Oil and the Budget

Thomas Balogh

The Budget is but a few days away. Thus the Publication of the White Paper on North

Sea Oil last week was perhaps not altogether coincidental. The Government is faced with two intertwined and complex Problems. The first is to restart the economy

Which has stagnated for five years and Inflicted unemployment on a million and a half. The second is to accomplish a fun uamental improvement of the international competitive power of Britain in the midst of

the worst depression the non-Soviet world has experienced since the War. This has eluded us even when world production and

trade were expanding at an unprecedented !ugh rate. It is the North Sea wealth, the importance of which has for so long been Ignored, which has emerged as the key for a change for the better.

Of the basic importance of the bounty of the oil and gas discoveries there can be no doubt. It should contribute to our balance

?.f Payments eventually some £5-6000 mil

ho p.a. or even more at last year's prices. There has been lately a tendency however to overlook two important limitations on the timing of the benefit that could be

derived. The first is the basic weakness inflicted by the vast 1972 licensing round on Our ability to secure an appropriate share of the bounty. Some two-thirds of the oil reserves — among them a large portion of the great Piper and Brent fields — belong to foreigners. The British 'take' in respect to these will depend entirely on the royalties and tax revenue: that is, on the expertise of the Inland Revenue and the Department of t nergy to exact precise information on !Oats and prices, and therefore on true pro!its. This task is not easy. The market for oil

IS dominated by the close and powerful cartel

o'4' OPEC on the one hand and by a scOre "r ,so of large companies possessing the refinery and distributing systems. Only on the basis of the closest possible direct experience will the country be able to dis

cover the true cost incurred. The same applies to prices. To think that taxation measures by themselves, without expert knowledge, can secure a rightful share for the nation is naive beyond words.

Only a State owned corporation can help to Perform this task and undertake at its t°Yvn risk measures for the control of deple1°n which would be considered Uneconomic by private companies. „Much has been accomplished in these u..lrections. The BNOC, which was established two years ago, is now a living and lir9wing entity which, in its direct oblig70ons as an operator, has shown itself as capable of executing tasks as any of the 8'3-called 'majors'. It would be a catastrophe

if oil were to become a party political football.

Considerable progress has also been made in repairing our tax-structure. Two problems stood out. There was, in the first place, a gaping loophole through which most profits earned by British based com panies escaped corporation tax When I became Minister of State in 1974 nothing had been prepared to meet this problem; but this loophole has been plugged. The second problem was the consequence of the vast physical differences between fields, with consequential differences in yields on capital invested. Thus a highly progressive tax system was needed if the most profitable fields were not to escape or the least for tunate prove unprofitable and their development abandoned, contrary to the public interest. The petroleum revenue tax with its complex exemptions has gone some way to create a system which answers these requirements.

Inevitably, the very progressiveness of the tax and the generous investment allow ances make it possible to use the cashflow from successful fields to develop new ones mainly at the cost of the revenue. From the national viewpoint, this is not altogether disadvantageous because oil will be recovered which otherwise would not be exploited. It means however that the flow of the Government revenue from the oil will be retarded and, if the new fields are not as profitable as the old ones, also reduced in absolute terms.

What is the record? There are some ominous signs in this respect on the horizon. The country in 1977 has produced some 37 million tons of oil and about an equivalent amount of natural gas. We have in fact already absorbed the £2,000 million worth of sea gas (partly by running down our coal industry, partly by increasing other imports). Moreover, in 1977 we still suffered a visible deficit of £1,657 million despite the additional oil contribution worth over £2,000 million. It is true that the overall visible trade deficit of £2,800 million was due to the import of oil while the non-oil trade achieved a surplus of £1,200 million. Thus if self-sufficiency is attained by the end of 1979 and maintained and improved on — with an export of say 40 million tons in the early 'eighties — we can count on an additional £6,000 million or so. !four present international competitiveness does not decline and the price of oil does not fall in real terms, this should provide some elbow-room, though delicate policy decisions will have to be taken if our national interests are to be protected and our non-oil trade is not to be permitted further to

deteriorate. The crows of misfortune are premature in already predicting failure.

In the meantime the oil market has come under unexpected pressure. The premium on our low sulphur oil has weakened as the result of the relaxation of the stringent anti-pollution measures, especially in America but also in other countries. The price of our oil has dropped from around $14.20 per barrel or some $100 per ton to around $13.50 ($95). This is a loss of some 5 per cent. In addition the uncapping — the upward floating —of the pound reduced the revenue by a further 12 per cent. This means that the fall in the value of the expected sixty five million tons production in 1978 will roughly be £650 million.

It is difficult to believe that this effect was seriously considered when the decision was taken to let the value of sterling drift upwards. Altogether we shall probably suffer from an appreciable retardation and diminution of the oil revenue. The balance of paymdnts moreover will suffer from the repatriation of foreign profits and the repayment of loans raised in the US for the development of the fields. Yet the timing of the flow of the revenue is the essential factor in the success of the operation. If the expansion of our business activity noticeably precedes the international balance of payments benefits of the expanding oil and gas supplies, we shall once more be threatened with a deficit and risk having a repetition of the confidence crises. It is essential to realise in this respect that the astronomical foreign exchange reserves we now show are not owned but borrowed. They are the result not of a surplus in the current account, but of vast hot money torrents bursting in from New York in fear of the depreciation of the dollar, just as contrary flows in 1976 threatened the pound. They could easily be withdrawn.

We now turn to the problem of the impact of the oil revenues on the desirable shape of the Budget. From this viewpoint the White Paper does not contain more than an enumeration of a series of options, based on the hypothesis that the short-term task of getting the economy going will not only not interfere with the long-term strategic aim but' foster it: the expansion of the fixed investment in industry; the improvement of the rather dismal performance of what investment we have or make; investment in energy both by creating alternative sources and increasing the capacity of others (like coal) and using all of them with the utmost care, indeed parsimony. Our foreign debt is to be reduced. Sooial services are to be reinforced to absorb those whom the rationalisation of manufacturing displaced from their present occupations. Social care is to be improved and education and training intensified, fields in which the need for expansion has become only too obvious. One is left, however, wondering how meaningful progress could be achieved in all these directions simultaneously on the basis of the likely 'take'. Surely a choice must be made and a scale of priorities must be estab lished. This austere and excellent list of aims is somewhat unexpected after the blessing extended for more mundane activities such as cuts in taxation. These received but two out of sixty-one paragraphs and are put firmly in place as intending to follow rather than to initiate the recovery.

Yet the political agitation has mainly been concentrated on immediate cuts in direct taxation of between Ll to £4,000 million, perhaps partially offset by increasing indirect ones including employer's social service contributions. But this would seem to be counter to the anti-inflationary endeavour, an endeavour which received absolute priority in the Government's recent tactical moves. The Liberal Party in particular seems oddly enough intent to worsen the regressiveness of general taxation by standardising VAT at 10 per cent and revalorising excise duties as well as increasing a Public Sector Borrowing Requirement. It is unlikely that so general an increase in the prices of essential goods will not once more lead to excessive wage demands.

The fact is totally ignored that our general competitive position in 1977 has not improved. It has in fact deteriorated, partly because of the untimely appreciation of the pound and rate of inflation which — though abating — is still higher than that experienced by most of our rivals. It was the stagnation of output which has 'helped our balance' by pressing on the demand for foreign goods. More than half of any rise in national income will, on present indications, increase imports.

It is in these delicate circumstances that the Government is to endeavour to restart the expansion of the economy. This presents, an uncommonly difficult task: as the result of a century or more of relative stagnation, a large part of British industry, even in the most technically advanced fields, is threatened with obsolescence through not having sufficient and up-to-date equipment. This has mainly been responsible for our mediocre performance in the world manufactures' markets. Our failure was aggravated by the connected labour trouble and the resistance to any further loss of employment. On the other hand Britain, as well as the whole world, is faced with heavy unemployment and excess productive capacity. A spontaneous burst of invest ment, or even a response to such restricted increase in consumption as would not cause a balance of payment crisis, is under these circumstances highly unlikely despite the expected gain from oil. Some positive stimulus would be needed either through subsidies or guarantees or other forms of collective help. Tax remission has only too often been tried to reinforce investment without much success. Any measure such as an appreciation of the pound which would further blunt the relative edge of British exports must therefore be viewed with great apprehension. It would be prudent to establish a lower level against the dollar, and provide for the export industries some certainty that it will not be permitted to rise — so as to enable them to plan the upgrading and expansion of their works.

A second condition is to try to deal with the international monetary upheaval. Its basic cause is the unprecedented and unpalatable oil surplus of the desert oil countries. This has been between $2545 billion p.a.

As these surpluses must necessarily imply obverse deficits it is no use preaching to Britain, Italy or more recently to the United States to 'strengthen their currencies' or to 'put their house in order'. All that these grandiloquent sentences mean is that the deficits will be kicked from one country to another with ever increasing pressure on production and employment.

Very different is the case of the surpluses produced by Germany and Japan: these represent the export of unemployment from these two fully developed areas to the rest of the world. If for reasons (which remind one of the painful ignorance of 1931-33) these countries refuse to share the burden of the OPEC oil surpluses they should be left to suffer an appreciation of their currencies until they are frozen out of the world markets of manufactures. Under no circumstances should they reap the reward of exchanging their dollar hoards into high yielding long-term loans. It is most unfortunate that the scarce currency clause of the IMF charter, which would have prescribed discriminating import quotas against persistent creditors, has not been

invoked, thus confirming its lapse. Herr Schmidt and Doctor Emminger are faithful

followers in their policy of Doctor Bruning

and Doctor Luther of the 'thirties who cre• ated Hitler by massive unemployment. If Mr. Callaghan is not able to bring about a change in German policy, some alternative measures of protection of import competing industries would seem to be inevitable so as to secure them a domestic market from which to expand abroad.

The Prime Minister inherited a deslY erately difficult situation despite the manna of oil. It is to his great credit that he did not choose to shirk dealing with restraint on incomes as the precondition for stability. Unless he can win Trade Union cooperation for an orderly system of wage bargaining and social policy, he will not be able to regain and secure our international competitiveness.

Our field of manoeuvre is greater than it has been; but if we are forced back to more of the 'stop' policies after a burst of eon' sumption we shall have drunk the oil for no good purpose —just as we have puffed awaY the gas. Large direct tax-concessions might be popular. They will not remain popular when their consequence are experienced. After some dozen 'stops', each nastier than the previous one, it is astonishing that this lesson has not been learnt. But unemployment and the fading hopes for our manufacturing survival are the' least auspicious methods to teach it. The Budget will show if the opportunity has been grasped.