I said in my Budget Statement in March that the action I was then taking must be provisional and that a further Budget would be necessary in the autumn. I have also made it clear that I would make fresh proposals at any time if they were required. I consider that the time has come to take some further action. I hope the House will feel it is convenient that I should summarise my proposals in a statement today in advance of the debate on the economic situation which starts tomorrow.
The first and main objective of the proposals I shall now describe is to attack inflation at its source. The General Council of the TUC has recently issued guidelines for collective bargaining which have been welcomed on both sides of the House. Those guidelines envisage that pay will rise in line with the cost of living. Threshold agreements already operate to this effect. So, by cutting the increase in the cost of living I can also reduce the rise in industrial costs, assist-both company liquidity and the competitiveness of our exports.
Retail prices have risen 16 to 17 per cent. in the past year. The threshold has now been triggered six times. The main reason has been the unprecedented increase in the price of commodities—above all oil. There now seems at last to be hope of relief from the upward pressure of import prices, perhaps by the end of this year. My aim is to steady the rate at which our cost of living increases before then and so to reduce the number of threshold payments, each of which produces further price increases within six months or so.
The threshold arrangements mean that price reductions now are likely to generate less extra demand in the short run than would otherwise be the case. Given the likely extent of threshold agreements I estimate that the demand effect of price reductions by the end of this year may be only three-quarters as high as is normal.
Now a word on the economic background to my proposals. In the four months since the Budget the balance of supply and demand in the economy as a whole has become a little clearer. The volume of exports has been higher than seemed likely early in the year and the latest estimate of industrial investment in the first quarter is also encouragingly high. Personal consumption seems to have been roughly in line with what I expected, a little higher in the first quarter and a little lower in the second. The rundown of stocks in the three-day week proved less than expected. Pressure in the economy as a whole is easing a little. Because there is less need to replenish stocks in the months ahead home demand will be lower and there will also be less demand for imports than seemed likely in March.
World-wide reactions to the oil crisis justify some concern that the prospect further ahead is for recession. Some recent domestic indicators must increase this concern. As I said in my Budget speech, if Britain were a closed economy my inclination would be to do more about domestic demand.
But Britain is part of the world economy, heavily dependent on the actions and attitudes of her partners in world trade. I must therefore ensure that action on prices does not upset the gratifying progress we are making on the balance of payments. The increased price of the oil we import has accounted for two-thirds of our total current account deficit so far this year. Apart from the extra cost of oil, our trade deficit was running in the second quarter of this year at a rate 40 per cent. lower than in the last quarter of 1973. Since the terms of trade seem to be steadying and the volume of our exports has been rising faster than the volume of imports, we can look for further improvement.
So far we have been able to finance our remaining deficit without having to maintain large interest rate differentials so as to attract funds to London. I want to keep interest rates as low as possible both for domestic reasons and to minimise the cost of servicing our debts. I do not expect difficulty in financing the deficit in the months ahead. I have not had to draw on the 2,500 million dollar loan, which was negotiated at the time of the Budget. And I am now able to tell the House of another welcome source of funds for public sector borrowers.
The Imperial Iranian Government has offered to provide the United Kindgom with a line of credit of 1,200 million dollars, to be drawn on in the form of three separate loans by public sector bodies within three years from now. We have reached agreement on this offer, and I hope that arrangements for the first loan will be made in the very near future.
I know that the willingness of the Iranian Government to enter into an arrangement of this kind reflects the concern of His Imperial Majesty the Shah of Iran over the difficulties facing the world economy and his constructive attitude to the problems at present facing the international monetary system. I believe that the House will join me in welcoming this development.
Against this background, I am introducing the following measures. First, a reduction of the rate of VAT from 10 per cent. to 8 per cent. with effect from next Monday, 29th July. An order will be laid later today under the VAT regulator powers contained in Section 9 of the 1972 Finance Act. A further order will be laid by my right hon. Friend the Secretary of State for Energy to reduce the maximum retail price of road fuel in line with the VAT reduction. This reduction in VAT will enable manufacturers and retailers to reduce prices of a very wide range of goods and services. It should initially cut the cost of living by about 1 per cent., and because of its effect on threshold agreements, by perhaps a further½per cent. in 1975. The direct reduction in revenue this year is estimated at about £140 million, though the full-year revenue effect would be £510 million.
Second, we shall introduce an immediate relief for those domestic ratepayers whose rates go up by more than 20 per cent. this year—a relief equivalent to 60 per cent. of the excess over 20 per cent. My right hon. Friend the Secretary of State for the Environment will publish details, and the necessary Supplementary Estimates will be presented to the House tomorrow. The estimated gross cost of this measure will be of the order of £150 million, but there will be some small offsetting savings on rate rebates.
In addition to this special measure of domestic rate relief from the beginning of October, there will be an increase in the needs allowance which is used for calculating rent and rate rebates and rent allowances. The details of this measure are being placed in the Vote Office by my right hon. Friend and the necessary regulations will be laid. The normal full-year cost of this measure would be £60 million.
The part-year cost in the present year is further reduced by the fact that special arrangements have already been made for pensioners, and is thus no more than £15 million. The effect of these measure on rate relief and the needs allowance will be further to reduce the retail price index by a little under½per cent.
Third, a further amount will be made available from the £500 million provided in my March Budget for food subsidies but not so far committed in full. This amount will be £50 million in a full year. The details of this measure, which includes the proposed subsidy for household flour, will be announced by my right hon. Friend the Secretary of State for Prices and Consumer Protection as soon as possible. This does not, of course, add to the public sector borrowing requirements since it was included in the Budget Statement. Indeed, there will still be something over £100:pillion of that provision still availabe for further subsidies to food.
These immediate actions on VAT, on rates and on food subsidies taken together should have a direct impact on retail prices of over 1½ per cent. within the next three months with more to come as the rest of the food subsidies are allocated. They will certainly avoid one threshold payment, and possibly two, by the end of October. This will bring substantial advantage both to private companies and to public sector employers, including the nationalised industries and local authorities. The eventual effect, bringing in all indirect savings on labour costs, should reduce the retail price index by about 2½ per cent.
My fourth measure is aimed not primarily at domestic prices, where it is helpful, but only marginally and in the longer term, but at the effective use of resources in the regions. The regional employment premium, which has remained unchanged at £1·50 per week for a male employee since it was introduced in September 1967, will be doubled as from 5th August. A draft order to this effect will be presented later today.
This step, which I know will be welcomed by both sides of industry, will have long-run beneficial effects both on regional employment and—through export prices—on the trade balance. It will also assist company liquidity. The expenditure cost in a full year will be roughly £118 million, but the cost this year is estimated at only about £60 million, and a Supplementary Estimate to provide for this will be laid tomorrow. Its eventual cost in resource terms will be much less than its money cost, since it brings into use unemployed resources.
The measures I have announced so far will not only help to cut the cost of living and to increase employment. They will also help industry both in their effect on demand and by reducing labour costs through their effect on thresholds, and through the REP.
In addition, I want to help industry to raise funds in the market to finance the new investment which is essential to preserve future employment and the competitiveness of our exports. For this reason, and in the light of the inflation since the last Government imposed the 5 per cent. limit early in 1973, I am modifying the dividend control to raise the limit on increases in distribution to 12½per cent. An order in this sense will be laid this evening. The rule permitting higher distribution where there is a ease for special treatment on investment grounds will be applied flexibly.
I should add that it is my intention to review the existing control comprehensively next year, and to seek assistance from the Royal Commission on Income Distribution in assembling some of the factual information for this review. This relaxation in dividend control will also help many retired people and assist the life insurance and pension funds which look after the savings of millions of people of modest means.
The total economic effect of all these measures reflects a careful balance of the considerations I set out at the beginning of this statement, and I will be reviewing the position again in the autumn. They will have an immediate and beneficial effect in slowing the rate of price increases and thus lessen the pay increases needed to maintain real earnings. The level of prices next year will for both reasons be significantly lower than would otherwise have been possible. This will help our exports to remain competitive.
The measures will help industry and employment by taking up some slack, especially in the development areas, without putting any strain on the economy as a whole, and their demand effect is likely to be under £200 million by the end of 1974. They will add only a relatively small amount—some £340 million—to the estimated public sector borrowing requirement in 1974–75. I am satisfied that this can be achieved without in any way jeopardising my objective of keeping the rate of growth of the money supply under control. Part of this sum will accrue to the corporate sector and thus improve the overall financial position of companies. But above all, these measures will help us to face the difficulties arising from the massive wave of imported inflation which has not yet spent its force. By emphasising and strengthening the social contract between the Government and the unions, I believe they will help to reinforce our overall economic position, both at home and abroad.