Setting interest rates is one of the most important ways of controlling the economy. Such decisions ought therefore to be exercised by democratically accountable politicians. Central bankers have a much narrower perspective. They are concerned primarily with minimising inflation and protecting the value of the currency, rather than with promoting economic growth and securing full employment.

Leaving future interest rate decisions to the Bank of England will thus almost certainly lead to interest rates, the exchange rate and unemployment being higher than they need be, and to economic growth being lower than it would otherwise have been.

Interest rates are now higher in Britain than in nearly all countries which are our major competitors - in some cases much higher. Tabled below are some of the latest figures for interest base rates, inflation, and thus the "real" interest rate:

Real

Country Base Rate Inflation Interest Rate

Britain 6.5% 2.4% 4.1%

USA 5.5% 2.5% 3.0%

Germany 3.0% 1.4% 1.6%

Not very well. The British economy grew by 2.4% in 1996, which is well below the world average, estimated by the IMF at 4%. The British broad money supply (£M4) has grown at nearly five times the rate of inflation over the last year, which is one of the main reasons why the economy is currently growing faster than in the past. High interest rates, leading to a high exchange rate, however, mean that the growth we are now experiencing is seriously unbalanced, and very likely to slow down. Consumer expenditure is continuing to grow at over 4% per annum, adding to our balance of payments deficit, which the high pound will almost certainly worsen. Our investment levels are lower than almost anywhere else in Europe. In 1996/97, the PSBR was £27.2bn excluding privatisation receipts, and £22.8bn after taking them into account. The interest charge on this borrowing represents a cumulative increased burden of about £1bn every year on the Exchequer, after allowing for inflation.

Apart from depressing exports and encouraging imports, an over-valued currency has a devastating longer term effect. It makes manufacturing unprofitable, thus ensuring that investment is low, that new technology is adopted slowly if at all, and that our exports become progressively less competitive. During the last twenty five years, the return on investment in British manufacturing has been barely half that achieved elsewhere in the economy, and far below the levels achieved in other countries. Low profitability drains talent out of industry. At every level, from the board room to the shop floor, better jobs, with more secure working conditions, are available in more sheltered parts of the economy. The result is that manufacturing industry in Britain, particularly that part of it involved in international trade, is not only poorly equipped, but inadequately managed to meet world competition.

Due to both the very high pound and the long standing hostile climate for manufacturing, British export prices, both for goods and services, are now grossly uncompetitive. On average, prices for British exports across the board have risen during the last quarter of a century by over 40% more than those of the rest of the world. The cost of manufacturing a wide range of mass produced goods in many other countries is now barely half what it is in Britain.

This is not primarily a wage cost issue. In the highly competitive economies wages are rising rapidly. It is wage costs per unit of output, adjusted for productivity, which count, and here Britain is at a decisive disadvantage. This is not, however, the only cause of our high costs. Other important factors have contributed to Britain’s narrow industrial base, its unprofitable industries, poor manufacturing management and low investment levels. These include high interest rates, financing difficulties, and higher raw material and state-of-the-art capital equipment costs, caused partly by lack of local supplies, and partly by EU based protectionist policies, for example on steel and chemicals, adding to manufacturing industry’s input costs.

Monetarist policies promote high interest rates, a restrictive money supply, and an over-valued exchange rate, all of which are very damaging to manufacturing, but which favour financial institutions, at least in the short term. In the longer term, however, policies of this kind make no more sense for the financial services industry than they do for anyone else. The end result of these policies is that the whole economy becomes relatively impoverished - exactly what has happened to Britain.

A key feature of monetarist policies is that they favour finance as against manufacturing, the City vis à vis industry, old money as against new, lenders vis à vis borrowers, and respectability versus making a living in trade, - attitudes all desperately damaging to British manufacturing and its future prospects.

The only way for our manufacturing industry to survive, where it has been subject to international competition, has been to invest in labour saving machinery. Employment in manufacturing has therefore halved over the last quarter of a century. Output, however, has barely risen, despite steep rises in productivity, and manufacturing output now is hardly any higher than it was during the three day week in 1973 under Edward Heath’s government - an almost unbelievable outcome. Output has almost completely stagnated for a quarter of a century as increases in productivity have been offset by increased unemployment. Furthermore, the return on the investment in capital equipment in British manufacturing industry has for a long time been very low. Added to higher exchange and interest rates, this is why, despite the current consumer boom, British manufacturing investment fell by 8% between 1995 and 1996, and is now flat at this lower level - an appalling omen for the future.

There are two principal reason why manufacturing is so important. The first is that it is much easier to achieve increases in productivity, and hence growth in average incomes, in manufacturing than it is elsewhere in the economy. The second is that in an economy like Britain’s, manufactured goods still account for about 60% of all our export earnings.

If manufacturing falters, therefore, two unavoidable results will ensue. The first is that the potential for significant increases in living standards will be unnecessarily foregone. The second is that we will have problems paying our way in the world, leading to deflationary policies being imposed to protect the balance of payments. The reason for Britain’s low growth rate compared to the rest of the world - 2.2% per annum compared to 3.7% cumulatively since 1945 - stems directly from these two factors

The slow rate of growth of the economy as a whole is directly responsible for unemployment being much higher now than it used to be. The impact of computers, better training, competitive pressures and more cost-effective management systems results in the productivity of those in work is steadily rising at about 2.5% per annum. This is much more than the increase in our growth rate which has averaged only 1.8% for the last twenty five years. In these circumstances, increased unemployment was, and is, inevitable.

The only solution to unemployment is to increase effective demand on the economy in order to increase its growth rate, so that output rises faster than productivity. This requires, however, much higher growth than existing policies are likely to produce. To eliminate unemployment, the British economy needs to expand at 5% or 6% per annum for several years. As at present there are no plans for any such an outcome, the medium term prospects for unemployment are depressingly poor.

It is no co-incidence that the faltering growth rates seen in Britain and elsewhere over the last quarter of a century have been accompanied by a massive increase in inequality of income and opportunity. High unemployment weakens the bargaining position of the less advantaged. It pre-empts state revenues into social security payments which would not be necessary if more people were in work. It weakens social cohesion by creating large sections of the population outside the norms of work and earned income, who unsurprisingly turn to crime, drugs and apathy. It reduces the revenues of the state for any given level of taxation as fewer people pay tax, while increasing the tax burden for those who are in work. The only practical way of creating a more equal society is to increase the growth rate, and in so doing to reduce unemployment.

If the growth rate in Britain - and the rest of the European Union - continues to be far below that achieved in the rest of the world, there is no doubt at all that Britain’s influence in the world - and also that of the EU - will steadily diminish. For the last twenty five years the EU average growth rate has been 2.0%. Britain’s has been 1.9%. The rest of the world, however, has grown at about 3.5%. Many Pacific rim countries have achieved 7% or 8%. China has grown cumulatively at over 9% per annum for the last twenty years. During these two decades, British Gross Domestic Product has risen by 47%, the EU’s by 44%, while China’s has gone up by 470%, and that of the rest of the world, excluding the EU, by a little over 100%. Should these trends continue, European standards of living are bound to be overtaken by those in many other parts of the world. The consequence will be a relentless and inevitable diminution in our economic, cultural, diplomatic, and military status.

Nothing is more important to any government than success on the economy. The danger facing the new Labour administration, elected with so much hope, is that it will stumble over the same unnecessary economic problems as its 1964-70 and 1974-79 predecessors. Inevitably, the results will then be the same falling electoral support, disillusionment among Labour supporters, and another huge lost opportunity.

There are solutions to Britain’s economic problems, but they do not rest with high interest rates, tight money, and an over-valued currency. Instead, the need is for the reverse of all these policies, to enable industry to flourish, exports to expand, the home market to be recaptured from foreign suppliers, the growth rate to rise, and unemployment to fall. Labour’s fate will depend very largely on the choices made on these critical macro-economic issues.