When I presented my first Budget just over a year ago Britain was simultaneously emerging from two months of three-day working and entering a period in which her own and the world economy were bound to be dominated by the effects of an unprecedented increase in the price of oil. Both the three-day week and the oil crisis created uncertainties about the development of our economy which made prediction dangerous and policy precarious.
A year later many of these uncertainties have diminished. We recovered more quickly than many expected at the time from the consequences of the three-day week, and in the middle quarters of 1974 output was 1 or 2 per cent. above the level of a year earlier. But now that the consequences of the oil crisis can be seen more clearly they provide a formidable setting for British economic policy in the next few years.
In the first place, the increase in the price of oil combined with the increases in the price of food and raw materials which we must import have inflicted a heavy blow on our real income ase a nation. Although through the year as a whole, taking into account the fall in the first two months and the later recovery, our gross domestic product was little changed, the savage lurch in the terms of trade against us between 1973 and 1974 meant that the nation's real income actually fell by about 4 per cent. last year—in effect, it took away 4 pence from every pound we earn.
We entered 1974 with a balance of payments deficit already running at a rate equivalent to 3 per cent. of GNP. But the cost of the oil we imported last year was about £2,900 million more than the year before, and this left us with a current deficit in 1974 of £3,800 million—equivalent to more than 5 per cent. of our GNP. In effect, we were spending 5 per cent. more as a nation than we were producing.
In 1974 we had little difficulty in borrowing sufficient money to cover this enormous deficit on commercial terms, from sources which imposed no policy conditions on their lending. But there is a danger in future that the supply of unconditional funds may prove inadequate to meet our needs. If we are to go on attracting such funds their owners must believe that the value of the money they have placed with us is not threatened by the consequences of our policy actions or inactions.
This brings me to the second consequence of the oil crisis—its impact on inflation in Britain. In February last the Retail Price Index had increased nearly 20 per cent. compared with February 1974. The major source of this inflation for most of last year was the increase in world prices to which oil made such a contribution. But for many months now the prices of most metals and nearly all other industrial materials have tended to fall. The price of most imported foodstuffs except sugar and beef has been fairly stable. The price of crude oil to the United Kingdom has been much the same since mid-1974. So for the last six months or so the main cause of rising prices in Britain has been the scale of wage and salary increases, which were far in excess of what could be justified by the increases in prices and could not possibly be offset by improvements in productivity. Also, whereas last year we were not alone among Western countries in having a very high rate of inflation, there is a risk that this year we shall be out on our own, far above the rest.