economic policies could hole the government below the water line. Inability to make the economy grow at a high and sustainable rate could all too easily cause unemployment to rise again, the fiscal balance to deteriorate, and investment to stay sluggish, while probably inflation may increase as well. Living standards might barely rise, especially for poorer people if the distribution of income becomes yet more unequal. Public services will then be perceived to be in crisis. This is no way to fulfil Labour’s aspirations, and no way to be reasonably certain of winning the next general election, which would almost certainly be won if the economy could be made to perform adequately. Whatever it has done to damp down expectations, New Labour now has a greater need to deliver success on the economy than the Tories ever had, and this requires us to widen and deepen the productive basis on which, alone, the good society can be built.

No section of Britain’s history since World War II exemplifies more clearly the inability of those responsible for Britain’s economic policies to get a clear grip on what matters and what does not than our chequered relationship over the past decades with what is now the European Union.

It became apparent in the late 1950s that the British economy was consistently achieving much lower growth rates than the countries originally making up the Common Market. In consequence, the view of the British establishment switched, over a very short period of time, from disdainful condescension about attempts to produce supra-national structures in Europe, to near desperation to join. After two vetoes from General de Gaulle, the third British application was successful, and the Treaty of Accession was signed in 1972. By this time, however, the growth rate in the EEC was slowing down to the same crawl that Britain had achieved over the previous 27 years since the end of World War II. Even supposing it had ever been true that Britain, by joining the EEC, would have increased its growth rate to that of the other members, by the time it did actually join, the EEC’s growth rate had tumbled to the miserable 2.1% achieved on average over the years between 1973 and 1997.

How could this scale of misjudgement have come about? The answer is that it was all too easy for those who did not understand what produced high rates of economic growth, and what militated against them, to make the miscalculations which led to the results which ensued. The reason why the original six EEC countries grew rapidly during the 1950s and 1960s had almost nothing to do with the establishment of the Common Market. Indeed, their rate of economic growth was slightly faster before the Common Market came into being than it was afterwards. The success of the Six in growth terms during this period, on the contrary, had everything to do with fast increasing exports, high levels of investment and rapidly rising demand, all stemming from the low exchange rates and the highly competitive position continental Western Europe found itself in once the immediate aftermath of World War II was behind it. If Britain had joined the Common Market in 1956, at the exchange rate then prevailing, there is no reason at all to believe that we would have fared better economically than we actually did. Almost certainly we would have done worse, as the tariff barriers came down, leaving us even more exposed to unmanageable competition, especially from Germany, than before the tariff began to fall.

The decline in the Community growth rate after 1973 is often blamed on the oil crisis and its aftermath, but this cannot be a correct explanation. The oil crisis affected the whole world, but only the Community growth rate slowed down dramatically. World growth did slow after 1973, but a major reason was that the Community growth rate fell so steeply. If the Community countries are excluded both before and after 1973, the average annual growth rate for the whole of the rest of the world fell from 4.6% between 1950 and 1973 to 3.2% from 1973 to 1992, a fall of 30%, while the EU growth rate went down from 4.7% to 2.2%, a drop of 53%. The real reason for the EU’s untypically slow growth from 1973 onwards, as we have seen above, was not the oil crisis but misguided attempts to lock the value of EU currencies together, first in the Snake, then in the ERM, and now with the Single Currency in prospect.

Having joined the Community, if we had managed to keep the value of sterling down, to provide ourselves with a competitive edge within the EU, we could well have increased our growth rate. In fact, no such policy ever appears to have been contemplated. When we did very briefly go into the Snake in 1972, we entered at too high a rate for the credibility of the markets, and sterling was forced out after only six weeks. We then stayed outside the EU currency alignments until 1990. During almost all the intervening 18 years, however, the value of sterling was too high rather than too low, as evidenced by the fact that for the whole of this period, the British growth rate was even lower than that of the EU. When we did join the ERM in 1990, by common consent we did so at too high a rate, This boxed the economy into an extremely damaging deflation, which lasted until our ejection from the ERM in September 1992. This was followed by a substantial fall in sterling, none of the extra inflation so confidently predicted by the pundits, and revived economic growth. Now we have allowed the value of sterling to soar up again to completely unrealistic levels, guaranteeing further economic problems in the course of the next year or two.

This constant misreading of the underlying economic realities by the authorities produces a demand from enthusiasts for further EU integration that we should join our EU partners, or at least a substantial number of them, in the Single Currency, scheduled to begin operations on 1st January 1999. We will probably not join in the first wave, but we might do so thereafter. The key issue, as always, will be whether such a step will provide the British economy with a competitive enough exchange rate to allow it to grow as fast as we want. Even if the rate at which we went in was appropriate - which on present trends seems very unlikely - the chances of it continuing to be appropriate indefinitely are remote. It appears much more likely that shocks to the economic system, or just changes in competitiveness, will make exchange rates which might be right in one set of circumstances wrong in another, if they are locked together.

Unfortunately, however, it is much more likely that a far less favourable set of circumstances will emerge. The pressure to maintain the Maastricht criteria will depress and deflate the whole of the EU economy. The deflation and cuts necessary to get public sector deficits across the EU down to the arbitrary 3% target have reinforced the EU’s role as a high unemployment blackspot, trapping its economies into self-reinforcing deflation. The resulting lack of investment will tend to make the whole EU less and less competitive with the Pacific Rim. The European Central Bank, charged with keeping inflation low as its over-riding priority, will then deflate the EU still further in a completely misguided attempt to avoid the value of the euro falling on the foreign exchanges. All the problems of EU lack of competitiveness will then become exacerbated, leaving Britain, almost certainly having joined at too high a rate, if we are by this time a member, suffering even worse deflationary problems than the average.

Even if the euro turns out to be a more competitive currency than once seemed probable, it is unlikely that it will produce the conditions necessary for the EU growth rate to climb again anywhere near where they were thirty or forty years ago. The main problem is that the EU lacks key conditions necessary for the success of a single currency. These are more or less equal levels of competitiveness throughout the area, a substantial taxation and redistributive system capable of transferring resources to the less favoured parts of the Single Currency zone, and mobility of labour and other factors of production to enable movements away from depressed to more prosperous areas.

On all three counts, the position of the EU is hardly appropriate for the circumstances. The result is, therefore, all too probably going to be similar to that experienced with the Snake and the ERM. Regional and national disparities will widen because there is no machinery for redistribution, and Member States in the Single Currency will have lost their capacity to adjust their exchange rates, enabling them to take shocks on the rate and not the real economy. Thus the only way of keeping the Single Currency together will be for the less successful economies to deflate. With high proportions of internal trade, however, this will inevitably depress even the relatively successful economies in the EU, whose export prospects will falter.

WHAT MUST BE DONE

If none of the prescriptions offered by Finance, Europe, the Conservatives or even New Labour holds out even minimal chances for increasing Britain’s growth rate, what should be done? In fact there is a whole range of policies which we could pursue, which would produce the required results in short order, not only producing faster growth, but also lower unemployment, a better fiscal balance, more equality, and manageable inflation levels. None are in breach of any of our existing international obligations. They would not damage any other countries, and would not therefore be at all likely to generate retaliation. They do not require complicated legislative changes. All they do require is a much clearer perception about how economies work nowadays than has been manifested for a long time among those responsible for formulating economic policies in Britain.

The primary goal has to be to make Britain an attractive place for the modern, footloose investment which is the key to fast growth. For this to be done, we need to ensure that total operating costs in Britain are competitive with those in the fast growing areas of the world. The more competitive we are, the faster the economy will expand. This means a much lower exchange rate, and there is a spectrum of possibilities, as some fairly simple calculations, published in other LEPG documents, show. If we want the economy to grow at 3% to 4% per annum, we will need to bring the value of sterling down to around DM 2.20 and $1.20. If we want to get the economy to grow cumulatively at 5% top 6% per annum, a much deeper devaluation will be required, probably to around DM 1.80 and $1.00.

The objective should be to kick start British manufacturing, and those parts of the services sector capable of responding in the same way to the same stimuli, into a major and cumulative expansion of output. This is how to soak up unemployment, to expand the tax base, to reduce the calls on government expenditure, and to provide the government with room for manoeuvre with public expenditure. Import substitution and expansion of exports would remove the balance of payments as a constraint on expansion. The high profitability achieved by the type of investment encouraged by a competitive exchange rate policy would push up the savings ratio in the economy, providing all the finance needed for further waves of expansion. In these circumstances, there certainly would be a major role for the government in providing training and education for the work force, and for enhancing the infrastructure and communications. There would be no risk, however, of expenditures on these headings going to waste in conditions of rapid expansion, as increased labour force skills moved to being at a premium, and the scope for using new investment of all sorts abounded.

How do we get the exchange rate down? A combination of policies is required. The money supply needs to be expanded substantially both to cater for a much higher level of economic activity, and to enable interest rates to be brought down to a much lower level - roughly equal to the rate of inflation so that base rates in real terms are zero. The Bank of England needs to announce that it is intent on bringing the exchange rate down, fully supported by the government. The government needs to make it clear that it has no intention of running a balance of payments surplus. If, as a result of increased competitiveness, British manufacturers proved sufficiently effective in increasing exports, and recapturing the home market, where the biggest gains are to be made because our import ratio is so abnormally high, so that a surplus loomed, the economy should be reflated to keep the country’s trade in balance. This would reduce the chance of pressure materialising to make the pound stronger again. If there were signs of overheating, the solution should be to encourage imports to fill the gap.

Would there be a problem with inflation? Good government is always required, and no doubt with enough mismanagement there would be problems with rising wages and prices. With competent government, however, there is no reason to believe that inflation, even with growth as high as 5% or 6% per annum, would be higher than about 3% to 4% per annum taking year on year. It would, however, almost certainly not be as low as the 2.5% level which is the current target, but that target is artificial anyway, and the real issue is not the cost of living but the standard of living, which will rise rapidly as more people got back to work and wages improve with output. There are two powerful reasons for believing, however, that a target of no more than 4%, and perhaps a little less, is realistic.

First, the widely held fear that moving the exchange rate down sharply increases inflation is almost wholly misplaced. There have been dozens of substantial exchange rate movements between major currencies over the last decades, and the increased inflation which is always feared by the devaluing countries almost never materialises. Of course the cost of imported goods and services has to rise, otherwise there is no gain from a depreciation. Almost invariably, however, these extra upward pressures on the price level are offset by other factors. Interest rates will always be lower with a lower exchange rate, and bringing down interest rates is highly disinflationary. Higher output means greater economies of scale, and falling costs. Switching from overseas to home production, where it is cheaper, will offset the need to pay for now more expensive imports. Finally, the improved fiscal balance can itself be used to reduce inflation, for example by directly reducing labour costs by lowering taxes on employment. When all these factors are taken into account, it becomes easy to see why even large exchange rate movements can take place with minimal impact on existing inflation rates.

Second, there is a large amount of historical evidence about the inflation rates which tend to prevail in economies which are expanding rapidly, at around the 5% to 6% per annum level. This was the condition of nearly all of continental Western Europe in the 1950s and 1960s. Japan expanded even faster for many years, and still had average increases in the domestic price level of only about 4% on average, while Japanese export prices hardly rose at all. Many of the Pacific Rim countries are now achieving growth rates of the same size. With few exceptions, their rates of inflation have clustered round 4% per annum, especially recently taking year on year, and they have done so again for easily explicable reasons.

When economies expand quickly, the growth in productivity is not evenly spread. It tends to be high in quickly expanding industries orientated to world trade with heavy investment programmes, and slow in other parts of the economy where productivity gains are much more difficult to secure. An averaging process then takes place, often described as leading sector inflation. This is why fast growing economies never have very low rates of inflation. Even Germany in the 1950s and 1960s, with the 1923 hyper-inflation still within living memory, had an inflation rate of 2.7% during this period, while the continental West European average was about 3%, rather less than the still relatively modest 4% which Japan achieved despite 10% cumulative growth per annum between 1950 and 1973.

The effect of leading sector inflation is not to lead to exponentially higher increases in the price level every year, and this again is easy to explain. When economies are growing fast, there are plenty of big productivity increases to absorb higher wages. Furthermore, the success achieved tends to generate a wage bargaining climate where rocking the boat with excessive claims begins to look irrational and greedy, rather than the only way to buck inexorable low real wage increase trends, as it was for years in Britain. It is wage bargaining conditions leading to moderate increases in relation to productivity gains which are a major bonus from fast growth, otherwise often only achievable by massive unemployment, as again British experience has shown.

There is, therefore, a range of internally consistent policies which could transform British economic performance, allowing us to combine high growth and full employment with a stable and sustainable foreign balance. Would they be internationally acceptable? They might not be if their consequence was for Britain to run a predatory balance of payments surplus, but this does not need to be done, and should not be allowed to happen. Without this occurring, no damage would be done to other countries by Britain making its economy grow faster. Indeed, we would become a larger market for other countries’ exports, at the same time as we offered them better products at cheaper prices. It is hard to see how rational complaints could be made in these circumstances. If they were we should ride them out. We still have the Maastricht Treaty opt out from the EU Single Currency, and we should use it.

This approach may be well outside the ambit of the prevailing orthodoxy, which wastes people to sustain its own interests. Yet is would transform Britain’s economic performance, and build a powerful British economy, generating more growth as well as buoyancy. It would cut the burden of debt which has been tightening its grip. It would enhance the prospects for public spending by painlessly widening the tax base. It would sustain altruism and encourage working together, building the good society.

A SELF CONFIDENT NATION AGAIN

The possibilities therefore still exist for an outstandingly successful Labour administration in economic as well as other terms, following the Party’s stunning victory in May 1997. Nothing stands in the way except a radical change of perception about the real reasons why some economies grow and prosper and others languish.

Economic growth and full employment are critical to creating the society for which Labour stands. Nor is there any shame in looking after our own interests, for that is the first responsibility of a national party, and why we were elected in the first place. There should therefore be no major problems about persuading the bulk of the Labour Party to adopt a more radical economic policy, and it is extremely unlikely that there would be sufficient opposition in Parliament to such a change of tack to make it inoperable. No doubt there would be an outcry from the City and its spokespeople, particularly at the Bank of England, but they could safely be ignored. The potent weapon the City can bring to bear is to threaten not to support the pound when the government is determined to keep its value high. If the government’s declared objective is to bring its value down, there is no countervailing threat that the City can credibly use. Muttering about losing confidence in sterling’s future strength, or speculating against it, would then buttresses the government’s policy rather than undermining it. There is also nothing the City could do to stop a determined government increasing the money supply and bringing interest rates right down, though this would require removal of the power of the Bank of England perpetually to push up interest rates, with all its potential to frustrate growth. The Bank must be made to act as an agent of the government, to boost the money supply and to reduce interest rates to accommodate the needs of manufacturing and not of finance.

There might be criticism in the press and in other media, but this too could be confidently brushed on one side. With the Maastricht opt out on Stage Three of the Single Currency, there is nothing the EU could do either to stop Britain implementing a fast growth orientated policy. There might be more serious opposition from some groups who would lose out in the short term, such as pensioners who would receive a lower return on their interest bearing investments, and from importers who would suffer from more competition from home supplies. Here, a policy of persuasion would be needed. It cannot be in the interest of pensioners in Britain to live in an economy with slow growth, and thus reduced capacity in future to pay a reasonable living to older people. Still less is it in their interest to live in a country where the ability of the state to make transfer payments to those not working is heavily diluted by benefits which have to be paid to a vast army of people who could be working but for whom currently there are no jobs. As for importers, they too, in anything but the short term, must benefit from being part of a more prosperous economy. In any event we need to switch business talent away from importing towards home production and exporting.

As for the Conservative Party and the Liberal Democrats, if Labour were to seize the initiative, and new growth orientated policies were introduced well ahead of the next general election, there is little doubt that Labour would reap a huge electoral dividend as their benefits came through. Labour’s Achilles heel has always been the economy, mainly because Labour governments have always been inclined to pay too much attention to economic orthodoxy and the City, to the point of breaking themselves in defence of interests nearly all of whose members would never dream of voting Labour. If solutions were found to the major economic problems which have plagued Britain for so long, it is hard to believe that there would not be the prospect of further well deserved terms of Labour government in Britain.

And then there really would be scope for radical change, generating a new, self confident Britain. If the growth rate was 5% to 6% per annum, mass unemployment a thing of the past, living standards were rising, and the tax base increasing at the same time, and inflation was under control, a period of exciting innovation and consolidation could be achieved against a background of solid economic advance. The good society can only be built on economic success and growth, leading to a snowballing process of improvement. Now is the time to begin, and to recover the ground so much of which has been unnecessarily lost. This work needs to begin before we throw away the huge goodwill which brought the Labour administration to power, by allowing failure on the economy to trap the government into the same deflationary failure which haunted the last two Labour terms of office. However big our majority, we cannot afford to throw away public confidence and enthusiasm, to produce the same feelings of betrayal as we did then. The élan, the goodwill and the hope of 1997 will never be recreated if they are thrown away.